Using PCAOB Inspection Reports to Add Credibility and Relevance While Teaching Auditing Concepts

By Professor Tad Miller, California Polytechnic State University

This teaching note assumes students learn better when they believe material is both credible and relevant. Because of this, I seek materials which increase the credibility of my lectures and illustrate the relevance of important topics. For example, I often show my students the cover of the AICPA Professional Standards and various pages from those standards so as to remind them that the material being discussed originated with the AICPA's Auditing Standards Board. Similarly, if we are covering material that originated with the SEC, I may project the SEC's homepage. The PCAOB's inspection reports (available at www.pcaobus.org) provide an additional way to reinforce the credibility and relevance of various auditing topics.

I prepared slides from the PCAOB inspection report title pages to illustrate that these comments involve the biggest and best auditing firms in the world. I also use slides with comments from PCAOB inspection reports to emphasize that topics being discussed in class relate to the real world. In order to avoid embarrassing any firm, I don't disclose the specific inspection reports from which the quotes are actually taken. Below are some example quotes from inspection reports that I have used in class.

The following comment has appeared in more than one inspection report and is the first PCAOB inspection report that I reference in my class. I use this quote to illustrate the third standard of field work which is central to much of what I teach in auditing.

"In this audit, the Firm failed in the following respects to obtain sufficient competent evidential matter to support its audit opinion."¹

The next quote also relates to the third standard of field work while demonstrating the need to properly document audit work.

"In some cases, the conclusion that the Firm failed to perform a procedure may be based on the absence of documentation and the absence of persuasive other evidence, even if the Firm claims to have performed the procedure. PCAOB Auditing Standard No. 3 … provides that … a firm that has not adequately documented that it performed a procedure, obtained evidence, or reached an appropriate conclusion must demonstrate with persuasive other evidence that it did so, and that oral assertions and explanations alone do not constitute persuasive other evidence. For purposes of the inspection, an observation that the Firm did not perform a procedure, obtain evidence, or reach an appropriate conclusion may be based on the absence of such documentation and the absence of persuasive other evidence."²

Initially, my students think of misstatements as mathematical miscalculations and have difficulty understanding that they are departures from GAAP. The following quote lends itself to a discussion about departures from GAAP as well as the classification assertion.

"In this audit, the Firm failed to address appropriately a departure from GAAP before issuing its audit report. The issuer incorrectly classified as part of operating income a gain on the sale of an interest in a joint venture. The gain should have been reported as part of other income."³

The next quote is a personal favorite because it covers multiple issues. First, the comment can be used to introduce the responsibility of an auditor to assess a client’s ability to continue as a going concern. Second, it shows that the assumptions auditors use to form an opinion must be consistent with the environment in which the client is operating. Finally, it illustrates the need to obtain evidence supporting audit assumptions.

"The Firm's evaluation of the issuer's ability to continue as a going concern was inadequate. The Firm's conclusion that the issuer had the ability to do so was based, in part, on the availability of the issuer's revolving credit facility. As a result, the Firm did not include a going-concern paragraph in its report… The issuer's access to the revolving credit facility, however, was dependent on the issuer's compliance with all the debt covenants, and the Firm failed to assess adequately the likelihood that the issuer would be able to meet one of these covenants, the 12-month trailing revenue covenant, for the first quarter of 2004. Specifically, although actual revenues for 11 of the 12 months to be used for measuring compliance with this covenant were available before the end of field work, and these amounts appeared to indicate that revenues for the 12 months would fall short of the amount that would allow the issuer to meet the covenant at the end of the first quarter, the Firm did not specifically evaluate the issuer's ability to meet this covenant for the first quarter, nor did it evaluate how the issuer would be able to continue as a going concern should it not meet the covenant. In addition, the Firm did not obtain a management representation covering projections and assumptions related to the covenant."⁴

The final comment addresses the need for auditors to provide a reasonable basis from which to assess control risk. It also illustrates the relationship between the required level of substantive testing and the assessment of control risk.

"When testing inventory, the Firm applied a controls reliance strategy, which included reliance on IT controls. The Firm's work papers indicated that the results of its tests of the issuer's information technology general controls did not support a conclusion that the issuer's information processing was reliable. The Firm, however, did not perform any additional procedures to address its finding, nor did it modify its audit strategy."⁵

These examples illustrate how PCAOB inspection reports can be used as a tool to establish the relevance and credibility of topics covered in an auditing class. The inspection reports contain other comments that can be used to establish relevance and credibility to topics such as analytical procedures, related party transactions, the rolling forward of interim work, sample size, reliance on service organizations and more.

¹ Public Company Accounting Oversight Board (PCAOB), 2007. [Release No. 104-2007-002] Report on 2005 Inspection of KPMG LLP (January 11, 2007) page 5 www.pcaobus.org Washington, D.C.: PCAOB.

² Public Company Accounting Oversight Board (PCAOB), 2007. [Release No. 104-2006-205] Report on 2005 Inspection of PricewaterhouseCoopers LLP (December 14, 2006) page 3 www.pcaobus.org Washington, D.C.: PCAOB.

³ Public Company Accounting Oversight Board (PCAOB), 2007. [Release No. 104-2007-001] Report on 2005 Inspection of Ernst & Young LLP (January 11, 2007) page 4 www.pcaobus.org Washington, D.C.: PCAOB.

⁴ Public Company Accounting Oversight Board (PCAOB), 2005. [Release No. 104-2005-089] Report on 2004 Inspection of Deloitte & Touche LLP (October 6, 2005) page 8 www.pcaobus.org Washington, D.C.: PCAOB.

⁵ Public Company Accounting Oversight Board (PCAOB), 2006. [Release No. 104-2006-202] Report on 2005 Inspection of Deloitte & Touche LLP (November 30, 2006) page 12 www.pcaobus.org Washington, D.C.: PCAOB.

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