Management

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Chapter 1 Managements Assertions
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PCAOB RELEASE NO. 104-2005-119

• When auditing the completeness, existence and
  valuation assertions for deferred revenue, the
  sample of items tested by the Firm was inadequate
  because the Firm used the wrong method of
  sampling.

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PCAOB RELEASE NO. 104-2005-119

• The issuer accounted for lease incentives
  received from landlords as a reduction of
  depreciation expense, rather than as a reduction
  of rental expense as is required by EITF No.
  88-3, Rental Concessions Provided by a Landlord
  and FASB Technical Bulletin No. 88-1, Issues
  Relating to Accounting for Leases. This treatment
  resulted in an understatement of depreciation
  expense and an overstatement of lease expense, as
  well as an understatement of deferred liabilities
  and fixed assets.11/ The Firm should have
  identified and addressed the incorrect accounting.

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Chapter 2 Generally Accepted Auditing
Standards GAAS Auditing Standards of the Public
Companies Oversight Board Auditing Standards of
the PCAOB
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PCAOB RELEASE NO. 104-2005-119

• On the audit of this issuer, the Firm represented
  that it relied on the work of internal audit
  related to the portion of the issuer's loan
  portfolio that is serviced by third parties
  however, the Firm failed to perform, or failed to
  include evidence in the work papers that it had
  performed, the following procedures to
  understand and evaluate the internal controls at
  the service organizations,

Chapter 2 GAAS
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PCAOB RELEASE NO. 104-2005-119

• In this audit, the Firm failed in several
  respects to obtain sufficient competent
  evidential matter to support its audit opinion

Chapter 2 GAAS
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PCAOB RELEASE NO. 104-2005-119

• . the Firm failed in several respects to obtain
  sufficient competent evidential matter to support
  its audit opinion

Chapter 2 GAAS
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PCAOB RELEASE NO. 104-2005-119

• the Firm failed in several respects to obtain
  sufficient competent evidential matter to support
  its audit opinion

Chapter 2 GAAS
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Chapter 12 Reports on audited Financial Statements
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PCAOB RELEASE NO. 104-2005-119

• 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 on the issuer's 2003
  financial statements. 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.13/ In addition, the Firm did not
  obtain a management representation covering
  projections and assumptions related to the
  covenant.

Chapter 12 Reports
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Chapter 5 Internal Control Evaluation
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PCAOB RELEASE NO. 104-2005-119

• The Firm relied on certain controls, in
  particular general computer controls, automated
  application controls and security controls,
  without performing, or without documenting in the
  work papers the performance of, sufficient
  testing to support reliance on those controls.
  Deficiencies included (1) the Firm's documented
  testing of certain controls only covered
  activities occurring outside the audit period,
  (2) the Firm's work papers indicated that it used
  reports generated by the payroll department to
  perform certain tests of controls, but the Firm
  did not document any test work over the
  completeness of those reports, (3) the Firm did
  not document the sample sizes, or how they were
  determined, for the testing of certain controls,

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• the Firm assessed control risk for revenue as
  below the maximum, without having performed
  sufficient tests of the issuer's general computer
  controls to support that assessment. The issuer's
  information system processing environment relies
  heavily on processing of orders through an
  electronic data interchange that links with an
  enterprise system that interfaces with a separate
  accounts receivable system. The Firm failed to
  perform tests of the electronic data interchange
  system or the financial statement system. In
  addition, for the controls that the Firm did
  test, the work papers did not provide evidence
  that the systems tested and relied upon during
  the audit continued to operate effectively
  throughout the period of intended reliance.

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• the Firm assessed control risk in one area as
  "low" without having performed sufficient tests
  of controls to support that assessment. The
  Firm's controls testing relied on
  system-generated reports, without the Firm having
  tested the underlying data, general IT controls,
  or related system application controls to gain
  assurance that the reports were accurate and
  complete.

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• There was also no evidence in the work papers to
  indicate that the Firm (1) audited the income tax
  provision beyond comparing the issuer's tax
  schedules to the financial statement disclosures
  (2) obtained testing results that supported the
  Firm's assessment of control risk as below the
  maximum (3) considered the effects of
  distributor agreements on revenue recognition,
  even though sales to third-party distributors
  contributed 64 percent of net sales in 2003 or
  (4) performed required journal entry testing or
  look-back testing of significant estimates.

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• PCAOB standards require the auditor to test
  internal controls before relying on them for the
  purpose of designing and performing the
  substantive audit procedures. In 13 instances
  involving the audits of 10 issuers, the Firm
  failed to test, or failed to perform sufficient
  tests of, controls that the Firm relied on in
  designing and performing its substantive audit
  procedures. The instances included the following

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• The Firm relied on information technology
  ("IT") application controls that had not been
  tested for several years.

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• The Firm relied on IT system-generated data
  without testing the IT general computer and/or
  application controls.

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• ... the Firm inappropriately relied on the IT
  general controls at a service organization that
  managed and operated the infrastructure for the
  issuer's centralized general ledger system,
  without sufficient testing of those controls.

Chapter 5 Internal control evaluation
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PCAOB RELEASE NO. 104-2005-119

• The Firm assessed control risk as "high" for
  expenses, but ....., failed to perform sufficient
  substantive procedures on expense balances.

Chapter 3 audit risk model
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PCAOB RELEASE NO. 104-2005-119

• the Firm failing to obtain, or failing to
  document in the work papers that it had obtained,
  sufficient competent evidential matter to support
  its audit opinion. Those deficiencies included
  the following.

Chapter 4 work paper documentation
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Chapter 11 Completing the Audit
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PCAOB RELEASE NO. 104-2005-119
On this audit, the Firm used the issuer's internal auditors to assist in auditing cash at an interim date. The Firm, however, failed to perform, or failed to have the internal auditors perform, audit procedures on the activity in the cash accounts between the interim date and year end.
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
the Firm audited certain accounts receivable balances at an interim date, but did not audit the issuer's analysis of the roll-forward of these balances to the year end.
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
the Firm tested the operating effectiveness of the controls over certain processes as of interim testing dates, but the work papers do not evidence any procedures to roll forward these tests to the balance sheet date, and the Firm therefore lacked a reasonable basis for extending its conclusions to the balance sheet date.
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
.. the Firm used analytical procedures as alternative procedures. The Firm, however, did not perform certain required steps, such as developing expectations and defining a significant difference threshold, when performing the analytical procedures.
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
, the Firm failed to obtain sufficient evidence, or failed to include sufficient evidence in its work papers, that the unallocated component of the allowance represented a supportable estimate of probable losses inherent in the issuer's loan portfolio. The Firm's documented testing specific to this aspect of the banks' ALL was limited to certain high level analytical procedures that were not substantive tests .
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
the Firm was aware of indications of deficiencies in the operating effectiveness of the issuer's controls over the allowance for loan losses. Particularly in light of the highly judgmental nature of the area, the Firm's knowledge of such indications rendered its assessment of the control risk with respect to the allowance for loan losses as "minimum" inappropriate. (Issuers D, E, F, and G)
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
.. the Firm apparently did not reconsider its assessment of risk and materiality or revisit its audit scope in light of the known and likely errors ... and did not reconsider its fraud risk assessment related to an issuer that is unwilling to correct known errors.
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
The work papers did not document the Firm's threshold for posting errors to the Score Sheet of Unadjusted Audit Difference, and several uncorrected errors noted in the work papers were not posted to the Score Sheet of Unadjusted Audit Difference, were not evaluated for materiality in the aggregate,
Chapter 11 completing the audit
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PCAOB RELEASE NO. 104-2005-119
During the issuer's first quarter of fiscal 2005, it reached a settlement with a customer that it included in net sales and did not disclose. As a result of including the entire settlement amount in net sales, the issuer's net sales increased from the first fiscal quarter of 2004 to the first fiscal quarter of 2005. If the entire settlement had been omitted from net sales, net sales would have decreased. The Firm failed to consider the appropriateness of including the settlement in net sales and not disclosing that fact.11/
Chapter 11 completing the audit