audit methodology

CPAs auditing Broker Dealers ought to take a hint from the second round of PCAOB inspections

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Results of the PCAOB’s CY12 inspections of 60 broker dealer audits are not a pretty picture.

Every one of the 43 firms contributed at least one deficient audit to the 57 of 60 engagements that had a deficiency. For me, the scary parts of the report are the widespread independence issues and the large number of firms whose involvement in the PCAOB world is performing exactly one BD audit.

Independence troubles

Differences of independence rules between the AICPA and PCAOB SEC caused some serious trouble for smaller firms. While the audit itself is performed under the AICPA SASs, auditors are required to comply with PCAOB SEC independence rules.

That didn’t go well.

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3 bank confirmation frauds

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Previously mentioned that AU-C 505.07 requires auditors to look at the address used on confirmations.

Here are three illustrations of how things can go sour when sending bank confirmations: PFGBest, Parmalat, and a small company in North Carolina:

PFGBest – Peregrin Financial Group

The organization’s CEO was sentenced to 50 years in prison and ordered to pay restitution of $215.5 million.

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Auditors need to verify the addresses on confirmations. Oops.

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Clarified section 505, which you can find here, discusses external confirmations.  One thing I missed previously is a new requirement to verify the address used on confirmations. I looked in the pre-clarity standards and couldn’t find that requirement there.

Put simply, we as auditors need to make sure confirmations are using good addresses.

For cash, there is a commercial service, Confirmation.com, that can be used to make sure your confirm gets to where you want it to go.

This issue also applies to:

  • Accounts receivable
  • Notes receivable
  • Investments
  • Accounts Payable
  • Notes Payable

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If we remember why it’s difficult for audits to detect fraud, we have better odds of doing so

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Tracy Coenen lists 9 reasons for “Escaping Detection: Why Auditors Do Not Find Fraud”.

If we understand why audits are a poor tool for detecting fraudulent financials, we can improve our chances of finding material frauds.

Check out her post, it will be worth your time.

Here are a few thoughts expanding on her list. …

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New models of analyzing fraud – triangle, diamond, double diamond, and MICE

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For a good stretch on how to analyze fraud, check out a great article “Beyond the Fraud Triangle,” in The CPA Journal, written by Jack Dorminey, Scott Fleming, Mary-Jo Kranacher, and Richard Riley. This article was mentioned by a commenter in an earlier post.

I heartily recommend the article for all auditors.  It goes beyond the standard fraud triangle and provides an overview of several other models, including:

  • a four-sided diamond model, which adds capability in addition to opportunity
  • a dual diamond which allows for separate analysis of accidental and predator fraudsters
  • MICE – money, ideology, corruption, and ego/entitlement – as a model of motivation for high-level, skilled fraudsters that don’t seem motivated by small-scale payoffs

If you want to stretch your knowledge of the concepts, check out those models. Hint for auditors: stretching your brain on fraud is a very good thing to do.

My thoughts:

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Most common audit deficiencies that generate ethics violation investigations

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The AICPA’s Professional Ethics Division has published their report on most common ethics violations in the last year.

About 40% of the cases investigated by the Division deal with audits of government agencies and NPOs.  That’s a depressing portion of ethical issues arising from those two areas. I doubt that is reflective of portion of total audits performed.

That statistic should end the perception that audits of government agencies and NPO don’t have risk. If there is a disproportionate possibility you will wind up in front of an AICPA Ethics hearing, you are not dealing with a low risk audit.

Their report provides a good survey of the major issues.

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Are balance sheets unauditable? 2

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Previous post raised the question whether it is possible that current accounting rules make a modern balance sheet so complex that it is essentially unauditable.

Another item described by Grumpy Old Accountant Anthony Catanach’ column Is FASB Killing the Auditing Profession? is the PwC audit tool of cumulative audit knowledge and experience.

Audit team experience as substantive assurance?

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Are balance sheets unauditable?

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Is it possible that current accounting rules make a modern balance sheet so complex and judgment filled that it is essentially unauditable?

The answer is a hesitant yes, if I’m correctly reading Grumpy Old Accountant Anthony Catanach’s column Is FASB Killing the Auditing Profession?

He contrasts two parts of the PCAOB reports on inspections of PricewaterhouseCooper (PwC).  The PCOAB released two consecutive inspection reports for the firm.

My understanding is the confidential portion gets released if you don’t fix the issues by the next inspection. That means to get two consecutive reports released means the problems identified during inspection one weren’t fixed before inspection two and still had not been resolved during inspection three. Ouch.

Reduce partner time on complex audits

Prof. Catanach combines two issues.

First, the firm’s response says the issues involved are …

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2 questions for those advocating mandatory auditor rotation. My research on the issue

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The post “Re-Structuring the Audit Profession: The UK’s Competition Commission Hunts the Woozle” by Jim Peterson discusses weaknesses in research behind the Commission’s conclusion that mandatory auditor rotation is necessary. He says:

Diligent digging through the Commission’s augean piles of paperwork makes clear that its ostensibly supportive “research” ranges from the shallow and irrelevant to a results-driven reflection of its confirmation bias.

Wow. Let’s unpack that:

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Double check your revised audit opinions with the AICPA Peer Review checklist

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You recall that your audit opinions will be completely revised starting with December 31, 2012 financial statements. The opinion is completely different.

I’ve discussed that here and here with sample reports.

After you draft your reports with the practice tools used by your firm, it would be wise to double-check them. What to use?

Check out Charles Hall’s article – The Clarity Project – Vetting Your Clarity Opinions with the AICPA Peer Review Checklist.

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7 lousy reasons for putting documentation in your audit work papers.

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There is a lot of stuff accumulated during the audit that doesn’t belong in the workpapers. Toss it.

Charles Hall provides a list of reasons things are sometimes included in the audit file that don’t belong there: Seven Reasons for Unneeded Work Papers.

Of course the list starts with SALY. Look at the last item:

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Lessons to learn *before* you get a call from a client saying they found an embezzlement fraud

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Would this call ruin your day?

You answer the phone and your client says:

“George, we just found out our controller has stolen about $70,000 per year for the last three years. Since you guys have been doing our audit, I thought I’d call and discuss what we need to do.” The caller does not verbally say it, but he intimates, “where were you guys?” and “how are you going to resolve this?”

That’s the sobering start to Charles Hall’s post at CPA-Scribo – Fraud Stings Auditor.

He outlines three mistakes you may have made on your latest audits:

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