AUDITS OF PCAOB PUBLIC COMPANY ISSUERS

AND
THE PCAOB AUDITING STANDARD NO. 2
A WORKING PAPER
BY
THOMAS HEATON SPITTERS, CPA
CALIFORNIA, U.S.A.
MAY 2014
INTRODUCTION
The obj ect i ve of t hi s wr i t i ng i s t o gener al l y i l l umi nat e t he over al l
i mpor t ance and char act er of i ndependent f i nanci al st at ement audi t s
wi t hi n t he f r amewor ks of account i ng as pr esent ed by t he var i ous
account i ng associ at i ons and bur eaus. Thi s i ncl udes i l l ust r at i ons of
t he det ai l s of assur ance ser vi ces such as audi t at t est at i ons as
det er mi ned by gui del i nes, st andar ds and r ul es as i ssued by t he
Amer i can I nst i t ut e of Cer t i f i ed Publ i c Account ant s, t he Fi nanci al
Account i ng St andar ds Boar d, t he Gover nment Account i ng St andar ds
Boar d, t he Feder al Account i ng St andar ds Advi sor y Boar d, t he Publ i c
Company Account i ng Over si ght Boar d, and t he Secur i t i es and Exchange
Commi ssi on. Of emphasi s her eby ar e t he AI CPA, FASB, and PCAOB and
t hei r pr ecedent and up t o dat e st andar ds, r ul es, pr onouncement s,
gui del i nes and t he l i ke under t he r ange of assur ance ser vi ces pl anned
and per f or med by cer t i f i ed publ i c account ant s t hat ar e ser vi ces
desi gned t o ampl i f y and summar i ze cor por at e and ot her busi ness
i nf or mat i on f or t he publ i c.
Auditing and PCAOB Standard No. 2 1
Dur i ng 2002, Congr ess passed and t he U. S. Pr esi dent si gned i nt o l aw
t he Sar banes Oxl ey Act of 2002 t hat encompassed a number of
f i nanci al r ef or ms t o addi t i onal l y abat e act s and i ncent i ves f or
cor por at e and busi ness f r aud, r egul at i ng t he di f f er ent t ypes of
ser vi ces t he pr of essi on coul d al l ow i n var i ous i nst ances i ncl udi ng
t he t ypes of consul t i ng t hat cer t i f i ed publ i c account ant s coul d
per f or mf or t hei r audi t cl i ent s, and cr eat i ng an over si ght boar d, t he
PCAOB f or pur poses of di r ect over si ght and r egul at i on of t he publ i c
account i ng pr of essi on f or CPA f i r ms t hat audi t publ i c compani es. The
Publ i c Company Account i ng Over si ght Boar d as est abl i shed pr ovi des
over si ght of account i ng f i r ms t hat audi t publ i c compani es by
est abl i shi ng or i nt egr at i ng i nt o t he account i ng pr of essi on di f f er ent
et hi cal r ul es and st andar ds, conduct i ng i nspect i ons of CPA f i r ms and
enf or ci ng compl i ance wi t h et hi cal st andar ds and r ul es. The PCAOB
adopt ed t he AI CPA et hi cal st andar ds i n 2003 as i nt er i mst andar ds
unt i l t he boar d coul d f or mul at e i t s own, al bei t si mi l ar st andar ds.
The Sar banes Oxl ey Act al so encompasses compl i ance wi t h r ul es,
st andar ds and gui del i nes t hat must be f ol l owed by t he i nt er nal audi t
f unct i on concer ni ng i nt er nal cont r ol s, company account i ng and human
r esour ces pol i ci es and pr ocedur es t hat have t o do wi t h compl i ance i n
t he ar eas of t he r equi r ed r epor t s by management on t he f i nanci al
st at ement s concer ni ng i nt er nal cont r ol .
The PCAOB as cr eat ed i s t he quasi f eder al r egul at or f or cer t i f i ed
publ i c account ant s audi t i ng publ i c compani es. I t has an
admi ni st r at i ve Boar d of f i ve member s under t he aut hor i t y of t he
Secur i t i es and Exchange Commi ssi on and has t he mi ssi on t o over see and
di sci pl i ne, by est abl i shi ng and adopt i ng var i ous r ul es and st andar ds
t hat have t o do wi t h t he pr epar at i on of audi t r epor t s as i ssued by
account i ng f i r ms f or SEC r egi st r ant s. These r ul es i ncl ude pr ovi si ons
f or t he pl anni ng and conduct of audi t s and at t est at i on ser vi ces,
Auditing and PCAOB Standard No. 2 2
et hi cal gui del i nes and r ul es, i ndependence and obj ect i vi t y st andar ds
and r ul es, and account i ng f i r mand audi t f unct i on qual i t y cont r ol
st andar ds and r ul es. The PCAOB al so mai nt ai ns a r egi st r y of publ i c
account i ng f i r ms t hat audi t SEC r egi st r ant s and t hat ar e subj ect t o
bur eau compl i ance i nspect i ons and i nvest i gat i ons t her eby i n vi ew of
sanct i ons compr i sed of di sci pl i nar y pr oceedi ngs and act i ons. The
PCAOB i s r esponsi bl e f or devel opment and compl i ance wi t h pr of essi onal
st andar ds f or audi t or s of SEC r egi st r ant s t hat appl y t o i nt egr at ed
f i nanci al st at ement audi t s of t hese same compani es. I nt egr at ed
audi t s ar e audi t s of t he appr opr i at e f i nanci al i nf or mat i on as wel l as
t he i nt er nal cont r ol s over f i nanci al r epor t i ng. The audi t i ng and
at t est at i on pr act i ce, qual i t y cont r ol , i ndependence and et hi cal
act i vi t i es of account i ng f i r ms r egi st er ed wi t h t he PCAOB ar e
r egul at ed t her eby and t he var i ous st at e boar ds of account ancy as
wel l . The PCAOB st andar ds have f eder al aut hor i t y, and PCAOB
r egi st r ant s mi ght be bar r ed f r omaudi t i ng publ i c compani es or have a
r egi st r at i on r evoked wi t h r espect t o non compl i ance i n publ i c
company audi t s.
The Publ i c Company Account i ng Over si ght Boar d r egul at es t he
i nt egr at ed audi t pr ocess f or SEC r egi st r ant s, of whi ch t he f ol l owi ng:
a. I t est abl i shes st andar ds f or audi t s of publ i c compani es
consi der i ng var i ous r ul es, r egul at i ons and gui del i nes, i ncl udi ng
t hose of t he AI CPA, i n t he ar eas of audi t i ng, at t est at i on, qual i t y
cont r ol , i ndependence and et hi cal behavi or . Agai n, t he PCAOB
st andar ds have f eder al aut hor i t y and ar e based upon l egi sl at i on
passed by Congr ess and si gned i nt o l aw by t he U. S. Pr esi dent . The
PCAOB al so mai nt ai ns a r egi st r y of CPA f i r ms t hat audi t publ i c
compani es and may r evoke or censur e a CPA f i r mf r ompar t i ci pat i ng i n
audi t s of publ i c compani es. The PCAOB does not have, however , a
st andar d set t i ng r ol e i n t he audi t i ng of non publ i c compani es,
nor f or CPA ser vi ces of non publ i c compani es.
Auditing and PCAOB Standard No. 2 3
As a f ur t her pr ecaut i on agai nst f i nanci al st at ement f r aud and
mi sr epr esent at i on, er r or s and omi ssi ons, et c. , t he Pr i vat e
Secur i t i es Ref or mAct of 1995 al l ows f or addi t i onal r equi r ement s
t hat publ i c compani es / i ssuer s and SEC r egi st r ant s and t hei r
audi t or s must obser ve, i ncl udi ng: Pr oper at t ent i on and t r eat ment of
an i l l egal act havi ng a mat er i al ef f ect on t he f i nanci al st at ement s,
seni or management and t he [ boar d of ] di r ect or s, sanct i ons f or same
f or not havi ng t aken appr opr i at e r emedi al act i on i n vi ew of t he
adver se mat er i al ef f ect ; and any f ai l ur e t o t ake r emedi al act i on on
t he par t of management or t he [ boar d of ] di r ect or s i s expect ed t o
r esul t i n a r esi gnat i on of one or mor e r esponsi bl e member s of t he
boar d and / or depar t ur e f r omt he st andar d l anguage i n t he audi t or ' s
r epor t . Wi t hi n a r easonabl e t i me, t he audi t or s must communi cat e
t hei r f i ndi ngs under t he ci r cumst ances t o t he di r ect or s, f or mal l y i n
di r ect communi cat i on, and wi t hi n one day t he company must not i f y t he
SEC of havi ng r ecei ved a r epor t of t he adver se ef f ect ( s) upon t he
f i nanci al st at ement s f r omt he audi t or s and must send a copy of t he
SEC r el at ed communi cat i on t o t he audi t or s. I f t he audi t or s do not
r ecei ve a communi cat i on wi t hi n t he r equi r ed one day t i me ( one
busi ness day, ) t hey must del i ver t o t he SEC t he f i nanci al st at ement s
on busi ness day ( agai n) af t er t he f ai l ur e of t he company t o gi ve
not i ce.
The pr i mar y end wor k pr oduct of t he i nt egr at ed audi t of a publ i c
company i s t he publ i shi ng and submi ssi on t o t he SEC of a r epor t t hat
expr esses t he audi t or ' s opi ni on on t he f i nanci al posi t i on of t he
ent i t y under exami nat i on, and whet her or not , among ot her i t ems, t he
f i nanci al st at ement s ar e r epr esent at i ve of t hat f i nanci al condi t i on
as pr esent ed accor di ng t o GAAP. Ther e ar e a number of opi ni ons t he
audi t or expr esses i n such r epor t s i ncl udi ng t he st andar d unqual i f i ed
opi ni on, qual i f i ed opi ni on, adver se opi ni on and di scl ai mer of
Auditing and PCAOB Standard No. 2 4
opi ni on. The basi c t ext of t he st andar d unqual i f i ed r epor t f or
i ssuer s can be r epr esent ed as t he f ol l owi ng:
INDEPENDENT AUDITOR'S REPORT
To t he Boar d of Di r ect or s and St ockhol der s, [ 1- 2- 3] Company:
We have audi t t he accompanyi ng bal ance sheet of [ 1- 2- 3] Company
as of December 31, 20XX, and t he r el at ed st at ement s of i ncome,
r et ai ned ear ni ngs, and cash f l ows f or t he year t hen ended. These
f i nanci al st at ement s ar e t he r esponsi bi l i t y of t he Company' s
management . Our r esponsi bi l i t y i s t o expr ess an opi ni on on t hese
f i nanci al st at ement s based on our audi t .
We conduct ed our audi t i n accor dance wi t h audi t i ng st andar ds
gener al l y accept ed i n t he Uni t ed St at es of Amer i ca. Those st andar ds
r equi r e t hat we pl an and per f or mt he audi t t o obt ai n r easonabl e
assur ance about whet her t he f i nanci al st at ement s ar e f r ee of mat er i al
mi sst at ement . An audi t i ncl udes exami ni ng, on a t est basi s, evi dence
suppor t i ng t he amount s and di scl osur es i n t he f i nanci al st at ement s.
An audi t al so i ncl udes assessi ng t he account i ng pr i nci pl es used and
si gni f i cant est i mat es made by management , as wel l as eval uat i ng t he
over al l f i nanci al st at ement pr esent at i on. We bel i eve t hat our audi t
pr ovi des a r easonabl e basi s f or our opi ni on.
I n our opi ni on, t he f i nanci al st at ement s r ef er r ed t o above
pr esent f ai r l y, i n al l mat er i al r espect s, t he f i nanci al posi t i on of
[ 1- 2- 3] Company as of December 31, 20XX, and t he r esul t s of i t s
Auditing and PCAOB Standard No. 2 5
oper at i ons and i t s cash f l ows f or t he year t hen ended i n conf or mi t y
wi t h account i ng pr i nci pl es gener al l y accept ed i n t he Uni t ed St at es
of Amer i ca.
[ Ci t y, St at e] Guud, Bee & Company
CPA' s
[ Repor t Dat e]
The st andar d audi t r epor t i n pr i nci pl e, st at es t he over al l
obl i gat i ons of t he obl i gat i ons of management i n r epor t i ng t he
company' s f i nanci al condi t i on as wel l as t he r esponsi bi l i t i es of t he
audi t or ( s) i n t he f i r st i nt r oduct or y par agr aph. The second
par agr aph, or scope par agr aph i n t he r epor t , descr i bes t he nat ur e of
t he audi t , and t he t hi r d, or opi ni on par agr aph i s a br i ef and cogent ,
and f or mal i zed st at ement as t o t he audi t or ' s opi ni on on t he ent i t y' s
f i nanci al condi t i on as embodi ed i n t he f i nanci al st at ement s i ncl udi ng
t he management di scussi on and anal ysi s and f oot not es, et c. , t aken as
a whol e. The st andar d unqual i f i ed r epor t does not pr ovi de absol ut e
assur ance t her e ar e no er r or s nor omi ssi ons, nor mat er i al
mi sst at ement s i n t he f i nanci al st at ement s as i ndi cat ed i n t he scope,
or second, par agr aph of t he r epor t , t hough assur ance i s pr ovi ded t he
audi t i ng pr ocesses and pr ocedur es per f or med dur i ng t he audi t pr ovi de
a r easonabl e basi s f or t he r epor t of t he audi t or s.
Pl ease not e t he f ol l owi ng wi t h r espect t o l evel s of assur ance and
aut hor i t y i n t he audi t or ' s r epor t :
Auditing and PCAOB Standard No. 2 6
Authoritative
Classification.
Non government
entities.
State and local
governments.
Federal
government
entities.
I.
Authoritative
pronouncements.
- FASB
Statements and
Interpretations.
- Auditing
Principles Board
Opinions.
- AICPA
Accounting
Research
Bulletins.
- Government
Auditing
Standards Board
Statements and
Interpretations.
- Financial
Accounting
Standards Board
and AICPA
pronouncements
made applicable
by GASB
statements and
interpretations.
- Federal
Accounting
Standards
Advisory Board
Statements and
Interpretations.
- AICPA, FASB,
and GASB
pronouncements
made applicable
by FASAB
statements and
interpretations.
II.
Pronouncements
composed for
public comment.
- FASB Technical
Bulletins.
- AICPA industry
audit and
accounting
guides and
approved (by the
FASB) Statements
of Position.
- GASB Technical
Bulletins.
- AICPA industry
audit and
accounting
guides and
approved
Statements of
Position.
- FASAB
Technical
Bulletins.
- AICPA industry
audit and
accounting
guides and
approved
Statements of
Position.
Auditing and PCAOB Standard No. 2 7
Authoritative
Classification.
Non government
entities.
State and local
governments.
Federal
government
entities.
III.
Pronouncements
exclusive of
public comments.
- FASB consensus
as published by
the Emerging
Issues
Task Force.
- FASB approved
AICPA Practice
Bulletins.
- FASB consensus
as published by
the Emerging
Issues Task
Force.
-GASB approved
AICPA Practice
Bulletins.
- Accounting and
Auditing Policy
Committee
Releases (FASAB.
)
- FASAB approved
AICPA Practice
Bulletins.
IV. Industry
standard
practices and
pronouncements.
- Staff
Questions and
answers issued
by FASB.
- AICPA
Accounting
Interpretations.
- Customary and
accepted
industry
practice.
- Staff
Questions and
answers issued
by GASB.
- Customary and
accepted
industry
practice.
- Staff
Implementation
Guides (FASAB.)
- Customary and
accepted federal
practices.
V. Other
authoritative
literature.
- FASB Concepts
Statements.
- Accounting
Principles Board
Statements.
- GASB Concepts
Statements.
- Pronouncements
in I. Through
IV. of non
- FASAB Concepts
Statements.
- Pronouncements
in I. Through
IV. of GASB and
Auditing and PCAOB Standard No. 2 8
Authoritative
Classification.
Non government
entities.
State and local
governments.
Federal
government
entities.
- AICPA Issues
Papers and
Technical
Practice Aids.
- International
Accounting
Standards
Committee
Statements.
- GASB
Statements,
Interpretations,
and Technical
Bulletins.
- Pronouncements
of professional,
or industry
groups and
regulators.
- Accounting
textbooks,
handbooks,
articles.
governmental
authority not
specifically
made applicable.
- Accounting
Principles Board
Statements.
- FASB Concepts
Statements.
- AICPA Issues
Papers,
Technical
Practice Aids.
- IASC
Statements.
- Pronouncements
of professional,
or industry
groups and
regulators.
- Accounting
textbooks,
handbooks,
FASB
governmental
authority not
specifically
made applicable.
- FASB, GASB
Concepts
Statements.
- AICPA Issues
Papers,
Technical
Practice Aids.
- IASC
Statements.
- Pronouncements
of professional,
or industry
groups and
regulators.
- Accounting
textbooks,
handbooks,
articles.
Auditing and PCAOB Standard No. 2 9
Authoritative
Classification.
Non government
entities.
State and local
governments.
Federal
government
entities.
articles.
Element of Quality
Control.
Basic Assurance
Objective.
Procedure (examples.)
Independence,
integrity,
objectivity.
- Audi t or s mai nt ai n
i ndependence and
obj ect i vi t y, i n f act
and appear ance, i n al l
r equi r ed
ci r cumst ances, per f or m
pr of essi onal ser vi ces
wi t h i nt egr i t y and
mai nt ai n obj ect i vi t y
i n t he di schar ge of
pr of esi onal dut i es.
- Resear ch and l ooki ng
i nt o t he busi ness
oper at i ons of t he f i r m
and i t s i ndependence
bef or e accept i ng an
engagement .
Personnel Management. - Suf f i ci ent compet ent
super vi si on i n t he
appr opr i at e conduct of
t he engagement .
- Per sonnel possess
r equi r ed ski l l s t o
conduct t he
engagement .
- Assi gnment of wor k
- Pr ospect i ve
empl oyees ar e r evi ewed
by audi t par t ner and a
per sonnel super vi sor
t o est abl i sh
suf f i ci ent compet ency
and abi l i t i es.
Auditing and PCAOB Standard No. 2 10
Element of Quality
Control.
Basic Assurance
Objective.
Procedure (examples.)
t o t hose wi t h
appr opr i at e t echni cal
t r ai ni ng.
- Audi t per sonnel
mai nt ai n pr of essi onal
compet ency t hr ough
appr opr i at e cont i nui ng
educat i on.
- Pr omot i on and
advancement of
qual i f i ed per sonnel .
Acceptance and
continuance clients
and engagements.
- Engagement
accept ance f or qual i t y
cl i ent s wi t h
i nt egr i t y.
- Resear ch i nt o
pr ospect i ve cl i ent s
i ncl udes backgr ound
sear ches of audi t
cl i ent s t o be
di scussed wi t h CPA
f i r mmanagement .
Engagement
performance.
- Conduct of
engagement s accor di ng
t o appl i cabl e
pr of essi onal st andar ds
and st andar ds of
i nt egr i t y and qual i t y
cont r ol , i ncl udi ng, i f
appl i cabl e and i f
r equi r ed, t he SEC
- Pr oper super vi sor y
r evi ew of audi t wor k
pr oduct by f i r m
per sonnel i n vi ew of
def i ci enci es t o be
di scussed wi t h audi t
per sonnel member s; SEC
wor ki ng paper s t o be
r evi ewed by audi t
Auditing and PCAOB Standard No. 2 11
Element of Quality
Control.
Basic Assurance
Objective.
Procedure (examples.)
Pr act i ce Sect i on
r equi r ement s f or t he
audi t i ng par t ner .
par t ner .
Monitoring. Pr oper l y and sui t abl y
- desi gned and
ef f ect i vel y appl i ed
moni t or i ng pol i ci es
and pr ocedur es f or
ever y engagement .
Fr equent super vi sor y
i nspect i ons t hr ough
t est i ng of f i r m
qual i t y cont r ol
pr ocedur es and t hei r
ef f ect i veness.
The Sar banes Oxl ey Act r equi r es t hat audi t or s of publ i c compani es
her e i n t he US per f or mi nt egr at ed f i nanci al st at ement audi t s t hat
i ncl udes assur ance t hat pr oper i nt er nal cont r ol s over f i nanci al
r epor t i ng exi st and t hat t hey ar e f unct i oni ng pr oper l y. I n t hese
at t est at i ons, t he audi t or s mi ght i ssue a var i et y of r epor t s dependi ng
upon t he r esul t s of t he audi t and t he f i nanci al condi t i on of t he
busi ness. Pr i mar i l y, audi t or s i ssue an audi t r epor t as separ at e f r om
an i nt er nal cont r ol r epor t , or t he f i r mmi ght i ssue a combi ned audi t
r epor t . I n t hese r epor t s, t he GAAP l anguage i s r epl aced by l anguage
i ndi cat i ng compl i ance wi t h t he st andar ds of t he PCAOB and a separ at e
sect i on or r epor t addr esses i nt er nal cont r ol .
I n t he audi t pr ocess, and i n or der t o est abl i sh and mai nt ai n pr oper
qual i t y cont r ol pol i ci es and pr ocedur es t o r easonabl y assur e
Auditing and PCAOB Standard No. 2 12
adher ence t o pr of essi onal st andar ds, account i ng f i r ms accor di ng t o
PCAOB r ul es f ol l ow a syst emof qual i t y cont r ol pol i ci es, of whi ch t he
f ol l owi ng:
I . Gener al At t est at i on St andar ds - -
a. The engagement shal l be per f or med by a pr act i t i oner havi ng
adequat e t echni cal t r ai ni ng and pr of i ci ency i n t he at t est
f unct i on.
b. The engagement shal l be per f or med by a pr act i t i oner or
pr act i t i oner s havi ng adequat e knowl edge i n t he subj ect mat t er
of t he audi t .
c. The pr act i t i oner or pr act i t i oner s shal l per f or mt he
engagement onl y i f he or she has r eason t o bel i eve t hat t he
subj ect mat t er i s capabl e of eval uat i on or measur ement agai nst
cr i t er i a, accept ed st andar ds and / or benchmar ks, t hat ar e
sui t abl e and avai l abl e t o user s.
d. I n al l mat t er s r el at i ng t o t he engagement , an i ndependence
i n ment al at t i t ude shal l be mai nt ai ned by t he pr act i t i oner .
e. Due pr of essi onal car e shal l be exer ci sed I t he pl anni ng and
per f or mance of t he engagement .
I I . Fi el dwor k At t est at i on St andar ds - -
a. The wor k shal l be adequat el y pl anned and assi st ant s, i f any,
shal l be pr oper l y super vi sed.
Auditing and PCAOB Standard No. 2 13
b. Suf f i ci ent appr opr i at e evi dence shal l be obt ai ned t o pr ovi de
a r easonabl e basi s f or t he audi t concl usi on t hat i s expr essed i n
t he r epor t .
I I I . Repor t i ng At t est at i on St andar ds - -
a. The r epor t shal l i dent i f y t he subj ect mat t er of t he
asser t i on bei ng r epor t ed on and st at e t he char act er of t he
engagement .
b. The r epor t shal l st at e t he pr act i t i oner ' s concl usi on about
t he subj ect mat t er or t he asser t i on based on t he cr i t er i a agai nst
whi ch t he subj ect mat t er was measur ed.
c. The r epor t shal l st at e al l of t he pr act i t i oner ' s si gni f i cant
r eser vat i ons about t he engagement .
d. The r epor t on an engagement t o eval uat e subj ect mat t er
t hat has been pr epar ed based on agr eed upon cr i t er i a or an
asser t i ons r el at ed t her et o, or on an engagement t o appl y
agr eed upon pr ocedur es, shoul d cont ai n a st at ement ,
r est r i ct i ng i t s use t o t he par t i es who have agr eed upon such
cr i t er i a or pr ocedur es.
As est abl i shed i n 2002, t he PCAOB r egul at es publ i c account i ng f i r ms
t hat audi t SEC r egi st r ant s ( i ssuer s, ) i ncl udi ng mai nt ai ni ng a
r egi st r y of t hose account i ng f i r ms, est abl i shi ng and / or adopt i ng
qual i t y cont r ol , et hi cs, i ndependence and obj ect i vi t y and ot her
at t est at i on st andar ds; conduct i ng i nspect i ons of publ i c account i ng
f i r ms and ot her act i vi t i es t o mai nt ai n t he pr of essi onal st andar ds f or
Auditing and PCAOB Standard No. 2 14
publ i c company audi t s and compl i ance wi t h t he Sar banes Oxl ey Act of
2002. Bef or e t he PCAOB, t he Publ i c Over si ght Boar d [ POB] ser ved as
par t of t he account i ng pr of essi on' s sel f r egul at or y syst emwi t h
many of t he same over si ght act i vi t i es of t he PCAOB, whi ch i ncl uded,
agai n unt i l 2002, super vi si on of t he AI CPA' s SEC Pr act i ce Sect i on
i ncl udi ng account i ng f i r mpeer r evi ew act i vi t i es. Of t he f i ve
member super vi si ng boar d of t he PCAOB, onl y t wo of t hose member s ar e
cer t i f i ed publ i c account ant s who have demonst r at ed and car r i ed out a
commi t ment t o t he i nvest ment communi t y and i t s i nt er est s and t hose of
t he publ i c wi t h r espect t o PCAOB r egul at ed i ssues. The PCAOB has
t he capabi l i t y, i n mai nt ai ni ng i t s r egi st r y of account i ng f i r ms, t o
i mpose sanct i ons i ncl udi ng monet ar y sanct i ons, t o suspend f i r ms and
account ant s f r omat t est at i on wor k on publ i c compani es and has t he
capabi l i t y as wel l t o r ef er t hose i n non compl i ance t o t he US
J ust i ce Depar t ment i n consi der at i on of cr i mi nal i nf r act i ons. The
PCAOB i t sel f per f or ms r egul at ed i nspect i ons of r egi st er ed account i ng
f i r ms f or compl i ance wi t h t he Sar banes Oxl ey Act of 2002 and i t s
st andar ds and r el at ed st andar ds and SEC r ul es and r equi r ement s at t he
same t i me. Appr opr i at e i nspect i ons of publ i c account i ng f i r ms
r egi st er ed wi t h t he PCAOB i ncl ude a. an i nspect i ons and r evi ew of
sel ect ed at t est at i on engagement s; b. an eval uat i on of t he
suf f i ci ency and qual i t y cont r ol of t he f i r mand i t s document at i on,
i nf or mat i on and communi cat i on syst em( s, ) and c. appr opr i at e
per f or mance t est i ng such as t hose necessar y i n or der t o assur e pr oper
pr act i ce and pr ocedur es i n t he audi t , super vi sor y and human
r esour ces / qual i t y cont r ol ar eas of t he f i r m. The PCAOB over al l
f ocuses on qual i t y cont r ol i ssues and mi ght consi der , f or exampl e,
addi t i onal l y, audi t super vi si on and f i r mmanagement i ncl udi ng
compensat i on. Any PCAOB r evi ew wi l l emphasi ze as wel l a sampl e of
at t est at i on engagement s of whi ch a r i sk based sel ect i on pr ocess f or
exami nat i ons, and wi t h r espect t o t hi s, at t est at i ons t hat ar e
i nspect ed ar e t hose agai n obvi ousl y t hat ar e hi gher r i sk, i n hi gh
r i sk i ndust r i es and t he l i ke. Once t he engagement i s sel ect ed f or
Auditing and PCAOB Standard No. 2 15
i nspect i on, appr opr i at el y hi gher r i sk ar eas of t hat engagement ar e
sel ect ed f or r evi ew such as t hat on r evenue r ecogni t i on, est i mat es or
ot her t opi cs. I n t he event of any l ack of compl i ance, t he PCAOB
at t empt s t o det er mi ne t he cause of t hi s and t he r el at ed r i sks and
f l aws i n t he f i r ms qual i t y cont r ol . A f or mal i nspect i on r esul t s i n a
wr i t t en r epor t t hat i s f i l ed wi t h t he SEC and ot her r egul at or s, as i s
a comment l et t er on t he i nspect i on by t he boar d i nspect or s al ong wi t h
any account i ng f i r mr esponses t o f i ndi ngs. Not e her e t hat whi l e t he
r esul t s of i nspect i ons ar e made publ i c t hat di scussi ons as t o qual i t y
cont r ol and t he l i ke at t he f i r mwi t h r egul at or s ar e not i n l i eu of
t he f i r mr emedyi ng t hese i ssues wi t hi n 12 mont hs of t he boar d
f i ndi ngs.
A CPA f i r mt hat audi t s publ i c compani es gener al l y cannot pr ovi de t ax
pr epar at i on ser vi ces f or t he compani es i t audi t s, nor ar e t he same
f i r ms al l owed t o accept cont i ngent f ees f or ser vi ces, ei t her . Thi s
i s due t o i ndependence and obj ect i vi t y and ot her et hi cal
consi der at i ons and st andar ds.
I ndependence and et hi cs st andar ds f or account i ng f i r ms audi t i ng
publ i c compani es i n t hei r appl i cat i on ar e cur r ent l y a combi nat i on of
AI CPA and SEC r ul es wi t h t he l egal r equi r ement s of t he Sar banes
Oxl ey Act , and ar e modi f i ed and enf or ced by t he PCAOB. The Sar banes
Oxl ey Act of 2002 has r ul es gover ni ng account ant i ndependence and a
r egi st er ed f i r mmay not per f or mnon at t est ser vi ces, and keep i n
mi nd t hat non at t est ser vi ces f or a cont i ngent f ee ar e agai nst
PCAOB r ul es as wel l .
Auditing and PCAOB Standard No. 2 16
The Secur i t i es Act of 1933 r equi r es a company i n t he pr ocess of
of f er i ng i t s secur i t i es f or sal e t o t he publ i c t o f i r st f i l e a
r egi st r at i on st at ement wi t h t he SEC t hat i ncl udes audi t ed f i nanci al
st at ement s and a pl et hor a of f i nanci al and non f i nanci al
di scl osur es. Under t he SEC 1933 Act , bot h t he company f i l i ng t he
r egi st r at i on st at ement and t he account i ng f i r m( i t s audi t or s) ar e
possi bl y l i abl e t o secur i t i es pur chaser s i n t he even t he r egi st r at i on
st at ement has been mat er i al l y mi sst at ed or had mat er i al omi ssi ons:
. . . i n case any par t of t he r egi st r at i on st at ement , when such a
par t became ef f ect i ve, cont ai ned and unt r ue st at ement of a mat er i al
f act or omi t t ed t o st at e a mat er i al f act any per son acqui r i ng such
secur i t y may sue ( Secur i t i es Act of 1933. ) A f eder al st at ut e
cover i ng t he sal e of secur i t i es t o t he publ i c t hat r equi r es due
di l i gence by audi t i ng account ant s wi t h ci vi l and cr i mi nal penal t i es
f or mi sr epr esent at i on. The f i nanci al and damages pr ot ect i on of f er ed
by t he Secur i t i es Act of 1933 has t o do onl y wi t h a l i mi t ed gr oup
t he act ual i nvest or s i n t he r egi st er ed secur i t i es and t he bur den of
pr oof as t o mat er i al mi sst at ement ( s) and / or omi ssi on( s) shi f t s f r om
t he pl ai nt i f f t o t he r egi st r ant / def endant wher eas t he pl ai nt i f f
need onl y pr ove a l oss was sust ai ned and t he r egi st r at i on st at ement
was mi sl eadi ng. I t i s i mpor t ant t o not e her e t hat pl ai nt i f f need not
act ual l y pr ove r el i ance upon t he r egi st r at i on st at ement ( s) or t hat
t he audi t or s i n t hei r wor k wer e def i ci ent or negl i gent . An except i on
exi st s as t o bur den of pr oof and mat er i al mi sst at ement or omi ssi on i n
t hat ( Act Sect i on 11) pr ovi des t hat i nvest or ( s) must r el y upon t he
f i nanci al st at ement s and t he r egi st r at i on st at ement i n t he pur chase
of t he r egi st r ant ' s secur i t i es af t er t he publ i shi ng of an ear ni ngs
st at ement t wel ve mont hs f ol l owi ng t he ef f ect i ve dat e of t he
r egi st r at i on st at ement .
Account i ng f i r ms qui t e of t en avoi d t he l i abi l i t y f or such
ci r cumst ances as pl ai nt i f f s i nvest ment l oss( es) , i ncl udi ng t hose i n
t he secondar y mar ket , by pr ovi ng t he audi t was conduct ed accor di ng t o
Auditing and PCAOB Standard No. 2 17
t he r ul es cover i ng of due di l i gence, i nvest or s' l osses wer e not
caused by t he mi sst at ed f i nanci al st at ement s and i nvest or ( s) knew of
t he mat er i al mi sst at ement ( s) at t he t i me t he secur i t i es of t he
r el at ed r egi st r ant wer e pur chased. The audi t or s ar e l i abl e onl y f or
mi sst at ement s and / or omi ssi ons onl y f or t hose por t i ons of t he
r egi st r at i on st at ement havi ng t o do wi t h t he audi t of f i nanci al
st at ement s and r el at ed r epor t . Audi t or account i ng f i r ms ar e l i abl e
f or mi sst at ement s or omi ssi ons onl y i n t he par t s of t he r egi st r at i on
st at ement i nvol vi ng t he audi t and r epor t . Addi t i onal l y, pl ai nt i f f i s
l i mi t ed by a st at ut e of l i mi t at i ons one year af t er t he di scover y of
t he mi sst at ement ( s, ) but no mor e t han t hr ee year s concer ni ng
di scover y of t he mat er i al mi sst at ement ( s) or omi ssi on( s) af t er t he
r egi st r ant ' s secur i t y was of f er ed f or sal e t o t he publ i c. The
Secur i t i es Act of 1933 r equi r es r egi st r ant s t o f i l e r egi st r at i on
st at ement s f or t he of f er i ng of secur i t i es f or sal e t o t he publ i c
t hr ough i nt er st at e commer ce or t he mai l s, save f or of f er i ngs of
cer t ai n char i t abl e or gani zat i ons and of f er i ngs of smal l dol l ar
amount s.
The due di l i gence r ul es of t he Secur i t i es Act of 1933 cal l s f or a
hi gh l evel of r esponsi bi l i t y f or t he audi t i ng account ant s and t hei r
pr oper l y per f or mi ng an audi t . Audi t or s, when char ged wi t h due
di l i gence quest i ons ar e l i abl e f or act s caused not onl y by al l eged
or di nar y negl i gence, but have t he bur den of pr oof of i nnocence
i nst ead of a si mpl e bur den of r ef ut at i on of al l egat i ons by
pl ai nt i f f s. Wi t h r espect t o t hi s and pr oper cl ar i f i cat i on of t he
possi bl e act i ons agai nst audi t or s of f i nanci al st at ement s and t hei r
bur den of pr oof , see t he 1968 i nt er pr et at i on of due di l i gence cour t
case Escot t v. Bar Chr i s Const r uct i on Cor por at i on t hat was t r i ed under
Sect i on 11 of t he 1933 Secur i t i es Act i n exami nat i on of t he f i l i ng of
a r egi st r at i on st at ement For mS 1 and compl i ance wi t h GAAP ( or S
Auditing and PCAOB Standard No. 2 18
1 r evi ew) . Thi s cour t case, as t r i ed year s ago, i s a pr ecedent case
f or many st r i ngent i nt er pr et at i ons of i nf r act i ons of due di l i gence
r ul es and t he 1933 Secur i t i es Act Sect i on 11 i nsof ar as account ant s'
l egal def enses and t he bur den of pr oof of account ant s' l i abi l i t y
t her eby ar e concer ned.
Secur i t i es Act of 1934: A f eder al l egal st at ut e r equi r i ng publ i cl y
t r aded compani es t o f i l e annual f i nanci al st at ement s wi t h t he
Secur i t i es and Exchange Commi ssi on t hat r equi r es audi t i ng account ant s
i n good f ai t h t o exami ne t he publ i c compani es of whi ch ci vi l and
cr i mi nal penal t i es f or mi sr epr esent at i on. The 1934 Secur i t i es Act
r equi r es t he f i l i ng of f i nanci al st at ement s annual l y by SEC
r egi st r ant s wi t h t he Secur i t i es and Exchange Commi ssi on. Thi s
st at ut e al so cal l s f or l i abi l i t i es and penal t i es f or t he f i l i ng
company and any par t y who buys or sel l s t he r el at ed cor por at e
secur i t i es i n al l event s i f t he annual f i nanci al st at ement s ar e
mat er i al l y mi sst at ed ( mi sl eadi ng) . Whi l e t he 1933 Secur i t i es Act
cal l s onl y f or penal t i es agai nst mi sst at ement s i nvol ved i n t he
begi nni ng di st r i but i on of secur i t i es ( publ i c of f er i ng) , t he 1934 Act
appl i es t o t he i ssuer s of f i nanci al st at ement s and l i abi l i t i es t o
secondar y pur chases and sel l er s of t he compani es' st ock on a nat i onal
st ock exchange or of equi t y secur i t i es t r aded as over t he count er
wi t h t ot al asset s exceedi ng $ 5 mi l l i on and wi t h 500 or mor e
st ockhol der s. Of t he t wo most i mpor t ant Sect i ons i n t he 1934 Act ,
t her e ar e Sect i on 10 ( of whi ch Rul e 10b 5) under Sect i on 10( b) t hat
r eads:
I t shal l be unl awf ul f or any per son, di r ect l y or
i ndi r ect l y, by t he use of any means of i nst r ument al i t y of i nt er st at e
commer ce or of t he mai l s, or of any nat i onal secur i t i es exchange - -
Auditing and PCAOB Standard No. 2 19
t o empl oy any devi ce, scheme or ar t i f i ce t o def r aud; t o make any
unt r ue st at ement of a mat er i al f act or t o omi t t o st at e a mat er i al
f act necessar y i n or der t o make t he st at ement s not mi sl eadi ng; or
t o engage i n any act , pr act i ce, or cour se of busi ness whi ch oper at es
or woul d oper at e as a f r aud or decei t upon any per son, i n connect i on
wi t h t he pur chase or sal e of any secur i t y.
Sect i on 18( a) of t he 1934 Secur i t i es Act havi ng t o do wi t h t he
mat er i al mi sst at ement of t he f i nanci al st at ement s of r egi st r ant s,
i ncl udes t hat any per son ( not knowi ng t hat such st at ement was f al se
or mi sl eadi ng) who, i n r el i ance upon such st at ement , shal l have
pur chased or sol d a secur i t y at a pr i ce whi ch was af f ect ed by such
st at ement , f or damages by such r el i ance, unl ess t he per son sued shal l
pr ove t hat he act ed i n good f ai t h and had no knowl edge t hat such
st at ement was f al se or mi sl eadi ng.
Under t he 1934 Secur i t i es Act , bot h or i gi nal pur chaser s and secondar y
buyer s and sel l er s of secur i t i es ar e pr ot ect ed as Sect i on 10 and
Sect i on 18 pl ai nt i f f s ( secur i t i es buyer s and sel l er s) have a bur den
of pr oof i nsof ar as l osses have been sust ai ned, t he f i nanci al
st at ement s exami ned ar e mi sl eadi ng, and t he f i nanci al st at ement s
t hemsel ves ar e r el i ed upon. Sect i on 10b and Rul e 10b 5 i n t hei r
j udi ci al i nt er pr et at i ons r equi r e t hat sci ent er , or i nt ent t o decei ve,
mani pul at e, def r aud, i s t he st andar d f or bur den of pr oof i n such
cases ( see j udi ci al case Er nst & Er nst v. Hochf el der whi ch i s a
l andmar k U. S. Supr eme Cour t case i n i l l ust r at i on of a f r aud scheme
i nvol vi ng t he i nvest ment account s of many br oker age cl i ent s, pr omi ses
of hi gh i nvest ment r et ur ns, t he di ver t i ng of i nvest or s' deposi t s f or
t he per sonal use of an i nvest ment bank pr esi dent ) . Such cases have a
hi er ar chy of al l egat i ons of mi sconduct agai nst publ i c account i ng
Auditing and PCAOB Standard No. 2 20
f i r ms and ot her st akehol der s, i ncl udi ng, i . e. , or di nar y negl i gence,
gr oss negl i gence, f r aud, et c. , and wi t hout del i ber at e ment i on of
sci ent er as i n t he Er nst & Er nst case ar e abl e t o quest i on t he
val i di t y and l egal i t y of t he act i ons of t he account i ng f i r mand t he
r egi st r ant , i ncl udi ng, as i n Er nst & Er nst , concer ni ng t he appar ent
mi shandl i ng of mai l and i nf r act i ons of r ul es i nvol vi ng t he mai l s and
i nt er st at e commer ce.
Wi t hout r espect t o r egi st r ant s' l egal def enses i n t he event of
al l egat i ons under Sect i on 18 of t he 1934 Act , audi t or s may submi t a
good f ai t h def ense i n or der t o avoi d l i abi l i t i es associ at ed wi t h
al l egat i ons of , i . e. , or di nar y negl i gence; t hough t hi s def ense i s not
used i n cases of gr oss negl i gence or f r aud. Addi t i onal l i abi l i t i es
of t he account i ng f i r mmi ght be avoi ded under a def ense i nvol vi ng
r el i ance on causat i on i n whi ch i nvest or s l osses ar e det er mi ned t o
have been due t o i t ems and cr i t i cal f act or s ot her t han t hose al l eged
agai nst t he account i ng f i r m( s) . Under t he 1934 Secur i t i es Act ,
gui l t y par t i es ar e j oi nt l y and sever al l y l i abl e f or t he l osses of t he
compl ai nant s, t hough t he Pr i vat e Secur i t i es Li t i gat i on Ref or mAct of
1995 pr ovi des as amended t hat t her e ar e l i mi t s on t he audi t or s'
l i abi l i t y or l i abi l i t i es t hat ar e at pr esent deemed pr opor t i onat e t o
def endant ' s wher ewi t hal t o pay back l osses account i ng f i r ms have
unl i mi t ed j oi nt and sever al l i abi l i t y or l i abi l i t i es t o cer t ai n smal l
i nvest or s onl y, and t hose l osses caused by ot her par t i es as pai d by
t he account i ng f i r ms ar e l i mi t ed not t o exceed 50 per cent of t he
audi t or s' pr opor t i onat e shar e of t he l osses as det er mi ned l egal l y.
I n al l event s of knowi ng and consci ous i nf r act i ons and vi ol at i ons of
st at ut e( s) , compl et e j oi nt and sever al l i abi l i t y by t he account i ng
f i r m( s) cannot be avoi ded. Wi t h r espect t o t he her et of or e, Congr ess
al so passed t he 1998 Secur i t i es Li t i gat i on Uni f or mSt andar ds Act t o
det er mi ne st andar ds, i ncl udi ng consol i dat i on and ot her r ul es, f or
Auditing and PCAOB Standard No. 2 21
secur i t i es cl ass act i on l i t i gat i on f or pl ai nt i f f s, t hei r l awyer s,
and ot her st akehol der s who must f ol l ow a number of cer t i f i cat i on
pr ocedur es i n l egal pr oceedi ngs.
Compar i son of t he t wo act s: The di f f er ence bet ween t he 1933
Secur i t i es act and t hat of t he 1934 Act have t o do wi t h t he way
st akehol der s ar e pr ot ect ed and upon whomr est s a bur den of pr oof i n
any l egal pr oceedi ng( s) . The 1933 Act essent i al l y pr ot ect s i ni t i al
i nvest or s who ar e i nvol ved i n a begi nni ng di st r i but i on of secur i t i es
wher eas t he 1934 Act pr ot ect s st akehol der s pur chasi ng and sel l i ng
t hese secur i t i es l at er on i n f act . Some si mpl e di f f er ences i n t he
bur den of pr oof under t he t wo act s can be obser ved easi l y, of whi ch
t he f ol l owi ng: St akehol der s do not have t o pr ove r el i ance upon t he
audi t ed f i nanci al st at ement s under t he 1933 Act , t hough t hi s i s
r equi r ed as pr oof under t he 1934 Act . The due di l i gence def ense
agai nst char ges under t he 1933 Act est abl i shes a bur den of pr oof wi t h
t he audi t i ng account i ng f i r m( s) , t hough t hi s def ense i s moot i n cases
even of or di nar y negl i gence. The 1934 Act i n i t s bur den of pr oof
r equi r es t he st akehol der s, agai n, t o pr ove sci ent er , or del i ber at e
decei t under i t s Sect i on 10 a much hi gher or der bur den and mor e
di f f i cul t t o pr ove. Sect i on 18 of t he 1934 Act , and i n vi ew of cases
al l egi ng gr oss negl i gence or f r aud, has an audi t or s' good f ai t h
def ense t hat i s al so di f f er ent i n char act er t han a due di l i gence
def ense havi ng t o do wi t h t he 1933 Act
The Sar banes Oxl ey Act of 2002 r equi r es r epor t i ng on i nt er nal
cont r ol by publ i c compani es on t he par t of management and t he
audi t i ng account ant s, of whi ch Sect i on 404 of t he Act t hat r equi r es
i n each f or m10 K f i l ed wi t h t he SEC t o i ncl ude ( a) a wr i t t en
st at ement of acknowl edgement and r esponsi bi l i t y by management f or
Auditing and PCAOB Standard No. 2 22
t he adequacy of i nt er nal cont r ol s over f i nanci al r epor t i ng; and ( b) a
wr i t t en assessment cer t i f i ed by management of t he ef f ect i veness of
i nt er nal cont r ol over f i nanci al r epor t i ng as of t he end of t he most
r ecent year . I n or der t hat t he Sect i on 404 r epor t be pr oper l y
cer t i f i ed and i ssued, pr ovi di ng f or t he adequacy of such wr i t i ngs,
management must accept r esponsi bi l i t y f or t he ef f ect i veness of
i nt er nal cont r ol s over f i nanci al r epor t i ng. Management must al so
have eval uat ed i nt er nal cont r ol s f or t he most r ecent year usi ng
appr opr i at e cr i t er i a and t he wr i t t en decl ar at i ons must be suppor t ed
by suf f i ci ent appr opr i at e evi dence. Publ i c company audi t or s ar e
r equi r ed t o exami ne and cer t i f y t he qual i t y as t o t hese asser t i ons
made by management accor di ng t o gui dance i n PCAOB Audi t i ng St andar d
Number 2 i n whi ch a. Management acknowl edges i t s dut y t o est abl i sh
and mai nt ai n i nt er nal cont r ol s ( pr event i ve, or t r ansact i on l evel
cont r ol s; det ect i ve, or var i ous t ypes of r epor t i ng cont r ol s; and of
whi ch t est i ng of t hese cont r ol s i n any f i nanci al st at ement audi t , )
and b. An appr opr i at e assessment i s made as t o t he ef f ect i veness of
t he i nt er nal cont r ol s as of t he end of t he year ( usual l y t he bal ance
sheet dat e. ) Thi s st andar d, ent i t l ed An Audi t of I nt er nal Cont r ol
over Fi nanci al Repor t i ng Per f or med i n Conj unct i on wi t h an Audi t of
Fi nanci al St at ement s, i ncl udes gui dance and r equi r ement s f or t he
i nt egr at ed audi t appr oach and t he cr i t er i a f or same usi ng t he
f r amewor k of The Commi t t ee of Sponsor i ng Or gani zat i ons addr essi ng an
audi t of bot h t he f i nanci al st at ement s and i nt er nal cont r ol wi t h t he
pr ovi si on f or speci f i c r equi r ement s of t he audi t of i nt er nal cont r ol .
Such at t est at i on engagement s and t hei r per f or mance r el y on sui t abl e
cr i t er i a, or st andar ds t hat ser ve as t he st andar ds and r ef er ent i al
poi nt s f or measur ement and pr esent at i on of asser t i ons and ot her i t ems
i n t he f i nanci al st at ement s. Sui t abl e cr i t er i a i ncl ude f or
i nt egr at ed f i nanci al st at ement audi t s of publ i c compani es, t he COSO
f r amewor k f or i nt er nal cont r ol wher e t he emphasi s mi ght be ment i oned
as on dat a and dat a pr ocessi ng and i t s cont r ol s, and t he di scl osur e
and ot her cont r ol s i n vi ew of gener al l y accept ed account i ng
Auditing and PCAOB Standard No. 2 23
pr i nci pl es f or audi t i ng t he f i nanci al st at ement s by ext er nal
audi t or s. The addi t i onal t est i ng of t he ef f ect i veness of i nt er nal
cont r ol ( s) under t he COSO f r amewor k gi ves cause f or ext r a t i me and
ef f or t i nvol ved i n i nt egr at ed audi t s.
As evi dence t o suppor t t he audi t or ' s r epor t i s der i ved f r omt he
r esul t s and eval uat i on of i nt er nal cont r ol s t est i ng and subst ant i ve
t est i ng, and audi t or s ar e al l owed t o pr i or i t i ze bet ween t he t wo
dependi ng upon t he di f f er ent el ement s of audi t r i sk and r i sk
di f f er ent r i sk assessment s and management of t hose r i sks, and
dependi ng agai n on t he over al l ef f i ci ency of t he di f f er ent t ypes of
t est i ng ( pr i mar i l y t est s of i nt er nal cont r ol s and subst ant i ve
t est i ng. ) Pr i or i t i es i n t est i ng mean t hat audi t or s have a choi ce of
t he t ypes of t est s t o per f or m, and based upon t hei r quant i t at i ve r i sk
anal ysi s and management , f or t he gr eat er par t , t he t est i ng of maj or
account s i n al l r espect s i n any audi t cannot be i gnor ed. The
audi t or s, agai n, must have made a compl et e assessment of i nt er nal
cont r ol s and r ender an opi ni on on same wi t h t he appr opr i at e r epor t s
as of t he l ast day of t he r epor t i ng per i od ( usual l y t he bal ance sheet
dat e. )
Sect i on 404 of t he Sar banes - Oxl ey Act of 2002 r equi r es t her e be
suf f i ci ent appr opr i at e audi t evi dence of management ' s asser t i ons on
i nt er nal cont r ol s and t hat t he st at ement s ar e of t he qual i t y t hat may
be r el i ed upon gi ven agai n t he basi c exi st ence and appr opr i at e
oper at i ng i nt er nal cont r ol s. The appl i cat i on of Audi t i ng St andar d
No. 2 i nt egr at es t he r el at i on of t he i nt er nal cont r ol s t hemsel ves and
t hei r pr oper pr ocesses and oper at i on t hat need be i nt er pr et ed as
i nt egr at ed f or pur poses of t he audi t .
Auditing and PCAOB Standard No. 2 24
( SI MPLI FI ED WI THOUT REPORT ON CERTAI N SCHEDULES) STANDARD REPORT
FOR PUBLI CLY TRADED COMPANI ES, PCAOB I SSUERS:
Repor t of Guud, Bee, LLP
I ndependent Regi st er ed Publ i c Account i ng Fi r m
The Boar d of Di r ect or s and St ockhol der s, Whi t eacr e. com, I nc. :
We have audi t ed t he accompanyi ng consol i dat ed bal ance sheet s of
Whi t eacr e. com, I nc. , as of December 31, 20XY, and 20XX, and t he
r el at ed consol i dat ed st at ement s of oper at i ons, st ockhol der s equi t y,
and cash f l ows f r o each of t he t hr ee year s i n t he per i od ended
December 31, 20XY. These f i nanci al st at ement s ar e t he r esponsi bi l i t y
of t he Company' s management . Our r esponsi bi l i t y i s t o expr ess an
opi ni on on t hese f i nanci al st at ement s based on our audi t s.
We conduct ed our audi t s i n accor dance wi t h t he st andar ds of t he
Publ i c Company Account i ng Over si ght Boar d ( Uni t ed St at es) . Those
st andar ds r equi r e t hat we pl an and per f or mt he audi t t o obt ai n
r easonabl e assur ance about whet her t he f i nanci al st at ement s ar e f r ee
of mat er i al mi sst at ement . An audi t i ncl udes exami ni ng, on a t est
basi s, evi dence suppor t i ng t he amount s and di scl osur es i n t he
f i nanci al st at ement s. An audi t al so i ncl udes assessi ng t he
account i ng pr i nci pl es used and si gni f i cant est i mat es made by
management , as wel l as eval uat i ng t he over al l f i nanci al st at ement
Auditing and PCAOB Standard No. 2 25
pr esent at i on. We bel i eve t hat our audi t s pr ovi de a r easonabl e basi s
f or our opi ni on.
I n our opi ni on, t he f i nanci al st at ement s r ef er r ed t o above
pr esent f ai r l y, i n al l mat er i al r espect s, t he consol i dat ed f i nanci al
posi t i on of Whi t eacr e. com, I nc. , at December 31, 20XY and 20XX, and
t he consol i dat ed r esul t s of i t s oper at i ons and i t s cash f l ows f or
each of t he t hr ee year s i n t he per i od ended December 31, 20XY, i n
conf or mi t y wi t h US gener al l y accept ed account i ng pr i nci pl es.
We al so have audi t ed, i n accor dance wi t h t he st andar ds of t he
Publ i c Company Account i ng Over si ght Boar d ( Uni t ed St at es) , t he
ef f ect i veness of Whi t eacr e. com, I nc. ' s i nt er nal cont r ol over
f i nanci al r epor t i ng as of December 31, 20XY, based on cr i t er i a
est abl i shed i n I nt er nal Cont r ol I nt egr at ed Fr amewor k i ssues by t he
Commi t t ee of Sponsor i ng Or gani zat i ons of t he Tr eadway Commi ssi on and
our r epor t dat ed Mar ch 4, 20XZ, expr essed an unqual i f i ed opi ni on
t her eon.
/ s/
Los Angel es, CA
Mar ch 4, 20XZ
Cor por at e management i s r esponsi bl e f or mai nt ai ni ng a pr oper
f r amewor k and syst emof i nt er nal cont r ol , and was so even bef or e t he
Sar banes Oxl ey Act of 2002 whi ch augment ed t he r esponsi bi l i t i es of
Auditing and PCAOB Standard No. 2 26
management over i nt er nal cont r ol : Management must now demonst r at e
t hat cont r ol s ar e i n pl ace, and t hey ar e oper at i ng ef f ect i vel y as
wel l . Thi s i s a hi gher l evel of assur ance t han bef or e and
r equi r ement s of SEC r egi st r ant s i ncl ude ( f or cor por at e management ) :
: An accept ance of r esponsi bi l i t y f or t he ef f ect i veness of
i nt er nal cont r ol .
: An eval uat i on, usi ng sui t abl e cr i t er i a, of t he ef f ect i veness of
i nt er nal cont r ol .
: Suf f i ci ent appr opr i at e audi t evi dence t o suppor t management ' s
i nt er nal cont r ol eval uat i on.
: The pr ovi si on of a f or mal r epor t on i nt er nal cont r ol s of t he
cor por at i on.
Management ' s asser t i ons as t o i nt er nal cont r ol s ar e i ncl uded i n a
r epor t t hat accompani es t he audi t or ' s opi ni on i n t he 10 K For mas
t i mel y f i l ed wi t h t he SEC. Management ' s r epor t on i t s asser t i ons on
i nt er nal cont r ol s i s r equi r ed t o be meani ngf ul , and i f t he ext er nal
audi t or s have conf i r med management has not been si ncer e i n i t s
r esponsi bi l i t i es, t he ext er nal audi t or must not i f y management of t hi s
t hr ough wr i t t en communi cat i on addr essed t o management and t he audi t
commi t t ee t hat t he audi t of i nt er nal cont r ol cannot be r el i ed upon /
compl et ed and t he audi t or wi l l i ssue a di scl ai mer of opi ni on on t he
f i nanci al st at ement s. The f or mal i zed wr i t t en l anguage of
management ' s r epor t on i t s asser t i ons on i nt er nal cont r ol i s not
det er mi ned ei t her by t he audi t or s or t he PCAOB, but cal l s f or t he
f ol l owi ng r epr esent at i ons:
Auditing and PCAOB Standard No. 2 27
: The r epor t must i ncl ude l anguage t hat i t i s management ' s
r esponsi bi l i t y t o est abl i sh and mai nt ai n i nt er nal cont r ol s.
: The r epor t must i dent i f y management ' s i nt er nal cont r ol
f r amewor k.
: The r epor t must i ncl ude management ' s assessment of t he
ef f ect i veness of t he busi ness' i nt er nal cont r ol over f i nanci al
r epor t i ng as of t he end of t he most r ecent r epor t i ng per i od,
i ncl udi ng l anguage t hat t he i nt er nal cont r ol s ar e ef f ect i ve.
: The r epor t must i ncl ude l anguage t he audi t or s have i ssued an
at t est at i on on t he assessment of management as t o i nt er nal
cont r ol s of t he busi ness.
For many i ssuer s, Sect i on 404 compl i ance was vi ewed i ni t i al l y as a
l ar ge one t i me pr oj ect of management ' s assessment s of i nt er nal
cont r ol , and r el at ed eval uat i ons, and r epor t i ng on and ef f or t s t o
i mpr ove i nt er nal cont r ol s of t he busi ness. These wer e ef f or t s t o
f aci l i t at e t he eval uat i on of t he ext er nal audi t or s on exami nat i on of
i nt er nal cont r ol s t hat t hey wer e oper at i ng ef f ect i vel y. PCAOB
Audi t i ng St andar d No. 2 pr ovi des f or t he ext er nal audi t or s t o
det er mi ne t he qual i t y of management ' s asser t i ons on i nt er nal cont r ol
by:
: Eval uat i ng di scl osur e and r el at ed cont r ol s.
: Eval uat i ng cont r ol s over account i ng pol i ci es t hat shoul d be i n
conf or mi t y wi t h US GAAP.
Auditing and PCAOB Standard No. 2 28
: Eval uat i ng ant i f r aud and whi st l ebl ower pr ogr ams and
cont r ol s.
: Eval uat i ng cont r ol s over account i ng ent r i es r equi r i ng est i mat es
or management ' s pr of essi onal j udgment .
: Eval uat i ng ent i t y l evel cont r ol s such as t he cont r ol
envi r onment and per i od cl osi ng pr ocesses and cont r ol s.
I nt er nal cont r ol over f i nanci al r epor t i ng i s def i ned i n SEC r ul es, i n
pr i nci pl e, as:
a pr ocess desi gned by, or under t he super vi si on of , t he
company' s pr i nci pal execut i ve and pr i nci pal f i nanci al of f i cer s,
or per sons per f or mi ng si mi l ar f unct i ons, and ef f ect ed by t he
company' s boar d of di r ect or s, management , and ot her per sonnel ,
t o pr ovi de r easonabl e assur ance r egar di ng t he r el i abi l i t y of
f i nanci al r epor t i ng and t he pr epar at i on of f i nanci al st at ement s
f or ext er nal pur poses i n accor dance wi t h gener al l y accept ed
account i ng pr i nci pl es and i ncl udes t hose pol i ci es an pr ocedur es
t hat : Per t ai n t o t he mai nt enance of r ecor ds t hat , i n r easonabl e
det ai l , accur at el y and f ai r l y r ef l ect t he t r ansact i on and
di sposi t i ons of t he asset s of t he company; Pr ovi de r easonabl e
assur ance t hat t r ansact i ons ar e r ecor ded as necessar y t o per mi t
pr epar at i on of f i nanci al st at ement s i n accor dance wi t h gener al l y
accept ed account i ng pr i nci pl es, and t hat r ecei pt s and
expendi t ur es of t he company ar e bei ng made onl y i n accor dance
wi t h aut hor i zat i ons of management and di r ect or s of t he company;
and Pr ovi de r easonabl e assur ance r egar di ng pr event i on or t i mel y
det ect i on of unaut hor i zed acqui si t i on, use, or di sposi t i on of
Auditing and PCAOB Standard No. 2 29
t he company' s asset s t hat coul d have a mat er i al ef f ect on t he
f i nanci al st at ement s.
The eval uat i ve pr ocess cal l s f or management t o i dent i f y di f f er ent
i nt er nal cont r ol s and sel ect t hemf or ef f ect i veness t est i ng.
Ext er nal audi t or s, t hough t hi s pr ocess can be compl i cat ed, ar e not
per mi t t ed t o r ender hel p t o management i n t hese ef f or t s i n any
si gni f i cant way i n or der t o mai nt ai n i ndependence and obj ect i vi t y,
wher eas management i s not per mi t t ed t o r el y nor t o mat er i al l y
dupl i cat e i n any way t he r el at ed assessment s of t he ext er nal
account ant ( s. )
The r epor t i ng pr ocess f i r st cal l s upon management t o under st and t he
cont r ol envi r onment and i nt er nal cont r ol s, t hen t o est abl i sh cont r ol
obj ect i ves and sel ect an i nt er nal cont r ol f r amewor k and r el at ed
cr i t er i a t o f aci l i t at e an exami nat i on and asser t i ons on i nt er nal
cont r ol s; t hen under st and and eval uat e t he ent i t y l evel i nt er nal
cont r ol s. Thi s i s f ol l owed by acqui r i ng an under st andi ng of i nt er nal
cont r ol and i t s pr ocesses f or cl asses of t r ansact i ons and
t r ansact i ons t hemsel ves, and t he eval uat i on of i nt er nal cont r ol
f ol l ows t hat exami nes t he ef f ect i veness of same i n vi ew of cont r ol
def i ci enci es, si gni f i cant def i ci enci es, and mat er i al weaknesses.
Thi s i s f ol l owed by est abl i shi ng ef f ect i ve cor r ect i ve cont r ol s t o
cor r ect t he mat er i al weaknesses and cont r ol def i ci enci es ( i f any, )
af t er whi ch t est i ng r esul t s ar e document ed and management f or mul at es
and i ssues i t s i nt er nal cont r ol r epor t .
For an i l l ust r at i on of t he basi s of , and a compar i son of adver se
i nt er nal cont r ol i ssues t hat ar i se i n f i nanci al st at ement audi t s, see
t he f ol l owi ng:
Auditing and PCAOB Standard No. 2 30
Possibility Potential for
Misstatement
Control Deficiency
(highest level)
I nt er nal cont r ol
desi gn her e does not
al l ow f or ( t i mel y)
det ect i on of
mi sst at ement s.
Any mi sst at ement
mat er i al or i mmat er i al
compr i ses a cont r ol
def i ci ency.
Significant Deficiency Mor e t han r emot e
possi bi l i t y f or
det ect i on of
mi sst at ement s.
Pot ent i al her e must be
mor e t han
i nsi gni f i cant .
Material Weakness
(low - level)
Mor e t han r emot e
possi bi l i t y f or
det ect i on of
mi sst at ement s.
Pot ent i al her e i s
mat er i al
mi sst at ement .
The obj ect i ve of a f i nanci al st at ement audi t i s t he expr essi on of an
opi ni on on t he f i nanci al st at ement s t aken as a whol e, and si mi l ar l y,
t he r epor t on i nt er nal cont r ol i s t o expr ess an opi ni on on t he
oper at i ng ef f ect i veness of t he busi ness' i nt er nal cont r ol over
f i nanci al r epor t i ng and t o r epor t on t he r el at ed i nt er nal cont r ol
ef f ect i veness. I n achi evi ng t hi s, t he audi t or s must pl an and per f or m
t he audi t i n or der t o obt ai n r easonabl e assur ance about whet her or
not t he busi ness has put i n pl ace and adequat el y and mat er i al l y
mai nt ai ned ef f ect i ve i nt er nal cont r ol s as of t he dat e of management ' s
i nt er nal cont r ol r epor t . The audi t of i nt er nal cont r ol i s per f or med
i n or der t o obt ai n, agai n, r easonabl e assur ance t hat mat er i al
Auditing and PCAOB Standard No. 2 31
weaknesses do not r esul t i n t he mat er i al mi sst at ement of t he
f i nanci al st at ement s as of t he end of t he year f i nanci al st at ement
dat e, usual l y t he bal ance sheet dat e. I n or der t o pr oper l y per f or m
t he f i nanci al st at ement audi t wi t h r espect t o i nt er nal cont r ol s and
( ot her ) f i nanci al st at ement asser t i ons, t he audi t or engages i n t he
f ol l owi ng st andar d audi t act i vi t i es:
a. Pl anni ng t he audi t engagement .
b. Eval uat i on of t he i nt er nal cont r ol assessment pr ocess of
management .
c. Obt ai ni ng an under st andi ng of t he cont r ol envi r onment , and
i nt er nal cont r ol over f i nanci al r epor t i ng.
d. Test and eval uat e - -
1. The desi gn and ef f ect i veness of i nt er nal cont r ol .
2. The oper at i ng ef f ect i veness of i nt er nal cont r ol .
e. Based on t he evi dence gat her ed, f or man opi ni on on t he
ef f ect i veness of i nt er nal cont r ol .
The audi t or s' r epor t on i nt er nal cont r ol over f i nanci al r epor t i ng
i ncl udes consi der at i ons such as t he adequacy of management ' s
r epr esent at i ons, t he r esul t s of t he audi t or eval uat i on of t he desi gn
of i nt er nal cont r ol s, t he r esul t s of t he t est i ng of i nt er nal cont r ol s
wi t h r espect t o t hei r ef f ect i veness al ong wi t h negat i ve r esul t s of
cer t ai n subst ant i ve pr ocedur es and any i dent i f i ed cont r ol
def i ci enci es. Gr ounds f or an unqual i f i ed opi ni on ar e pr esent when
t her e ar e no mat er i al weaknesses, nor i nt er nal cont r ol weaknesses, as
Auditing and PCAOB Standard No. 2 32
of t he dat e of t he audi t or ' s r epor t . A si ngl e mat er i al weakness i n
i nt er nal cont r ol cal l s f or an adver se opi ni on on t he f i nanci al
st at ement s.
PCAOB Audi t i ng St andar d No. 2 al l ows publ i c company ext er nal audi t or s
t o use cer t ai n wor k of ot her audi t i ng f i r ms or t o use t he wor k of
i nt er nal audi t or s, i f compat i bl e wi t h t hat of ext er nal audi t or s and
t hat does not i mpai r i ndependence, t hat mi ght f ur ni sh a r epor t on t he
ef f ect i veness of i nt er nal cont r ol , and cer t ai n ot her wor k among t he
ext er nal audi t or ' s f unct i ons, pr ovi ded t hi s i s di scl osed i n t o t he
publ i c i n t he audi t or ' s r epor t . The I nst i t ut e of I nt er nal Audi t or s
had publ i shed gui dance on t hese t opi cs t hat i ncl ude St andar ds f or
Pr of essi onal Pr act i ce of I nt er nal Audi t i ng. Management must
nonet hel ess mai nt ai n i t s t asks of det er mi ni ng t he busi ness i s
compl i ant wi t h account i ng r ul es and r egul at i ons, especi al l y t hose set
down by t he SEC and PCAOB ( Sar banes Oxl ey Act of 2002. )
Publ i c compani es ar e as wel l r equi r ed t o f i l e i nt er i mf i nanci al
r epor t s wi t h t he SEC: I ssuer s, ar e r equi r ed i n addi t i on t o year
end st at ement t o f i l e i nt er i mor quar t er l y st at ement s t o whi ch
St at ement of Audi t i ng St andar ds No. 100 appl i es ( AU 722, ) I nt er i m
Fi nanci al I nf or mat i on, as compar ed t o di f f er ent l i t er at ur e ( f or
exampl e, PCAOB Audi t i ng St andar d No. 2) f or t he year end r epor t ( s. )
SAS No. 100 i s admi ni st er ed by t he PCAOB as wel l , and t he i nt er i m
r evi ew of publ i c company f i nanci al st at ement s i s per f or med i n or der
t o pr ovi de assur ance about whet her any mat er i al modi f i cat i ons shoul d
be made t o i nt er i mf i nanci al i nf or mat i on i n or der f or i t t o be i n
conf or mi t y wi t h GAAP. Many of t he pr ocesses and pr ocedur es i n an
i nt er i maudi t ar e t he same as f or t he year end f i nanci al st at ement
audi t f r omt he under st andi ng and accept ance of t he engagement , t o
Auditing and PCAOB Standard No. 2 33
under st andi ng t he cont r ol envi r onment and cl i ent ' s busi ness, t o
t est i ng and per f or mi ng pr ocedur es and r epor t i ng r esul t s.
Auditing and PCAOB Standard No. 2 34
Further Reading
1. Account i ng and Fi nanci al Li t er at ur e at www. scr i bd. com
2. Bar r on' s Di ct i onar i es.
3. Fi nanci al Account i ng St andar ds.
4. ht t p: / / www. ai cpa. or g/ i nt er est ar eas/ f r c/ assur anceadvi sor yser vi ces/ p
ages/ assur anceadvi sor yser vi ces. aspx
5. St af f Account i ng Bul l et i ns.
6. St at ement s on Audi t i ng St andar ds.
7. St at ement s on St andar ds f or Account i ng and Revi ew Ser vi ces.
8. St at ement s on St andar ds f or At t est at i on Engagement s.
Auditing and PCAOB Standard No. 2 35