SOX 2002 & PCAOB

Question 1

What is the audit committee’s responsibility regarding Nonaudit services not specifically prohibited by Title II of the Sarbanes-Oxley Act?

Answer 1

The issuer’s audit committee is required to approve any nonaudit services, including tax services, that are not specifically prohibited by Title II.

Question 2

What is the purpose of the Sarbanes-Oxley Act of 2002?

Answer 2

The purpose is to address a series of perceived corporate misconduct and alleged audit failures (including Enron, Tyco, and WorldCom, among others) and to strengthen investor confidence in the integrity of the U.S. capital markets.

Question 3

The Sarbanes-Oxley Act of 2002 consists of 11 “Titles,” the first four of which are directly applicable to auditors. What is the purpose of Title II?

Answer 3

It established independence requirements for external auditors, which addressed perceived conflicts of interest [limiting nonaudit services, establishing a five year rotation for the audit partner and review partner, and restricting members of the audit firm from taking key management positions (including CEO, CFO, controller, or chief accounting officer) during the one year period preceding the audit engagement].

Question 4

List the two primary revenue sources through which the Public Company Accounting Oversight Board’s (PCAOB) budget is funded.

Answer 4

Registration and annual fees from public accounting firms; and An annual “accounting support fee” assessed on issuers based on their relative monthly market capitalization.

Question 5

List the standard setting responsibilities of the Public Company Accounting Oversight Board (PCAOB).

Answer 5

Auditing and related attestation, quality control, ethics and independence standards.

Question 6

The Sarbanes-Oxley Act of 2002 consists of 11 “Titles,” the first four of which are directly applicable to auditors. What is the purpose of Title I?

Answer 6

It establishes the PCAOB, gives standard-setting authority to the PCAOB regarding auditing, quality control, and independence standards, and creates its role in overseeing the accounting firms required to register with the PCAOB.

Question 7

The Sarbanes-Oxley Act of 2002 consists of 11 “Titles,” the first four of which are directly applicable to auditors. What is the purpose of Title IV?

Answer 7

To address a variety of “enhanced financial disclosures,” the most well-known of which deals with required internal control reporting (Section 404), among other matters.

Question 8

The Sarbanes-Oxley Act of 2002 consists of 11 “Titles,” the first four of which are directly applicable to auditors. What is the purpose of Title III?

Answer 8

It established requirements related to “corporate responsibility” to make executives take responsibility for the accuracy of financial reporting (including a requirement for certification by the entity’s “principal officers”) and to make it illegal for management to improperly influence the conduct of an audit.

Question 9

How frequently is the Public Company Accounting Oversight Board (PCAOB) required to conduct inspections of registered public accounting firms?

Answer 9

The frequency of inspection depends on the number of issuers that a firm audits. Firms that provide audit reports for at least 100 issuers - PCAOB must inspect annually; Firms that provide audit reports for fewer than 100 issuers - PCAOB must inspect every three years.

Question 10

List the five primary responsibilities of the PCAOB.

Answer 10

Registration of public accounting firms; Inspection of registered public accounting firms; Standard setting; Enforcement; Funding.

Question 11

What interim standards were adopted by the Public Company Accounting Oversight Board (PCAOB)?

Answer 11

PCAOB adopted the American Institute of Certified Public Accountants’ (AICPA) auditing standards in existence on April 16, 2003, as “interim standards, on an initial, transitional basis.”

Question 12

Differentiate between the American Institute of Certified Public Accountants’ (AICPA) and the Public Company Accounting Oversight Board’s (PCAOB) requirements regarding the documentation completion date.

Answer 12

AICPA: A complete and final set of audit documentation should be assembled no later than 60 days after the report release date for audits of “nonissuers.” PCAOB: A complete and final set of audit documentation should be assembled no later than 45 days after the report release date for audits of “issuers.”

Question 13

Differentiate between the American Institute of Certified Public Accountants’ (AICPA) and the Public Company Accounting Oversight Board’s (PCAOB) requirements regarding “retention” of audit documentation.

Answer 13

AICPA: requires retention of audit documentation for five years for audits of “nonissuers;” PCAOB: requires retention of audit documentation for seven years for audits of “issuers.”

Question 14

Define “report release date.”

Answer 14

The date when the auditor grants permission to use the auditor’s report in connection with the issuance of the entity’s financial statements. This date must be documented by the auditor.

Question 15

Describe the level of detail in the audit documentation required by Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 3.

Answer 15

The documentation should be prepared in sufficient detail to permit an experienced auditor without prior connection to the engagement to understand the procedures performed and the conclusions reached and to determine who performed the work and on what date.

Question 16

What are deemed “significant findings or issues” that must be documented by the auditor?

Answer 16

1) Issues involving the application of accounting principles; 2) Circumstances causing modification of planned audit procedures; 3) Matters that could result in modification of the auditor’s; 4) Material misstatements; 5) Significant deficiencies or material weaknesses in internal control; 6) Difficulties in applying auditing procedures; and 7) Disagreements among members of audit team.

Question 17

List the three general documentation requirements under Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 3.

Answer 17

Demonstrate the auditor’s compliance with PCAOB standards; Support the basis for the auditor’s conclusions regarding every relevant financial statement assertion; and Demonstrate that the underlying accounting records agree to or reconcile with the financial statement elements.

Question 18

Describe the limited changes in audit documentation that are permitted after the documentation completion date.

Answer 18

No documentation can be deleted; but Documentation can be added - must indicate the date the information was added, the name of the person preparing the additional documentation, and the reason for adding it.

Question 19

List the five conditions required for an engagement to report whether a previously reported material weakness continues to exist under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 4.

Answer 19

1) Management accepts responsibility for internal control over financial reporting; 2) Management evaluates the effectiveness of the specific controls that address the material weakness; 3) Management provides an assertion that the specific control is effective; 4) Management supports its assertion with evidence; and 5) Management provides a written report to accompany the auditor’s report.

Question 20

What is the engagement objective as prescribed under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 4?

Answer 20

To express an opinion as to whether a previously reported material weakness (one or more) in internal control continues to exist as of a specified date. Such an engagement is strictly voluntary, because PCAOB standards do not require reporting on whether a previously reported material weakness continues to exist.

Question 21

What opinion choices does an auditor have when engaged to report on whether a previously reported material weakness continues to exist under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 4?

Answer 21

The auditor may either express (1) an unqualified opinion or (2) a disclaimer of opinion. A qualified opinion is not permitted.

Question 22

What is meant by the term “stated control objective” in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 4?

Answer 22

The specific control objective identified by management that, if achieved, would result in the material weakness no longer existing.

Question 23

Define “control deficiency.”

Answer 23

A weakness that exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

Question 24

Define “deficiency in design.”

Answer 24

A deficiency that exists when a control necessary to meet the control objective is missing or when an existing control is not properly designed so that, even if the control operates as designed, the control objective is not always met.

Question 25

List some indicators of material weaknesses.

Answer 25

Identification of fraud involving senior management, whether or not material; Restatement of previously issued financial statements; Identification by the auditor of a material misstatement of the financial statements in the current period; and Ineffective oversight of the company’s external financial reporting and internal control by the company’s audit committee.

Question 26

List the procedures associated with testing operating effectiveness of internal controls.

Answer 26

Inquiry, observation, inspection, re-performance.

Question 27

In what circumstance is the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 5 applicable?

Answer 27

When engaged to “perform an audit of management’s assessment of the effectiveness of internal control over financial reporting” (ICFR) - the objective of such an engagement is to express an opinion on the effectiveness of ICFR.

Question 28

Define “material weakness” in internal control.

Answer 28

A deficiency, or combination of deficiencies, in internal control over financial reporting, that creates a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis.

Question 29

Define “entity-level controls.”

Answer 29

Controls related to the control environment, controls over management override, the company’s risk assessment process, controls to monitor results of operations or other controls, controls over the period-end financial reporting process; and policies that address significant business control and risk management practices.

Question 30

List the procedures associated with testing design effectiveness of internal controls.

Answer 30

Inquiry, observation, inspection.

Question 31

Define “walkthrough.”

Answer 31

The process of following a transaction from origination through the company’s processes until reflected in the financial records.

Question 32

List the two categories of control deficiency.

Answer 32

(1) Deficiency in design and (2) deficiency in operation.

Question 33

Define “deficiency in operation.”

Answer 33

A deficiency that exists when a properly designed control does not operate as designed or when the person performing the control does not possess the necessary authority or qualifications to perform the control effectively.

Question 34

Describe the top-down approach.

Answer 34

A risk-based approach to auditing that begins at the financial statement level and with the auditor’s understanding of the overall risks to internal controls over financial reporting (ICFR). The auditor then focuses on “entity-level” controls and works down to significant accounts and disclosures and their relevant assertions.

Question 35

Define “significant deficiency.”

Answer 35

A deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.

Question 36

What type of opinion is required on internal control over financial reporting when a material weakness exists?

Answer 36

Adverse opinion.

Question 37

What effects on the auditor’s report, if any, does a change in the classification in previously issued financial statements have?

Answer 37

The auditor’s report does not usually require recognition of the matter unless the change represents a change in accounting principle or the correction of a material misstatement.

Question 38

List the four criteria the auditor should evaluate when there is a change in accounting principle.

Answer 38

1. Whether the newly adopted principle is GAAP; 2. Whether the method of accounting for the effect of the change conforms to GAAP; 3. Whether the disclosures related to the change are adequate; and 4. Whether the company has justified that the alternative accounting principle is preferable.

Question 39

What effects on the auditor’s report, if any, does a correction of a material misstatement to previously issued financial statements have?

Answer 39

The auditor’s report should include an explanatory paragraph describing the inconsistency; The auditor should evaluate the adequacy of the company’s disclosure regarding any such restatement.

Question 40

What effects on the auditor’s report, if any, does a change in the reporting entity resulting from a transaction or event, such as the purchase or disposition of a subsidiary, have?

Answer 40

The auditor’s report does not require recognition of the matter.

Question 41

What are the two specific matters that affect the auditor’s evaluation of consistency of financial statements as prescribed in the Public Company Accounting Oversight Board’s Auditing Standard No. 6?

Answer 41

1. A change in accounting principle; and 2. A restatement to correct a misstatement in previously issued financial statements.

Question 42

Describe the engagement quality review “cooling off” restriction as explained in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7.

Answer 42

The person serving as engagement partner during either of the two audits preceding the audit subject to engagement quality review is not permitted to serve as engagement quality reviewer, unless the registered firm qualifies for a specific exemption to this requirement.

Question 43

What are the requirements regarding concurring approval of issuance of an engagement report as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7?

Answer 43

The firm cannot give permission to the client to use the engagement report until the engagement quality reviewer provides concurring approval of issuance. The engagement quality reviewer cannot express such approval if there is any “significant engagement deficiency.”

Question 44

Under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7, what should the engagement quality reviewer do to evaluate the significant judgments and conclusions of the engagement team?

Answer 44

To evaluate the significant judgments and conclusions of the engagement team, the engagement quality reviewer should: Hold discussions with the engagement partner and other members of the engagement team; and Review documentation.

Question 45

What is the purpose of the engagement quality reviewer under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7?

Answer 45

To perform an evaluation of the significant judgments made by the engagement team and the related conclusions reached and in preparing any engagement report(s).

Question 46

List the qualifications required of an engagement quality reviewer under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7.

Answer 46

Must be an “associated person” of a registered public accounting firm; and Must have competence, independence, integrity, and objectivity.

Question 47

Describe the basic requirement associated with the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7, “Engagement Quality Review.”

Answer 47

PCAOB Auditing Standard No. 7 requires an engagement quality review and concurring approval before issuing the report for audit (or review) engagements conducted under PCAOB standards.

Question 48

List the differences in the American Institute of Certified Public Accountants (AICPA) Statements on Quality Control Standards (SQCS) relative to the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 7.

Answer 48

SQCS do not Require an “engagement quality review” for any type of engagement; Impose a “cooling off” restriction or a requirement that the reviewer must be an “associated person” of a registered public accounting firm; Require a “concurring approval of issuance” before issuing a report; Specifically require that engagement quality review documentation must be retained with other documentation.

Question 49

Describe the audit plan that an auditor is responsible for establishing under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 9.

Answer 49

The audit plan is more specific than the audit strategy and deals with the nature, timing, and extent of the auditor’s planned procedures (including risk assessment procedures, tests of controls, and substantive procedures).

Question 50

List the circumstances that impact the extent of supervision as outlined in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 10.

Answer 50

The size and complexity of the company; Nature of the work assigned to engagement personnel; Capabilities of each engagement team member; and The risks of material misstatement.

Question 51

What is the auditor’s objective for audit planning as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 9?

Answer 51

The objective is to plan the audit so that the audit is conducted effectively.

Question 52

List the two levels at which the risks of material misstatement should be assessed as outlined in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 8?

Answer 52

1. At the financial statement level; and 2. At the assertion level.

Question 53

What is the auditor’s objective as it relates to responding to the risks of material misstatement as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 13?

Answer 53

The objective is to address the risks of material misstatement through appropriate overall audit responses and audit procedures.

Question 54

What is the auditor’s objective for the consideration of materiality in planning and performing the audit as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 11?

Answer 54

The objective is to apply the concept of materiality appropriately in planning and performing audit procedures.

Question 55

List the five financial statement assertions outlined in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 15.

Answer 55

Existence; Completeness; Rights and obligations; Valuation or allocation; and Presentation and disclosure.

Question 56

As outlined in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 12, list the specific risk procedures an auditor should perform to assist in assessing risks of material misstatement.

Answer 56

Obtaining an understanding of the company and its environment; Obtaining an understanding of internal control over financial reporting; Considering information from client acceptance/retention, planning, prior audits, and other engagements for the company; Performing analytical procedures; and Inquiring about the RMM.

Question 57

List the matters that are to be evaluated by the auditor per the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 15.

Answer 57

Results of analytical procedures performed as the overall review; Misstatements accumulated during the audit; The qualitative aspects of the company’s accounting practices; Conditions identified related to fraud risk; The presentation (including disclosures) of the financial statements; and Adequacy of evidence obtained.

Question 58

What is the auditor’s responsibility regarding “reasonable assurance” as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 8?

Answer 58

To reduce audit risk to an appropriately low level.

Question 59

What is the auditor’s objective for identifying and assessing risks of material misstatement as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 12?

Answer 59

To identify and appropriately assess the risks of material misstatement, thereby providing a basis for designing and implementing responses to the risks of material misstatement.

Question 60

Describe the different treatments regarding financial statement assertions between the American Institute of Certified Public Accountants Statement on Auditing Standards (SAS) No. 106 and the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 15.

Answer 60

The PCAOB identifies five financial statement assertions, whereas the AICPA identifies 13 assertions in total of three categories of assertions (involving (1) account balances at the period end; (2) transactions and events for the period; and (3) presentation and disclosure). The AICPA’s discussion of assertions is consistent with International Standards on Auditing.

Question 61

What is the auditor’s objective for audit risk as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 8?

Answer 61

To conduct the audit of financial statements in a manner that reduces audit risk to an appropriately low level.

Question 62

What are the engagement partner responsibilities as outlined in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 10?

Answer 62

The engagement partner is responsible for the engagement and its performance, including the proper supervision of the engagement team members and compliance with PCAOB standards.

Question 63

What is the auditor’s objective for supervision of the audit engagement as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 10?

Answer 63

The objective is to supervise the audit engagement so that the work is performed as directed and supports the conclusions reached.

Question 64

What is the auditor’s objective for evaluating audit results as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 14?

Answer 64

To evaluate the results of the audit to determine whether the audit evidence obtained is sufficient and appropriate to support the opinion.

Question 65

What is the auditor’s objective for obtaining audit evidence as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 15?

Answer 65

To plan and perform the audit to obtain appropriate audit evidence that is sufficient to support the opinion.

Question 66

As outlined in the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 12, what is the purpose of risk assessment procedures?

Answer 66

The auditor should perform risk assessment procedures sufficient to provide a reasonable basis for identifying and assessing the risks of material misstatement and designing further audit procedures.

Question 67

Describe the structural differences between the Public Company Accounting Oversight Board’s (PCAOB) and American Institute of Certified Public Accountants (AICPA) risk assessment standards.

Answer 67

The AICPA issued a total of five “risk assessment” standards; the PCAOB issued eight. In three instances, the PCAOB issued two separate standards on topics that the AICPA had combined into a single pronouncement. The PCAOB standards apply to integrated audits (on financial statements and on internal control over financial reporting).

Question 68

Describe the overall strategy that an auditor is responsible for establishing under the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 9.

Answer 68

The overall strategy involves rather high level audit resource allocation issues involving the scope, timing, and direction of the audit activities.

Question 69

List the two categories of auditor responses regarding risks of material misstatement as prescribed by the Public Company Accounting Oversight Board’s (PCAOB) Auditing Standard No. 13.

Answer 69

1. Overall responses; and 2. Responses involving the nature, timing, and extent of audit procedures at the relevant assertion level.

Question 70

What 4 matters should be communicated to an issuer’s audit committee related to the entity’s accounting policies, estimates, and significant unusual transactions?

Answer 70

1. Significant accounting policies and practices. 2. Critical accounting policies and practices (and why they are considered critical). 3. Critical accounting estimates (and management’s processes and significant assumptions). 4. Significant unusual transactions (outside the normal course of business).

Question 71

Describe the PCAOB requirements as to the form of the auditor’s communications with an entity’s audit committee.

Answer 71

The communications may be oral or in writing, unless otherwise specified. For example, an engagement letter is obviously a written communication.

Question 72

What specific matters should be communicated to the audit committee about the auditor’s evaluation of the quality of financial reporting?

Answer 72

(1) Qualitative aspects of significant accounting policies; (2) assessment of critical accounting policies and practices; (3) conclusions about critical accounting estimates; (4) significant unusual transactions (and the business rationale); (5) conformity with the applicable financial reporting framework; (6) new accounting pronouncements affecting financial reporting; and (7) alternative accounting treatments discussed with management.

Question 73

What are the 4 objectives of the auditor related to communications with audit committees that are identified in PCAOB Auditing Standard No. 16?

Answer 73

1. Communicate responsibilities and establish an understanding of the engagement’s terms. 2. Obtain information from the audit committee relevant to the audit. 3. Communicate information about the strategy and timing of the audit. 4. Provide the audit committee with timely observations about significant audit matters.

Question 74

What is the meaning of the term critical accounting estimate?

Answer 74

An accounting estimate where (a) the nature of the estimate is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and (b) the impact of the estimate on financial condition or operating performance is material.

Question 75

Describe the PCAOB requirements as to the timing of the auditor’s communications with an entity’s audit committee.

Answer 75

The required matters should be communicated on a timely basis, and prior to the issuance of the auditor’s report.

Question 76

What is the meaning of the term critical accounting policies and practices?

Answer 76

A company’s accounting policies and practices that are both most important to the portrayal of the company’s financial condition and results, and require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.