Ethical Obligations and Decision Making in Accounting, 4/e 15
communication of both significant deficiencies and material weaknesses in internal
control to the audit committee. Auditors must also communicate certain matters relating
to fraud, illegal acts, and other matters to the audit committee. These communications
may be either given orally or in writing. Both the AICPA and PCAOB require that the
audit committee be informed about fraudulent or illegal acts that the auditors become
The auditor should communicate to the audit committee the following.
• Significant accounting policies and practices.
• Critical accounting policies and practices and reasons for considering them to be
critical. Critical accounting policies and practices are a company’s accounting
policies and practices that are both most important to the portrayal of the
• Uncorrected and corrected misstatements.
In this case the auditor should discuss with the audit committee, or determine that
management has adequately discussed with the audit committee, the basis for the
determination that the uncorrected misstatements were immaterial, including the
qualitative factors considered. The auditor also should communicate that
uncorrected misstatements or matters underlying those uncorrected misstatements
reasons for the modification, and the wording of the report; and
o When the auditor expects to include explanatory language or an
explanatory paragraph in the auditor’s report, the reasons for the
explanatory language or disagreements with management.
• Disagreements with management
The auditor should communicate to the audit committee any disagreements with
management about matters, whether or not satisfactorily resolved, that
individually or in the aggregate could be significant to the company’s financial
• Difficulties encountered in performing the audit.
The auditor should communicate to the audit committee any significant
difficulties encountered during the audit. Significant difficulties encountered
during the audit include, but are not limited to:
o Significant delays by management, the unavailability of company
personnel, or an unwillingness by management to provide information
needed for the auditor to perform his or her audit procedures;
o An unreasonably brief time within which to complete the audit;
18. Evaluate the costs and benefits of having a two-year “cooling off period for
engagement partners.
The Sarbanes-Oxley Act instituted an audit rotation period after five years for the “lead”
partner as of January 1, 2004. A firm will not be independent if it violates the rule, which
is incorporated into SEC regulations. The Act imposes a five-year cooling off period, up
The PCAOB requires a two-year cooling off period before the lead partner can return to
the engagement. The European Union currently requires only partner rotation every seven
years and a cooling-off period of two years.
There is a tradeoff between having a cooling off period and not having one. The main
benefit is that of enhanced independence that would presumably strengthen objectivity,
professional skepticism, and due care. On the other hand, the client may be denied the
positive effects of partner tenure due to industry and/or technical expertise and
19. Explain how PCAOB inspections can lead to improvements in audit
engagement quality.
PCAOB inspects registered public accounting firms to assess compliance with the
Sarbanes-Oxley Act, the rules of the Board, the rules of the Securities and Exchange
Commission, and professional standards. The inspections look at the firm’s performance
PCAOB inspections focus on how a firm conducted selected audits and on the
effectiveness of the firm’s quality control policies and procedures. Inspections are
designed to identify whether there are deficiencies in how the accounting firm performs
public company audits and whether there are weaknesses in its quality controls over
public company auditing.
Beyond focusing on these recurring deficiencies, inspectors select audit engagements
and focus areas within the inspected audits based on risk factors that include:
• The characteristics of the particular issuer or its industry, such as the size of
market capitalization, the nature of the issuer’s operations and related
developments in relevant industry sector risks;
• Potential audit or accounting issues likely to
be encountered, such as revenue
recognition that involves more complex considerations (e.g.,
construction-type
contracts and multiple-element arrangements);
The report suggests that:
• PCAOB-registered firms consider whether the types of deficiencies identified in
the report could occur at their firms.
• Firms monitor the effectiveness of engagement quality reviews.
team.
• Audit committees use the report to fulfill their oversight responsibilities.
Engagement quality reviews can contribute to audit quality by serving as a safeguard
against erroneous or insufficiently supported audit opinions, according to the PCAOB.
The requirements for engagement quality reviews are designed to provide a meaningful
check on the work performed by the engagement team.
20. Discuss the cultural factors that create barriers for the Chinese units of Big
Four firms to receiving support from the Chinese authorities to share audit
information with the PCAOB to aid its inspection process.
Using Hofstede’s measure of cultural values we can see that China has a high score on
Power Distance (80) indicating that Chinese culture tends to be more authoritative than in
the U.S. In China, the people expect that the government will establish detailed rules
which determine what can and cannot be done under the law, and this authoritative
approach allows for very little personal exploration within the confines of the rules.
Additionally, China has a low score on Individualism (20) indicating that its culture
emphasizes the importance of the family unit; group-work unity; and society in general.
Ethical Obligations and Decision Making in Accounting, 4/e 20
21. In its report prepared for audit committees and other stakeholders in
December 2014, “Our Commitment to Audit Quality,” EY acknowledges
that recent PCAOB findings indicate the need for improving audits of
internal control over financial reporting (ICFR), increasing the focus on
controls over the use of electronic audit evidence (EAE), scoping multi–
location audits, auditing management’s estimates, and performing
substantive analytical procedures. In its opening letter in the report, the firm
states: “At EY, the delivery of quality audits is central to our purpose, values,
management processes…Our reputation is based on providing quality audit
services objectively, independently, and with appropriate skepticism.” Given
the 50 percent audit deficiency rate cited by the PCAOB in its inspection of
EY audits, would you conclude that the firm failed in its role to adequately
protect the public interest?
It’s a stretch to say that EY failed in its role to adequately protect the public interest.
Deficiencies in quality controls within the firm and failing to adequately assess the
internal controls over financial reporting of clients do not indicate intent to deceive the
public or a desire to place the interests of a client or the firm ahead of that of the public.
Nevertheless, a 50 percent rate is troublesome especially since other firms’ deficiency
rates were lower. The 50 percent rate was for 2013 audits. Recently the PCAOB
announced its results for 2014.
A deficiency, as defined by the PCAOB, means the audit firm hadn’t obtained enough
evidence to support its approvals of a company’s financial statements and internal
controls. It doesn’t mean the financial statements are inaccurate or that the problems
found haven’t since been addressed. Thus, we believe it doesn’t mean EY has abandoned
its commitment to the public interest.
22. The International Auditing and Assurance Standards Board has issued a
new standard effective December 15, 2016, requiring that engagement
partners physically sign the audit report with their names instead of the
name of the firms, as is done in the United States. What value do you believe
this new requirement might bring to the end-user of the audit report? Is it a
necessary provision? Explain.
This is an excellent question for an assigned project for students because of the
contentious nature of the issue and PCAOB’s proposal to have audit partners sign the
audit report. That proposal was issued on June 30, 2015, and has been met with a
negative response from the Big Four firms including PwC’s response referred to below.
Instructors should ask students to update the issue since June 2015.
IAASB Action
In January 2015, the International Auditing and Assurance Standards Board (IAASB)
revised its auditor reporting standards for member bodies of the International Federation
of Accountants (IFAC) that now require disclosing the name of the engagement audit
partner. One concern is it might create a conflict between U.S. rules and the international
standards. The PCAOB has a rule pending on this matter as discussed below.
Ethical Obligations and Decision Making in Accounting, 4/e 22
U.S. Council of Institutional Investors (CII)
The U.S. Council of Institutional Investors (CII) is a strong proponent of the idea of
having the auditor sign the report, although it initially wanted the engagement partner to
sign the report, a proposal since changed by PCAOB.
The CII view is that disclosure in the auditor’s report of the name of the engagement
partner would facilitate the ability of shareowners to obtain useful information about the
track record of lead audit partners. This is “information that many investors demand and
deserve to know,” CII believes. “We would have preferred that the PCAOB require the
signature of the engagement partner,” a previous CII letter addressing the PCAOB stated.
“However, we continue to believe the required disclosure of the name of the engagement
partner has most of the potential benefits as the signature requirement.”
PCAOB Proposals
Ethical Obligations and Decision Making in Accounting, 4/e 23
On June 30, 2015, the Public Company Accounting Oversight Board (PCAOB) issued for
public comment a request for comment on its re-proposal to require auditors to disclose
the name of the engagement partner and information about certain other participants in
the audit.7 The PCAOB is considering an alternative whereby this information would be
required to be disclosed on a new PCAOB form instead of in the auditor’s report. The
supplemental request for comment seeks commenters’ views. The PCAOB is considering
requiring disclosure of:
• The name of the lead engagement partner for the current period’s audit.
• The names, locations, and extent of participation of other independent public
accounting firms (the “other firm”), including other firms within the same
network as the group auditor, that took part in the group audit. If the other firm
PwC Response to Original PCAOB Proposal
Big Four firms lament the need for such a proposal and possible unfair series of lawsuits
targeting just one auditor, the one who signs the report. Audit firms point out that several
partners are involved in formulating the final opinion including the lead audit partner, the
engagement partner, a technical review partner, and the managing partner of the firm.
Firms also point to secrecy issues in their response to the proposal.
Ethical Obligations and Decision Making in Accounting, 4/e 24
Auditors say the information is not useful to investors or the markets because the global
firms stand behind their work and that individual partners could potentially be exposed to
additional legal liability. That’s disputed by investors and the attorneys who sue audit
firms on behalf of investors after frauds or significant accounting errors depress share
prices.
PwC sent a letter to the PCAOB in response to its initial proposal in 2009 that reflects the
views of the audit profession and can be considered a valid view with respect to the 2015
The main points made by PwC in its 2009 letter are summarized below.
• The notion that having an engagement partner sign the audit report would enhance
audit quality because it might increase the engagement partner’s sense of
accountability to financial statement users, which could lead the partner to
PwC issued another response letter in 2014. In that letter it makes points about the overall
proposal including:9
• Concerns about whether users receive meaningful information or increase
transparency
• Audit reliability and other quality issues will not be enhanced
Text Authors’ View
Ethical Obligations and Decision Making in Accounting, 4/e 25
A harms and benefits approach would seem to indicate the proposal is unnecessary and
creates an additional burden on the signing auditors beyond the one already established
through the firm’s own quality control system and mandate to place the public interest
ahead of all other interests. The AICPA Code and PCAOB audit, independence, and
ethics standards already hold in check bad behavior by the firms and all of its partners.
23. Do you agree that a professional accountant providing professional services
to a client that is not an audit client of the firm or a network firm, who is
unable to escalate a matter pertaining to an illegal act within the client,
should be required to disclose the suspected illegal act to the entity’s external
auditor? If not, why not and what action should be taken? What about
informing the SEC? Under what circumstances, if any, should the auditor
consider a whistleblowing action against the client and/or the firm under
Dodd-Frank?
This question centers on the ethical and professional responsibilities of a professional
accountant who is not involved in providing auditing services for client; instead, the
services provided are nonaudit. For example, they could be bookkeeping services. The
issue is whether an illegal act/suspected fraud by the client rises to the level of needing to
report it to the external auditor or the SEC. The question states that the accountant was
unable to escalate the matter within the client. We can assume that steps were taken to do
so to no avail.
Ethical Obligations and Decision Making in Accounting, 4/e 26
24. Audit morality includes moral sensitivity, moral judgment, moral
motivation, and moral character. Explain how audit morality plays a key
role in determining best audit practices that influence audit performance.
Audit morality includes the elements of Rest’s model: moral sensitivity, moral judgment,
moral motivation, and moral character. Audit morality is related to audit performance in a
positive way. These components are an antecedents of audit performance.
Audit morality enhances auditors’ ability to be aware of right practices in order to
achieve job successes in their duties and functions. Auditors with audit morality are likely
25. Dennis just got hired after not working for two years following his reporting
of financial statement fraud by his previous employer. Dennis was treated as
an outcast and ultimately fired after the company “trumped up” some
Ethical Obligations and Decision Making in Accounting, 4/e 27
unsubstantiated claims of poor performance. Dennis fought the dismissal in
court as wrongful termination but lost. It was two difficult years during
which time his marriage broke up. In order to get hired for the new job,
Dennis felt compelled to shade the truth about why he left the job. Here is
what Dennis told the recruiter when asked whether he had left the company
because of any differences:
“I didn’t feel as though there was a good growth path and that it didn’t make sense
to stay somewhere that wasn’t going to work out for me.”
Did Dennis do the right thing? Explain.
Dennis is deceiving his future employer, a dishonest act. If Dennis truly believes he was
treated unfairly/wrongly then he should explain his side of the story. Even though he lost
the lawsuit for wrongful dismissal, that doesn’t mean he did anything wrong. The
company’s lawyers may have submitted a convincing case using trumped-up charges and
false data about his performance. Dennis may have had ineffective legal counsel.
The Rights Theory holds that an employer has a right to know about the circumstances of
dismissal when hiring a new employee. In the real world this may be easier said than
done. The previous employer is not going to want to talk about a legal settlement with
Dennis so the burden falls entirely to him to be above board with his future employer.
