Introductory Audit Homework Handouts: A Bridge from Class to Auditors' Professional Responsibilities Free

In senior-level and graduate-level introductory audit courses, professors face a challenge in helping students bridge the knowledge they are learning in class to actual events from the auditing profession. Experiential learning can provide many benefits for students. Wright (2000, 124) posits that short-term experiential learning (which includes observation) can “mitigate some of the drawbacks to long-term experiential exercises, but still elicit similar benefits.” Lawson et al. (2014) recommend that accounting curricula should focus on students' long term careers. Liu, Yao, and Hu (2012) discuss improving ethics education in accounting. Three Homework Handouts are presented in which auditing students are exposed to real-world situations that they may face at various points in their auditing careers. By observing these situations and addressing questions posed in the assignments, students will be better prepared to make better ethical decisions and avoid similar mistakes in their own careers. These assignments will help students to bridge in-class learning to their professional responsibilities as auditors and help them to better fulfill those responsibilities.

Students will be ready for in-class discussion after completing the assignments. Homework Handout #1 is titled “Auditor/Management Responsibilities, Representation Letters, and Independence” and covers auditor independence (auditors' role to avoid managerial decisions) and management representation letters. Homework Handout #2 is titled “Ethical Dilemmas and the Code of Professional Conduct” and covers ethical dilemmas faced by auditors and sanctions against CPAs for violating the Code of Professional Conduct. Finally, Homework Handout #3 is titled “PCAOB Inspection Reports” and covers the PCAOB Inspection Reports. The Homework Handouts are available for download as Word documents, please see Appendix A.

Students reported that completing the Homework Handouts was a valuable learning experience. Students also reported that the Homework Handouts were effective as a means of tying what they had been learning in class to actual events in the accounting/auditing profession. Students found the Homework Handouts to be interesting, relevant to the audit course, and recommended that the Homework Handouts be used in future audit courses. Finally, students agreed that the Homework Handouts were effective for illustrating decisions that auditors might make, which can help them in making similar decisions.

The Homework Handouts described have been used in audit courses at three large public universities at which there is only one introductory audit course offered. If instructors have different constraints or teach auditing over multiple courses, then the Homework Handouts are easily adaptable to fit instructors' needs. Also, if instructors would like students to spend more time on discovering the audit profession, then ideas are presented to help instructors expand the assignments. The next section presents Homework Handout #1, #2, and #3, respectively. The “Case Learning Objectives and Implementation Guidance” section presents Introducing and Assigning the Homework Handout, Grading, Classroom Implementation Issues, Evidence of Effectiveness, and Expanding the Assignments for each of the Homework Handouts following the cases.

A New York Times article stated:

When there is an auditor change for a Securities and Exchange Commission (SEC) registrant, the SEC Division of Corporate Finance Financial Reporting Manual, Section 4510, contains the requirement that the company is to file an 8-K, Item 4.01 (SEC 2016). Turner, Williams, and Weirich (2005) state: “When an auditor is informed by a company that it has been terminated, or informs the company that it will no longer serve as the independent auditor, the auditor is required to send a form letter directly to the Office of the Chief Accountant of the SEC. This letter must be sent within four business days, and is matched with the Form 8-K filings.” Molex filed an 8-K, Item 4.01, dated November 13, 2004 on November 18, 2004 describing the change in accountant. Molex filed an amended 8-K on December 1, 2004. Molex's auditor, Deloitte & Touche (Deloitte), sent a letter to the SEC in response to the 8-K, Item 4.01 that Molex filed on November 18, 2004. Deloitte's response letter can be found in the Exhibit 16.1 attachment to the amended 8-K filed by Molex on December 1, 2004. You will read and analyze these documents to complete Homework Handout #1.

After reading the documents, some of the actions taken by Molex management may lead you to ask: “Where is the auditor?” Molex is a case where the auditor was definitely present.

The 8-K where the management of Molex discusses the auditor resignation can be found at: http://www.sec.gov/Archives/edgar/data/67472/000006747204000174/c8k111804.txt/. Focus on the section that is titled Item 4.01 Changes in Registrant's Certifying Accountant. The 8-K containing Deloitte's response can be found at: http://www.sec.gov/Archives/edgar/data/67472/000006747204000178/a8k120104.txt/.

Turn in answers to the following questions (limit your responses to one typed page):

• (1) 

  What event led the auditors to ask for the CEO and CFO to step down?

• (2) 

  Do you agree or disagree with the auditor's request?

• (3) 

  Write a paragraph describing what leads you to your decision in (2).

• (4) 

  Were there other questionable activities going on at Molex that you can ascertain from the 8-Ks? If there are, list them.

Make a decision on Requirement 2 and support it in Requirement 3. If you do not feel comfortable with your response in 3, then you may want to consider possible support for the alternate decision. Work on this assignment individually. The assignment is due one week from the day assigned. Come ready for some class discussion on the assignment due date.

PCAOB AS 1001, Responsibilities and Function of the Independent Auditors,¹ states the following:

• .02 The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements are detected.

• .03 The financial statements are management's responsibility. The auditor's responsibility is to express an opinion on the financial statements. Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The entity's transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management. The auditor's knowledge of these matters and internal control is limited to that acquired through the audit. Thus, the fair presentation of financial statements in conformity with generally accepted accounting principles is an implicit and integral part of management's responsibility. The independent auditor may make suggestions about the form or content of the financial statements or draft them, in whole or in part, based on information from management during the performance of the audit. However, the auditor's responsibility for the financial statements he or she has audited is confined to the expression of his or her opinion on them.

AU-C Section 580 (AICPA 2015) describes what management should include in the management representation letter. Paragraphs .10, .11, and .14 contain managements' responsibility for written representations about “Preparation and Fair Presentation of the Financial Statements,” “Information Provided and Completeness of Transactions,” and “Uncorrected Misstatements,” respectively, as follows:

• .10 The auditor should request management to provide a written representation that it has fulfilled its responsibility, as set out in the terms of the audit engagement,

• • a. for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework; and

  • b. for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

• .11 The auditor should request management to provide written representations that

• • a. it has provided the auditor with all relevant information and access, as agreed upon in the terms of the audit engagement, and

  • b. all transactions have been recorded and are reflected in the financial statements.

• .14 The auditor should request management to provide written representations about whether it believes the effects of uncorrected misstatements are immaterial, individually and in the aggregate, to the financial statements as a whole. A summary of such items should be included in, or attached to, the written representation.

In the Code of Professional Conduct, ET Section 1.295.030 states that “If a member were to assume a management responsibility for an attest client, the management participation threat would be so significant that no safeguards could reduce the threat to an acceptable level and independence would be impaired.”

In December 2012 the PCAOB issued Staff Audit Practice Alert No. 10. The Practice Alert states that “scheduling and workload demands can put pressure on partners and other engagement team members to complete their assignments too quickly, which might lead auditors to seek audit evidence that is easier to obtain rather than evidence that is more relevant and reliable, to obtain less evidence than is necessary, or to give undue weight to confirming evidence” (PCAOB 2012, 7).

Jay Hanson, former PCAOB Board Member, delivered a speech on March 28, 2014 at the Beta Alpha Psi Midwest Regional Meeting. He stated that “one of the biggest impediments to auditor skepticism…is the calendar. Public companies have filing deadlines to meet, and they are rarely missed. When they are missed, the consequences can be serious, including declining share prices and harm to investors. If potential issues are discovered late in the audit process, or an issue is not resolved in a timely manner, auditors may feel pressure to cut corners. We have seen it in inspections and enforcement matters: Auditors recognize that there may be a problem with management's estimates or conclusions but allow themselves to be talked out of doing anything about it” (Hanson 2014).

Ann Marie Fitzpatrick was affected by “scheduling and workload” demands. The PCAOB is involved in disciplinary proceedings against offending accountants. Read the disciplinary proceeding taken against Ann Marie Fitzpatrick, CPA. This can be found at: http://pcaobus.org/Enforcement/Decisions/Documents/12-14_Fitzpatrick.pdf/.

Turn in answers to the following questions (limit your responses to one typed page):

• (1) Prior to making her decision, what were the ethical issues that Ann Marie faced?

• (2) Prior to making her decision, who would be affected by the outcome of the dilemma and how would each group or person be affected?

• (3) What were the alternatives available to Ann Marie, prior to making her decision?

• (4) What were the likely consequences of each alternative listed in (3) above?

• (5) List the evidence regarding whether the Pennsylvania State Board of Accountancy took disciplinary action against Ann Marie? If yes, what evidence did you find? The URL for the Pennsylvania State Board of Accountancy website is: http://www.dos.pa.gov/ProfessionalLicensing/BoardsCommissions/Accountancy/Pages/default.aspx/.

Work on this assignment individually. The assignment is due one week from the day assigned. Come ready for some class discussion on the assignment due date.

The PCAOB does yearly inspections of audit firms that audit 100 or more public companies. You are going to look at the inspection for the Big 4 accounting firms for the year 2015 (the reports are dated 2016).

• If your last name starts with the letters A through J, then read the PCAOB Inspection Reports for Deloitte and PwC.

• If your last name starts with the letters K through Z, then read the PCAOB Inspection Reports for KPMG and Ernst & Young.

• Make sure you select the firm and not their international affiliates (e.g., KPMG and not KPMG Canada).

These inspection reports can be found at: http://pcaobus.org/Inspections/Reports/Pages/default.aspx

Turn in answers to the following questions (limit your responses to one typed page):

• (1) Section A of each report lists a review of audit engagements. For each accounting firm, list one audit deficiency that you think is the worst.

• (2) List why you think it is the worst.

• (3) At the end of the inspection, you will find the auditor's response to the PCAOB. Did they respond to the deficiency you thought was the worst? What was their response?

• (4) Finally, out of the two audit firms you looked at, who had the worst deficiency? What reasons led you to this conclusion?

Work on this assignment individually. The assignment is due one week from the day assigned. Come ready for some class discussion on the assignment due date.

See Exhibit 1 for an overview of the learning objectives that are associated with each Homework Handout.

The objectives of Homework Handout #1 include:

• (1) 

  introducing students or reviewing with the students management's responsibilities with regard to the financial statement and the auditor's responsibilities;

• (2) 

  introducing students to or reviewing with students the management representation letter and its importance;

• (3) 

  illustrating the importance of the Control Environment in a company;

• (4) 

  helping students make a decision about whether auditors are violating AICPA Code of Professional Conduct with regard to ET Section 1.200—Independence; and

• (5) 

  illustrating decisions that auditors might make, which can help students when making similar decisions.

Homework Handout #1 will help introduce/reinforce the fact that management of Molex is responsible for the financial statements and that Molex management will state in writing for the auditors that the financials are free of material misstatements (Objectives 1 and 2). The assignment will also illustrate the importance of “tone at the top” at Molex and how a poor control environment can lead to poor accounting choices (Objective 3). The assignment will let students decide whether Deloitte is violating the rules for independence by asking the CFO and CEO to step down (Objective 4). Finally, by learning about the accounting choices of Molex and the responses of Deloitte, Homework Handout #1 will help auditing students become better audit decision makers (Objective 5).

Instructors will choose where this assignment best fits in their courses and how to grade the assignment. The author assigns Homework Handout #2 at the end of the fifth week of the semester and gives the students one week to complete the assignment.² To avoid answering repeat questions outside of class, instructors should take a few minutes to discuss with the students what they are required to do.

When the author makes the assignment, students will have read about and discussed the AICPA Code of Professional Conduct (AICPA 2015).³ Students may ask whether Deloitte's request to have the CEO and CFO step down is a violation of the Code of Professional Conduct because the auditors are making a request that appears to be similar to a managerial decision. As part of the assignment, the students need to decide whether the auditors violated the Code of Professional Conduct. The students will do this by responding to Requirements 2 and 3.

Students are awarded 1 percent of their overall course grade for successfully completing the assignment. Based on the students' performance on the assignment, this is an adequate incentive. In the open-ended section of the student assessment survey, none of the introductory audit graduate students (out of 31 respondents) and one undergraduate student (out of 46 respondents) stated that they would like the assignment to be worth more points for the time they spent. The students are awarded points for completing the assignment, not on the correctness of the responses. Instructors may choose to increase the total points awarded and/or also grade the students' writing. In the open-ended section of student assessment survey, one graduate student wrote: “I like that my difference of opinion regarding the actions of the auditors did not affect my overall grade.”

As the author has assigned this assignment in the past, some students would not make a decision on Requirement 2: Do you agree or disagree with the auditor's request? These students would gave the author two paragraphs, one to support agreement and the other to support disagreement. The author informed the students that they need to make a decision and then defend it in Requirement 3 (“Give me a paragraph on what leads you to your decision in #2”). Students are instructed that if they do not make a decision, then they will lose points. Students do not lose points if they make a decision that is not consistent with the instructor's opinion, but instead lose points if they do not form and support an opinion of their own. Also, some students may question why they are looking at a case that is so dated (i.e., over a decade has passed). The author has searched and has not been able to find a similar situation since the management of Molex filed their 8-Ks with the SEC. Instructors may want to discuss this with their students and ask: Why do you think there has not been a similar situation since the Molex case?

The author used this assignment most recently during the Fall 2016 semester at a large public university in a three-credit undergraduate introductory audit course. The undergraduate students completed a 12-item survey after completing Homework Handout #1.⁴ The author also used the assignment at a large public university in a graduate introductory audit course, prior to arriving at the current university. The graduate students completed an eight-item survey that matched the first eight statements from the undergraduate survey. The students were asked to respond on a five-point scale (1 = strongly disagree, 5 = strongly agree). Table 1 contains the responses from 46 undergraduate and 31 graduate students. The median response for all 12 statements was either 4, 4.5, or 5. Students agreed that the assignment was a valuable learning experience (Statement 1, Mean = 4.45, Median = 5) and that the assignment was relevant to the audit course (Statement 5, Mean = 4.49, Median = 5). In accordance with Learning Objective 5, students agreed that Homework Handout #1 was effective for illustrating mistakes that auditors might make, which can help students avoid making similar mistakes (Statement 8, Mean = 4.45, Median = 5). One of the overall objectives of the assignment is to help students bridge the knowledge they gain in class to the auditing profession. Students agreed that Homework Handout #1 achieved this objective (Statement 2, Mean = 4.45, Median = 5). The undergraduate students agreed that Homework Handout #1 helped them meet the remaining learning objectives (Statements 9–12, Means = 4.30–4.48, Medians = 4 or 4.5).

If instructors would like students to spend more time on discovering the audit profession, then an expanded assignment is suggested below. On November 17th and 18th of 2004, the Standing Advisory Group (SAG) of the PCAOB met for their annual meeting to discuss the Boards' Standard-Setting Agenda for 2005. Instructors may choose to expand the assignment by either having their students listen to the SAG Meeting excerpts or by having their students read the excerpt transcripts listed below in the expanded assignment and then requiring them to answer more questions after having the students listen to or read the excerpts. Instructors may also have the students read about the April 26, 2004 administrative proceedings against Ernst & Young as described in Footnote 9.

On November 17th and 18th of 2004, the Standing Advisory Group (SAG) of the PCAOB met for their annual meeting to discuss the Boards' Standard-Setting Agenda for 2005. Following the discussion of agenda items on November 17th, the PCAOB Chief Auditor and Chairman of the SAG, Doug Carmichael, opened up time at the end of the second session for a discussion on emerging issues that the SAG members felt were important, but had not been included in the agenda. Don Chapin, who was a member of the SAG at the time, started a discussion on Molex:⁵

Doug Carmichael followed up Don Chapin's comments with the following:⁶

Charles Niemeier, PCAOB Board Member from 2002–2011 and present at the meeting, followed up on the comments by Don Chapin by stating:⁷

Lynn Turner, former Chief Accountant of the SEC and member of the SAG during this meeting, also commented on Molex.⁸ He stated the following:

Ernst & Young took over as external auditor after Deloitte resigned at Molex. The SEC found that Ernst & Young had violated independence guidelines in their audit of PeopleSoft and suspended Ernst & Young from accepting new Commission registrant audit clients for a period of six months starting April 26, 2004.⁹ The suspension would have ended around October 26, 2004 and therefore Molex would have been one of the first new clients Ernst & Young added following their suspension.

• (1) 

  How can an audit firm agree to audit a client that was effectively “discarded” by another firm?

• (2) 

  How are client acceptance decisions made?

• (3) 

  How important is the public perception of an auditor's choice about adding or dropping clients?

• (4) 

  What effect might the SAG and outspoken critics of the profession have on firms?

The objectives of Homework Handout #2 include:

• (1) 

  introducing students to disciplinary actions taken by the PCAOB;

• (2) 

  having students evaluate and walk through the process of making a decision when faced with an ethical dilemma;

• (3) 

  having students find disciplinary proceedings that are taken by a state board of accountancy for failure to follow the AICPA Code of Professional Conduct; and

• (4) 

  illustrating mistakes that auditors might make, which can help students avoid making similar mistakes.

Homework Handout #2 provides students with an overview of the disciplinary action taken by the PCAOB against Ann Marie Fitzpatrick (Audit Manager) and/or Stephen J. Nardi (Audit Partner) and learn the reasons why the action was taken (Objective 1). The assignment will also allow students to identify and evaluate an ethical dilemma faced by Ann Marie and/or Stephen J., who were employees in the Philadelphia Office of BDO Seidman (Objective 2). Students will identify the sanctions taken against Ann Marie and/or Stephen J. for their actions. Identifying the sanctions will help students understand the potential consequences for not following the Code of Professional Conduct (Objective 3). Finally, by learning about the choices of two practicing auditors when faced with an ethical dilemma, Homework Handout #2 should help auditing students become better audit decision makers (Objective 4). There are multiple disciplinary proceedings from the PCAOB that deal with audit documentation manipulation, following the issuance of an audit report.¹⁰ This disciplinary proceeding continues to be timely and the case was specifically chosen because of the unique feature that Ann Marie Fitzpatrick was faced with an ethical dilemma when she had just returned from vacation.

The author assigns Homework Handout #2 at the end of eighth week of a 15-week semester and gives the students one week to complete the assignment.¹¹ To avoid answering repeat questions outside of class, instructors should take a few minutes to discuss with the students what they are required to do. The author gives this assignment after the students have had an opportunity to learn about and discuss professional ethics and audit evidence. The lecture on audit evidence covers audit documentation. Alternatively, this assignment can be given toward the end of the semester when instructors are discussing the completion of the audit. This gives instructors an opportunity to have a discussion on final review of the audit documentation.

Requirements 1 through 4 of the assignment are based on the framework for resolving ethical dilemmas described in Arens, Elder, Beasley, and Hogan (2016, 81–83). Instructors may choose to change Requirements 1 through 4 to match the framework for resolving ethical dilemmas from their current textbook or from an ethics course at their college or university. The reading for the case comes from the “Enforcement” section, “Settled Disciplinary Orders” subsection of the PCAOB website (http://pcaobus.org/Pages/default.aspx). The PCAOB states in the Settled Disciplinary Orders subsection: “Listed below are all of the Board orders in settlements that the Board has reached with registered firms or their associated persons.”

As with the first Homework Handout, students are awarded 1 percent of their overall course grade for successfully completing the assignment. Based on the students' performance on the assignment, this is an adequate incentive. In the open-ended section of the student assessment survey, none of the introductory audit graduate students (out of 39 respondents) and one undergraduate student (out of 46 respondents) stated that they would like the assignment to be worth more points for the time they spent. Consistent with the other homework handouts, the students are awarded points for completing the assignment.

The ethical dilemma presented in Homework Handout #2 focuses on a subordinate (Ann Marie Fitzpatrick) and her interactions with her supervisor (Stephen J. Nardi). Instructors can vary the assignment and have it focus on the supervisor (Stephen J. Nardi) and how he was faced with an ethical dilemma. The expanded assignment also focuses on Stephen J. Nardi. Instructors may also choose to split the class and have half of the class focus on the subordinate (Ann Marie) and her ethical dilemma, and the other half of the class focus on the ethical dilemma faced by the supervisor (Stephen). In the past, the author has noticed that some students have said they were not able to find disciplinary actions against Ann Marie or Stephen J. when trying to complete Requirement 5. When introducing the assignment in class, the author has announced that there are disciplinary actions and that the students will have to search for them. This has helped to alleviate this issue.

Students in one section of a three-credit, undergraduate (graduate), introductory audit course completed an 11-item (eight-item) survey after completing Homework Handout #2.¹² The students were asked to respond on a five-point scale (1 = strongly disagree, 5 = strongly agree). Table 2 contains the responses from 46 (39) undergraduate (graduate) students. The median response for the 11 statements was either 4 or 5. Students agreed that the assignment was a valuable learning experience (Statement 1, Mean = 4.45, Median = 4) and that the assignment was relevant to the audit course (Statement 5, Mean = 4.47, Median = 4). In accordance with Learning Objective 4, students agreed that Homework Handout #2 was effective for illustrating mistakes that auditors might make, which can help students avoid making similar mistakes (Statement 8, Mean = 4.57, Median = 5). One of the overall objectives of the assignment is to help students bridge the knowledge they gain in class to the auditing profession. Students agreed that Homework Handout #2 achieved this objective (Statement 2, Mean = 4.44, Median = 4). The undergraduate students agreed that Homework Handout #2 helped them meet the remaining learning objectives (Statements 9–11, Means = 4.35–4.59, Medians = 4 or 5).

Stephen J. Nardi was the engagement partner described in the PCAOB Disciplinary Order of Ann Marie Fitzpatrick. A PCAOB Disciplinary Order was issued for Stephen J. Nardi on the same day as Ann Marie Fitzpatrick (December 14, 2007) and can be found on the PCAOB website (http://pcaobus.org/Enforcement/Decisions/Documents/12-14_Nardi.pdf). To enhance the assignment, instructors may focus the assignment on Stephen J. Nardi and add some additional questions for additional discovery.

Read the disciplinary proceeding taken against Stephen J. Nardi, CPA. This can be found at the following website: http://pcaobus.org/Enforcement/Decisions/Documents/12-14_Nardi.pdf

• (1) 

  How would you feel about Mr. Nardi's actions if you were a fellow partner with him at BDO Seidman? How could Mr. Nardi's actions expose you to legal liability if you were a fellow partner?

• (2) 

  What is the process the PCAOB follows for disciplinary proceedings?

• (3) 

  What additional punishments were taken against Mr. Nardi outside of the actions of the PCAOB due to the decisions Mr. Nardi made in regard to the Hemispherx audit?

• (4) 

  Do you feel the punishment and the length of the punishment Mr. Nardi received was appropriate for the violation?

• (5) 

  Compare the punishments that were given to Ann Marie Fitzpatrick and Stephen J. Nardi. Are the differences in punishments appropriate?

The objectives of Homework Handout #3 include:

• (1)

  introducing students to PCAOB inspection reports;

• (2)

  having students compare the knowledge gained through an introductory audit course to the deficiencies described by the PCAOB inspection reports of Big 4 audit firms; and

• (3)

  having students identify audit deficiencies they can avoid when they become practicing auditors.

Through completing Homework Handout #3, students have an opportunity to read through the most current inspection reports for the Big 4 audit firms (Objective 1). Each student is assigned two of the Big 4 audit firms and evaluates audit deficiencies that are identified during the firms' PCAOB inspections. Students use the audit procedures they have gained from the audit course to decide which is the worst deficiency listed for an individual firm and which of the two firms they examine has the overall worst deficiency (Objective 2). This evaluation can help introductory audit students realize that the audit procedures they have learned in class are important and will be used in their careers. Also, identifying the deficiencies will hopefully help students to avoid the same deficiencies in their audit careers (Objective 3). The Big 4 firms are the focus of this assignment and this is not meant to bias students against these firms. If instructors are worried about this potential bias, then they can add the next four largest firms (e.g., RSM US, Grant Thornton LLP, BDO USA, LLP, and Crowe Horwath LLP) to the assignment to allow students to be more objective.

The author assigns Homework Handout #3 as close to the end of the semester as possible and gives the students one week to complete the assignment. To avoid answering repeat questions outside of class, instructors should take a few minutes to discuss with the students what they are required to do. The PCAOB describes the inspection process as follows on their website (https://pcaobus.org/Inspections/Pages/InspectedFirms.aspx and https://pcaobus.org/inspections/Pages/default.aspx):

The author mentions inspection reports early in the semester when discussing the CPA profession quality control and accounting firm peer reviews. The author reviews the PCAOB's description of the inspection process with students before assigning Homework Handout #3. If instructors have not shared this information with their students, then they can use the above description as an appropriate introduction.

As with Homework Handouts #1 and #2, students are awarded 1 percent of their overall course grade for successfully completing the assignment. Based on the students' performance on the assignment, this is an adequate incentive. In the open-ended section of the student assessment survey, only one graduate student (out of 37 respondents) and one undergraduate student (out of 43 respondents) stated that they would like the assignment to be worth more points. The students are awarded points for completing the assignment, not on the correctness of the responses. Talking points are provided for instructors in the Teaching Notes. Suggested solutions are not provided in the Teaching Notes as this assignment will change each year when the new PCAOB inspection reports are issued. Instructors will need to read through the inspection reports to prepare for in-class discussion. Instructors should decide which deficiencies they feel are the worst prior to class, and can decide if they want to bring this into the discussion.

The major implementation issue for instructors with this assignment is to decide when to give the assignment. Assigning Homework Handout #3 to students late in the semester allows students to maximize their auditing knowledge. One of the problems with assigning Homework Handout #3 toward the end of the semester is that students have many end-of-the-semester assignments and projects and this may add undue stress. In past semesters, during which the author did not give assessment surveys along with Homework Handout #3, students would let the author know in office hours or through course evaluations that they were displeased to have the assignment at the busiest part of the semester. In the past, the author gave the assignment earlier in the semester to alleviate the workload toward the end of the semester. In the open-ended section of the student assessment survey given during that semester, three introductory audit graduate students (out of 37 respondents) and one undergraduate student (out of 16 respondents) stated that they would like the assignment to be given later in the semester to maximize their audit knowledge available to complete the assignment.

The students are split by their last name and roughly half the class is assigned to look at the inspection reports of Deloitte and PwC, and the remainder is assigned to Ernst & Young and KPMG. If instructors choose to stay with this format, then they will need to adjust the alphabetical groups to make sure each group contains roughly half the class. As the author has given the case over multiple years, there have been classes in which the students were hesitant to share what they thought were the worst deficiencies. For these cases, the author would randomly call on students from the different groups and ask them to share what they had written for their completion of the assignment requirements.

Students in one section of a three-credit undergraduate (graduate) introductory audit course completed an 11-item (eight-item) survey after completing Homework Handout #3.¹³ The students were asked to respond on a five-point scale (1 = strongly disagree, 5 = strongly agree). Table 3 contains the responses from 43 (37) undergraduate (graduate) students. The median response for each statement was either 4 or 5. Students agreed that the assignment was a valuable learning experience (Statement 1, Mean = 4.18, Median = 4) and that the assignment was relevant to the audit course (Statement 5, Mean = 4.23, Median = 4). In accordance with Learning Objective 3, students agreed that Homework Handout #3 was effective for illustrating mistakes that auditors might make, which can help students avoid making similar mistakes (Statement 8, Mean = 4.38, Median = 5; Statement 11, Mean = 4.37, Median = 4). One of the overall objectives of the assignment is to help students bridge the knowledge they gain in class to the auditing profession. Students agreed that Homework Handout #3 achieved this objective (Statement 2, Mean = 4.30, Median = 4). The undergraduate students agreed that Homework Handout #3 helped them meet the remaining learning objectives (Statements 9 and 10, Means = 4.47 and 4.37, Medians = 5 and 4, respectively).

To add some additional discovery about the PCAOB inspection process, instructors may choose to have their students read the PCAOB's explanation of how inspections are conducted and reported upon. The rules for inspection can be found at the PCAOB website (https://pcaobus.org//Rules/Pages/Section_4.aspx). The rules talk about general guidelines, including the frequency of inspections and how to handle violations. The rules do not discuss how samples are selected. In a May 21, 2008 address to the Association of Audit Committee Members, Mark W. Olson, former chairman of the PCAOB outlined the evolution of PCAOB inspections.¹⁴ In his speech, Chairman Olson talks about how the PCAOB selects a firm's audit clients to be inspected. Assigning these two readings to students will help students to understand the nature of inspections (e.g., non-random, risk-based selection criteria; timeliness issues; response process by firms) and it will help them interpret inspection reports in that broader context. These suggestions can be found in the Homework Handout #3 Expansion below.

To get a more complete view of the Big 4 firm performance, it would be helpful to examine the firms' performance year after year. This suggests a possible follow-up assignment, which is not found in the suggested expansion below. Instructors may choose to ask students to look at the Big 4 accounting firms' performance over time. Students could identify whether the total number of deficiencies for a specific firm decreases year after year. Students could also identify whether there are similar deficiencies being identified in the inspection reports year after year, or whether they are different. This type of analysis by the students provides a better judgment of how the Big 4 accounting firms are doing in their audits.

Another follow-up assignment is to look at the PCAOB inspection reports for a smaller, local firm in the area of the instructor's college or university. Again, this is not found in the suggested expansion below. As the author has done this with students, he has picked a local firm with one or two public company audit clients. The students' and author's expectations were that the local firms would work hard to ensure that they had no deficiencies. This was the case for the firms we examined. This can lead to a discussion on what affect a deficiency might have on an accounting firm that only audits a small number of public companies.

Read the PCAOB rules for inspection. The rules for inspection can be found at the PCAOB website (https://pcaobus.org//Rules/Pages/Section_4.aspx). Also read the speech by Mark W. Olson, former Chairman of the PCAOB, given to the Association of Audit Committee Members. The speech can also be found at the PCAOB website (http://pcaobus.org/News/Speech/Pages/05212008_OlsonAssociationofAuditCommitteeMembers.aspx).

• (1) 

  How are an audit firm's clients selected by the PCAOB for the inspection process?

• (2) 

  What features of the audit firm and areas of the audit do the PCAOB focus on in their inspections?

• (3) 

  What reporting process does the PCAOB follow after their inspections and what is the response process of the audit firms being inspected?

• (4) 

  How might you expect this inspection and reporting process to “improve” the audit process?

This case contains three Homework Handouts that can be used to help students to bridge the knowledge they are gaining in class to actual events from the auditing profession. The assignments are constructed to give students a brief experiential learning experience to supplement the material they learn in class. Each assignment requires a one-page or less, typed response to be turned in for grading. Just prior to students turning in the written assignment, instructors lead an in-class discussion that focuses on the Homework Handout. The assignments cover auditor independence (auditors' role to avoid managerial decisions), management representation letters, ethical dilemmas faced by auditors, sanctions against CPAs for violating the Code of Professional Conduct, and PCAOB inspection reports. Each Homework Handout contains suggestions for expanding the assignment to help instructors easily adapt the assignments to fit his or her needs.

In their assessments, students agreed that completing the Homework Handouts was a valuable learning experience and effective as a means of tying what they had been learning in class to actual events in the accounting/auditing profession. Students found the Homework Handouts to be interesting, relevant to the audit course, and recommended that the Homework Handouts be used in future audit courses. Finally, students agreed that the Homework Handouts were effective for helping them avoid mistakes in the future.

Teaching Notes and the Student Version of the Case are available only to non-student-member subscribers to Current Issues in Auditing through the American Accounting Association's electronic publications system at http://www.aaapubs.org/. Non-student-member subscribers should use their usernames and passwords for entry into the system where the Teaching Notes can be reviewed and printed. The “Student Version of the Case” is available as a supplemental file that is posted with the Teaching Notes. Please do not make the Teaching Notes available to students or post them on websites.

If you are a non-student-member of AAA with a subscription to Current Issues in Auditing and have any trouble accessing this material, please contact the AAA headquarters office at [email protected] or (941) 921-7747.

Homework Handout 1: http://dx.doi.org/10.2308/ciia-51868.s01

Homework Handout 2: http://dx.doi.org/10.2308/ciia-51868.s02

Homework Handout 3: http://dx.doi.org/10.2308/ciia-51868.s03