Learning Objectives
11-сhapter (COMPLETING THE AUDIT)
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In September 2003, former Ernst & Young partner Thomas C. Trauger was arrested for obstructing an examination into NextCard Inc. by federal-bank regulators by altering and deleting working papers from its year 2000 audit of the company. (Bryan-Low & Weil 2003) On October 31, 2001, NextCard announced in a press release that the Office of the Comptroller of the Currency had asked the company to make certain changes regarding NextBank’s accounting practices, including changes regarding the classification of losses on credit cards. NextBank, the bank subsidiary, was also asked to change the treatment of some allowances and securitizations of loans. In the summer of 2001, the Office of the Comptroller of the Currency asked Ernst & Young for a portion of its audit working papers regarding E&Y’s audit of NextCard. (Bryan-Low & Weil 2003) Trauger became concerned that E&Y’s audit work would be examined. Along with the help of two senior managers, Trauger is alleged to have ordered the altering of audit documents and destroying documents that were inconsistent with the changes he was directing. These alterations consisted of both addition and deletions to the work papers. Specifically, the audit partner altered the summary review memorandum as well as memo- randa regarding the audit of NextCard’s allowance for loan and lease losses securitizations of receivables. (SEC 2003) It is alleged that Trauger had his senior managers change the date on their laptop com- puters to make it seem like the work on the documents had been done during the time the original audit had actually occurred. The alterations and deletions made it appear as though E&Y had thoroughly considered all of the appropriate issues and available facts relating to NextCard’s allowance for loan losses and NextCard’s securitization of receivables. (SEC 2003) A SEC official said Trauger, who had approved an earlier “clean audit” of NextCard, was trying to downplay or eliminate evidence of problems that would have been red flags. (Iwata 2003) |
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Discussion ■ How are work papers important to proving that the audit was done correctly? Questions ■ What would an auditor accomplish by altering or destroying the work papers? | |
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References |
Bryan-Low, C. and Weil, J., 2003, “Former Partner at Ernst Is Arrested,” Wall Street Journal, September 26. Iwata, E., 2003, “Accountant arrested under Sarbanes-Oxley; Harsher penalties possible for former E&Y senior partner,” 10 USA Today, September 26. SEC, 2003, Litigation release 48543, “Commission Issues Orders Alleging That Auditors Violated Rules of Practice By Altering and Deleting Audit Working Papers,” US Securities and Exchange Commission, September 25. |
DOCUMENT RETENTION
Document Retention
ISA 230 states: “The auditor should adopt appropriate procedures for maintaining the confidentiality and safe custody of the working papers and for retaining them for a period sufficient to meet the needs of the practice and in accordance with legal and professional requirements of record retention.” 11 The standard provides no further guidance on documentation retention.
By contrast, the proposed International Standard on Quality Control, ISQC 1, addresses the issue of document retention in the context of the firm’s system of quality control. The high-level guidance in ISQC 1 states: “The firm retains this documentation for a period of time sufficient to permit those performing monitoring procedures to evaluate the firm’s compliance with its system of quality control, or for a longer period if required by law or regulation.” 12
PCAOB and SOX Document Retention
The US SEC introduced detailed regulation (Rule 210.2-06) 13 on document retention as mandated by the Sarbanes-Oxley Act (SOX). The regulation specifies detailed requirements regarding the types of document (e.g. working papers, memos, correspondence, etc. that contain conclusions, opinions, analyses, etc.) that should be retained and the specific period of time they should be retained, regardless of whether such documents support, or are inconsistent with, the final audit conclusions.
Under SOX Section 103, 14 each registered public accounting firm is required to prepare and maintain audit working papers and other information related to any audit report for a period of not less than seven years. 15 PCAOB’s Documentation standard states: “Audit documentation must be retained for seven years from the date of completion of the engage- ment, as indicated by the date of the auditor’s report, unless a longer period of time is required by law.” 16
Under SOX Section 105, 17 the PCAOB may also:
require the testimony of the firm or of any person associated with a registered public accounting firm;
require the production of audit work papers and any other document or information in the possession of a registered public accounting firm or any associated, and may inspect the books and records of such firm or associated person to verify the accuracy of any documents or information supplied;
request the testimony of, and production of any document in the possession of, any other person, including any client of a registered public accounting firm.
Adding To or Altering Documentation
Circumstances may require subsequent additions to the audit documentation, for example, if evidence is obtained after completion of the engagement, or if work performed before engagement was finished is documented after completion. When additions are made, according to PCAOB, 18 the documentation added must indicate the date the information was added, by whom it was added, and the reason for adding it.
Audit documentation must not be deleted or discarded. SOX describes criminal penalties for altering documents: “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration ... shall be fined under this title, imprisoned not more than 20 years, or both.” 19
Who Owns Working Papers?
ISA 230 states that working papers are generally considered to be the property of the auditor. 20 Although portions of or extracts from the working papers may be made available to the entity audited at the discretion of the auditor, they are not a substitute for the entity’s accounting records. In international practice generally the only time anyone, including the client, has a legal right to examine the papers is when they are subpoenaed by a court as legal evidence.
During the audit a considerable amount of information of a confidential nature is gathered, including officer salaries, product cost and product plans. This information can be damaging to the client and useful to competitors if it gets out of the hands of the auditors. Therefore, auditors must take care to protect the working papers at all times.
Permanent and Current Files
There are two main divisions of audit working papers:
the permanent (or continuing) audit file;
the current audit file.
The permanent file is audit working papers containing all the data that are of continuing interest from year to year. The current work paper file contains all papers accumulated during the current year’s audit.
Permanent File
The permanent file is intended to contain data of historical or continuing nature pertinent to the current audit. This file provides a convenient source of information about the audit that is of continuing interest. The permanent file of working papers ordinarily includes: 21
information concerning the legal and organizational structure of the entity such as copies or excerpts of company documents such as corporate charter or articles of association, corporate bylaws, plans, job manuals, and the corporate organizational chart;
extracts or copies of important legal documents, agreements and minutes such as contracts, loan agreements, pension plans, agreements with parent company and subsidiaries, minutes of board of directors or executive committees, and profit-sharing documents.
prior year analysis of fixed assets, long-term debt, terms of stock and bond issues, intangibles, allowances, and results of analytical procedures.
information concerning the industry, economic environment and legislative environment within which the entity operates.
Illustration 11.A.2 is a sample listing of the contents of a permanent file. The illustration includes items not mentioned above.
ILLUSTRATION 11.A.2
Sample Work Papers – Permanent File Contents
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