Q 4a. Auditors are required to issue a standard Unqualified Opinion if there is a justified departure from GAAP that is immaterial. If the auditor determines that the justified departure from GAAP is material, Rule 203 of the AICPA Code of Professional Conduct permits the issuance of a standard Unqualified Opinion with an explanatory paragraph either before or after the opinion paragraph, to describe the departure from GAAP, its approximate effects (if it can be practically determined) and the reason why complying with GAAP will cause the financial statements to be misleading.
4b. Cases involving an unjustified departure from GAAP, the type report required to be issued by the auditor depends on the materiality and pervasiveness of the GAAP departure. If the departure can be isolated to one item, a Qualified Opinion is appropriate. If the GAAP departure is more pervasive and involves more than one item, an Adverse Opinion is required.
5. The case points out the cloud of suspicion of bad accounting practices pertaining to Xerox’s use of margin normalization combined with the ROE model. This suspicious revenue recognition practices came to the attention of Ronald Safran (KPMG’s engagement partner) but him and the KPMG team never looked deeper into the flawed recognition accounting practice of Xerox. Neither was the anomaly communicated to the Audit Committee. Ignoring such a conspicuous red flag indicates the KPMG audit team failed to follow through their skepticism of the bad accounting practice referenced in internal memos within KPMG.
Similarly, Michael Conway (a senior partner on the KPMG audit team in 2000) failed to heed to warnings from KPMG UK that “Xerox Europe had little empirical data to evidence commercial sales price or service rates” and the use of margin normalization.
In both instances described above, KPMG in the U.S. failed to do further testing of Xerox’s transactions and assumptions for revenue recognition. Professional Skepticism was not exhibited despite the alerts and warning signals received.
7a. The PCAOB’s Engagement Quality Review, Auditing Standard No. 7provides for a rigorous review that serve as a meaningful check on the work performed by audit engagement teams. The key provisions are as follows:
(i) In-House Reviewer: Partner or an Individual in an Equivalent Position
The standard required an engagement quality reviewer from within the firm issuing the engagement report to be a partner or another individual in an equivalent position, but also allowed a qualified individual from outside the firm to perform the EQR. In either event, the reproposed standard required the reviewer to be an associated person of a registered public accounting firm. This provision was included in the standard due to concerns over reviewers being more likely to succumb to pressure from the engagement partner or other firm personnel, such as members of the firm's national office in the absence of such a provision.
(ii) Qualified Reviewer from Outside the Firm
The reproposed standard also allowed a qualified reviewer from outside the firm to conduct the review. In the reproposing release, the Board expressed the view that allowing a sufficiently qualified professor or other individual not employed by an accounting firm to perform the EQR should not negatively affect audit quality and may mitigate the compliance burden on sole practitioners and smaller firms.
(iii) Independence, Integrity, and Objectivity
The standard required the reviewer to be independent of the company, perform the review with integrity, and maintain objectivity. The reason for this provision was to maintain objectivity of the engagement quality reviewer by ensuring that the quality reviewer does not "supervise the engagement team with respect to the engagement subject to the engagement quality review."
