Auditors who adhere to the professional auditing standards are viewed as conducting a quality audit. A lack of adherence to the professional auditing standards heightens the risk that the auditor will provide an unqualified audit opinion on financial statements that are materially misstated. This lesson is highlighted in the 2004-2006 audits of Thornton Precision Components, Limited (TPC) performed by Ernst & Young, LLP UK (E&Y UK). TPC became a wholly owned U.K. subsidiary of Symmetry Medical, Inc. in 2003. Symmetry became a public company in 2004 and was listed on a U.S. stock exchange. Its consolidated financial statements included TPC's financial data. Beginning in 2003, Ernst & Young, LLP (E&Y US) became Symmetry's audit firm. In connection with the 2004-2006 audits of Symmetry, E&Y US engaged E&Y UK to perform audits of TPC, using PCAOB auditing standards. During the 2004-2006 audits, E&Y US relied on E&Y UK's audits to issue unqualified audit opinions for Symmetry. From 1999 through September 2007, TPC's management participated in multiple schemes to increase TPC's revenues, net income, and other performance indicators. These schemes included booking fictitious revenues, understating costs of goods sold, creating fictitious inventories, and improperly capitalizing certain expenses. The fraud at TPC was not discovered by the auditors but only came to light in 2007 when a TPC employee alerted Symmetry's CEO to the fraud. In 2008, Symmetry restated its financial statements, which included among other items, significant reductions in Symmetry's net income. In 2012, the SEC concluded that E&Y UK (a firm registered with the PCAOB) had conducted its audits in such a way that the audits did not adhere to the relevant professional auditing standards. Deficiencies in E&Y UK's 2004-2006 audits of TPC included a failure to perform appropriate procedures to audit the accounts receivable balances; adequately review top-side journal entries; properly audit inventory; and a failure to plan, staff, and supervise the audits. During the audit, the audit partner and manager did not appropriately question management's representations, did not fully document the results of testing, did not appropriately consider the risks of misstatements due to fraud, and did not exercise due professional care and professional skepticism. The SEC prohibited both the audit manager and partner of TPC from auditing U.S. public companies for two years. For further details on this case, see Securities and Exchange Commission Accounting and Auditing Enforcement Release No. 3359 (January 2012).
a. What is the role of auditing standards and their underlying principles in promoting a quality audit?
b. How does the fundamental concept of professional skepticism relate to audit quality?
c. What audit evidence is necessary for opining on a client's financial statements?
d. How does audit documentation provide evidence related to audit quality?
e. What audit activities are conducted during the audit opinion formulation process to provide reasonable assurance about a client's financial statements?
f. How does professional judgment and ethical decision making contribute to audit quality?