PCAOB Brings Case on Audit Documentation

by Brooks Pierce

[authors: , ]

The Public Company Accounting Oversight Board brought a settled action on November 13th against three outside auditors whose errors were measured not in substance, but in process. Dale Arnold Hotz, Jyothi Nuthulaganti Manohar, and Michael Jared Fadner – all CPAs and respectively a partner, director, and assurance manager at then-McGladrey & Pullen – issued a clean audit opinion for an unnamed public company’s 2009 financial statements in 2010. The PCAOB called on November 17, 2010, and announced an inspection of this particular audit that would commence on December 6th. Even then, the three auditors were fairly dormant for about two weeks. But then the scrambling started.


On December 1st a colleague recommended to Hotz that he review the audit work papers to refresh his memory before the inspection. That same day, Hotz and Manohar received a firm email reminding them to have the hard copy work paper files available for the inspection team to review. Hotz, Manohar, and Fadner planned a conference call for December 3rd to prepare for the inspection. Before that call, Manohar and Fadner reviewed the audit documentation and identified two missing documents: a signed engagement letter and a cash flow worksheet. During the call, Hotz and Manohar noticed that a fair value memorandum of financial instruments was also missing. Unfortunately, they decided to obtain or create these documents and add them to the hard copy work papers.

Fadner found an electronic copy of the cash flow worksheet on his laptop’s hard drive, but it included no tick marks or other evidence that audit procedures were appropriately performed. Manohar directed Fadner to print the document and add it to the hard copy work papers. On the morning of December 6th, the actual day of the inspection, Fadner handwrote tick marks, cross-references, footings and recalculations on the worksheet to reflect work purportedly performed during the audit. On the cover page, he wrote his initials and backdated the worksheet to March 6, 2010, and then added it to the hard copy work paper files.

Manohar contacted the client on December 3rd to request a new (signed) copy of the engagement letter, and then asked Fadner to follow up on her request. Fadner emailed the client’s corporate controller on the same day and asked that the letter be delivered early on the morning of December 6th. The letter arrived as promised on that morning, and Fadner added it to the hard copy work papers.

On the evening of Sunday, December 5th, Manohar drafted a Fair Value Memorandum for the audit. She emailed her first draft of the memo to Hotz, who commented on it and sent edits back to Manohar. Manohar then sent a revised draft to Hotz, who approved it as final. Hotz then printed the memo, initialed it, and added it to the hard copy work paper files.

Other documents were manipulated, initialed and signed, well after they were supposed to have been. In none of these instances did the auditors note the actual dates the documents were added to the work papers or the reasons for adding them, as the auditing standards require. They also did not advise the PCAOB’s inspectors that any of the documents in the work papers had been improperly created, backdated, added to the work papers, or altered in December 2010. Hotz also noted, on both the original and amended submissions of the PCAOB 2010 Inspection Period Engagement Profile, that no changes had been made to the audit documentation “subsequent to the documentation complete [sic] date.”


PCAOB Rule 4006 says:

Every registered public accounting firm, and every associated person of a registered public accounting firm, shall cooperate with the Board in the performance of any Board inspection. Cooperation shall include . . . cooperating and complying with any request . . . to – (a) provide access to, and the ability to copy, any record in the possession, custody, or control of such firm or person, and (b) provide information by oral interviews, written responses, or otherwise.

Auditing Standard No. 3, Audit Documentation, is too long to allow for easy quotation in this space. But it says in part:

“The auditor must prepare audit documentation in connection with each engagement conducted pursuant to the standards of the PCAOB. Audit documentation should be prepared in sufficient detail to provide a clear understanding of its purpose, source, and the conclusions reached. Also, the documentation should be appropriately organized to provide a clear link to the significant findings or issues.”

Needless to say, one cannot wish documents into work papers after an audit has been completed and still comply with these rules. The PCAOB thus found that the auditors had violated both Rule 4006 and Auditing Standard No. 3 and censured all three of the auditors. The Board then barred Hotz from associating with a registered public accounting firm for at least two years, after which he can petition for reinstatement. The PCAOB also suspended Manohar from associating with a registered public accounting firm for a year.

Lessons from the Case

Remarkably, given the problems surrounding the auditors’ documentation of their audit, the PCAOB did not find issues or impose sanctions related to the audit opinion itself. Though it’s cliché at this point, it wasn’t the crime, it was the cover-up. The lessons are pretty clear. If you are an auditor in this position, keep careful track of the audit work papers as you go. If you need a signed engagement letter (and you do), get one at the engagement’s outset.

Also, keep Auditing Standard No. 3 handy and refer to it often. The audit documentation should support the audit opinion by the report release date. If audit documentation is assembled for retention within the 45-day period after the report release date, as allowed by Auditing Standard No. 3, then properly document who added the documentation and reasoning. Auditing firms ought to have one or more checklists listing the more significant work papers required. This engagement team overlooked these checklists and/or did not properly complete them. Interestingly enough, the engagement quality reviewer, who is not included in this PCAOB settled action, also appears to have overlooked the missing work papers.

Finally, if required documents are missing, do not make them up after the fact to mask shoddy documentation along the way. The PCAOB will be less excited about sanctioning auditors for missing work papers than for deliberate and willful misrepresentations designed to mislead its inspectors. Accepting one’s fate in that situation will be the safest course.

–Many thanks to John Stewart, audit partner at Dixon Hughes Goodman LLP, for co-authoring this piece.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Brooks Pierce | Attorney Advertising

Written by:

Brooks Pierce

Brooks Pierce on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.