Jamen HKU: Thanks Annie for recapping the case background.

Before exploring the accounting and auditing

issues, I’d like to share on management assertions of IAASB and PCAOB.
Jamen HKU: In IAASB ISA 315 "Identifying and assessing the risks of material misstatement through
understanding the entity and its environment", Assertions used to consider different types of potential
misstatements that may occur fall into this three categories: Assertions about transactions and events,
account balances at the period end, and presentation and disclosure.
Jamen HKU:
(a) Assertions about classes of transactions and events for the period under audit:
(i) Occurrence: Recorded transactions and events have occurred and pertain to the entity.
(ii) Completeness: all transactions and events have been recorded.
(iii) Accuracy: The amounts and other data relating to transactions and events have been recorded
appropriately.
(iv) Cutoff: transactions and events have been recorded in the correct accounting period.
(v) Classification: transactions and events have been recorded in the proper accounts.
Jamen HKU:
(b) Assertions about account balances at the period end:
(i) Existence: assets, liabilities, and equity interests exist.
(ii) Rights and obligations: assets are the rights, and liabilities are the obligations of the entity.
(iii) Completeness: all assets, liabilities, and equity interests have been recorded.
(iv) Valuation and allocation: assets, liabilities, and equity interests are included at appropriate amounts, and
any resulting valuation or allocation adjustments are appropriately recorded.
Jamen HKU:
(c) Assertions about presentation and disclosure:
(i) Occurrence and rights and obligations: disclosed events, transactions, and other matters have occurred and
pertain to the entity.
(ii) Completeness—all disclosures have been included in financial statements.
(iii) Classification and understandability—financial information is appropriately presented and described, and
disclosures are clearly expressed.
(iv) Accuracy and valuation—financial and other information are disclosed fairly and at appropriate amounts.
Jamen HKU:
As what we have learnt in the lectures, Auditing Standard No. 15 - "Audit Evidence" of PCAOB describes these
5 management assertions. When comparing them to IAASB, We can find that they actually described the same
assertions, however, ISA 315 provides more clarity over them by dividing the major 5 assertions into further 3
categories. On an overall level what ISA 315 and what AS-15 explains is the same.
Lemme pass the time to Tommy so you guys can think about how these assertions could be highlighted in our
Deloitte Brazil case.

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Tommy HKU: After having brief description of the background of the case and the comparison between IAASB
and PCAOB, we will then move into elaborate more about the major accounting and auditing issue of Deloitte
Brazil and Gol Intelligent airlines.
Tommy HKU: The first auditing issue is about the maintenance deposit, in 2010 the balance sheet of Gol
airlines overstated 52.6 million dollars of unsupported maintenance deposit, Actually, this deposit belonged to
2009 balance sheet and they plan write off this fraud by debiting the overstated maintenance expense and
credit maintenance deposit in 2011.
Tommy HKU: Such problem is discovered by the PCAOB division that there is failure of the engagement team,
including but not limited to no professional skepticism, consideration of fraud, evaluate control and deficiency
as well as obtaining supporting evidence. We have found out different section of auditing standard to show
how the engagement fail to follow the standard. Firstly, according to auditing section 230, external auditor
should have a questioning mind and use its professional knowledge to objectively evaluate the evidence.
However, they did not concern about the unsupported evidence of the maintenance deposit asset.
Tommy HKU: Secondly, they failed to consider the deposit were indicative of fraud. Take reference of auditing
standard section 316, auditors should care about the significant unusual records, especially for those that may
achieve certain financial targets, complex transaction and etc. In this case, the maintenance deposit
represents 14% of pre-tax income but still no one pay attention to it if it was a indicative of fraud.
Tommy HKU: Thirdly, the engagement team fail to evaluate controls and deficiency over Gol accounting to
judge whether it represented a material weakness. Which violate auditing standard No.5 to evaluate severity
of deficiency and determine material weakness. Overall, the above 4 points show that the maintenance
deposit problem violate the section 10b of exchange act and have an untrue statement of material fact and
omission of material fact.
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Michael HKU: Thank you Tommy for explaining the fraudulent financial reporting of maintenance deposit
assets. The second accounting issue of Gol is related to its accounts reporting on advance ticket sales and
passenger revenue.
For Gol, advance ticket sales was a deferred revenue liability account that represented passenger tickets sold
for future travel dates. Gol reduced the advance ticket sales liability and recorded passenger revenue when
transportation was provided, or when an unused ticket expired.
Michael HKU: The firm’s engagement team identified both accounts as significant accounts, and used a control
reliance approach which reduced the level of substantive testing and held the belief that the controls over
those accounts were operating effectively.
Michael HKU: However, the engagement team failed to identify improper revenue recognition as presenting a
risk of material misstatement due to fraud, and missed the documentation to justify this presumption.
Moreover, when the engagement team reviews the reconciliation between the advance ticket sales balance
reported in Gol’s accounting system and the balance reported by its separate reservation system, the team
failed to obtain sufficient competent evidence to support the nature of material adjustments.
Michael HKU: During the reconciliation, it identified a significant difference between the reservation and
accounting system balances of US $23 million. In the work papers, it describes overstating the passenger
revenue and understating the advance ticket sales as an unexplained misstatement and potential
misstatements.
However, According to the PCAOB Assertions, liability should be completed (without any omission and should
not be understated) and revenues should occur in the income statement (without overstating).
Michael HKU: Eventually, the engagement team proposed to Gol that to reduce its reported revenue and
increase its liability by the same amount to reflect the potential misstatement, but management declined with
the reason that the analysis of potential misstatement is incomplete, and they won’t make any adjustment
before the investigation is done. The engagement team should consider performing additional procedures
before issuing the audit reports, but the Gol Engagement partner determined that the team should not
perform any additional procedures.
Michael HKU: Concerning the violated standards and sections, Deloitte Brazil issued two unqualified audit
reports which violated Exchange Act Section 10(b) and Exchange Act Rule 10b-5 – Make any untrue statement
of a material fact or to omit to state a material fact necessary in order to make the statements not misleading.
It also violated several PCAOB standards, including failure to perform adequate procedures relating to fraud
risks in revenue recognition, and failing to obtain competent audit evidence to assess the materiality. This is
why Deloitte Brazil was imposed a civil money penalty in the amount of $8 million. To avoid similar fraud
happening,
I will pass the time to Luke to elaborate the recommendation.
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Luke HKU: Thank you Michael and Tommy for explaining the major accounting and auditing issues, we will
now make some recommendations to the firm. The recommendations can be divided into two categories:
preventive activities to prevent invalid transactions and assets from being processed and misappropriated,
and detective activities to detect errors or fraud in transactions after they have occurred and identify missing
assets or invalid transactions.
Luke HKU: In terms of the preventive activities for the maintenance deposit issue, training can be provided to
the engagement team. The training should focus on ethics and integrity, the rules of PCAOB and the
engagement quality review to improve their professional competence. The training should be held regularly
and the duration of it should be long enough to ensure the effectiveness of the training. For example, the
training can be held monthly while the annual total amount should be at least 25 hours. Therefore, the skills
and quality of the engagement team can be improved which will be beneficial to the audit quality.
Luke HKU: Policies and procedures, as the preventive activities, can also be set up for tackling the issue of
advance ticket sales and passenger revenue. Additional policies and modification of existing procedures
concerning ethics and integrity, sufficient appropriate audit evidence and so on can regulate the action of the
engagement team to be more correspondent with audit standards. Also, the audit firm culture can be more
emphatic in ethics and honesty. Hence, their awareness of following the audit standards can be increased,
especially when they implement tests of balances and obtain sufficient evidence to support the nature of
material adjustments.
Luke HKU: Enhanced reporting procedures should be adopted as detective activity when they encounter
similar issues like the maintenance deposit. Diversified reporting means should be added such as telephone
and website and the whistle-blowing mechanism with high confidentiality should be established to make the
reporting system more effective and secure. For example, the system should be anonymous and the password
for accessing the reporting record should be kept by management. Obtaining appropriate and sufficient
information, the engagement team can have efficient communication with the audit committee in respect
of audit scope and identified risk which will be beneficial for planning follow-up actions.
Luke HKU: Apart from that, independent monitors should be hired for the detective activities. Collaborating
with the monitor, who can be deemed as an independent third party, the quality control system can be
monitored and reviewed. Monitor QC Report will be provided to the firm and PCAOB staff, and
recommendations will be made concerning improvements to its policies, procedures, or practices. Thus,
additional assurance can be provided in reliability of financial statements and effectiveness of internal control.
Now, I will pass the time to Chloe for the extended research part.
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Chloe Chin HKU: Upon this case, the PCAOB has announced sanctions against the former Chairman and the
former Chief Executive Officer of Brazil-based Deloitte Touche Tohmatsu Auditores Independentes for
violations related to failures to cooperate with a Board investigation.
These actions follow a December 2016 PCAOB enforcement order against Deloitte Brazil in which the Board
found that the firm and certain individuals attempted to cover up audit violations, including through improper
alteration of documents and provision of false testimony to investigators.
For the individual penalty, the order bars Morrell from associating with a PCAOB-registered firm for 5 years,
and he was fined for thirty five thousand dollars
As for Araujo, he was sanctioned for refusing to testify in the PCAOB investigation and is permanently banned
from associating with a PCAOB-registered firm
"The order against the former CEO demonstrates that individuals who refuse to cooperate with Board
investigations face some of the stiffest sanctions."
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Ellice Chan HKU: Regarding enforcement news, recently, there is an allegation that KPMG was providing ‘false
and misleading information’ documents in 2018 and 19 about collapsed construction giant, Carillion. The
formal complaint launched by the Financial Reporting Council indicated that misconduct was involved.
Another two pieces of enforcement news happened last year. The first one is about Wirecard, a supplier of
electronic payment processor and financial services provider, whose bank statements had not been checked
by its external auditors, EY, for three years. It was found that about 1.9billion euro was ”missing’. 3.5billion
euro of penalty was eventually paid by EY and it also spent additional 2.5billion euro to improve its audit
quality. The last one is also about EY, as it failed to report its audit client’s fraud to regulators even though
auditors had acknowledged the fabricated sales. The audit client eventually agreed to pay 180million USD to
settle charges of fraud and accounting irregularities.
Ellice Chan HKU: There are some cases also similar to our case. A local based CPA firm was sanctioned by
PCAOB, meaning that its registration on SEC was revoked, as it refused to produce documents in response to a
formal demand. Fortunately, the firm can still apply for registration after three years. Another one is senior
partners being sanctioned related to misconduct in connection with a PCAOB investigation. The partners
identified the issue of alteration but didn’t stop it. They are barred from associating with any PCAOB-
registered firm. The rationale for the judgement is because ”integrity begins with senior leaders and the tone
they set for the audit practices they oversee.”, which we can recall chapter three, control environment, the
component of the internal control.
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Chloe Chin HKU: As seen from the recent enforcement news and the similar cases, the frequency of fraud
allegation in Big 4 firms is higher than that of the smaller accounting firms
The reason behind this is because Big 4 firms are too big to fail in the accounting world.
The market shares of the big 4 are over 50% in a sample size of 200 companies
Big 4 are so large and so interconnected that their failure would be disastrous to the greater economic system,
and that they therefore must be supported by regulatory authorities when they face potential failure
So what should we do about it?
Chloe Chin HKU: We put forward the solution of using pro-rata basis on audit engagement fee for fraud
penalty.
The rationale behind the higher proportion of big 4 committing fraud than small accounting companies is that
the audit engagement fee received by Big 4 is a lot higher than the standardized potential penalty of alleged
fraud.
So, assuming that Big 4 firms have a client base of large cap companies and receive a higher audit engagement
fee than the smaller accounting firms on average, setting the fraud penalty on pro-rata basis of audit
engagement fee has a higher deterrent effect on Big 4 audit firms