Report on Inspection of Ernst & Young LLP (Headquartered in New York, New York) Public Company Accounting Oversight Board

Transcription

1 1666 K Street, N.W. Washingtn, DC Telephne: (202) Facsimile: (202) Reprt n 2011 Inspectin f Ernst & Yung LLP (Headquartered in New Yrk, New Yrk) Issued by the Public Cmpany Accunting Oversight Bard THIS IS A PUBLIC VERSION OF A PCAOB INSPECTION REPORT PORTIONS OF THE COMPLETE REPORT ARE OMITTED FROM THIS DOCUMENT IN ORDER TO COMPLY WITH SECTIONS 104(g)(2) AND 105(b)(5)(A) OF THE SARBANES-OXLEY ACT OF 2002 PCAOB RELEASE NO

2 PCAOB Release N Ntes Cncerning this Reprt 1. Prtins f this reprt may describe deficiencies r ptential deficiencies in the systems, plicies, prcedures, practices, r cnduct f the firm that is the subject f this reprt. The inclusin f certain deficiencies and ptential deficiencies, hwever, shuld nt be cnstrued t supprt any negative inference that any ther aspect f the firm's systems, plicies, prcedures, practices, r cnduct is apprved r cndned by the Bard r judged by the Bard t cmply with laws, rules, and prfessinal standards. 2. Any references in this reprt t vilatins r ptential vilatins f law, rules, r prfessinal standards are nt a result f an adversarial adjudicative prcess and d nt cnstitute cnclusive findings f fact r f vilatins fr purpses f impsing legal liability. Similarly, any descriptin herein f a firm's cperatin in addressing issues cnstructively shuld nt be cnstrued, and is nt cnstrued by the Bard, as an admissin, fr purpses f ptential legal liability, f any vilatin. 3. Bard inspectins encmpass, amng ther things, whether the firm has failed t identify financial statement misstatements, including failures t cmply with Securities and Exchange Cmmissin ("SEC" r "Cmmissin") disclsure requirements, in its audits f financial statements. This reprt's descriptins f any such auditing failures necessarily invlve descriptins f the apparent misstatements r disclsure departures. The Bard, hwever, has n authrity t prescribe the frm r cntent f an issuer's financial statements. That authrity, and the authrity t make binding determinatins cncerning whether an issuer's financial statements are misstated r fail t cmply with Cmmissin disclsure requirements, rests with the Cmmissin. Any descriptin, in this reprt, f financial statement misstatements r failures t cmply with Cmmissin disclsure requirements shuld nt be understd as an indicatin that the Cmmissin has cnsidered r made any determinatin regarding these issues unless therwise expressly stated.

3 PCAOB Release N INSPECTION OF ERNST & YOUNG LLP Preface In 2011, the Public Cmpany Accunting Oversight Bard ("PCAOB" r "the Bard) cnducted an inspectin f the registered public accunting firm Ernst & Yung LLP ("E&Y" r "the Firm") pursuant t the Sarbanes-Oxley Act f 2002 ("the Act"). The Bard is issuing this reprt in accrdance with the requirements f the Act. 1/ The Bard is releasing t the public Part I f the reprt, Appendix C, and prtins f Appendix D. Appendix C prvides an verview f the inspectin prcess fr annually inspected firms. 2/ Appendix D includes the Firm's cmments, if any, n a draft f the reprt. 3/ A substantial prtin f the Bard's criticisms f a firm (specifically criticisms f the firm's quality cntrl system), is nnpublic, unless the firm fails t make sufficient prgress in addressing thse criticisms. 1/ In its Statement Cncerning the Issuance f Inspectin Reprts, PCAOB Release N (August 26, 2004), the Bard described its apprach t making inspectin-related infrmatin publicly available cnsistent with legal restrictins. 2/ The Act requires the Bard t cnduct an annual inspectin f each registered public accunting firm that regularly prvides audit reprts fr mre than 100 issuers. 3/ The Bard des nt make public any f a firm's cmments that address a nnpublic prtin f the reprt. In additin, pursuant t sectin 104(f) f the Act, 15 U.S.C. 7214(f), and PCAOB Rule 4007(b), if a firm requests, and the Bard grants, cnfidential treatment fr any f the firm's cmments n a draft reprt, the Bard des nt include thse cmments in the final reprt at all. The Bard rutinely grants cnfidential treatment, if requested, fr any prtin f a firm's respnse that addresses any pint in the draft that the Bard mits frm, r any inaccurate statement in the draft that the Bard crrects in, the final reprt.

4 PCAOB Release N Inspectin f Ernst & Yung LLP Page 2 Bard inspectins are designed t identify and address weaknesses and deficiencies related t hw a firm perfrms audit wrk. 4/ T achieve that gal, Bard inspectins include reviews f certain aspects f selected audit wrk perfrmed by the firm and reviews f certain aspects f the firm's quality cntrl system. It is nt the purpse f an inspectin, hwever, t review all f a firm's audit wrk r t identify every respect in which reviewed wrk is deficient. Accrdingly, a Bard inspectin reprt shuld nt be understd t prvide any assurance that the firm's audit wrk, r the relevant issuers' financial statements r reprting n internal cntrl, are free f any deficiencies nt specifically described in an inspectin reprt. If the Bard inspectin team identifies deficiencies that exceed a certain significance threshld in the audit wrk it reviews, thse deficiencies are summarized in the public prtin f the Bard's inspectin reprt. 5/ The Bard cautins, hwever, against extraplating frm the results presented in the public prtin f the reprt t brader cnclusins abut the frequency f deficiencies thrughut the Firm's practice. Audit wrk is selected fr inspectin largely n the basis f an analysis f factrs that, in the inspectin team's view, heighten the pssibility that auditing deficiencies are present, rather than thrugh a prcess intended t identify a representative sample. 4/ This fcus n weaknesses and deficiencies necessarily carries thrugh t reprts n inspectins and, accrdingly, Bard inspectin reprts are nt intended t serve as balanced reprt cards r verall rating tls. 5/ Inclusin f a deficiency in an inspectin reprt des nt mean that the deficiency remained unaddressed after the inspectin team brught it t the firm's attentin. When audit deficiencies are identified after the date f the audit reprt, PCAOB standards require a firm t take apprpriate actins t assess the imprtance f the deficiencies t the firm's present ability t supprt its previusly expressed audit pinins. Depending upn the circumstances, cmpliance with these standards may require the firm t perfrm additinal audit prcedures, r t infrm a client f the need fr changes t its financial statements r reprting n internal cntrl, r t take steps t prevent reliance n previusly expressed audit pinins. The inspectin team may review, either in the same inspectin r in subsequent inspectins, the adequacy f the firm's cmpliance with these requirements. Failure by a firm t take apprpriate actins, r a firm's misrepresentatins, in respnding t an inspectin reprt, abut whether it has taken such actins, culd be a basis fr Bard disciplinary sanctins.

5 PCAOB Release N Inspectin f Ernst & Yung LLP Page 3 PART I INSPECTION PROCEDURES AND CERTAIN OBSERVATIONS Members f the Bard's inspectin staff ("the inspectin team") cnducted primary prcedures fr the inspectin frm April 2011 t December The inspectin team perfrmed field wrk at the Firm's Natinal Office and at 31 f its apprximately 66 U.S. practice ffices. A. Review f Audit Engagements The 2011 inspectin f the Firm included reviews f aspects f 55 audits perfrmed by the Firm and a review f the Firm's audit wrk n anther issuer audit engagement in which the Firm played a rle but was nt the principal auditr. The inspectin team selected the audits and aspects t review, and the Firm was nt allwed an pprtunity t limit r influence the selectins. The inspectin team identified matters that it cnsidered t be deficiencies in the perfrmance f the wrk it reviewed. Thse deficiencies included failures by the Firm t identify, r t address apprpriately, financial statement misstatements, including failures t cmply with disclsure requirements, 6/ as well as failures by the Firm t perfrm, r t perfrm sufficiently, certain necessary audit prcedures. In sme instances, fllw-up between the Firm and the issuer led t a change in the issuer's accunting r disclsure practices. In sme cases, the cnclusin that the Firm failed t perfrm a prcedure was based n the absence f dcumentatin and the absence f persuasive ther evidence, even if the Firm claimed t have perfrmed the prcedure. 7/ 6/ When it cmes t the Bard's attentin that an issuer's financial statements appear nt t present fairly, in a material respect, the financial psitin, results f peratins, r cash flws f the issuer in cnfrmity with applicable accunting principles, the Bard's practice is t reprt that infrmatin t the SEC, which has jurisdictin t determine prper accunting in issuers' financial statements. 7/ PCAOB Auditing Standard ("AS") N. 3, Audit Dcumentatin prvides that, in varius circumstances including PCAOB inspectins, a firm that has nt adequately dcumented that it perfrmed a prcedure, btained evidence, r reached an apprpriate cnclusin must demnstrate with persuasive ther evidence that it did

6 PCAOB Release N Inspectin f Ernst & Yung LLP Page 4 One f the deficiencies described belw relates t auditing aspects f an issuer's financial statements that the issuer restated after the primary inspectin prcedures. 8/ The inspectin team cnsidered certain f the deficiencies that it bserved t be audit failures. Specifically, certain f the identified deficiencies were f such significance that it appeared that the Firm, at the time it issued its audit reprt, had failed t btain sufficient apprpriate audit evidence t supprt its audit pinin n the financial statements and/r n the effectiveness f internal cntrl ver financial reprting ("ICFR"). The audit deficiencies that reached these levels f significance are described belw. 9/ A.1. Issuer A In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR The issuer's revenue was prduced frm numerus lcatins, each with its wn accunting persnnel and general ledger systems. Each lcatin prcessed similar classes f rutine transactins. The engagement team identified risk factrs assciated with individual lcatins, including ineffective cntrls ver access t the general ledger system used at the lcatins and instances f fraud at certain f the lcatins. The Firm and the issuer's internal audit ("IA") identified multiple cntrl deficiencies, including deficiencies at several lcatins tested, but these cntrl deficiencies were nt the same at all lcatins. In planning and perfrming tests f cntrls, the Firm assumed that risks and cntrls were the same acrss all lcatins and, therefre, reduced the number f s, and that ral assertins and explanatins alne d nt cnstitute persuasive ther evidence. 8/ The Bard inspectin prcess did nt include review f any additinal audit wrk related t the restatement and adjustment. 9/ The discussin in this reprt f any deficiency bserved in a particular audit reflects infrmatin reprted t the Bard by the inspectin team and des nt reflect any determinatin by the Bard as t whether the Firm has engaged in any cnduct fr which it culd be sanctined thrugh the Bard's disciplinary prcess.

7 PCAOB Release N Inspectin f Ernst & Yung LLP Page 5 lcatins selected fr testing. As these assumptins were incrrect, the Firm's testing was insufficient. The Firm relied n the effective peratin f certain f the issuer's review cntrls t reduce the scpe f its testing, and it identified these review cntrls as cmpensating cntrls fr certain f the identified cntrl deficiencies. The Firm's testing f the review cntrls was deficient, as fllws The Firm failed t perfrm sufficient prcedures t test the effectiveness f the review cntrls, including whether they perated at a level f precisin t prevent r detect errrs that culd result in a material misstatement t the financial statements. Specifically, the Firm's prcedures were limited t inquiring f management, verifying that certain actins perfrmed as part f the cntrls had ccurred, and, fr each cntrl, attending ne meeting at which reviews ccurred. The Firm understd that the nature and extent f the reviews varied, as several individuals perfrmed the reviews, and the issuer had nt prescribed the perfrmance indicatrs t be reviewed r the threshlds t be used. The Firm failed t evaluate the specific perfrmance indicatrs reviewed, the criteria fr fllw-up f variances, and the apprpriateness f the actins taken as a result f the reviews. The Firm failed t identify and test any cntrls ver the manually generated reprts that the issuer used in the peratin f the review cntrls. The Firm failed t sufficiently evaluate whether the cntrl deficiencies that it and the issuer's IA had identified at the issuer's lcatins were, in cmbinatin, material weaknesses. Specifically, the Firm failed t evaluate the extent t which the identified cntrl deficiencies wuld be applicable t the issuer's lcatins that were nt tested. In additin, the Firm identified, as cmpensating cntrls fr certain f the deficiencies, the review cntrls discussed abve, f which the Firm's testing was deficient. Despite the varying degrees f risks assciated with the cntrls, the Firm's prcedures t update its testing f cntrls fr the five-mnth perid between its interim testing and year end were limited t btaining a

8 PCAOB Release N Inspectin f Ernst & Yung LLP Page 6 memrandum frm IA summarizing the results f IA's inquiries f the cntrl wners. The Firm failed t test jurnal entries recrded at the issuer's individual lcatins, despite ineffective cntrls ver access t the lcatins' general ledger systems, instances f fraud at the lcatins, and a significant vlume f jurnal entries prcessed at the lcatins. The Firm failed t identify and test any cntrls ver a significant cmpnent f revenue at any f the issuer's lcatins. Instead, the Firm relied n the review cntrls discussed abve that were insufficiently tested. In additin, the Firm failed t perfrm sufficient substantive prcedures t test this cmpnent f revenue. Specifically, in perfrming analytical prcedures that the Firm intended as its primary substantive tests, the Firm failed t (1) apprpriately develp its expectatins, as it failed t btain supprt fr its expectatin that revenue wuld be cnsistent with revenue in prir perids; (2) fr sme analytical prcedures, set a threshld fr investigatin f unexpected differences at a level that wuld detect a material misstatement; (3) test the cmpleteness and accuracy f certain data used in certain f the analytical prcedures; and (4) btain crrbratin f management's explanatins fr significant differences. The Firm failed t perfrm sufficient substantive prcedures t test the cmpleteness, existence, and valuatin f certain inventry. Specifically, the Firm failed t Test whether the adjustments resulting frm the issuer's physical inventry cunts were recrded t the general ledger in the prper perid; Perfrm prcedures fr the fur- t six-mnth perid between its interim testing and year end related t the existence f inventry at the issuer's individual lcatins; and Perfrm substantive prcedures t test the cst f certain inventry.

9 PCAOB Release N Inspectin f Ernst & Yung LLP Page 7 A.2. Issuer B In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinin n the effectiveness f ICFR The issuer had multiple prductin lcatins within tw f its divisins, and many accunting functins were distributed amng the crprate ffice, divisins, and certain prductin lcatins. The Firm and the issuer's IA identified multiple cntrl deficiencies at the lcatins, including deficiencies at mst lcatins, but the nature and causes f the cntrl deficiencies were nt cnsistent acrss all lcatins. Further, the issuer had recently implemented wrkfrce changes and reductins, which increased the risk f incnsistent applicatin f cntrls. Despite these factrs, in planning and perfrming tests f cntrls, the Firm assumed that risks and cntrls were the same acrss all lcatins within these divisins and, as a result, reduced the number f lcatins selected fr testing. As these assumptins were incrrect, the extent f the Firm's testing fr these tw divisins was insufficient. The issuer's perid-end financial reprting prcess was decentralized and included manual activities at the varius lcatins. The Firm identified deficiencies related t cntrls ver jurnal entries at the lcatins invlved in the perid-end financial reprting prcess. The Firm als determined that large numbers f persnnel had the ability t mdify general ledger recrds related t the perid-end financial reprting prcess. The Firm failed t perfrm sufficient testing f certain cntrls related t the perid-end financial reprting prcess. Specifically The Firm failed t identify and evaluate a cntrl deficiency related t the apprval f jurnal entries. The Firm failed t select and test cntrls ver the specific userdefinable settings that the issuer's general ledger system applied in the autmated cnslidatin prcess. The Firm tested certain f the entity-level cntrls ("ELCs") that the issuer used t mnitr its financial results, but this testing was insufficient. Specifically, fr sme f these cntrls, the Firm failed t test whether the cntrls perated at a level f precisin t prevent r detect errrs r fraud that culd result in a material misstatement. Fr anther cntrl, the Firm's

10 PCAOB Release N Inspectin f Ernst & Yung LLP Page 8 testing f the perating effectiveness was limited t verifying that relevant dcumentatin was prepared by an apprpriate level f management r inspecting evidence f sign-ff withut evaluating the underlying review prcess. The Firm failed t sufficiently evaluate whether the numerus and pervasive cntrl deficiencies that it and the issuer's IA had identified were, individually r in cmbinatin, material weaknesses. Specifically There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated whether there were multiple cntrl deficiencies affecting the same accunt r disclsure that, in cmbinatin, resulted in a material weakness. In evaluating the cntrl deficiencies, the Firm identified certain mitigating cntrls. The Firm, hwever, failed t evaluate whether identified deficiencies in thse mitigating cntrls affected their ability t cmpensate fr the identified deficiencies in the ther cntrls. The Firm determined that certain cntrl deficiencies were remediated befre year end, but the remedial actins the Firm cited cnsisted f future actins, and the Firm did nt perfrm prcedures t determine whether these actins had ccurred. The Firm used the wrk f IA as evidence regarding the effectiveness f certain imprtant cntrls related t multiple prcesses, including in areas that the Firm assessed as higher risk, such as inventry, revenue, and accunts receivable. IA made selectins frm bth the year under audit and the prir year t test the perating effectiveness f cntrls fr which the Firm used IA's wrk as evidence. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated whether IA's testing f cntrls fr the year under audit was sufficient t supprt a cnclusin n the perating effectiveness f thse cntrls as f the end f the year under audit.

11 PCAOB Release N Inspectin f Ernst & Yung LLP Page 9 A.3. Issuer C In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR The Firm failed t sufficiently test cntrls ver the perid-end financial reprting prcess fr ne f the issuer's significant divisins invlved in that prcess. The cntrls the Firm selected fr testing in this area generally were manual cntrls that included recnciliatins, reviews f financial results, and reviews and apprvals f jurnal entries at certain lcatins within the divisin. The deficiencies in that testing were as fllws The Firm used the wrk f the issuer's IA, and retested IA's wrk fr certain imprtant cntrls ver the inventry prcess. The issuer's IA identified multiple exceptins in its cntrl testing, including exceptins at many f the lcatins selected fr testing. The Firm failed t sufficiently evaluate whether the exceptins that IA had identified were cntrl deficiencies that individually, r in cmbinatin, were material weaknesses. Specifically, there was n ratinale in the wrk papers fr treating nly certain f the exceptins as cntrl deficiencies that wuld be accumulated fr evaluatin. Further, the Firm failed t evaluate the extent t which the identified cntrl deficiencies wuld be applicable t the issuer's lcatins that were nt tested. The Firm failed t sufficiently test the design and perating effectiveness f certain imprtant cntrls. In certain instances, the Firm relied n walkthrugh prcedures that did nt include testing f relevant cntrl attributes. In ther instances, the Firm failed t determine whether the review cntrls perated at a level f precisin that wuld prevent r detect material misstatements, as the Firm's testing generally was limited t inquiring f management, bserving signatures as evidence f review, and/r therwise verifying that certain actins perfrmed as part f the cntrl had ccurred. In additin, fr certain review cntrls, the Firm failed t test cntrls ver the cmpleteness and accuracy f the systemgenerated infrmatin used in the perfrmance f the cntrls.

12 PCAOB Release N Inspectin f Ernst & Yung LLP Page 10 The Firm cncluded that jurnal entry cntrls were perating effectively thrughut the year, but this cnclusin was nt sufficiently supprted, as the Firm's testing f the cntrl requiring review and apprval f the jurnal entries was limited t bserving signatures as evidence f review. The Firm's prcedures t update its testing f certain cntrls between its interim testing and year end were limited t inquiry, despite the varying degrees f risk assciated with cntrls and deficiencies nted during its interim testing. The Firm relied n the cntrls nted abve as cmpensating cntrls fr a number f cntrl deficiencies it had identified; hwever, this reliance was nt justified in light f the nature and extent f exceptins identified fr these cntrls and the deficiencies in testing described abve. The Firm failed t sufficiently test cntrls ver, and perfrm sufficient substantive prcedures related t, inventry. Specifically The Firm failed t identify and test any cntrls ver certain f the issuer's significant inventry prcesses. The Firm failed t sufficiently test the design and perating effectiveness f certain autmated cntrls. Specifically, there was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated whether the applicatins were cnfigured t meet certain relevant cntrl bjectives and, with respect t certain autmated cntrls, it tested nly ne scenari even thugh varius scenaris were reasnably pssible. Further, there was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had tested the accuracy f an imprtant system calculatin. The Firm failed t sufficiently test the effectiveness f certain f the issuer's review cntrls, as the Firm's testing was limited t inspecting evidence f sign-ff and apprval withut testing the precisin f the underlying review.

13 PCAOB Release N Inspectin f Ernst & Yung LLP Page 11 There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated whether the level f reliance n cntrls that it applied in its substantive testing was apprpriate in light f the exceptins identified in its cntrl testing, and the exceptins identified in its testing f the cmpensating cntrls it identified (which are discussed abve). The Firm failed t perfrm substantive prcedures t test the capitalized labr and verhead cmpnent f finished gds inventry. The Firm perfrmed inventry testing prcedures within tw f the issuer's divisins; hwever, it failed t test a significant remaining prtin f inventry, which aggregated t nine times the Firm's established materiality level and included wrk-in-prcess inventry as well as inventry held at divisins nt tested. In additin, althugh the Firm perfrmed cnfirmatin prcedures at an interim date t test the existence f inventry held ff-site, the Firm did nt update this testing, r perfrm ther prcedures, t test the existence f this inventry at year end. The Firm failed t btain a sufficient understanding f the issuer's infrmatin system relevant t financial reprting fr ne significant lcatin. As a result, it failed t identify that the issuer used spreadsheets, and nt the inventry applicatin, as the primary system fr maintaining inventry pricing and quantities, and failed t test any cntrls ver this prcess at this lcatin. The Firm placed unwarranted reliance n certain imprtant systemgenerated data and reprts related t the recrding and prcessing f inventry, and/r the perid-end financial reprting prcess, as it failed t perfrm sufficient prcedures as fllws The Firm cncluded that Infrmatin Technlgy General Cntrls ("ITGCs") fr change management related t certain systems were ineffective. The Firm tested a sample f changes t certain f these systems; hwever, this apprach did nt address the risk f unauthrized changes t the systems. In additin, fr anther f these systems, the Firm relied n management's review f certain data prduced by the system, as well as the results f its

14 PCAOB Release N Inspectin f Ernst & Yung LLP Page 12 substantive prcedures, fr evidence f the reliability f the system. The substantive prcedures, hwever, did nt address the risk f unauthrized changes t cnfigurable settings, and the reviews did nt perate at a sufficient level f precisin t d s. The Firm determined that ITGCs ver tw payrll applicatins were ineffective, and its testing f applicatin cntrls ver the cmpleteness and accuracy f data prduced by these applicatins was insufficient. Specifically, fr ne cntrl, the Firm's test cnsisted f high-level analytical prcedures, but these prcedures prvided n infrmatin regarding the peratin f the cntrl. Fr the ther cntrl, the Firm's tests were t limited t cver the entire perid f reliance n the systems' data and reprts. The Firm determined that ITGCs ver three systems used fr inventry and/r revenue prcesses at certain lcatins where it perfrmed testing were ineffective. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had, in determining the scpe f its testing and its ability t rely n data and cntrls related t these prcesses, cnsidered that ther lcatins that were nt tested used these same systems. A.4. Issuer D In this audit, the Firm failed t sufficiently test the valuatin f the issuer's lnglived assets, which cnsisted f grups f assets at multiple, separate lcatins. The issuer calculated earnings befre interest, taxes, depreciatin, and amrtizatin ("EBITDA") by lcatin and selected the lcatins with negative EBITDA bth in the current perid and a recent perid fr further evaluatin fr ptential impairment. The Firm failed t identify that the issuer's analysis Did nt include certain expenses in the EBITDA calculatins fr mst f the lcatins, and Did nt identify fr further evaluatin certain lcatins fr which the current level f EBITDA was insufficient t cver the recrded amunt f the asset grup ver its remaining useful life.

15 PCAOB Release N Inspectin f Ernst & Yung LLP Page 13 A.5. Issuer E In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinin n the financial statements The Firm failed t sufficiently test whether the issuer's lease arrangements met the requirements fr sales-type lease accunting under generally accepted accunting principles ("GAAP"). Specifically, fr lease arrangements that the issuer evaluated by cmparing the present value f future minimum lease payments t the fair value f the leased equipment, the Firm recalculated the fair value f the leased equipment based n the issuer's standard price list and specific terms in the respective leases, but failed t use market infrmatin in its testing. Fr lease arrangements that the issuer evaluated by cmparing the lease term t the ecnmic life f the leased equipment, the Firm failed t evaluate the apprpriateness f the issuer's inclusin f equipment that custmers returned befre the expiratin f the respective lease in the ecnmic life calculatin. The Firm failed t perfrm prcedures, beynd reading a managementprepared mem and inquiring f management, t test the residual value f returned leased equipment. A.6. Issuer F In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR. The Firm failed t perfrm sufficient tests f cntrls and substantive prcedures related t the issuer's allwance fr lan lsses ("ALL"). Specifically The Firm failed t perfrm sufficient prcedures t test the issuer's cntrls ver lan grading. The Firm's selectin f a sample f lans fr testing these cntrls was nt designed in a manner that wuld be expected t prduce a representative sample, as it excluded lan relatinships belw a mnetary threshld frm the ppulatin subject t testing. The Firm failed t test cntrls ver the issuer's prcess fr reviewing appraisals n real estate that served as cllateral fr impaired lans.

16 PCAOB Release N Inspectin f Ernst & Yung LLP Page 14 Fr certain impaired lans that the Firm selected fr testing, the Firm failed t test the specific reserves, beynd inquiring f management. The Firm failed t sufficiently test the design and perating effectiveness f cntrls ver, and failed t perfrm sufficient substantive prcedures t test, the calculatin f the general and unallcated cmpnents f the ALL as fllws Fr its substantive testing, the Firm chse t review and test management's prcess fr estimating the unallcated and general ALL reserves. The Firm's wrk papers included varius incnsistencies and anmalies related t these tw cmpnents f the ALL, such as the use f the same lss factrs fr categries f lans with different lan grades representing different lss risks, the exclusin f the furth quarter lsses frm the determinatin f the ALL assumptins, and the decisin that n reserves were needed fr lans in several lan grades representing varying degrees f credit risk. While the Firm inquired f management and perfrmed certain prcedures t btain crrbratin f management's explanatins f certain f the incnsistencies and anmalies, the Firm failed t evaluate whether management's decisins related t these incnsistencies and anmalies were apprpriate. The recrded ALL included reserves fr specific lans, certain cmpnents calculated based n lss percentages, and an unallcated reserve. The size f the unallcated reserve fluctuated significantly during the year and, at year end, the unallcated reserve was apprximately tw times the Firm's established level f materiality. The Firm, hwever, limited its prcedures t test the unallcated reserve t evaluating the verall directinal cnsistency f that cmpnent f the reserve. The Firm failed t perfrm prcedures beynd inquiry t test cntrls ver the issuer's analysis f histrical lsses in its lan prtfli, which the issuer used t develp a critical assumptin used in the ALL calculatin. The Firm's testing f cntrls ver the prcess fr charging ff lans, r designating them as nn-accrual status, was nt perfrmed at an apprpriate level f precisin. Specifically, the

17 PCAOB Release N Inspectin f Ernst & Yung LLP Page 15 testing was limited t verifying management's apprval f a frm, and did nt include an evaluatin f the timeliness f the chargeffs and changes t nn-accrual status. The Firm failed t sufficiently test a review cntrl cnsisting f the peridic analysis f the ALL, as its testing was limited t reviewing the issuer's bard and cmmittee meeting minutes, and nting that a memrandum summarizing the analysis was sent t the bard and t management. A.7. Issuer G In this audit, the Firm failed t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR. The Firm's failures related t cntrl and substantive testing with respect t the ALL and investment securities. Regarding the Firm's prcedures related t the ALL The Firm failed t sufficiently test an imprtant cntrl ver the issuer's lan grading. The issuer used an external party t review the lan grades assigned by lan fficers. Fr thse lans where the external party recmmended a different lan grade, the Firm failed t evaluate whether the infrmatin management used t assign the final lan grade supprted that grade. The Firm failed t sufficiently test the issuer's review cntrls ver the ALL calculatin. Specifically, the Firm's prcedures were limited t reading meeting minutes and btaining evidence f apprval, withut evaluating the underlying review prcess r the basis fr the apprval. The Firm failed t identify and test cntrls ver certain data and reprts the issuer used t calculate the ALL, and did nt test the cmpleteness and accuracy f thse data and reprts. The Firm failed t sufficiently test specific reserves fr impaired lans. Specifically, the Firm failed t evaluate the apprpriateness f the methds and reasnableness f the assumptins the issuer's appraisers used t determine cllateral values fr certain impaired

18 PCAOB Release N Inspectin f Ernst & Yung LLP Page 16 lans that the Firm selected fr testing. In additin, fr certain f thse impaired lans, the issuer calculated a specific reserve using a lwer value fr the underlying cllateral than the appraised value, and the Firm failed t perfrm prcedures beynd inquiry t evaluate the reasnableness f the issuer's discunt t the appraised value. The Firm failed t perfrm prcedures, beynd reading issuer mems and perfrming high-level analytical prcedures, t test certain types f reserves within the ALL. Regarding the Firm's testing related t the issuer's investment securities The Firm failed t btain an understanding f the specific methds and/r assumptins underlying fair value measurements that were btained frm pricing services r ther third parties and used in the Firm's testing f the fair value measurements f certain financial instruments withut readily determinable fair values ("hard-t-value financial instruments"). Fr the valuatin f investment securities, the Firm relied n cntrls at an external service rganizatin, but these cntrls did nt address the valuatin f the securities, and the Firm failed t identify and test ther cntrls ver that assertin. A.8. Issuer H In this audit, the Firm failed t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR. The issuer had multiple lines f business at numerus lcatins, each with different accunting systems. The Firm selected several ELCs fr testing, and its strategy fr the financial statement audit included significant reliance n these ELCs. The Firm's testing f the perating effectiveness f the ELCs was nt sufficient, as these prcedures did nt include determining whether the ELCs perated at a level f precisin t prevent r detect a material misstatement. Specifically, the testing was limited t inquiring f management, verifying that certain actins perfrmed as part f the cntrl had ccurred, reading dcuments prepared in cnnectin with the peratin f the cntrls, cmparing certain data used in the cntrls t ther issuer-supplied data, and reading IA's reprts. In additin, the Firm failed t sufficiently test cntrls ver the issuer's prcess fr updating the mnthly financial frecasts prepared by each lcatin that were

19 PCAOB Release N Inspectin f Ernst & Yung LLP Page 17 used in the ELCs. Specifically, the Firm's testing was limited t verifying that the issuer prepared the mnthly frecasts and cmparing the data used in the ELCs t the reprting packages submitted by each lcatin. A.9. Issuer I In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and the effectiveness f ICFR The Firm identified a cntrl deficiency related t the issuer's prcess fr reserving fr credit mems. The Firm failed t apprpriately evaluate the severity f this cntrl deficiency in the fllwing respects The Firm's analysis fcused n the actual amunt f the errr, rather than the magnitude f the ptential misstatement, and this analysis included nly credit mems issued during an apprximately tw-mnth perid after year end. The Firm failed t cnsider whether additinal credit mems shuld be cntemplated, as nearly half f the credit mems included in the tw-mnth perid had been issued mre than tw mnths after the sale date. The Firm identified reviews ccurring at peridic management meetings as a cmpensating cntrl; hwever, the Firm failed t determine whether this cntrl was designed and perating at a level f precisin t prevent r detect material misstatements related t credit mems. The Firm failed t perfrm sufficient prcedures t evaluate the cllectability f a significant receivable wed by a frmer custmer. The issuer and this frmer custmer had filed lawsuits against each ther, and the receivable was significantly past due. The Firm's prcedures t evaluate cllectability cnsisted f inquiring f management, btaining management representatins, and btaining letters frm lawyers invlved in the tw lawsuits. While bth lawyers indicated that the litigatin was in the early stages, the lawyer invlved in the suit t cllect the receivable indicated that anther lawyer wuld be in a better psitin t assess the prbability f a favrable utcme. The Firm failed t perfrm prcedures t cntact this ther lawyer.

20 PCAOB Release N Inspectin f Ernst & Yung LLP Page 18 The issuer recrds the majrity f its revenue based n delivery data received electrnically frm a large number f vendrs. The Firm failed t test cntrls ver, r therwise test, the cmpleteness and accuracy f thse data. Further, the Firm failed t evaluate the implicatins f the significant differences between the delivery date and the invice date fr mst f the transactins selected during tests f cntrls f unbilled revenue. A.10. Issuer J The Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its audit pinins n the financial statements and n the effectiveness f ICFR The Firm's testing related t the issuer's accrual fr advertising and prmtins ("A&P") expenses was insufficient. Specifically The Firm failed t identify and test any cntrls ver the accrual fr A&P expenses nt yet paid ("A&P calculatin") fr ne f the issuer's business lines. Althugh the Firm identified certain management review cntrls, its testing did nt establish that these cntrls perated at a level f precisin t address the A&P calculatin. The Firm failed t determine the types and timing f advertising and prmtinal prgrams that the issuer had ffered in the current and prir perids in rder t evaluate whether it was reasnable t calculate the assumptins underlying the accrual based n histrical activity. Specifically, the issuer's A&P calculatin relied n tw key assumptins: the amunt f advertising and prmtinal discunts as a percent f sales, and the time lag between when the issuer ffered such discunts and when the custmer claimed them. The issuer calculated bth f these assumptins using histrical A&P activity, even thugh the types f A&P discunts ffered varied ver time, and the time lag had varied significantly frm perid t perid. The issuer had implemented a strategy f grwth thrugh acquisitins, and intangible assets resulting frm business cmbinatins represented

21 PCAOB Release N Inspectin f Ernst & Yung LLP Page 19 the majrity f the issuer's ttal assets. During the year, the issuer acquired tw businesses, ne fr which the purchase price was apprximately 35 times the Firm's established level f materiality. The Firm identified an ELC, which cnsisted f a review f quarterly financial statements, that it asserted prvided assurance ver the issuer's prcess fr recgnizing assets acquired and liabilities assumed in business cmbinatins. The Firm failed t sufficiently test this cntrl, as its prcedures were limited t btaining evidence that such reviews had ccurred, withut evaluating whether the cntrl perated at a level f precisin that wuld prevent r detect material misstatements related t business cmbinatins. The Firm als asserted that its substantive testing f the assets acquired and liabilities assumed was dual-purpse in nature and prvided evidence f the peratin f ther cntrls in this area. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, hwever, that the Firm's tests included prcedures t evaluate the design and perating effectiveness f these ther cntrls. A.11. Issuer K In ne audit f this issuer, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinin n the financial statements The issuer cncluded that n reserve was required fr certain tax assessments by a freign jurisdictin. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated the technical merits f the issuer's tax psitin. The Firm failed t maintain cntrl ver the cash cnfirmatin prcess, as it allwed a curier service hired by the issuer t deliver the requests fr cnfirmatin. In the next year's audit f the issuer, the Firm failed t btain sufficient apprpriate audit evidence t supprt its pinin n the effectiveness f ICFR. The issuer made tw significant acquisitins during the year, and the Firm identified a significant risk related t business acquisitins. The Firm, hwever, failed t test any cntrls ver the accunting fr business acquisitins.

22 PCAOB Release N Inspectin f Ernst & Yung LLP Page 20 A.12. Issuer L In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinin n the effectiveness f ICFR Sales rders frm the issuer's custmers are frequently custmized and sales prices fluctuate based upn underlying cmmdity prices. T address cntrls ver pricing, the Firm tested certain review cntrls, but it failed t sufficiently test the perating effectiveness f these cntrls. Specifically, the Firm failed t identify and test any cntrls ver the cmpleteness and accuracy f reprts that the issuer used when perfrming the review cntrls, and the Firm failed t determine whether the review cntrls perated at a sufficient level f precisin t detect material errrs related t pricing. The Firm failed t sufficiently test cntrls ver the perid-end financial reprting prcess. Specifically The Firm failed t determine whether certain review cntrls that it selected fr testing perated at a level f precisin that wuld prevent r detect material misstatements. The Firm failed t identify and test any cntrls ver the cmpleteness and accuracy f certain f the reprts used in the peratin f certain f these cntrls. There was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had evaluated whether the failure f persnnel at certain f the issuer's lcatins t fllw the issuer's plicy regarding accunt recnciliatins represented a cntrl deficiency. The Firm inapprpriately used the wrk f an issuer cmpliance grup in testing certain f these cntrls. Specifically, this grup had a direct reprting relatinship t a member f management in the accunting department wh was respnsible fr r perfrmed certain f the cntrls in the perid-end financial reprting that the cmpliance grup tested.

23 PCAOB Release N Inspectin f Ernst & Yung LLP Page 21 A.13. Issuer M In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR The Firm failed t perfrm sufficient prcedures with respect t the valuatin f lng-lived assets. The issuer cncluded that it did nt need t test any f its lng-lived assets fr impairment despite the fact that certain asset grups had incurred current and histrical perating lsses. T test the issuer's cnclusin, the Firm develped a high-level cash flw analysis; hwever, the analysis cntained errrs. Had the errrs been crrected, the analysis wuld have identified an additinal indicatr f ptential impairment fr ne f the asset grups that the Firm shuld have evaluated in perfrming its tests. The Firm failed t sufficiently test the issuer's cntrls ver the evaluatin f the ptential impairment f lng-lived assets. Specifically, the Firm failed t evaluate whether the issuer's cntrls were designed t identify all relevant indicatrs f ptential impairment. Fr ne cntrl, which invlved management's review fr indicatrs f ptential impairment, the Firm's testing was limited t inquiry f management, and the Firm did nt btain evidence that the ther cntrls it tested were precise enugh t identify indicatrs f ptential impairment. A.14. Issue N In this audit, the Firm failed t btain sufficient apprpriate audit evidence t supprt its pinins n the financial statements and n the effectiveness f ICFR. The issuer used tw service rganizatins t prcess custmer transactins and used certain f the data and reprts prduced by these service rganizatins in the perfrmance f several f the cntrls that the Firm selected fr testing. The Firm als used certain f these data and reprts in its cntrl and substantive testing f cash and investments, payables t custmers, and certain receivable accunts, and in its testing f cntrls related t certain significant services the issuer prvided t its custmers. The Firm failed t perfrm sufficient prcedures t test the cmpleteness and accuracy f these data and reprts as fllws

24 PCAOB Release N Inspectin f Ernst & Yung LLP Page 22 The Firm btained a service auditr's reprt n cntrls at ne f the service rganizatins, but this reprt addressed cntrls ver nly sme f the reprts prduced by the service rganizatin. The Firm failed t test, r therwise btain evidence f the design and perating effectiveness f, cntrls ver the cmpleteness and accuracy f the ther data and reprts identified abve. The Firm failed t perfrm prcedures t btain evidence regarding the design and perating effectiveness f any f the cntrls at the ther service rganizatin. A.15. Issuer O In this audit, the Firm failed in the fllwing respects t btain sufficient apprpriate audit evidence t supprt its pinin n the effectiveness f ICFR The Firm failed t sufficiently test cntrls ver the issuer's prcess fr determining the ALL Fr certain categries f lans, the Firm failed t sufficiently test the perating effectiveness f review cntrls ver lan grading, as the Firm's prcedures did nt include testing the effectiveness f the issuer's review. Specifically, the Firm limited its testing f the perating effectiveness f the cntrl ver risk rating t verifying that a review f the ratings was perfrmed and reviewing the recmmended changes t the ratings, withut testing the precisin f the review. The Firm failed t sufficiently test the perating effectiveness f certain recnciliatin and review cntrls ver the calculatin f the general cmpnent f the ALL, as the Firm failed t evaluate whether the cntrls perated at an apprpriate level f precisin t detect a material misstatement. The Firm failed t select and test cntrls ver certain significant inputs int the calculatin f the general cmpnent f the ALL, including lan riginatin dates, lan prduct types, and histrical default data.

25 PCAOB Release N Inspectin f Ernst & Yung LLP Page 23 The issuer identified a deficiency in a cntrl ver the risk-rating f lans in ne f the issuer's lan prtflis. The Firm failed t sufficiently evaluate the severity and implicatins f this deficiency, as fllws The Firm failed t cnsider whether the existence f this deficiency shuld have affected the extent f its cntrl testing fr ther lan prtflis, as the same cntrl applied t all f the issuer's prtflis. The Firm's evaluatin f the severity f this deficiency failed t include cnsideratin f ther cntrl deficiencies, unadjusted audit differences related t the issuer's ALL and weaknesses identified by the issuer's primary regulatr related t the issuer's identificatin f credit deteriratin. A.16. Issuer P In this audit, the Firm failed t btain sufficient apprpriate audit evidence t supprt its pinin n the effectiveness f ICFR. The issuer used an external service rganizatin t execute and prcess transactins related t the issuer's available-frsale ("AFS") securities, and t maintain custdy f thse securities. The issuer used infrmatin prvided by this service rganizatin t recrd the transactins and t recrd the fair value f the securities in its general ledger. The Firm failed t btain an understanding f cntrls at the service rganizatin, and the Firm failed t test, r therwise btain evidence f, the perating effectiveness f cntrls related t the existence f the AFS securities and the cmpleteness and accuracy f infrmatin prvided by the service rganizatin. A.17. Issuer Q In this audit, the Firm failed t perfrm sufficient prcedures t assess the remaining estimated useful lives f certain intangible assets. The Firm's analysis relied n prcedures perfrmed in a prir year when the assets were acquired. In that year, hwever, the Firm had failed t sufficiently test the reasnableness f the estimated useful lives f the assets, as it failed t evaluate, beynd inquiry f management and the issuer's specialist, cntrary evidence cnsisting f histrical annual custmer retentin data that differed significantly frm the retentin assumptins the issuer used t value and amrtize the assets.

26 PCAOB Release N Inspectin f Ernst & Yung LLP Page 24 A.18. Issuer R In this audit, the Firm failed t btain sufficient apprpriate audit evidence t supprt its pinin n the effectiveness f ICFR. The Firm selected fr testing certain review cntrls ver the valuatin f AFS securities, but failed t sufficiently test these cntrls. Specifically, there was n evidence in the audit dcumentatin, and n persuasive ther evidence, that the Firm had btained an understanding f the review prcedures perfrmed by management, evaluated the criteria management used t identify price changes fr investigatin, and determined whether pricing exceptins were apprpriately reslved. A.19. Issuer S In this audit, the Firm failed t sufficiently test the valuatin f certain types f the issuer's derivative cntracts. The Firm tested these derivative cntracts by selecting a sample and independently calculating the fair values f the selected cntracts. Fr mst f the derivative cntracts in the sample, the issuer's fair value measurement was significantly higher than the fair value measurement the Firm determined; the ttal f the differences apprximated 50 percent f the recrded value f thse cntracts. The Firm, hwever, failed t evaluate the implicatins f these significant differences. A.20. Issuer T In this audit, the Firm failed t btain an understanding f the specific methds and/r assumptins underlying fair value measurements that were btained frm pricing services r ther third parties and used in the Firm's testing f certain hard-t-value financial instruments. B. Review f Quality Cntrl System In additin t evaluating the quality f the audit wrk perfrmed n specific audits, the inspectin included review f certain f the Firm's practices, plicies, and prcesses related t audit quality. This review addressed practices, plicies, and prcedures cncerning audit perfrmance and the fllwing five areas (1) management structure and prcesses, including the tne at the tp; (2) practices fr partner management, including allcatin f partner resurces and partner evaluatin, cmpensatin, admissin, and disciplinary actins; (3) plicies and prcedures fr cnsidering and addressing the risks invlved in accepting and retaining clients, including the applicatin f the Firm's risk-rating system; (4) prcesses related t the Firm's use f audit wrk that the Firm's freign affiliates perfrm n the freign