Tuesday 6 March 2018
Clients have been known to complain that auditors are never happy. They refuse to accept management's explanations at face value, regardless of how thorough and professional the work of the preparers has been.
Frustrations can arise in different areas. What supporting evidence can be provided for a particular position? Why was a treatment accepted last year, but this year is being challenged, and different evidence demanded? Why, when an audit team member has already accepted a client's explanation, is the issue being revisited as a result of a review higher up in the auditing process?
Why is this?
Auditors are required to be independent when carrying out engagements. Independence is linked to the fundamental principles of objectivity and integrity: auditors should not only be, but also be seen to be, independent. Independence, both of mind and appearance, is necessary. Independence of mind is defined in the IFAC's Code of Ethics for Professional Accountants in paragraph 290.8 as the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional scepticism."
International Standards on Auditing refer to the requirements for professional scepticism. It is defined in ISA 200[¹] as an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence. The remaining auditing standards refer to the application of professional scepticism at all stages of the audit, including the evaluation of whether audit evidence obtained is sufficient and appropriate in the circumstances. In auditing financial statement items which include a significant degree of management estimation or judgement, considerable professional scepticism is required. It is natural that the level of professional scepticism improves with experience.
Is the level of scepticism warranted?
Over recent years, the auditing profession has faced challenging questions about the roles and diligence of some firms in financial reporting and governance-related scandals. Allegations of negligence and a lack of independence and professional scepticism have been made. It can be argued that, not only is the level of scepticism warranted, but that there is sufficient evidence to suggest that it is not enough.
Business practices and financial reporting have become more complex, requiring greater use of estimates, fair value accounting, and management assumptions and judgements in applying an approach based on the conceptual framework. Add to this the increased volumes and complexity of big data, information technology, data integrity and security risks, as well as an increasingly interested and active society. In the current environment, scepticism has to become part of an auditor's DNA.[²]
What does this mean for auditors?
The profession's standard-setting bodies all recognise the need to improve all pronouncements, codes and standards that define the professional standards of public accountants, and are working on projects to enhance definitions and guidance and to integrate the concept of professional scepticism. While these on-going projects represent a long-term approach, in the short-term publications by IFAC and its boards periodically give guidance on applying new concepts and enhanced principles.
Auditors must ensure that all staff are effectively engaged with these enhancements and their practical application in their daily work. Practical, real training, from engagement partners to audit team juniors, will not only improve their ability to develop this attitude and apply it, but will also improve their abilities to accurately assess the nature of audit evidence and management's estimates and judgements, working professionally with their clients to request the correct level of evidence and assess it effectively and professionally. This applies throughout the audit process and includes the quality of documentation of audit working papers to demonstrate professional judgement and prove professional scepticism.
What does this mean for clients?
Finance staff, and in particular management and leadership in finance, would be well placed to seek to understand the concept of professional scepticism and adopt this same attitude when preparing accounting records and financial statements. Especially those that support the recognition, measurement, presentation and disclosure of financial statement items that include a high degree of estimation, the application of judgement and the use of experts. Preparation of supporting documentation which outlines the accounting principles, thought processes, inputs and their sources, considerations, calculations and decisions, will make a significant impact on the efficiency of audit procedures on these items.
The future of financial reporting and professional scepticism
With the digital revolution and global changes to accountability and transparency of governance and integrated reporting, the requirement for professional scepticism is going to become increasingly fundamental to a fair presentation, for both finance professionals and their auditors. It is best to be well prepared.
[¹] ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing
[²] Towards Enhanced Professional Skepticism: Observations of the IAASB-IAESB
-IESBA Professional Skepticism Working Group - Aug 2017 (Page 4)
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