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Professional Skepticism

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29 views6 pages

Professional Skepticism

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ahsan ahmed
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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accaglobal.

com

Professional scepticism
ACCA - https://www.accaglobal.com

12–15 minutes

In recent years regulatory bodies including the International Auditing and


Assurance Standards Board (IAASB) and the UK Financial Reporting
Council (FRC) have issued documents highlighting the importance of
professional scepticism in an audit of financial statements. The objective of
this article is to explain the importance of professional scepticism as an
essential part of the auditor’s mindset, and to consider the reasons why
approaching an audit with an attitude of professional scepticism is becoming
increasingly important.

What is professional scepticism?

The glossary of terms contained in the IAASB’s Handbook of International


Quality Control, Auditing, Review, Other Assurance, and Related Services
Pronouncements contains the following definition of the term ‘professional
scepticism’:

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 evidence.

ISA 200, Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with International Standards on Auditing, contains
more guidance on how and why the auditor should act with an attitude of
professional scepticism. ISA 200 contains a specific requirement in relation
to professional scepticism:

The auditor shall plan and perform an audit with professional scepticism
recognising that circumstances may exist that cause the financial
statements to be materially misstated.

This overall objective is the fundamental driver for the relevant learning
outcomes within the Paper P7 syllabus, namely:
To discuss the importance of professional scepticism in planning and
performing an audit (B1e), and

To assess whether an engagement has been planned and performed with


an attitude of professional scepticism, and evaluate the implications (B1f).

The application paragraphs of ISA 200 contain more guidance on what is


meant by applying professional scepticism when conducting an audit:

Professional scepticism includes being alert to, for example:

Audit evidence that contradicts other audit evidence obtained.

Information that brings into question the reliability of documents and


responses to inquiries to be used as audit evidence.

Conditions that may indicate possible fraud.

Circumstances that suggest the need for audit procedures in addition to


those required by the ISAs. (ISA 200 A.18).

Essentially, ISA 200 requires the use of professional scepticism as a means


of enhancing the auditor’s ability to identify risks of material misstatement
and to respond to the risks identified. Professional scepticism is closely
related to fundamental ethical considerations of auditor objectivity and
independence. Professional scepticism is also linked to the application of
professional judgment by the auditor. An audit performed without an attitude
of professional scepticism is not likely to be a high quality audit. At its core
the application of professional scepticism should help to ensure that the
auditor does not neglect unusual circumstances, oversimplify the results
from audit procedures or adopt inappropriate assumptions when
determining the audit response required to address identified risks, all of
which should improve audit quality.

How does the auditor apply professional scepticism?

The auditor is likely to apply professional scepticism at various stages from


client acceptance and at various points during the audit process, and some
typical examples are given below:

When assessing engagement acceptance – at this stage the auditor should


consider whether the management of the intended audit client acts with
integrity and whether there are any matters that may impact on the auditor
being able to act with professional scepticism if they accept the
engagement, such as ethical threats to objectivity.

When performing risk assessment procedures – an auditor should be


sceptical when performing risk assessment procedures at the planning
stage of the audit. For example, when discussing the results of analytical
procedures with management, the auditor should not accept management’s
explanations at face value, and should obtain corroboratory evidence for the
explanations offered.

When obtaining audit evidence – the auditor should be ready to challenge


management, especially on complex and subjective matters and matters
that have required a degree of judgement to be exercised by management.
The reliability and sufficiency of evidence should be considered, especially
where there are risks of fraud. There may also be specific issues arising
during an audit which impacts on professional scepticism – for example, if
management refuses the auditor’s request to obtain evidence from a third
party. The auditor will have to consider how much trust can be placed on
evidence obtained from management – for example, evidence in the form of
enquiry with management or written representations obtained from
management. ISA 200 states that ‘a belief that management and those
charged with governance are honest and have integrity does not relieve the
auditor of the need to maintain professional scepticism or allow the auditor
to be satisfied with less than persuasive audit evidence when obtaining
reasonable assurance’.

When evaluating evidence – the auditor should critically assess audit


evidence and be alert for contradictory evidence that may undermine the
sufficiency and appropriateness of evidence obtained.

The auditor should also apply professional scepticism when forming the
auditor’s opinion, by considering the overall sufficiency of evidence to
support the audit opinion, and by evaluating whether the financial
statements overall are a fair presentation of underlying transactions and
events.

Ultimately, the application of professional scepticism should reduce


detection risk because it enhances the effectiveness of applied audit
procedures and reduces the possibility that the auditor will reach an
inappropriate conclusion when evaluating the results of audit procedures.

Specific applications of professional scepticism

Fraud
ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements, specifically refers to professional scepticism stating
that ‘when obtaining reasonable assurance, the auditor is responsible for
maintaining professional scepticism throughout the audit, considering the
potential for management override of controls and recognising the fact that
audit procedures that are effective for detecting error may not be effective in
detecting fraud’ (ISA 240.8).

ISA 240 goes on to state a specific requirement for the auditor: ‘The auditor
shall maintain professional scepticism throughout the audit, recognising the
possibility that a material misstatement due to fraud could exist,
notwithstanding the auditor’s past experience of the honesty and integrity of
the entity’s management and those charged with governance’ (ISA240.12).

The application paragraphs of ISA 240 emphasise the importance of


assessing the reliability of the information to be used as audit evidence and
the controls over its preparation and maintenance. In addition, ISA 240
states that ‘management is often in the best position to perpetrate fraud.
Accordingly, when evaluating management’s responses to inquiries with an
attitude of professional scepticism, the auditor may judge it necessary to
corroborate responses to inquiries with other information’ (ISA 240.A17).
This is significant in that ISA 240 reminds the auditor that when
management provides the auditor with audit evidence – be that in the form
of answers to enquiries, written representations or other forms of
documentary evidence – the auditor should carefully consider the integrity
of that evidence and whether additional corroboratory evidence should be
obtained from a more reliable source.

Other aspects of an audit where professional scepticism may be


important
The IAASB has issued a Staff Questions and Answers document entitled
Professional Scepticism in an Audit of Financial Statements, which outlines
some of the areas of the audit where the use of professional scepticism may
be important. These are outlined below and largely relate to areas of the
audit that are complex, subjective or highly judgmental.

Accounting estimates – this can include fair value accounting estimates, the
use of significant assumptions by management in developing accounting
estimates, and reviewing the judgements and decisions used by
management for management bias in developing accounting estimates.

Going concern – the auditor should review management’s assessment of


going concern and whether management’s plans are feasible, this being
particularly important where there is a significant doubt over the entity’s
ability to continue as a going concern.

Related party relationships and disclosures – it can be difficult to obtain


information on related parties, as knowledge may be confined to
management meaning that the auditor may have to rely on management to
identify all related parties The auditor should also be sceptical when
assessing the business rationale behind related party transactions.

Consideration of laws and regulations – the auditor should be alert


throughout the audit for indications that there may have been a suspected
non-compliance with laws and regulations.

The increasing importance of professional scepticism

The IAASB Staff Questions and Answers document contains a foreword by


Arnold Schilder, IAASB chairman, which emphasises the increasing need for
auditors to apply professional scepticism. One reason for this is the
increased use of judgment and subjectivity in management’s financial
reporting decisions. This is due to the application of International Financial
Reporting Standards (IFRS), which are largely principle-based, and often
require the preparers of financial statements to exercise significant
judgment when making decisions on accounting treatments.

The global financial crisis of 2008–2009 also focused attention on


professional scepticism. Auditors in many jurisdictions were criticised for not
applying sufficient professional scepticism at that time, particularly in
relation to the audit of fair values, related party transactions and going
concern assessments. One of the reasons for the IAASB issuing the Staff
Questions and Answers document was to re-emphasise the importance of
professional scepticism especially in the audit of financial statements where
there is a high risk of material misstatement due to financial distress.

The UK’s Financial Reporting Council (FRC) has issued a Briefing Paper on
professional scepticism which suggests that professional scepticism is the
cornerstone of audit quality. It proposes that the auditor should actively look
for risks of material misstatement, and that this is only possible when a high
degree of knowledge of the audited entity’s business and the environment in
which it operates is obtained. The document contains proposals for how
audit firms can encourage audit teams to approach audits with a sceptical
mindset, and it considers that some audit firms may need to change their
culture to allow this to happen.

The IAASB’s Work Plan for 2015–16, Enhancing Audit Quality and
Preparing for the Future – issued in December 2014 – prioritises the issues
that impact on audit quality, including group audits, quality control, and
professional scepticism. It is clear the professional scepticism is to stay on
the agenda of the regulatory authorities for some time to come, as it is so
intrinsically linked to other key audit issues such as audit quality, ethics and
independence and, ultimately, the confidence that the public has in the
auditing profession.

Conclusion

The IAASB states that ‘the need for professional scepticism cannot be
overemphasised’ and that ‘adopting and applying a sceptical mindset is
ultimately a personal and professional responsibility to be embraced by
every auditor’. Given the increasingly complex and subjective nature of
IFRS requirements, auditors must be confident to challenge management on
a range of matters relevant to the preparation of the financial statements
and the IAASB and national bodies such as the FRC are keen to support
auditors in the application of professional scepticism. This, they believe, is
an essential element of quality control, and in safeguarding the credibility of
the audit opinion.

Written by a member of the Paper P7 examining team

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