Matters to be discussed:
(i) Introduction regarding professional scepticism.
(ii) What is Professional Scepticism?
How does the auditor apply professional scepticism
(iii) When assessing engagement acceptance.
(iv) When performing risk assessment procedures.
(v) When obtaining audit evidence.
(vi) When evaluating evidence.
(vii) How should the auditor apply professional scepticism? (iv) When performing risk assessment procedures.
(v) When obtaining audit evidence.
(vi) When evaluating evidence.
Specific applications of professional Scepticism
(viii) Fraud
(ix) Accounting Estimates
(x) Going Concern
(xi) Related Party Relationships and Disclosures
(xii) Consideration of laws and regulations.
(xiii) The increasing importance of Professional Scepticism
(xiv) Conclusion
__________________________________________________________________
(i) Introduction regarding professional scepticism.
1) 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 FS.
(ii) What is Professional Scepticism?
Financial Reporting Council (FRC) have issued documents highlighting the
importance of professional scepticism in an audit of FS.
(ii) What is Professional Scepticism?
1) The IAASB's Handbook of International Quality Control, Auditing, Review,
Other Assurance, and Related Services Pronouncements contains the following
definition of the term 'professional sceptcism'.
2) Professional Scepticism = An attitude that include a questioning mind, being
alert to conditions which may indicate possible
misstatement due to error and fraud, and a critical
assessment of evidence.
3) 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.
4) Specific requirement of ISA 200 = Auditor shall plan and perform an audit with
professional scepticism recognising that circumstances may exist that cause the
financial statements to be materially misstated.
5) Overall objective:
- Discuss the importance of professional scepticism in planning and performing
an audit (B1e), and
- Assess whether an engagement has been planned and performed with an attitude
of professional scepticism, and evaluate the implications (B1f).
6) Application paragraphs of ISA 200 = Contain more guidance on what is meant by
applying professional scepticism when
conducting an audit.
7) Professional scepticism = Being alert to:
- 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)
8) 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.
9) Professional Scepticism = Related to fundamental ethical considerations of
auditor objectivity and independence.
= Linked to application of professional judgement by
auditor.
10) The application of professional scepticism ensure 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.
- Improve audit quality.
[An audit performed without an attitude of professional scepticism is not likely to
be a high quality audit.]
How does the auditor apply professional scepticism
Other Assurance, and Related Services Pronouncements contains the following
definition of the term 'professional sceptcism'.
2) Professional Scepticism = An attitude that include a questioning mind, being
alert to conditions which may indicate possible
misstatement due to error and fraud, and a critical
assessment of evidence.
3) 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.
4) Specific requirement of ISA 200 = Auditor shall plan and perform an audit with
professional scepticism recognising that circumstances may exist that cause the
financial statements to be materially misstated.
5) Overall objective:
- Discuss the importance of professional scepticism in planning and performing
an audit (B1e), and
- Assess whether an engagement has been planned and performed with an attitude
of professional scepticism, and evaluate the implications (B1f).
6) Application paragraphs of ISA 200 = Contain more guidance on what is meant by
applying professional scepticism when
conducting an audit.
7) Professional scepticism = Being alert to:
- 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)
8) 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.
9) Professional Scepticism = Related to fundamental ethical considerations of
auditor objectivity and independence.
= Linked to application of professional judgement by
auditor.
10) The application of professional scepticism ensure 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.
- Improve audit quality.
[An audit performed without an attitude of professional scepticism is not likely to
be a high quality audit.]
How does the auditor apply professional scepticism
(iii) When assessing engagement acceptance.
1) Auditor should consider whether the management of the intended audit clients
acts with integrity and whether there are matters that impact on the auditor
being able to act with professional scepticism. (If they accept the engagement,
such as ethical threats to objectivity)
(iv) When performing risk assessment procedures(RAP).
1) Auditor should sceptical at the planning stage of the audit.
(When performing risk assessment procedures)
2) Example: When discussing the results of analytical procedures with
management, auditor should:
- Not accept management's explanations at face value.
- Obtain corroboratory evidence for the explanations offered.
(v) When obtaining audit evidence.
1) Auditor should ready to challenge management.
(Especially on complex and subjective matter and matters that have required a
degree of judgement to be exercised by management)
2) The reliability and sufficiency of evidence should be considered.
(Especially where there are risks of fraud)
3) Specific issues arising during an audit which impacts on professional scepticism.
- Example: If management refuses the auditor's request to obtain evidence from
a 3rd party = The auditor will have to consider how much trust can
be placed on evidence obtained from management.
(Eg. Evidence in the form of inquiry with management or written
representations obtained from management)
4) ISA 200 = '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'.
(vi) When evaluating evidence.
1) Auditor should critically assess audit evidence and be alert for contradictory
evidence that may undermine the sufficiency and appropriateness of evidence
obtained.
(vii) How should the auditor apply professional scepticism?
1) When forming auditor's opinion = By considering the overall sufficiency of
evidence. (To support the audit opinion)
= By evaluating whether the FS overall are a
fair presentation of underlying transactions
and events.
2) Application of Professional Scepticism
= Reduce detection risk. (Because it enhances the effectiveness of applied
audit procedures)
= Reduces the possibility that auditor will reach an inappropriate conclusion
(When evaluating the results of audit procedures)
Specific applications of professional Scepticism (Areas of audit that are complex,
subjective or highly judgemental)
(viii) Fraud
1) ISA 240, The Auditor's Responsibilities Relating to Fraud in an Audit of
Financial Statements = Refer 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]
2) ISA 240 = 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' [ISA 240.12].
3) Application paragraph of ISA 240 = Emphasise the importance of assessing
the reliability of the information to be used as audit evidence and controls
over its preparation and maintenance.
4) ISA 240 = '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 240.12]
5) ISA 240 reminds the auditor that when management provides the auditor with
audit evidence (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.
(ix) Accounting Estimates
1) Fair value accounting estimates.
2) The use of significant assumptions by management in developing accounting
estimates.
3) Reviewing the judgements and decisions used by management for management
bias in developing accounting accounting estimates.
(x) Going Concern
1) 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)
(xi) Related Party Relationships and Disclosures
1) Difficult to obtain information on related parties.
(As knowledge may be confined to management = Auditor have to rely on
management to identify all related parties)
2) The auditor should also be sceptical when assessing the biz rationale behind
related party transactions.
(xii) Consideration of laws and regulations.
1) Auditor should be alert throughout the audit for indications that there may
have been a suspected non-compliance with laws and regulations.
(xiii) The increasing importance of Professional Scepticism
1) Arnold Schilder, IAASB chairman emphasises the increasing need for auditors
to apply professional scepticism. (Contain in the IAASB staff Q&A documents)
2) 1st reason: The increased use of judgement and subjectivity in management's
financial reporting decisions.
(Due to the application of International Financial Reporting Standards (IFRS),
which are largely principle-based, and often require the preparers of FS to
exercise significant judgement when making decisions on accounting treatments)
3) 2nd reason: The global 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)
[Reason for IAASB issuing Staff Q&A document was to re-emphasise the
importance of professional scepticism especially in the audit of FS where there
is a high risk of material misstatement due to financial distress.]
4) UK's Financial issued a Briefing Paper on professional scepticism which suggest
Professional Scepticism is the cornerstone of audit quality.
(It proposes that 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.]
5) The IAASB's Work Plan for 2015-16, Enhancing Audit Quality and Planning for
the Future (Issued in 12/2014) prioritises the issues that impact on audit quality,
including group audits, quality control, and professional scepticism.
(It is clear that 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.]
(xiv) Conclusion
1) 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'.
2) Auditors must be confident to challenge management on a range of matters
relevant to 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.
3) It is an essential element of quality control, and in safeguarding the credibility
of the audit opinion.
1) Auditor should consider whether the management of the intended audit clients
acts with integrity and whether there are matters that impact on the auditor
being able to act with professional scepticism. (If they accept the engagement,
such as ethical threats to objectivity)
(iv) When performing risk assessment procedures(RAP).
1) Auditor should sceptical at the planning stage of the audit.
(When performing risk assessment procedures)
2) Example: When discussing the results of analytical procedures with
management, auditor should:
- Not accept management's explanations at face value.
- Obtain corroboratory evidence for the explanations offered.
(v) When obtaining audit evidence.
1) Auditor should ready to challenge management.
(Especially on complex and subjective matter and matters that have required a
degree of judgement to be exercised by management)
2) The reliability and sufficiency of evidence should be considered.
(Especially where there are risks of fraud)
3) Specific issues arising during an audit which impacts on professional scepticism.
- Example: If management refuses the auditor's request to obtain evidence from
a 3rd party = The auditor will have to consider how much trust can
be placed on evidence obtained from management.
(Eg. Evidence in the form of inquiry with management or written
representations obtained from management)
4) ISA 200 = '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'.
(vi) When evaluating evidence.
1) Auditor should critically assess audit evidence and be alert for contradictory
evidence that may undermine the sufficiency and appropriateness of evidence
obtained.
(vii) How should the auditor apply professional scepticism?
1) When forming auditor's opinion = By considering the overall sufficiency of
evidence. (To support the audit opinion)
= By evaluating whether the FS overall are a
fair presentation of underlying transactions
and events.
2) Application of Professional Scepticism
= Reduce detection risk. (Because it enhances the effectiveness of applied
audit procedures)
= Reduces the possibility that auditor will reach an inappropriate conclusion
(When evaluating the results of audit procedures)
Specific applications of professional Scepticism (Areas of audit that are complex,
subjective or highly judgemental)
(viii) Fraud
1) ISA 240, The Auditor's Responsibilities Relating to Fraud in an Audit of
Financial Statements = Refer 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]
2) ISA 240 = 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' [ISA 240.12].
3) Application paragraph of ISA 240 = Emphasise the importance of assessing
the reliability of the information to be used as audit evidence and controls
over its preparation and maintenance.
4) ISA 240 = '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 240.12]
5) ISA 240 reminds the auditor that when management provides the auditor with
audit evidence (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.
(ix) Accounting Estimates
1) Fair value accounting estimates.
2) The use of significant assumptions by management in developing accounting
estimates.
3) Reviewing the judgements and decisions used by management for management
bias in developing accounting accounting estimates.
(x) Going Concern
1) 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)
(xi) Related Party Relationships and Disclosures
1) Difficult to obtain information on related parties.
(As knowledge may be confined to management = Auditor have to rely on
management to identify all related parties)
2) The auditor should also be sceptical when assessing the biz rationale behind
related party transactions.
(xii) Consideration of laws and regulations.
1) Auditor should be alert throughout the audit for indications that there may
have been a suspected non-compliance with laws and regulations.
(xiii) The increasing importance of Professional Scepticism
1) Arnold Schilder, IAASB chairman emphasises the increasing need for auditors
to apply professional scepticism. (Contain in the IAASB staff Q&A documents)
2) 1st reason: The increased use of judgement and subjectivity in management's
financial reporting decisions.
(Due to the application of International Financial Reporting Standards (IFRS),
which are largely principle-based, and often require the preparers of FS to
exercise significant judgement when making decisions on accounting treatments)
3) 2nd reason: The global 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)
[Reason for IAASB issuing Staff Q&A document was to re-emphasise the
importance of professional scepticism especially in the audit of FS where there
is a high risk of material misstatement due to financial distress.]
4) UK's Financial issued a Briefing Paper on professional scepticism which suggest
Professional Scepticism is the cornerstone of audit quality.
(It proposes that 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.]
5) The IAASB's Work Plan for 2015-16, Enhancing Audit Quality and Planning for
the Future (Issued in 12/2014) prioritises the issues that impact on audit quality,
including group audits, quality control, and professional scepticism.
(It is clear that 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.]
(xiv) Conclusion
1) 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'.
2) Auditors must be confident to challenge management on a range of matters
relevant to 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.
3) It is an essential element of quality control, and in safeguarding the credibility
of the audit opinion.
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