What is Professional Skepticism? What makes it professional?
Trust Me…
I’m a Skeptic
There’s been a renewed focus on professional skepticism lately. Why?
• 35-40% audit failure rate at PCAOB in 2012 meaning the audit firm
should not have signed off. Not that the statements were misstated,
but that the auditors didn’t follow the standards. A lack of professional
skepticism was noted in over 60% SEC investigations of fraudulent
financial reporting leading to sanctions against auditors.
• Some say that factors such as non-audit services or long audit tenures
can threaten audit quality over time. The perception is that
management assertions are sometimes accepted without sufficient
The concepts of professional skepticism are relatively straight-forward, but
it seems there is a lack of common understanding or practical guidance on
what it actually is and how it can be demonstrated and documented.
It’s not that audits are useless, but that they’re just ONE of the ways
to exercise skepticism.
What do the standards say?
AU-C 200: Overall Objectives for the Independent
Auditor and the Conduct of an Audit in Accordance
with GAAS
.17 The auditor should plan and perform an audit with
professional skepticism, recognizing that
circumstances may exist that cause the financial
statements to be materially misstated.
What do the standards say?
.A22 Be alert to the following:
Audit evidence that contradicts other evidence obtained
Information that brings reliability into question
Conditions that may indicate possible fraud
Circumstances that require procedures outside of GAAS
.A26 The auditor neither assumes that management is
dishonest nor assumes unquestioned honesty. The auditor
cannot be expected to disregard past experience of the
honesty and integrity of the entity’s management and those
charged with governance.
Skepticism can have a much broader approach for internal auditors
than external auditors. External are primarily focused on the
financial risk factors a few times throughout the year, where internal
auditors include, not just financial, but operational, compliance, and
business/strategic risks that organizations deal with everyday.
Recurring thought: Professional Skepticism is the idea that the
existing practices are not the final result, but to always be reaching
for something better.
Why the increased non-compliance? Perhaps it’s due to the
standards vague references. There is very little guidance adequately
linking the professional skepticism mandate to actually being
skeptical with specific ways of cognitively processing audit evidence.
What do the standards say?
AU-C 240: Consideration of Fraud in a Financial
Statement Audit
.13 If conditions identified during the audit cause the
auditor to believe that a document may not be authentic or
that terms in a document have been modified but not
disclosed to the auditor, the auditor should investigate
.A9 Maintaining professional skepticism requires an
ongoing questioning…particularly…when considering the
risks of material misstatement due to fraud.
To be reflective and inquisitive of all things.
1. Against every statement its contradiction may be
advanced with equal justification
2. Preserve an attitude of intellectual suspense
3. The impossibility of knowledge
So, let’s go to the beginning. The word itself actually means “to be
reflective and inquisitive”. It’s different than constant doubt, but
more of thinking critically and giving equal weight to the other side
of every argument.
Story of Pyrrho (360 BC - 270 BC) – Painter turned philosopher who
traveled with Alexander the Great throughout India and Persia. He
brought back the idea that nothing can be known for certain. The
senses are easily fooled, and reason follows too easily our desires.
Widely viewed as the first ‘skeptic’.
Basically, he taught that nothing can be truly known. This is certainly
true in the world of accounting where the sheer number of
transactions and judgments required make it impossible to truly
know just about anything. It’s the knowledge of not knowing that
keeps us professionally skeptical.
Two Main Views
1. Neutral
Management is neither honest nor dishonest
2. Presumptive Doubt
Management is guilty until proven innocent
So, what does this have to do with auditing?
We tend to stay in one of these two camps and varied practice is
inevitable. One firm will have very different takes as a culture.
Partners within those firms will do the same and individuals on audit
teams add another layer of judgment.
• Neutral – don’t assume management is either honest or
dishonest, but rather, you keep in mind that fraud can be
Most auditing standards leave us here. With this approach, auditor
evaluates evidence carefully, but without a presumed carelessness,
incompetence or fraud on management’s part.
Many practitioners side with this approach, but can lead to overly
high levels of detection risk
• Presumptive Doubt – assume some dishonesty unless data
indicates otherwise (opposite of innocent until proven guilty).
This is where most regulators tend to land and can lead to an over
accumulation of audit evidence and eliminate efficiencies gained by
Skepticism Continuum
But, if we take skepticism more seriously, it gets more complicated
than this. So maybe there’s another view…
Six Ways to Skepticism
1. Suspension of Judgment
2. Search for Knowledge
3. Interpersonal Understanding
4. Questioning Mindset
5. Autonomy
6. Self-Esteem
Definition: Withholding judgment until appropriate evidence is
Suspension of Judgment
How often do we start the audit assuming a clean opinion?
With audit software linking just about everything there is, this is
getting tougher to do. We’ll talk about the anchoring bias later.
PCAOB’s audit failure observations note that, in most cases, the
compromising evidence was IN THE WORKPAPERS. The audit team
noted the issue and concluded against it. This typically isn’t new
information, but a lack of mindset for the auditors. They WANT
there to be no issues.
Definition: A desire to investigate beyond the obvious, with a desire
to corroborate.
Search for Knowledge
• Asking 5 Why’s
• Is SAS 99 dead?
When you’re conducting a fraud interview, how seriously are your
people/clients taking them?
Is there a hope that you don’t find things so that you don’t have to
do more work?
When do you conduct these interviews? At the end of fieldwork,
during, or before planning?
When discrepancies do appear, are you more vigilant in finding a
way around them so you can meet budget and not have to alter your
original audit plan?
The Broken Machine
Hey boss! The time system is down.
When confronted with a problem, researchers have found it takes an
average of asking ‘why’ 5 times to get to the root cause.
Wait what? Why?
Because a particular server failed.
Why did it fail?
Definition: Recognition that people’s motivations and perceptions
can lead them to provide biased or misleading information.
Interpersonal Understanding
• Are communication skills getting worse?
• There’s a lot to be gained from face-to-face meetings, yet many
new staff are caught in an impersonal trap.
• There’s no app for auditing
• We are finding that future generations of auditors develop and
exercise professional skepticism differently than more
experienced auditors
• Reinforce the importance of interviewing and inquiry skills in the
audit process, including consideration of non-verbal cues.
Autonomy Definition: The self-direction, moral independence, and
conviction to decide for oneself, rather than accepting the claims of
Autonomy / Self-Esteem
Self-Esteem Definition: The self-confidence to resist persuasion and
to challenge assumptions or conclusions.
There is a generation gap where junior auditors simply take the word
of an older, more experienced auditor. Are your people confident?
The Dangers of Groupthink
Groupthink (where individuals suppress their own views because of
an assumption that consensus in the group signals good judgment) –
this can especially be true in cases where a prominent member of
the group expresses his/her views early.
• Both US and International auditing standards require
brainstorming sessions. Research, however, suggests that group
brainstorming sessions can actually inhibit professional
skepticism due to groupthink.
• How to overcome –
• Leader of the meeting sets tone by encouraging diversity
of thought
• Auditors come to the meeting with identified risks and
potential audit responses prior to the meeting
• Flip the meeting. In Japan, many businesses require the
lower level employees to begin the brainstorming while
the executives stay silent. Then, the next level speaks and
on up the chain until the executives are the last to speak.
• A Schaub & Lawrence study in early 1999 showed that, in many
cases, the level of skepticism is highest among staff and seniors
than in managers and partners.
• Quickest thinking from a group can lead to extreme
overconfidence (more on this later)
• Fostering healthy debate and avoiding early consensus is key to
avoiding unhealthy tendencies toward suppression of views or
early, potentially premature, consensus.
• Do you encourage and stimulate debate and different
Barriers and Biases
The human mind is capable of solving incredibly complex problems
and developing new and creative solutions.
1. Anchoring
2. Availability
3. Confirmation
Yet, that same mind can be subject to predictable judgment traps
and biases. This does not mean that auditors are bad as much as it
means that they are simply human.
4. Overconfidence
Anchoring Bias
The tendency to make assessments in gathering and evaluating
information by starting from an initial value and then adjusting
insufficiently away from that initial value in forming a final
This is commonly exhibited when auditors begin the audit of a
specific account by viewing the account details from the previous
year or by examining unaudited balances. This quickly taints our
ability to think skeptically and objectively about our expectations of
the actual results.
This is why we hear salesmen start with “These services are worth
$200, but I’m offering them to you for only $99.” Once we’re
anchored, we have a tendency to not move very far from that initial
Think about how this can impact our analytics. This is why it’s so
important to develop an expectation BEFORE we see any numbers.
The fact is, we are heavily and unconsciously swayed by information.
When conducting analytics, expectations, risk assessments; be sure
to consider what information might be affecting your process. You
might say nothing is, but the people in the above survey felt the
same way.
Each participant was to determine the appropriateness of interest income
using 2 different methods. Materiality was set at $525,000 (4.2% of Net
Test Tube Auditing
 67 seniors from a Big Four firm
 34.5 months of audit experience
2 Audit Tests
AGGREGATED – All participants were asked to calculate expected annual
interest income for hypothetical bank using annual loan receivable
balances and a weighted average annual interest rate for all loan
categories combined. Participants were given a copy of the PY analysis.
 Aggregated
 Disaggregated
2 Groups
 Significant Difference
 No Significant Difference
DISAGGREGATED – After doing this, they were asked to calculate expected
annual interest income using quarterly loan receivable balances and
weighted average quarterly interest rates by loan category (ex.
Commercial, real estate, individual, etc.).
Significant Difference Group: These auditors would calculate interest
income that would differ materially ($792,300) from what the client
recorded during the AGGREGATE test.
Test Tube Auditing
Strength of
Part A
No Significant Difference Group: These auditors would calculate interest
income that would not differ materially ($146,200) from what the client
recorded during the AGGREGATE test.
Assess Evidential Strength – Participants were asked 3 questions:
• Can you accept interest income as reported?
• What is the likelihood that interest income was materially misstated
on a scale of 0 to 100 (where 100 was labeled “definitely misstated”)?
• Evaluate the strength of the evidence provided by the interest income
analytical procedure on a 7 point scale (where 0 is Extremely
Weak/Useless and 7 is Extremely Strong/Removes all doubt).
Glover, Prawitt, Wilks, 2004
After Disaggregated Procedure, participants were asked the same 3
questions and one additional question:
Now reevaluate the analytical procedure used in Part A. Please indicate on
a scale of 1-7 the strength of evidence provided by the interest income
analytical procedure in Part A.
Evidential strength: 1 (extremely weak) to 7 (extremely strong)
Test Tube Auditing
Estimates of Evidential Strength for
Part A-Aggregate
Procedure (Initial
Part B-Disaggregated
Procedure – Suggests
Material Misstatement
No Significant
Significant Difference
Outcome of Aggregate
Analytical Procedure
Glover, Prawitt, Wilks, 2004
So, we find that auditors attributed significantly more evidential
strength to a weak analytical procedure that suggested no
significant difference than to an identical procedure based on the
same underlying data that suggested a potential misstatement.
Further, when the auditors in the no-significant-difference condition
reconsidered the aggregated analytical procedure after conducting
stronger, more precise analytical procedures based on disaggregated
data, they significantly reduced their strength of evidence ratings
for the aggregate analytical procedure, while auditors in the
significant difference condition did not.
The tendency of decision makers to overestimate their own abilities
to perform tasks or make accurate assessments of risk or other
judgments and decisions. Someone who knows they may not know,
can stop. Overconfidence tempts you to make decisions without
adequate reflection.
We all have the sense that we know better. We know where the risks
are. When the opinion is signed, we’ve thought of everything. And if
it falters, it was someone else’s fault. Humans have an uncanny
tendency to feel overly awesome.
Do you do better audit work than your competitors?
Do you work harder than most at your company?
Most of us greatly overestimate our looks, intelligence, morals, etc.
In one survey, more people claimed they thought they were going to
heaven than thought Mother Theresa was.
Trust Me…
I’m a Skeptic
Jonathan Kraftchick
[email protected]