Discussion Paper
AUDITOR SCEPTICISM: RAISING THE BAR
August 2010
The
Auditing Practices
Board
Auditor scepticism: Raising the bar
Contents
Page
Introduction
3
Nature of auditor scepticism
5
Growing importance of auditor scepticism
8
Importance of scepticism in practice
9
Development and promotion of auditor scepticism within audit
firms
10
Can more be done to promote auditor scepticism?
13
Questions
18
Appendices
1.
Academic research on auditor scepticism
2.
References to scepticism in ISAs (UK and Ireland)
19
28
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Auditor scepticism: Raising the bar
AUDITOR SCEPTICISM: RAISING THE BAR
Introduction
Audit is essential to public and investor confidence in companies. It is far from easy
to do well, requiring judgement and technical competence, often in complex
circumstances. This paper discusses the degree of scepticism that auditors need to
apply to conduct an audit to a high standard. This issue is particularly timely as, in the
wake of the banking crisis, regulators have challenged audit firms on whether
sufficient scepticism was demonstrated and the need for audit firms to exercise
greater professional scepticism was a key message in the Audit Inspection Unit (AIU)
2009/10 Annual Report1.
The application of an appropriate degree of professional scepticism is a crucial skill
for auditors. Unless auditors are prepared to challenge management’s assertions they
will not act as a deterrence to fraud nor be able to confirm, with confidence, that a
company’s financial statements give a true and fair view. However, scepticism can be
taken too far; challenging everything in a well run company will slow down the
publication of its financial statements and risks unnecessary costs.
The challenge for audit firms is to identify, develop and retain people with the
necessary skills and to deploy them appropriately. This paper shows the importance
of choosing and investing in the right people and developing the right processes to
drive quality, through nurturing appropriate sceptical behaviour. Audit firms need to
be vigilant about such matters and ensure that they foster the right level of scepticism
in their people, despite possible incentives to do otherwise.
The role of regulation is also important. Auditors work to technical and ethical
standards, including requirements on rotation of partners. These seek to achieve a
balance between scepticism, knowledge and over familiarity. Furthermore, audits of
listed companies are inspected by the AIU which looks for evidence that the right
questions have been asked and the right judgements made. The challenge for
regulators is to protect investors in ways that enable audit skills and judgement to
flourish.
Corporate behaviour also plays a significant role. Audit firms and audit partners
should not fear removal from their role if they challenge management strongly.
Management and Audit Committees also have a responsibility for ensuring that the
corporate culture and environment is one which encourages open dialogue with their
auditors at all levels.
This paper goes to the heart of some important issues and the views we hope it will
elicit will be of great interest to both the Auditing Practices Board (APB), which
issues Auditing Standards and guidance, and the Professional Oversight Board (POB),
which (through the AIU) monitors the conduct of audits of larger entities. Because of
its importance to audit quality, both Boards have worked together to develop this
Discussion Paper.
1
The AIU’s Annual Report, which was published on 21 July 2010, can be found at
www.frc.org.uk/pob/audit/reports.cfm.
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Auditor scepticism: Raising the bar
The APB and POB welcome the views of those stakeholders and other parties
interested in audit quality. In particular we would welcome views on the following:
1. Do you agree with the emphasis that this paper places on the importance of
auditor scepticism? Are there aspects of the analysis, including the summary of
academic research in Appendix 1, with which you particularly agree, or disagree?
If so, what are they?
2. Regulators have recently challenged audit firms on whether sufficient scepticism
was demonstrated on some audits:
•
•
•
Do you think that this problem is widespread or limited to certain types of audits
or circumstances?
What factors do you believe do, or could, in practice create disincentives for
auditors to apply an appropriate degree of professional scepticism and what
should be done about them?
In what areas do you think auditors should be more (or less) sceptical in their
approach?
3. How do you think audit firms should promote and develop professional scepticism
in their partners and staff? Do they need to do more and, if so, what?
4. Do you think that others, including companies, should be doing more to promote,
develop and support professional scepticism in auditors? If so, what?
Commentators should not feel constrained by these questions, or required to answer
all of them. However, it will assist collation of views, if the questions are used to
structure responses on this topic.
The APB and POB would prefer to receive responses in electronic form. These may
be sent by e-mail to j.grant@frc-apb.org.uk. If this is not possible, please send letters
of comment to:
JEC Grant
Financial Reporting Council
5th Floor Aldwych House
71 – 91 Aldwych
London WC2B 4HN
In either case, letters of comment should be sent so as to be received no later than 31
October 2010.
All responses will be regarded as being on the public record unless confidentiality is
expressly requested and will be posted to the APB’s website soon after receipt.
© The Financial Reporting Council Limited 2010. The Financial Reporting Council Limited is a company limited by guarantee.
Registered in England number 2486368. Registered Office: 5th Floor, Aldwych House, 71-91 Aldwych, London WC2B 4HN.
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Auditor scepticism: Raising the bar
Nature of auditor scepticism
1. Auditing Standards2 define professional scepticism as3 ‘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’.
This definition suggests that scepticism influences the scope of the work, helps
the auditor evaluate audit findings and ultimately conclude whether sufficient
appropriate audit evidence has been obtained to enable a ‘true and fair view’
opinion to be expressed on an entity’s financial statements4.
2. It is widely acknowledged that a sceptical attitude of mind is essential if an audit
is to be rigorous and performed with due professional care5; however, auditing
literature is less forthcoming about the degree of scepticism to be applied in
practice. The degree of scepticism to be applied is important because it influences
both the effectiveness and the efficiency of an audit. Too little scepticism
endangers audit effectiveness; too much risks unnecessary cost. Achieving the
right balance is vital. Unless audit inquiries are to be pursued without regard to
cost or time, in practice there must be a limit on the degree to which auditors
inquire about particular issues and the extent of audit procedures performed. This
thinking probably underlies the famous judicial view that an auditor should be ‘a
watchdog not a bloodhound’.6
3. In understanding how scepticism influences the conduct of audit in practice it is
worth exploring both the auditor’s initial mindset and how the auditor reacts to
evidence obtained during the audit process. Initially, auditors approach an audit
without a strong predisposition to believe that either the financial information is
misstated or that management are other than honest and candid. Through the
process of gathering audit evidence, auditors may obtain information that
suggests that the financial information could be misstated. In this situation
auditors become more intense in their enquiries and seek to obtain more audit
evidence to resolve issues, especially if they develop concerns about the veracity
of the evidence or the integrity of those providing it. To understand the practical
application of scepticism it may therefore be helpful to view it as being applied by
auditors on a ‘sliding scale’ where the intensity of their scrutiny and challenge
reflects both the auditor’s initial mindset and their response to audit findings.
2
References to Auditing Standards in this paper are to the Clarified ISAs (UK and Ireland) that are
effective for audits of accounting periods ending on or after 15 December 2010.
3
ISA (UK and Ireland) 200, paragraph 13.
4
Auditing Standards require the auditor to obtain sufficient appropriate audit evidence. They provide
guidance that this comprises information that both supports and contradicts management’s assertions.
However, how the auditor addresses conflicts in evidence obtained and what comprises sufficient
appropriate audit evidence are essentially matters for the audit team’s judgement.
5
Many of the responses to the FRC’s ‘Promoting Audit Quality’ confirmed the view that sound auditor
judgement is a critical element of audit quality and that this is highly dependent on the personal
qualities of audit partners and staff, including the degree of scepticism exhibited. The importance of
auditor scepticism was also a theme of many responses to the APB’s 1998 Consultation Paper ‘Fraud
and audit: Choices for society’.
6
In Re: Kingston Cotton Mills Co. (1896), Lord Justice Lopes stated that an auditor is not bound to be
a detective - he is a watchdog, not a bloodhound. In the later case of Fomento (Sterling Area) Ltd. v
Selsdon Fountain Pen Co. Ltd. (1958), Lord Denning stated ‘to perform his task properly he must come
to it with an enquiring mind - not suspicious of dishonesty - but suspecting that someone may have
made a mistake somewhere and that a check must be made to ensure that there has been none.’
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Auditor scepticism: Raising the bar
Initial mindset
4. When considering the auditor’s initial mindset a distinction can be made between
a neutral position (where the auditor does not assume either that the financial
statements are misstated or that management is dishonest) and a more questioning
approach that is sometimes referred to as ‘presumptive doubt’.
5. The recently updated Auditing Standards can be characterised as reflecting a
presumptive doubt approach. In particular ISA (UK and Ireland) 200 states ‘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’7. An attitude of presumptive doubt is reinforced by ISA (UK and
Ireland) 240 which states ‘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’8.
Whilst the auditor does not disregard past experience of the competence, honesty
and integrity of the entity’s management and those charged with governance when
making risk assessments, this does not detract from the initial mindset of the
auditor.
6. Recognising that the initial mindset is largely a personal attribute, questions arise
about whether all individuals are likely to have the same attitude of mind and, if
not, what causes differences.
7. As more fully described in Appendix 1 academics have identified a number of
character traits that underlie auditor scepticism, including:
• Curiosity / having a questioning mind,
• Deferral of judgement / not jumping to premature conclusions,
• Understanding management behaviour and motivations,
• Self-confidence, and
• Freedom of action.
8. However, there are a number of important questions yet to be answered, for
example:
- is scepticism an innate or an acquired condition?
- does scepticism vary between cultures?
9. While it is possible that some individuals are innately more curious than others, it
seems likely that a sceptical mindset can be influenced by experience, by direct
and indirect forms of training and by the cultural environment within the audit
firm, including the formal and informal incentive mechanisms that apply within it.
Indeed, the notion of ‘professional’ scepticism suggests that it is through
professional development and experience that an auditor learns the ‘right’ level of
scepticism to be applied in different circumstances. This seems consistent with
anecdotal evidence that auditors become more sceptical after they have been
7
8
ISA (UK and Ireland) 200 Paragraph 15
ISA (UK and Ireland) 240 Paragraph 12
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Auditor scepticism: Raising the bar
personally involved in an investigation of an audit failure.
10. In contrast, if success at university requires curiosity and an enquiring mind it is
likely that new recruits will commence their career with this trait. Indeed some
academic research suggests that new staff level auditors demonstrate significantly
higher levels of sceptical thought and action than their superiors.
11. If, at least to a degree, a sceptical mindset can be either acquired, or subdued,
there are some important questions about how it is acquired or maintained and the
degree to which audit firms actively encourage and foster it.
Reaction to audit findings
12. Auditing Standards establish requirements in relation to the need to perform
additional work in reaction to negative findings9. However, judgement is required
when determining what findings are ‘negative’ and what additional work needs to
be performed in the context of the particular circumstances encountered. While
the personal traits of individual auditors are also likely to influence judgements
and the actions taken to respond to concerns identified, subsequent behaviour is
also likely to be influenced by auditors working collectively as a team and by the
audit firm’s policies and procedures.
13. Auditors usually work in hierarchical teams. The work of junior auditors will be
supervised by more senior staff and the more important decisions will be taken by
managers and, ultimately, partners. In the event of negative audit findings there is
likely to be communication between team members about what has been
discovered and what should next be done. While the importance of team
behaviour is acknowledged by academics, little research has been undertaken in
this area as much of this communication is informal and it is often difficult to
reconstruct the audit team’s thought process after the event. Audit regulators face
the same challenge (see paragraph 58).
14. Audit firm policies and procedures, normally embodied in audit methodologies,
will also often address how audit teams should respond to particular issues
including the possible detection of frauds or illegal activity within the audited
entity.
9
For example ISA (UK and Ireland) 500 paragraph 11 states that ‘If: (a) audit evidence obtained from
one source is inconsistent with that obtained from another, or (b) the auditor has doubts over the
reliability of information to be used as audit evidence, the auditor shall determine what modifications
or additions to audit procedures are necessary to resolve the matter, and shall consider the effect of the
matter, if any, on other aspects of the audit’.
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Auditor scepticism: Raising the bar
Growing importance of auditor scepticism
15. Towards the end of the 1990’s the APB published two Discussion Papers both of
which attached considerable importance to professional scepticism:
• ‘Fraud and audit: Choices for society’10
• ‘Aggressive Earnings Management’11
16. In the case of ‘Fraud and audit: Choices for society’, professional scepticism was
identified as being especially important for junior staff who, because of their
contact with client management and their direct involvement in inspecting and
testing transactions, had the best opportunity of identifying suspicious
circumstances.
17. In ‘Aggressive Earnings Management’ the APB described the opportunities that
exist for companies to mislead the capital markets about their performance and
profitability by biasing accounting estimates. While recognising the difficulties
that auditors face in identifying and responding to such situations, the APB
encouraged auditors to be more sceptical in their audit of accounting estimates. As
a result of APB’s work in this area requirements relating to the application of
scepticism have been embedded in Auditing Standards and the relevant standard12
relating to the audit of estimates has been extended to cover the audit of fair
values.
18. Changes in accounting requirements, especially the increase in estimation
involved in preparing financial statements in accordance with IFRS, means that
scepticism throughout the audit team has become even more important for audit
quality. Scepticism is needed by auditors both to challenge management about
whether accounting estimates are appropriate and to challenge themselves as to
whether sufficient appropriate audit evidence has been obtained to support those
estimates. This often involves auditors assessing whether the assumptions
underlying estimates seem plausible. Assessing the plausibility of assumptions can
not be performed without an appropriate degree of scepticism and challenge.
19. The AIU has raised concerns over insufficient auditor scepticism with the
leadership of the major global audit firms and has sought action plans setting out
how these firms intend to address the root causes.
10
November 1998. www.frc.org.uk/apb/publications/other
June 2001. www.frc.org.uk/apb/publications/other
12
ISA (UK and Ireland) 540 ‘ Audit of Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures’
11
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Auditor scepticism: Raising the bar
Importance of scepticism in practice
20. Over the years, disciplinary investigations into Equitable Life Assurance Society,
London International Group, Independent Insurance, TransTec, Wickes and ERF
Holdings have identified audit failings. These include instances of over reliance
on management representations, failure to investigate conflicting explanations and
failure to obtain appropriate third party confirmations - which may suggest that
the auditors in these cases were not sufficiently sceptical.
21. A lack of scepticism has also been reported by the AIU. One of the findings
described in their 2009/10 Annual Report13 was that audit firms are not always
applying sufficient professional scepticism in relation to key audit judgements. In
particular, audit firms sometimes approach the audit of highly judgmental
balances by seeking to obtain evidence that corroborates, rather than challenges,
the judgments made by their clients.
22. The AIU also reported that auditors should exercise greater professional
scepticism when reviewing management’s judgements relating to fair values and
the impairment of goodwill and other intangibles and future cash flows relevant to
the consideration of going concern.
23. In the US, research has shown that the failure to demonstrate an appropriate level
of scepticism was a deficiency found in 60% of the cases where the SEC brought
fraud related actions against auditors14.
24. This is consistent with the findings of the US Panel on Audit Effectiveness. The
Panel, which was set up by the Securities and Exchange Commission (SEC) in
1998, conducted a very thorough review of the effectiveness of large audits by the
large audit firms15. The Panel reasserted the importance of professional scepticism
and observed that:
•
•
•
auditing standards needed to provide better guidance on how to implement the
concept,
audit firms should more effectively teach the concept of professional
scepticism, and
audit firms should develop or expand training for auditors at all levels oriented
toward responsibilities and procedures for fraud detection. These programs
should emphasise interviewing skills and the exercise of professional
scepticism, as well as testing techniques.
13
Published on 21 July 2010
Beasley, M.S., J.V. Carcello & D.R Hermanson, 2001. Top 10 audit deficiencies. Journal of
Accountancy 191 (4):63-66
15
At the request of the SEC, the Public Oversight Board appointed the Panel on Audit Effectiveness in
October1998 to assess whether independent audits of the financial statements of public companies
adequately serve and protect the interests of investors. The Panel reviewed and evaluated the way that
audits were performed, and assessed trends in audit practices to determine whether they were in the
public interest. It studied the audit policies, methodologies and other forms of guidance used primarily
by the large audit firms, certain aspects of auditor independence and the auditing profession’s selfregulatory structure.
14
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Auditor scepticism: Raising the bar
25. The academic work summarised in Appendix 1 also provides some indicators that
auditors may not be sufficiently sceptical, although it is recognised that much of
this is US research and the findings may not apply to auditors working in different
environments.
Development and promotion of auditor scepticism within audit firms
26. Scepticism is an important element of audit quality and, in the medium to long
term, audit failures can expose audit firms to litigation and reputational damage.
Consequently audit firms have policies and procedures aimed at achieving audit
quality.
27. However, it is also clear that audit firms place considerable importance on
retaining their client base. Emphasis on client service planning and relationship
management within the firms may act as a disincentive for auditor scepticism if
audit teams believe that by demonstrating scepticism they risk having an ‘unhappy
client’.
28. Particular problems are likely to arise if scepticism results in a delay in the
completion of the audit. The timetable for an audit is usually agreed in advance,
especially if the entity is a listed company which has agreed a date upon which to
announce its results. Delays caused by the auditor pursuing additional inquiries
that cause the audit not to have been completed by the agreed date can be
problematic, especially if the auditors’ concerns prove to be unfounded.
29. Furthermore, application of scepticism can also directly threaten short term
profitability. The fees for most audits are agreed in advance on the basis of time
estimates; additional fees for variances from the plan are negotiated after the audit
is completed . Initial fee estimates are often prepared on the basis that the entity’s
controls will be shown to be operating effectively and that few other problems
will be revealed. The audit market is competitive and such fee estimates do not
usually contain contingencies for dealing with the unexpected. Negotiations for
additional fees after the audit has been completed can adversely impact client
relationships. In this environment there may be an incentive for the audit team to
adhere strictly to the plan. Keeping to the plan is also a plausible strategy for
junior staff who are already working long hours and may not wish to work even
longer16.
30. Two particular areas that are likely to be relevant to the development and
promotion of auditor scepticism are (a) recruitment, training and motivation /
reward processes and (b) audit methodologies.
16
B Pierce and B Sweeney ‘Cost quality conflict in audit firms: an empirical investigation’ and M Page
‘A survey of time budget pressure and irregular auditing practices among newly-qualified UK
chartered accountants’.
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Auditor scepticism: Raising the bar
Recruitment, training and motivation/reward processes
31. If the underlying characteristics of scepticism are largely innate then initial
recruitment policies are likely to be important in helping audit firms employ staff
with the appropriate attitude.
32. While recognising that there are a number of different qualities that audit firms
will be seeking in new recruits, more could perhaps be done to extend the
electronic screening that is often currently used to seek out the character traits
underlying sceptical behaviour. Even if initial recruitment does not focus on
scepticism, subsequent promotion/retention policies could be used to promote its
importance.
33. If underlying characteristics are largely an acquired skill then training and
development in the firm become more important. In this context lessons might be
learnt from how the US audit firms responded to the US Panel on Audit
Effectiveness’ recommendation that firms should more effectively teach the
concept of professional scepticism.
34. However, irrespective of how effective the ‘classroom training’ might be, it will
be lost in the pressure of practice unless it is reinforced through the culture of the
firm and its mentoring and reward systems. Many believe that nurturing the ‘right’
professional qualities is best achieved through junior staff working closely with
more experienced partners and staff provided that such senior personnel already
have the ‘right’ qualities.
35. A key stimulus to achieving an appropriate level of scepticism in junior staff is
likely to be through coaching undertaken as part of the review process. Research
suggests that one way to enhance professional scepticism is for reviewees to
understand that scepticism is a priority of the reviewer. It also suggests that junior
auditors who expect a face-to-face review undertake more thorough work than
those who anticipate interacting with the reviewer electronically or who do not
anticipate being reviewed at all.
36. This is consistent with the importance given to coaching and mentoring in the
FRC’s publication ‘Promoting Audit Quality’.
37. It is possible that the level of innate scepticism varies between cultures. If so this
is likely to be a challenge for audit firms undertaking group audits where the work
on overseas subsidiaries is undertaken by national firms. While there is a
requirement in Auditing Standards17 for the group auditor to obtain an
understanding of the subsidiary auditor’s professional competence there is no
specific indication that this should include the degree of scepticism and indeed
this could be very difficult to achieve in practice. Although Auditing Standards
require the group auditor to be actively involved in the audit of significant
subsidiaries it is questionable whether this could fully compensate for a systematic
lack of scepticism in the local team. Other techniques such as staff secondments
17
ISA (UK and Ireland) 600 paragraph 19
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Auditor scepticism: Raising the bar
from other countries may be a more effective approach to national variations in
scepticism if they exist.
Audit methodologies
38. Audit firms, particularly the largest, invest significant amounts in their audit
methodologies and quality control systems.
39. In recent years audit methodologies have grown both in their complexity and their
influence on what audit work is done in practice, especially by more junior
members of the audit team. This is, in part, influenced by developments in
Auditing Standards and other regulatory activity but also by the larger audit firms’
wish to standardise parts of the audit and to take advantage of control techniques
that become available in electronic working papers.
40. The FRC’s ‘Promoting Audit Quality’ observed that electronic working papers
had the potential to distance both partners and staff from the company being
audited and reported anecdotal evidence that the proportion of audit time spent by
staff sitting in the audit room completing electronic schedules seemed to be
increasing at the expense of time spent reviewing client records, discussing
accounting issues with client staff and otherwise obtaining audit evidence.
41. It is of course easier to imagine auditor scepticism being applied when auditors
are ‘walking the floor’, observing and inspecting the company's operations, rather
than sitting in the audit room completing electronic schedules - but there are also
wider issues associated with the integration of methodologies and electronic
working papers. Self-determination or freedom to act appears to be one of the
character traits that fosters sceptical behaviour. This involves individual auditors
having the ability to pursue their own inquiries when needed and the motivation to
do so. Rather than requiring auditors to perform predefined audit tasks and
complete checklists, professional scepticism might be better fostered by
methodologies encouraging auditors to ask management relatively open questions
and follow up on responses.
42. Academic research, albeit before the latest generation of electronic working
papers, suggests that the firms’ documentation systems are reducing the amount of
detailed comments that show how thinking on a particular topic evolves and how
final conclusions are reached. Documentation of this nature would seem to be
especially important to support judgements, for example on the acceptability of
fair values, when the work of relatively junior staff is reviewed and challenged by
more senior members of the audit team who apply their wider knowledge of the
entity and their greater experience to the judgements. An absence of a clear
‘thought trail’ is likely to reduce the opportunity for juniors to learn and inhibit the
effectiveness of review processes18.
18
A clear record of the auditor’s thought process is also likely to be beneficial to audit quality more
generally as documentation often helps structure a thought process and helps the author and subsequent
reviewers identify illogicalities and inconsistencies.
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Auditor scepticism: Raising the bar
43. Active consideration of how auditors make, and document, important judgements
is likely to be a useful area of future research. In particular it may be worth
exploring how members of the team, especially the partners and managers, review
the work of the rest of the audit team in an electronic environment, how they raise
review points and how the actions taken in response to them are documented. It
would also be worth discussing why review notes are not usually retained once the
audit has been completed.
44. It is apparent that audit firms often request their clients to prepare, in advance of
the audit, specific schedules and analyses (‘client co-operation arrangements’). In
some cases the level of client assistance may be greater and include, for example,
extracting records from files and other work. While saving audit costs, there is a
danger that such arrangements may influence the auditor’s mindset and make
them over-trusting. Academic research in Ireland19 suggests that co-operation and
trust seem to be mutually reinforcing conditions and that excessive trust may
reduce auditor scepticism.
45. Where client co-operation arrangements are established, it is important that audit
teams do not allow them to reduce the level of scepticism demonstrated and that
such arrangements do not allow client management to influence the extent and
nature of audit work performed.
Can more be done to promote auditor scepticism?
46. Audit firms – Audit firms have invested significantly in recent years in the
automation of their systems in order to obtain efficiency and effectiveness
benefits. This may be an appropriate stage for them to take stock of the progress
made and to evaluate the impact of their systems on the judgemental aspects of the
audit and in particular on the mindset of staff at all levels.
47. Further consideration of aspects of their recruitment, training, methodology, and
motivation and reward processes may provide opportunities for increased auditor
scepticism and, therefore, improve audit quality.
48. Auditing Standards - Auditing Standards applicable in the UK and Ireland20
require the auditor to plan and perform an audit with professional scepticism21 and
guidance as to the importance of scepticism is provided in supporting application
material. Reference to the need for auditor scepticism is also made in a number of
other Auditing Standards (see Appendix 2) most notably ISA (UK and Ireland)
200 on the overall objectives of the auditor and ISA (UK and Ireland) 240 on
fraud.
19
‘ Extended Clan: External Influences on Audit Team Behaviour’ Sweeny and Pierce
The ISAs (UK and Ireland) are the ISAs issued by the International Auditing and Assurance
Standards Board ( IAASB) supplemented, where appropriate, with additional requirements to address
specific UK and Irish regulatory requirements and additional guidance that is appropriate in the UK
and Irish national legislative, cultural and business context.
21
ISA (UK and Ireland) 200 paragraph 15
20
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Auditor scepticism: Raising the bar
49. Over recent years, the Auditing Standards, have been revised to make them more
rigorous22. This has involved, in part, imposing requirements on all auditors to
perform certain procedures which, while normally undertaken by a sceptical
auditor, were not always performed in practice. Examples include:
• Mandatory meetings of the audit team to discuss the susceptibility of the entity
to:
- misstatements (ISA 315),
- fraud (ISA 240), and
- fraud or error that could result from related party relationships (ISA 550),
• Reviewing the outcome of opening provisions (ISA 540),
• Checking a sample of journal adjustments (ISA 240),
• Evaluating risks in relation to revenue transactions based on the presumption
that there are risks of fraud in revenue recognition (ISA 240), and
• Investigating significant related party transactions outside the entity’s normal
course of business (ISA 550).
50. That said, experience from audit inspections would suggest that further action
could be taken; for example consideration could be given to whether Auditing
Standards inadvertently lead auditors to place undue reliance on management’s
work and whether there might be new requirements for:
• Fuller documentation of the rationale for key audit judgements, perhaps by
mandating Audit Completion Memoranda,
• The retention of review notes as part of audit documentation,
• Meetings of the audit team after most of the work has been completed, but
before the audit report is signed, to discuss findings,
• Ensuring that reviews are undertaken in person rather than remotely.
51. However, in considering whether more should be done to make Auditing
Standards more specific, consideration needs to be given to the risk that a further
move away from ‘principles’ towards ‘rules’ will demotivate audit staff and add
unnecessarily to the cost of some audits. Furthermore, specification of required
procedures does not necessarily ensure that the work is performed in a sceptical
manner and that there is adequate follow up of the findings.
52. Guidance - Rather than adding more requirements to standards, APB could
perhaps develop guidance on audit scepticism to help audit firms understand its
nature and how best it might be encouraged. Such guidance might build on
research undertaken in a UK context.
53. Another possibility might by for APB, or another body, to publish summaries of
the lessons learnt from investigations into possible audit failures. ‘War stories’ of
this nature may help increase auditor scepticism and assist with fraud detection.
22
Some of these changes were introduced for UK and Irish audits of accounting periods ending on or
after 15 December 2010 when the Clarified ISAs (UK and Ireland) became effective.
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Auditor scepticism: Raising the bar
54. Ethical Standards – Some academics consider that there is an inverse
relationship between scepticism and trust. As one observed ‘As the auditor-client
relationship lengthens, a behavioural bond develops between the auditor and the
auditee as they become more familiar with each other and mutual trust replaces
the auditor’s necessary professional scepticism’. At some point, it is argued, the
degree of trust can become so great that violations will not be challenged as
auditors instinctively favour evidence that confirms their prior beliefs. One of the
difficulties here is that two of the vital ingredients of a high quality audit –
scepticism and knowledge of the client’s business - seem to be pulling in different
directions.
55. Ways of avoiding auditors placing too much trust in their clients are traditionally
addressed in Ethical Standards. Methods used to enhance auditor objectivity and
independence include:
• Rotation (both of firms and partners and staff),
• Prohibition of certain non-audit services – especially those that create a
mutuality of interest with management, and
• Prohibition of employment, by the audited entity, of ex-audit team
members.
56. These topics were debated during the Government’s enquiry by the Co-ordinating
Group on Audit and Accounting Issues (CGAA) into the implications of the Enron
failure for UK auditing and accounting. These areas are also addressed in APB’s
Ethical Standards for Auditors which were first issued in 2004 and subsequently
reviewed in 2007. Neither the CGAA nor the APB thought that it was necessary to
introduce mandatory rotation of audit firms, but the rotation period of audit
partners on listed company audits was reduced from seven years to five.
57. Audit inspection. The AIU is responsible for monitoring the audits of all listed
and other major public interest entities23. This involves, inter alia, the AIU
forming a view on the quality of the important judgements made during the audits
they inspect and evaluating whether sufficient scepticism has been demonstrated.
As noted above, the AIU has commented that audit firms are not always applying
sufficient professional scepticism in relation to key audit judgements.
58. One of the challenges faced by audit inspectors is that there are two aspects to
scepticism – sceptical thinking and sceptical actions. Sceptical thinking operates,
or does not operate, within an individual auditor’s mind. While it can probably be
witnessed on a real time basis, the transparency to others of sceptical thought
rapidly reduces over time. Audit inspectors, who review audit documentation
some time after it is performed and do who not see original client records, may see
evidence of sceptical actions but, without knowing what was in the auditor’s mind
at the time, it is difficult to evaluate the adequacy of these. The problem of
evaluating the degree of sceptical thinking within an audit team is exacerbated by
the removal from the audit documentation of review notes on completion of the
audit (see paragraph 13 above).
23
The AIU’s scope is the audits of all UK incorporated companies with listed securities (both equity
and non-equity securities) and other entities in whose financial condition there is considered to be a
major public interest. The AIU reviews a sample of audits each year.
15
Auditor scepticism: Raising the bar
59. Companies – Corporate culture and behaviour can impact auditor scepticism –
too close a relationship between management and the auditor may reduce auditor
scepticism; too hostile a relationship, whether resulting from excessive challenge
by the auditor or from a defensive attitude by the audited entity’s management
and/or staff, may be intimidating to the auditor and/or may create an environment
in which there is a lack of openness in responding to auditor enquiries.
60. Periodically audit committees may wish to consider whether there is an
appropriate relationship between management and the auditors and, if not what
can be done to change it. However, deciding what to do if the relationship is not
right is likely to be challenging. It is not easy to change management behaviour
and while requiring changes in the audit team, or indeed changing the audit firm,
may appear an easier solution, audit committees will be aware that such actions
were sometimes taken in the past and some audit failures have demonstrated that
this had the effect of weakening audit quality rather than strengthening it. One
possible safeguard to this concern might be the mandatory rotation of audit firms
but there are well documented disadvantages to such a requirement.
61. The UK Corporate Governance Code anticipates that the audit committees of
listed companies will review and monitor the effectiveness of the audit process.
As well as considering the relationship between management and the audit team,
audit committees may wish to consider whether the audit partner and staff
exhibited sufficient levels of professional scepticism in their work and were robust
in dealing with issues identified during the audit24. In this context, the AIU issues
reports on the individual audits reviewed each year and the auditors are required
to provide copies to the audit committee of the audited entity – these should
provide further input to their consideration of audit effectiveness, where
applicable. Direct consideration of whether the audit team was sufficiently
sceptical, and communication with the audit firm if this was not the case, is likely
to help increase the emphasis audit firms place on this.
62. Audit committees can also influence scepticism in advance of the audit. Open
discussion with the auditors about business and accounting issues will help alert
them to risk areas. Furthermore, when discussing proposed audit fees, audit
committees may wish to challenge whether they include an appropriate
contingency for dealing with any unexpected developments (see paragraph 29).
63. Accountancy bodies – There is likely to be a link between scepticism and
training. While much of the audit related training is provided by the audit firms,
the accountancy bodies have responsibility for the curriculum leading to
qualification as an accountant and also have requirements relating to continuing
professional development (CPD).
24
See the FRC’s Audit Quality Framework.
16
Auditor scepticism: Raising the bar
64. More could perhaps be done to enhance auditor scepticism through training
provided by the accountancy bodies. One possible mechanism might be through
developing training videos. It is interesting to observe that films such as ‘The
Auditor in Court’25 and ‘Billion Dollar Bubble’26 that were viewed by many older
auditors are no longer readily available to younger members of the profession.
65. Academics - One of the inevitable conclusions to academic research papers is that
‘more research needs to be carried out’ and this is clearly the case in relation to
auditor scepticism and how it can be increased. Possible topics include:
Conceptual
• To what extent are underlying characteristics of scepticism innate or acquired?
• If innate do these vary with cultural background?
• How do the different underlying factors combine (for example are they
additive or multiplicative)?
• Do sceptics respond to time / client pressure in the same way as non-sceptics?
• What is the relationship between levels of education and scepticism?
Training and development
• Can scepticism be taught? If so, how?
• What is best practice within firms for developing and maintaining scepticism?
• Do firms encourage or discourage self-determination?
• How do firms evaluate/reward staff for scepticism?
Audit methodologies
• Do methodologies encourage auditors to ask questions?
• Do electronic working papers facilitate the making and recording of the
important audit judgements? Do they encourage sceptical behaviour?
• Can improvements be made to how:
o auditors make, and document, important judgements?
o partners and managers review work in an electronic environment?
o partners and managers raise review points and how the actions taken in
response to them documented?
66. The APB and the POB would welcome copies of any research studies undertaken
in the UK and Ireland on auditor scepticism or related topics and being informed
if studies are underway or due to commence.
25
26
An ICAEW film that followed the cross examination of an audit practitioner accused of negligence.
The story of the Equity Funding fraud
17
Auditor scepticism: Raising the bar
Questions
1. Do you agree with the emphasis that this paper places on the importance of
auditor scepticism? Are there aspects of the analysis, including the summary of
academic research in Appendix 1, with which you particularly agree, or disagree?
If so, what are they?
2. Regulators have recently challenged audit firms on whether sufficient scepticism
was demonstrated on some audits:
•
•
•
Do you think that this problem is widespread or limited to certain types of audits
or circumstances?
What factors do you believe do, or could, in practice create disincentives for
auditors to apply an appropriate degree of professional scepticism and what
should be done about them?
In what areas do you think auditors should be more (or less) sceptical in their
approach?
3. How do you think audit firms should promote and develop professional scepticism
in their partners and staff? Do they need to do more and, if so, what?
4. Do you think that others, including companies, should be doing more to promote,
develop and support professional scepticism in auditors? If so, what?
18
Auditor scepticism: Raising the bar
Appendix 1
Academic research on auditor scepticism
This appendix outlines the manner in which academic research has investigated the
characteristics underlying auditor scepticism and the degree to which it is likely to be
exhibited in practice, and provides illustrative findings from that research.27
Studies of auditor scepticism fall within a broad field of research concerned with
judgement and decision making in auditing, looking at the manner in which individual
attributes and contextual variables are associated with the judgements auditors form
and the actions they take when conducting an audit. Much of the research in this field
has been undertaken by US academics and it should be noted that the findings may
not apply equivalently to auditors working in different countries and environments.
Furthermore, due to the difficulty of gaining research access to ‘real life’ situations,
many studies have relied upon hypothetical case examples tested using surveys or in
settings outside practice rather than data drawn from actual audit engagements. While
research designs employing hypothetical cases are useful in illustrating the
significance of specific factors they cannot easily capture all the complexities that are
found in practical situations.
While some of the research is current, some dates back to the 1990s and before. To
the extent that the audit firms have changed attitudes and behaviour, for example by
responding to the recommendations of the US Panel on Audit Effectiveness, this will
not be reflected in the older research.
This summary draws attention to research findings in the following three categories:
•
Studies that seek to identify characteristics underlying auditor scepticism;
•
Studies that explore the factors which may influence the degree of scepticism
reflected in auditor behaviour;
•
Studies that explore the scepticism in the context of the audit firm.
Characteristics underlying auditor scepticism.
Some researchers have sought to identify the elements which characterise sceptical
behaviour. This approach goes beyond seeking simply to define auditor scepticism to
identify the characteristics that are associated with differing levels of scepticism
between individuals and the resulting types of behaviour which reflect the application
of professional scepticism. Distinction is often drawn between sceptical judgement
and sceptical actions. While individual judgements may be more or less sceptical, it is
only when scepticism reaches a threshold that the judgement will lead to consequent
identifiable action by the auditor, such as obtaining more evidence or seeking
adjustments.
27
An in-depth review of the literature can be found in: Nelson, M., “A Model and Literature review of
Professional Skepticism in Auditing”, Auditing a Journal of Practice and Theory, Vol. 28, No. 2,
November 2009, pp. 1-34.
19
Auditor scepticism: Raising the bar
Approaches to investigating professional scepticism in the research literature, and also
to applying it in practice standards, adopt differing views about what professional
scepticism means in terms of the initial mindset that the auditor should have in
undertaking an engagement. Contrast can be drawn between a “neutral” mindset, in
which the auditor neither accepts management figures and explanations in an
unquestioning way nor assumes that there is error or misstatement, and “presumptive
doubt” where the auditor exhibits a heightened awareness of the risk that the figures
could be affected by error or dishonesty28. Auditors have sometimes been criticised
for not applying sufficient professional scepticism, implying that more doubt would
have led auditors to have investigated further or look for more persuasive evidence
and to have avoided alleged failures as a result. However, greater doubt is not
unambiguously a good thing as it may lead to unnecessary procedures, over-auditing
and inefficiency.
Hurtt, Eining and Plumtree29 studied how scepticism was treated in early
philosophical writings and in other relevant disciplines (including scepticism reflected
in the work of psychologists, jury behaviour and consumer behaviour in relation to
advertising). They identified four behaviours expected of sceptics, namely:
• Expanded information search – sceptics always demand reasons, evidence,
justification and proof ,
• Increased contradiction detection – sceptics seek out inconsistencies
• Increased alternative generation – sceptics construct alternative explanations
• Increased security of source reliability – sceptics make links with
understanding people’s motivation / behaviour. A sceptic will be concerned
about the reliability and independence of data sources.
Based on this approach they developed a model (the Hurtt Model) of auditor
scepticism which involves:
Factor
Underlying characteristics
1 Examination of
• Questioning mind – a sceptic questions everything
evidence characteristics
even their own judgements.
• Suspension of judgement – sceptics want to see
evidence before making conclusions; they are
slow to form a judgement.
• Search for knowledge / curiosity - sceptics seek
knowledge for its own sake.
2 Understanding
• Interpersonal understanding – understanding
evidence providers
peoples motivation and behaviour is a
fundamental requirement in scepticism.
3 Characteristics to act
• Self-confidence – the propensity to challenge
on the information
assumptions.
• Self-determination – an auditor must individually
decide when a sufficient level of information has
been obtained.
28
Bell,T.B, M.E. Peecher, and I. Solomon. 2005. The 21st Century Public Company Audit, New York.
Hurtt, K., M. Eining and D. Plumtree, “Professional Skepticism: A Model with Implications for
Research, Practice and Education”, working paper, University of Wisconsin – Madison, 2002.
29
20
Auditor scepticism: Raising the bar
The Hurtt Model has been applied in research undertaken with practicing auditors in
the Netherlands. Quadackers, Groot and Wright30 tested the strength of the
relationship between four possible determinants of auditor scepticism (trust,
suspension of judgement, locus of control and the Hurtt Model). A total of 376
practitioners from the Big Four in the Netherlands responded to a case scenario where
the results of an analytical procedure showed an unusual increase in sales and a fairly
superficial management response. The results showed that 2 of the 4 determinants
(trust and the Hurtt Model) had the highest explanatory power in predicting sceptical
behaviour.
Hurtt has used the Model herself31 to explore auditor behaviour and concludes that
while less sceptical auditors may be better at identifying factual errors, more sceptical
auditors are better at identifying situations containing contradictory information and
adopting a holistic view of evidence. While acknowledging that both skills are
valuable she postulates that while less sceptical auditors focus on the details more
sceptical auditors are better at developing a coherent conceptualisation of evidence
taken as a whole.
Factors influencing the degree of scepticism reflected in auditor
behaviour
A further line of research has investigated how various factors can influence the
degree of professional scepticism reflected in auditors’ judgements and actions. While
some of this research seeks to model the potentially complex interactions between
different factors, for present purposes it is sufficient to note that studies have shown
that auditor knowledge, personal traits and incentives may be linked to variations in
auditor scepticism32.
Auditor knowledge, experience and training
Increased knowledge, specialist experience and training have been shown to enhance
auditors’ awareness of potential causes of error and the ability to recognise patterns
and respond to risk factors. However, increased knowledge may not always result in
increased scepticism as some studies have shown that knowledge also increases the
likelihood that reasons other than error will be accepted by specialists as explanations
for unusual patterns.
30
Quadackers, L.,M., T.L.C.M. Groot and A. Wright, “Auditors’ Skeptical Characteristics and their
Relationship to Skeptical Judgments and Decisions”, working paper, VU Amsterdam, 2009.
31
K. Hurtt, M. Eining and D. Plumlee, “Linking professional skepicism to auditor behaviours”, Baylor
University, working paper 2010.
32
See Nelson M., 2009, op. cit., for a more detailed review of studies on each of these factors.
21
Auditor scepticism: Raising the bar
Incentives
Several incentive factors may influence the likelihood that auditors will behave in a
manner that reflects increased scepticism and studies have shown that incentives do
affect auditors’ behaviour. These incentive factors include the relationship with the
client company and opportunities for additional services and revenue generation, the
nature of review and performance appraisal within the firm and related recognition
and reward, and regulatory inspection and threats to reputation. It is the overall
balance which is likely to affect judgements and actions in an audit engagement.
Overall, the evidence suggests that auditors’ judgements will exhibit more scepticism
where concern for reputation and exposure to litigation is greater rather than concern
for firm revenue or the potential loss of a client. Less is known about how
performance evaluation and reward systems within audit firms can be used to promote
appropriate levels of professional scepticism in auditors’ behaviour.
Traits
An important question that has been investigated by a number of researchers is
whether underlying personal attributes are influential on the degree of scepticism
exhibited by auditors. For example, problem solving ability has been shown to be
relevant to the ability to identify potential errors. Ethical and moral development also
appears to be related to auditors’ ability to identify potentially inappropriate actions
by a client. The characteristics included in the earlier table describing the Hurtt
model, such as self-confidence, self-determination and interpersonal understanding
also relate to the personal attributes, or traits, possessed by the individual auditor.
Several studies have examined how interpersonal trust affects sceptical judgements
and actions.
Rennie, Kopp and Lemon 33 explored the tension between trust and professional
scepticism. They note that trust is a practical necessity for the efficient conduct of an
audit but over time trust accumulates and that at some point too much trust destroys
audit quality. Research in this area suggests that co-operation and trust are mutually
reinforcing. What is important, it is suggested, is how the auditors respond to
evidence of a trust violation. In the US, Lewicki and Bunker34 use an existing model
of trust to explore at what point the auditor might place too much trust on
management:
33
Rennie, M.D., L.S. Kopp and W.M. Lemon, "Exploring Trust and the Auditor-Client Relationship:
Factors Influencing the Auditor's Trust of a Client Representative", Auditing a Journal of Practice and
Theory, 2010.
34
Lewicki, R.J. and B.B. Bunker. 1996. “Developing and maintaining trust in work relationships”- in
“Trust in Organizations: Frontiers in Theory and Research” edited by Kramer R and T .Tyler: Newbury
Park, CA.
22
Auditor scepticism: Raising the bar
Category of
trust
Calculus-based
Knowledge
based
Identification
based
Characteristics
Fragile. An early stage of a
relationship where trust is based
on a rational assessment of the
relative costs and benefits giving
or withholding trust.
More robust. A higher level of
trust based primarily on the
history of interaction between
individuals.
Highly robust. The highest level
where an individual identifies
with the others desires and
intentions
Response to evidence of a trust
violation.
Trust likely to be terminated
Relationship more forgiving – if
an adequate explanation can be
found for the violation it will
often be accepted.
Sense-making process likely to
apply – auditors will favour
evidence that confirms their
beliefs. Ambiguous or
incomplete information will be
interpreted in a way not to
change the belief.
Lewicki and Bunker suggest that the optimal level is calculus-based trust. They
indicate that trust can be strongly influenced by members of management previously
being employed by the audit firms – especially if that individual is personally known
to the audit team. In such cases past-trust is often not re-evaluated in the new context.
The authors also note the influence that the provision of advice / non- audit services
can have on trust35.
Also in the US, Shaub and Lawrence36 noted that the Independence Standards Board37
had identified inappropriate trust as one of the five biggest threats to auditor
independence and explored the auditor-client relationship. They identified two types
of trust: (a) rational (emotional) trust and (b) deep auditor-client interdependence and
postulated that deep auditor-client interdependence is likely to be troublesome for
auditor independence / scepticism (especially where there is information asymmetry).
35
The authors cite the Panel on Audit Effectiveness’ 2000 report which noted that some services can
subvert neutrality, impartiality and scepticism and create a mutuality of interest with management.
36
Shaub, M.K. “Trust as a Threat to Independence : Emotional Trust, Auditor-client Interdependence,
and their impact on Professional Skepticism”, 2004
37
The Independence Standards Board (ISB) was established in May 1997 as a result of discussions
between the American Institute of Certified Public Accountants (AICPA) and the U.S. Securities and
Exchange Commission (SEC). The operating policies of the ISB were designed to permit timely,
thorough, and open study of issues involving auditor independence and to encourage broad public
participation in the process of establishing and improving independence standards. The ISB ceased its
operations in 2001.
23
Auditor scepticism: Raising the bar
Work in Ireland by Sweeney and Pierce38 provides an insight into the relationship
between trust and auditor scepticism. This study involved interviews with 18 client
staff39 to assess the extent to which client staff can influence audit team behaviour,
recognising that there needs to be a balance between professional scepticism and the
need for client co-operation. The conclusion was that client staff can, and do,
influence behaviour, for example by imposing over-demanding deadlines, late
delivery of information, selecting samples and providing misleading answers to
questions. The suggestion is that this manipulation is easier when audit staff are
young and have no real business experience. The study also gives some interesting
insights into what auditor scepticism is and how it can be achieved. The main aspects
of scepticism identified are:
Character of the
auditor
•
•
•
•
Audit firms systems –
positive factors
•
•
Audit firms systems –
negative factors
•
•
•
Confidence and knowledge – junior staff find it
difficult to say ‘I don’t understand that’
Probing skills / persistence. This may be impacted by
culture
Not shying away from confrontation, and
Strength of character in dealing with challenging or
confrontational situations
Strong manager / partner reviews especially if they are
knowledgeable about the clients business
Strong contact between manager / partner and junior
staff
Increasing documentation requirements
Too many check lists in methodology – lack of
emphasis on understanding the client’s business
Over aggressive budgets / timetables
Professional scepticism in the context of the audit firm
While much of the research on sceptical behaviour has focused on the behaviour of
the individual auditor, the context of the professional firm and the audit team are also
relevant to the exercise of professional scepticism. For example, in his review of the
literature in this area, Nelson40 cites several ways in which professional firms can
enhance professional scepticism:
• Recruitment processes that include assessment of relevant attributes;
• Training in error recognition and in negotiation;
• Performance evaluation and promotion systems that reward appropriate
professional scepticism;
• Review processes that are structured to favour professional scepticism;
• Decision aids such as checklists and procedural or documentation
requirements;
• Incentives that promote challenge in the audit process.
38
Sweeney, B. and B. Pierce, “The Extended Clan: External Influences on Audit Team Behaviour”,
working paper.
39
The clients were listed companies audited by the Big Four, generally out of their Dublin offices.
40
Nelson, M., 2009, op. cit.
24
Auditor scepticism: Raising the bar
A number of studies have looked at how the firm context impacts on the exercise of
professional scepticism. In the US Shaub and Lawrence41 explored how socialisation
within the firm can affect professional scepticism and tested this using a case study
involving 710 auditors from a single large US firm. The study distinguished between
sceptical thinking (judgement) and sceptical behaviour (action). In general the work
demonstrated that there is a significant degree of professional scepticism in auditors at
all levels. However, they found that new staff level auditors demonstrate significantly
higher levels of sceptical thought and action than their superiors (seniors, managers
and partners). While overall the scepticism of seniors is similar to those of managers
and partners there is some evidence that the level of sceptical thinking of seniors is
greater than managers and partners.
Shaub and Lawrence suggest that the relationship between sceptical thinking and
sceptical behaviour is rather inelastic, in other words that an auditor’s scepticism must
reach a certain threshold before an auditor is willing to take action. They postulate
that a possible reason why this threshold is higher for partners and managers are
‘market factors’ ie the commercial pressure that they are under. The research
suggested that staff are more prepared than partners and managers to be sceptical on
those clients which are important to the firm for referrals and that partners are much
less sceptical than others when dealing with the office’s single biggest audit client.
A number of studies have demonstrated the importance of selection and socialisation
in developing and maintaining a firm’s culture of shared values and practices42.
Selection involves both recruitment and promotion. One study has shown that auditors
are more likely to be promoted if their level of moral reasoning is similar to that of
their superiors and that principled moral reasoning falls away in the manager and
partner ranks43. Other research44 shows that the high turnover of public accounting
firms helps to establish cultural stability – those who disagree with the firm’s value
leave it.
The suggestion that there is a tendency towards harmonising levels of scepticism
within an audit firm may be challenged by other work undertaken by Shaub and
Lawrence in the US45. They developed four categories reflecting individuals’
tendency to think sceptically and to act sceptically and, using a sample of 37546
auditors explored the relationship between those categories and (1) age/experience
and (2) ethical disposition.
41
Shaub, M.K. and J.E. Lawrence, “Differences in Auditors’ Professional Skepticism Across Career
Levels in the Firm” Advances in Behavioural Accounting Research, 2: 61-83, 1999.
42
For example, see: Pratt, J., and P. Beaulieu, “Organizational Culture in Public Accounting: Size,
Technology, Rank, and Functional Area.” Accounting, Organizations & Society, 17(7):.667-684..
43
Ponemon, L., “Ethical reasoning and selection-socialization in accounting”, Accounting,
Organizations and Society, 17(3-4): 171-189, 1992
44
Harrison, J.R. and G.R. Carroll.. “Keeping the Faith: A Model of Cultural Transmission in Formal
Organizations”, Administrative Science Quarterly, 36: 552-582, 1991.
45
Shaub, M.K. and J.E. Lawrence, “A Taxonomy of Auditors’ Professional Skepticism” , Research on
Accounting Ethics, 8: 167 -194, 2002.
46
The original sample was 710 but pre-screening eliminated those that did not consistently fit the
categorisation system.
25
Auditor scepticism: Raising the bar
Their categorisation system was:
Characteristics (tendency to think sceptically/ to act sceptically
Measured sceptics
Low thought / high action. Not overly suspicious of routine
behaviour but very alert when something out of the ordinary
happens – ‘activated professional scepticism’.
Aggressive sceptics
High thought / high action. These auditors are generally more
suspicious than others and are sensitive to harmful motives.
They take action even in low risk situations – likely to result
in inefficient auditing and client dissatisfaction.
Reluctant sceptics
Low thought / low action. A rational approach but one that
likely to result in poor audit quality – unlikely to detect
management fraud.
Conflicted sceptics
High thought / low action. These auditors demonstrate risk
recognition skills but they are not acted upon. Possible that
they are influenced by client reaction / cost issues. Tendency
to become cynical.
The results of the test, undertaken within a single large US firm, were:
Measured sceptics
12% of sample. These have the highest concern for
professional ethics.
Aggressive sceptics
26% of sample. Generally the youngest / least experienced.
Reluctant sceptics
36% of sample. Significantly more experience/age than the
other categories.
Conflicted sceptics
26% of sample – the least idealistic auditors.
The authors emphasise the superiority of the measured sceptic category and note that
it is troubling that 36% of the sample, are in the reluctant sceptic category. They also
find it troubling that 80% of partners and managers are either reluctant sceptics or
conflicted sceptics (in both cases the tendency to act is low). This may be because
repetitive experiences may leave them less susceptible to the surprise/shock that leads
to increased scepticism. The number of conflicted sceptics suggests cynicism,
disillusionment and low career satisfaction.
The authors draw out a number of implications for the profession including:
• If the goal is to develop more ‘measured sceptics’ training and reinforcement
are necessary.
• It will be necessary to teach new auditors recognition skills and feedback so
that they are not continually over-reacting.
• Conflicted auditors need to be rewarded not punished for their recognition
skills. A mentoring programme has the opportunity to assist in this
development.
• Additional training on recognition may not be helpful for the reluctant sceptics
who are generally the older auditors. They may need peers and supervisors to
challenge their thinking.
26
Auditor scepticism: Raising the bar
Further work by Shaub and Lawrence47 explored auditors’ propensity to confront
client across experience levels and gender within the firm. Based on responses from
700 auditors from a single large US firm to questions in a case study scenario, they
found that the willingness to question a client in detail declines based on experience
although for men there is some evidence of a pick-up at partner / manager level (the
number of partners included in the sample was however small). Partners appeared less
confrontational however in situations where the client is very large or is an active
purchaser of non-audit services. For women there is no sign of a pick up at manager
level (there were no female partners in the sample).
Summary
This brief review has illustrated how academic research has investigated the
characteristics underlying auditor scepticism, the manner in which factors such as
knowledge, personal attributes and incentives influence the degree of scepticism
reflected in the judgements and actions of auditors and the behaviour of individuals in
the context of the audit firm. The results provide insights into the nature of scepticism
in auditing, variations between the likely judgements and actions between different
auditors and the manner on which different elements can be used to enhance
professional scepticism. There remains considerable scope for research into the
culture of scepticism in UK auditing and how this is realised in actual audit practice.
47
Shaub, M.K. and J.E. Lawrence, “Exercising Professional Skepticism Through Client
Confrontation”, 2004
27
Auditor scepticism: Raising the bar
Appendix 2
References in scepticism in ISAs (UK and Ireland)
Para
Ref
Text from ISA
200. Overall Objectives of the Independent Auditor and the Conduct of an Audit
in Accordance with International Standards on Auditing (UK and Ireland)
7.
The ISAs (UK and Ireland) contain objectives, requirements and application
and other explanatory material that are designed to support the auditor in
obtaining reasonable assurance. The ISAs (UK and Ireland) require that the
auditor exercise professional judgment and maintain professional skepticism
throughout the planning and performance of the audit and, among other
things: ….
13(l)
Professional skepticism – 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.
15.
The auditor shall plan and perform an audit with professional scepticism
recognizing that circumstances may exist that cause the financial statements to
be materially misstated. (Ref: Para. A18-A22)
A16.
In the case of an audit engagement it is in the public interest and, therefore,
required by the IFAC Code, that the auditor be independent of the entity
subject to the audit. The IFAC Code describes independence as comprising
both independence of mind and independence in appearance. The auditor’s
independence from the entity safeguards the auditor’s ability to form an audit
opinion without being affected by influences that might compromise that
opinion. Independence enhances the auditor’s ability to act with integrity, to
be objective and to maintain an attitude of professional scepticism.
A18. Professional skepticism 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 (UK and Ireland).
28
Auditor scepticism: Raising the bar
A19.
Maintaining professional skepticism throughout the audit is necessary if the
auditor is, for example, to reduce the risks of:
•
Overlooking unusual circumstances.
•
Over generalizing when drawing conclusions from audit observations.
•
Using inappropriate assumptions in determining the nature, timing, and
extent of the audit procedures and evaluating the results thereof.
A20.
Professional skepticism is necessary to the critical assessment of audit
evidence. This includes questioning contradictory audit evidence and the
reliability of documents and responses to inquiries and other information
obtained from management and those charged with governance. It also
includes consideration of the sufficiency and appropriateness of audit
evidence obtained in the light of the circumstances, for example in the case
where fraud risk factors exist and a single document, of a nature that is
susceptible to fraud, is the sole supporting evidence for a material financial
statement amount.
A21.
The auditor may accept records and documents as genuine unless the auditor
has reason to believe the contrary. Nevertheless, the auditor is required to
consider the reliability of information to be used as audit evidence.48 In cases
of doubt about the reliability of information or indications of possible fraud
(for example, if conditions identified during the audit cause the auditor to
believe that a document may not be authentic or that terms in a document may
have been falsified), the ISAs (UK and Ireland) require that the auditor
investigate further and determine what modifications or additions to audit
procedures are necessary to resolve the matter.49
A22.
The auditor cannot be expected to disregard past experience of the honesty
and integrity of the entity’s management and those charged with governance.
Nevertheless, 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 skepticism or allow the auditor to be satisfied with lessthan-persuasive audit evidence when obtaining reasonable assurance.
48
49
ISA (UK and Ireland) 500, “Audit Evidence,” paragraphs 7-9.
ISA (UK and Ireland) 240, paragraph 13; ISA (UK and Ireland) 500, paragraph 11; ISA (UK and
Ireland) 505, “External Confirmations,” paragraphs 10-11, and 16.
29
Auditor scepticism: Raising the bar
A43.
Detection risk relates to the nature, timing, and extent of the auditor’s
procedures that are determined by the auditor to reduce audit risk to an
acceptably low level. It is therefore a function of the effectiveness of an audit
procedure and of its application by the auditor. Matters such as:
•
….
•
the application of professional scepticism; and
•
….
assist to enhance the effectiveness of an audit procedure and of its application
and reduce the possibility that an auditor might select an inappropriate audit
procedure, misapply an appropriate audit procedure, or misinterpret the audit
results.
A69.
220
A13.
50
In using the objectives, the auditor is required to have regard to the
interrelationships among the ISAs (UK and Ireland). This is because, as
indicated in paragraph A53, the ISAs (UK and Ireland) deal in some cases
with general responsibilities and in others with the application of those
responsibilities to specific topics. For example, this ISA (UK and Ireland)
requires the auditor to adopt an attitude of professional skepticism; this is
necessary in all aspects of planning and performing an audit but is not
repeated as a requirement of each ISA (UK and Ireland). ….
Quality Control for an Audit of Financial Statements
Direction of the engagement team involves informing the members of the
engagement team of matters such as:
•
Their responsibilities, including the need to comply with relevant ethical
requirements, and to plan and perform an audit with professional
skepticism as required by ISA (UK and Ireland) 200.50
•
…..
ISA (UK and Ireland) 200, “Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with International Standards on Auditing (UK and Ireland),” paragraph 15.
30
Auditor scepticism: Raising the bar
230
A7
Audit Documentation
…
•
In relation to requirements that apply generally throughout the
audit, there may be a number of ways in which compliance with
them may be demonstrated within the audit file:
o For example, there may be no single way in which the auditor’s
professional skepticism is documented. But the audit
documentation may nevertheless provide evidence of the
auditor’s exercise of professional skepticism in accordance with
the ISAs (UK and Ireland). Such evidence may include specific
procedures performed to corroborate management’s responses
to the auditor’s inquiries.
240
The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements
8.
When obtaining reasonable assurance, the auditor is responsible for
maintaining professional skepticism throughout the audit, considering the
potential for management override of controls and recognizing the fact that
audit procedures that are effective for detecting error may not be effective in
detecting fraud. The requirements in this ISA (UK and Ireland) are designed to
assist the auditor in identifying and assessing the risks of material
misstatement due to fraud and in designing procedures to detect such
misstatement.
12.
In accordance with ISA (UK and Ireland) 200, the auditor shall maintain
professional skepticism throughout the audit, recognizing 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. (Ref: Para. A7- A8)
13.
Unless the auditor has reason to believe the contrary, the auditor may accept
records and documents as genuine. 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
shall investigate further. (Ref: Para. A9)
A7.
Maintaining professional skepticism requires an ongoing questioning of
whether the information and audit evidence obtained suggests that a material
misstatement due to fraud may exist. It includes considering the reliability of
the information to be used as audit evidence and the controls over its
preparation and maintenance where relevant. Due to the characteristics of
fraud, the auditor’s professional skepticism is particularly important when
considering the risks of material misstatement due to fraud.
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Auditor scepticism: Raising the bar
A8.
Although the auditor cannot be expected to disregard past experience of the
honesty and integrity of the entity’s management and those charged with
governance, the auditor’s professional skepticism is particularly important in
considering the risks of material misstatement due to fraud because there may
have been changes in circumstances.
A9.
An audit performed in accordance with ISAs (UK and Ireland) rarely involves
the authentication of documents, nor is the auditor trained as or expected to be
an expert in such authentication.51 However, when the auditor identifies
conditions that 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, possible procedures to investigate further may include:
•
Confirming directly with the third party.
•
Using the work of an expert to assess the document’s authenticity.
A17.
Management is often in the best position to perpetrate fraud. Accordingly,
when evaluating management’s responses to inquiries with an attitude of
professional skepticism, the auditor may judge it necessary to corroborate
responses to inquiries with other information.
A33.
Determining overall responses to address the assessed risks of material
misstatement due to fraud generally includes the consideration of how the
overall conduct of the audit can reflect increased professional skepticism, for
example, through:
•
Increased sensitivity in the selection of the nature and extent of
documentation to be examined in support of material transactions.
•
Increased recognition of the need to corroborate management
explanations or representations concerning material matters.
It also involves more general considerations apart from the specific
procedures otherwise planned; these considerations include the matters listed
in paragraph 29, which are discussed below.
250 A Consideration of Laws and Regulations in an Audit of Financial
Statements
8.
51
52
The auditor is required by this ISA (UK and Ireland) to remain alert to the
possibility that other audit procedures applied for the purpose of forming an
opinion on financial statements may bring instances of identified or suspected
non-compliance to the auditor’s attention. Maintaining professional
skepticism throughout the audit, as required by ISA (UK and Ireland) 200,52
is important in this context, given the extent of laws and regulations that affect
the entity.
ISA (UK and Ireland) 200, paragraph A47.
ISA (UK and Ireland) 200, paragraph 15.
32
Auditor scepticism: Raising the bar
300
Planning an Audit of Financial Statements
Appendix - Considerations in Establishing the Overall Audit Strategy
Significant Factors, Preliminary Engagement Activities, and Knowledge
Gained on Other Engagements
….
•
The manner in which the auditor emphasizes to engagement team
members the need to maintain a questioning mind and to exercise
professional skepticism in gathering and evaluating audit evidence.
•
….
•
330
A1.
The Auditor’s Responses to Assessed Risks
Overall responses to address the assessed risks of material misstatement at the
financial statement level may include:
○
Emphasizing to the audit team the need to maintain professional
skepticism.
○
….
540
Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures
A40.
The review of prior period accounting estimates may also assist the auditor, in
the current period, in identifying circumstances or conditions that increase the
susceptibility of accounting estimates to, or indicate the presence of, possible
management bias. The auditor’s professional skepticism assists in identifying
such circumstances or conditions and in determining the nature, timing and
extent of further audit procedures.
550
Related Parties
7.
Planning and performing the audit with professional scepticism as required by
ISA (UK and Ireland) 20053 is therefore particularly important in this context,
given the potential for undisclosed related party relationships and transactions.
The requirements in this ISA (UK and Ireland) are designed to assist the
auditor in identifying and assessing the risks of material misstatement
associated with related party relationships and transactions, and in designing
audit procedures to respond to the assessed risks.
53
ISA (UK and Ireland) 200, paragraph 15.
33
Auditor scepticism: Raising the bar
A9.
Matters that may be addressed in the discussion among the engagement team
include:
•
….
•
An emphasis on the importance of maintaining professional
scepticism throughout the audit regarding the potential for
material misstatement associated with related party relationships
and transactions.
•
….
34