Auditor scepticism is an increasing concern for the profession and stakeholders of UK Companies - Essay Example

? Auditor scepticism is an increasing concern for the profession and stakeholders of UK Companies Introduction In this essay I will discuss about howauditor scepticism is an increasing concern for the profession and stakeholders of UK Companies. As the society is becoming more complex, decision makers are increasingly provided with unreliable information (Edmund, 2005). In the similar manner, several organizations around the world used to portray financial statements which are sometimes unreal as well as unauthentic. Therefore due to fake and unauthentic information, decision makers get adversely affected as the information leads them towards the wrong direction. The principal rationale for the companies to provide unreal data is remoteness of information, complex transactions and voluminous data. Now, in order to get rid of this problem, the society on a whole developed a common way of obtaining reliable information and termed it as audit. Auditing is a process of verifying information. The audited information then helps in the decision making process (Collier, 1993). It is also essential for the stakeholders and public for having confidence in the companies. The primary objective of auditing is about detecting and preventing any kind of frauds and errors. Despite of that, some companies still comes up with unreal data and manages to evade tax. According to reports, the major reason behind this phenomenon is the reduced scepticism level among the auditors. In UK, due to reduced scepticism among the auditors, stakeholders are finding it difficult to make proper decision pertaining to investment. As before investing, it is essential for the stakeholders to have confidence in the companies where they are investing. Therefore to get deep insights about the issue, the report will emphasize on how auditor scepticism is becoming a cause of concern for the stakeholders of the companies based on UK. In addition the report will also cover the areas associated with auditor scepticism. Finally based on the findings of the study, a conclusion will be drawn and recommendations regarding how auditor’s scepticism can be improved will be made. Auditor scepticism can be defined as the level of cynicism that an auditor needs to employ while conducting an audit. The notion became prominent in recent times when issues such as banking crisis came in the limelight. The regulatory authorities have raised question on the auditing firms on whether they demonstrated the level of scepticism needed to carry out an audit (Kan, 2007). Similarly in UK, the stakeholders of the companies are getting increasingly concerned about the low level of scepticism among the auditors. In addition to this, the auditing profession is also getting negatively impacted. According to auditing standards (ISA 200) professional scepticism is defined as an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence (PCAOB, 2010). Based on this definition, it can be identified that scepticism has high influence on the scope of the work. In addition, it also help the auditor’s to analyse the findings of audit thereby concluding whether appropriate evidences has been acquired for proving whether accounts are depicting true and fair view. There is a belief about the fact that a sceptical mind set and attitude is essential for an audit to be rigorous and carried out with a professional care. Scepticism is also important as it plays a crucial role in enhancing the efficiency and effectiveness of an audit. On the other hand too much scepticism negatively impacts the audit process. Hence a right balance of scepticism is necessary for an audit. However there is no predefined or standard degree of scepticism required to put into practice (Financial Reporting Council, 2010). The principal objective an audit is to enable that the auditors provide an outlook on the financial statements. The purpose is also to provide reasonable declaration that the statements are accurate and offering true and fair view. In addition, the intention of auditing financial statements is also to ensure that the statements are prepared in accordance with the proper accounting standards. Discussion According to several researchers, audit can bring about large amount of benefits to the organization in many ways. However, according to some of the managers of organizations, audit brings about lot of disruptions and increases the cost of a company. Audit is basically a statutory requirement and primary cause of an audit is to verify the authenticity of company’s information. Auditing helps to increase the investor’s confidence towards a company and attracting new investors. However the cost associated with it, sometime becomes a cause of concern (Kumar and Sharma, 2006). One of the most important forms of auditing is statutory audit. A statutory audit is a process by which the accuracy of a company’s financial records is reviewed. It is an audit relating to a particular financial year and is done only after the completion of that financial year. The primary function of a statutory audit is to determine whether the establishments are providing accurate and fair representations of their financial statements. The verification is mainly done by examining the bookkeeping records, bank balances and financial transactions. However it has large differences with the accounting. There are generally three hypothesis of auditing namely the information hypothesis, agency theory and the insurance hypothesis. The information hypothesis states that auditors are needed, as information becomes more reliable after it has been audited. The agency theory suggests that audit is necessary and justified as the resource providers cannot trust on the executives and managers to utilise their resources properly. Audit report reflects how and where the company has utilized the resources. The insurance hypothesis on the other hand points out to the fact that the auditor does offer insurance to any person or organisation relying upon the information that has been audited. However, in UK there have been doubts over the authenticity of financial information of a company event after it has been audited. This is primarily due to reduced scepticism level of the auditors. There have been large issues over the insufficient auditor scepticism. For example, in the recent past disciplinary investigations in the companies such as London International Group, Equitable Life Assurance Society, Independent Insurance and Independent Insurance clearly revealed audit failings. The reasons behind audit failure are over dependence on the company’s management, unable to examine conflicting explanations and also major failure in obtaining proper third party conformation. The failures clearly suggest that auditors were not sceptical to the required level. Apart from that some of the other establishments have also raised questions about the low level of scepticism among the auditors of UK. One of the findings of those establishments was that the auditing firms are not applying professional scepticism in accordance with the judgements of an audit. In general, audit firms approach the audit of high judgemental steadiness. This is carried out by seeking to find evidence that substantiates the judgements made by the customers, rather than finding evidences which challenges their judgements. In this context the establishment has stated that auditors must exercise higher level of professional scepticism, while reviewing the management’s judgement. Concerns of auditor scepticism are not only limited to the companies of UK, but several others are also dealing with it. For example, companies such as Barclays, MF Global, JP Morgan and Chesapeake Energy have all suffered due to audit failures. The most interesting about them is that, the auditor was PricewaterhouseCoopers (PWC) for each of the companies. Scepticism can be regarded as an important element for audit quality and failure to maintain the quality may expose audit firms of UK towards litigation. In addition, it may also damage the reputation of a firm. For example, due to level of scepticism, even a renowned audit firm may lose or fail to attain new clients. Now in the context of the stakeholders, scepticism among the auditors is as important as the performance of the company. The stakeholders heavily depend upon the audit reports to make their decisions pertaining to investment. Moreover, audit report is the only instrument which let the stakeholders know about whether the company is operating transparently or not. For example, it helps to increase stakeholder’s confidence for a company. Moreover, an audit report is the only element which is visible to the external people. In general it is a formal document that describes the activities carried out, the main findings and also the recommendations to the company. According to a number of authors, audit report can be considered as a way of communicating the auditor’s work to the management of the organization. Therefore it is important for the auditor’s to be extremely clear with their views and must be concisely presented. Hence large number of things depends upon the auditing and consequently auditor scepticism is equally important. For this reason the perspective of stakeholders and shareholders has been embedded in the auditing standards in accordance with materiality, and scepticism must drive in those perspectives in order to make the audit judgements (Financial Reporting Council, 2012). The literature of auditing has also demonstrated that there is an existence of expectation gap. Society has huge expectations from the auditors and has a belief that auditors will provide full assurance about the accurateness of the financial statements (Hassink, Bollen, Meuwissen and De Vries, 2009). For example the auditor’s role in a company’s scams is one area where expectation gaps are created and found. There have been cases where the auditors intentionally avoid the legal liability so as to protect themselves from any kind of claims (Humphrey, Turley and Moizer, 1993). Along with scepticism, it is important for the auditors to maintain the code of ethics while performing the duty. The ethical principles which govern an audit are objectivity, integrity, independence, confidentiality, professional behaviour and performing duty with care and professional competence (Gupta, 2004; El-Moukammal, 2009). Hence, the audit firm or the auditor is expected to follow these guidelines. However, violation often takes place. In this context, the failure of Lehman Brothers can be cited as an example. The audit firm for Lehman Brothers was Earnst & Young, and the audit firm violated the ethical guideline by handling off-balance sheet deals. To prevent such happenings, it is important that companies change their auditors every 5 years. This will prevent over-familiarity between the client and the auditor, thereby increasing the transparency (Green, 2008). For example, if the companies do not change the auditor and keeps on working for a certain period of time, a sense of familiarity may develop among the two. This may threat the transparency of the company as they may come up with fake financial data to influence investors. According to some reports, the scepticism lacks mainly with the managers of the global audit firms. Due to this, the managers are also failing to impart training for improving scepticism among the new auditors and raising issues. For example, if the managers fail to provide appropriate training to the new auditors, they will automatically lack the required level of scepticism and is a cause of concern. According to ISA 200 (UK and Ireland) the auditor shall plan and perform an audit with professional scepticism recognising that circumstances may exist that causes the financial statements to be materially misstated (Puttick, Esch and Kana, 2008). However there are some risks associated with auditor scepticism. The risks are mainly audit risk and business risk. Audit risk is defined as the risk that auditors may provide qualified audit opinion on the financial statements. It recognizes risks pertaining to raw materials at the assertions and entity levels (Smith, Omar, Idris and Baharuddin, 2005). On the other hand, business risk could adversely affect an organization’s ability to achieve objectives. Basically there are two types of business risks namely inherent risk and control risk. Apart from that there is also one more type of risk which is highlighted as detection risk. Inherent Risk: - Inherent risk mainly points out to the risk of errors that may cause due to deviations or misstatements (Miller, Cipriano and Ramsay, 2012). Control Risk: - Control risk is a risk which may arise when the internal control system of the client fails to prevent, correct or even detect the errors (Puttick, Esch and Kana, 2008). Detection risk – risk auditor will not detect a material misstatement. Now in order to get rid of these risks, companies can make use of audit risk models which control these risks. It helps to determine the best auditing procedure. For example, by employing audit risk models, the auditor can determine the level of audit risk involved, examine the control and inherent risk, and based on that auditors can design the most appropriate procedure. In order to asses those risks the following formula can be used. AR = IR*CR*DR DR= AR/ (IR*CR) Although auditor scepticism is important, the independence of auditor is also imperative. Auditor independence can be referred to as the liberty of the external auditor or of the internal auditor from the stakeholders whose business in getting audited (Vanasco, 1996). Independence needs objective approach and integrity towards the auditing (Martinov-Bennie, Cohen and Simnett, 2011). Some of the required independences for the auditor’s are freedom to investigate, avoid threats to credibility, access to all books and records, freedom to investigate, practitioner independence and professional independence (Financial Times, 2013). A quality audit is expected if the auditor has high level of scepticism and is provided with independence. Conclusion For a longer period of time, the auditing profession has always put emphasis on the significance of professional scepticism. The study has conducted a thorough analysis on professional audit and reviewed literature available on auditing. The study revealed that auditor’s scepticism is extremely important for an audit professional as it has a positive impact on the work. Moreover the study also showed that scepticism has high influence on the scope of the work. Apart from that it also helps auditors to critically analyse the findings of the audit and check whether the financial records are fair or not. With the improvement of professional scepticism, the auditing process can be more effective. The discussion part of the study reflected that an audit professional must possess certain characteristics so as to perform their duties properly. The characteristics are mainly scepticism and fair & unbiased nature. Also there are some principles which help in guiding the audit process. The principles as identified from the study are integrity, objectivity, independence, confidentiality, professional behaviour, professional competence and care. Likewise, there are some legal and professional duties of an auditor. The most important one is to detect any frauds in the financial documents of the company. Despite of that, auditors sometime do not perform their duties ethically and carries out illegal tasks. This is the reason why an expectation gap among the stakeholders is created. The study also revealed that ISA 200 is the accounting standard followed in the UK. The ISA 200 also encourages the audit professionals to employ higher level of scepticism on the work. However, there are some risks associated with it. The risks as identified from the study are inherent risk, control risk and detection risk. Now in this context, the study was about identifying the importance of auditor scepticism, which is increasingly becoming the cause of concern for the profession and stakeholders of companies in UK. The study revealed that in UK, the auditors lack the required level of scepticism for a comprehensive audit. Due to this factor, stakeholders are also losing confidence on the audit report and are restricting them in making further investments. The aim of the study was also to provide recommendations by which professional scepticism can be improved. The recommendations for enhancing the level of professional scepticism are provided below. Recommendations In UK, stakeholders of the companies are highly concerned about the low level of scepticism among the auditors. Hence to improve auditor’s scepticism in UK, following are the recommendations: - The organizational culture plays an important role in improving the scepticism. Therefore it is highly recommended that the audit firms of UK should develop an organizational culture which fosters the application of scepticism among the auditors. Training also plays a crucial role in improving sceptic. The UK firms should therefore train the auditors properly, so that they think sceptically and put it into practise during the auditing process. Fraud brainstorming session can be a way of improving professional scepticism. Therefore it is recommended that audit firms in the UK should arrange fraud brainstorming sessions in order to enhance professional scepticism among the auditors. In order to improve professional scepticism, the changes need to be made at the firm level. It is therefore recommended that the auditing forms of UK must establish procedures and policies that promote an internal culture which put emphasis on the quality of work and encourage auditor’s scepticism. In addition, it is also recommended that the communication process is superior. To improve auditor’s scepticism, changes also need to be made at the engagement level. In this context periodic reviews of the works carried out will help to serve the purpose of improving professional scepticism. The engagement partners can review the work as they have much knowledge and experience. Moreover they can also impart knowledge to the less experienced members. Therefore timely reviews of the performance will help to enhance quality as well as the professional scepticism. References Collier, P. A., 1993. Audit Committees in Major UK Companies. Managerial Auditing Journal, 8 (3), pp. 25-30. Edmund, N. W., 2005. End the Biggest Educational and Intellectual Blunder in History: A $100,000 Challenge to Our Top Educational Leaders. Florida: Scientific Method Publishing. El-Moukammal, H., 2009. Auditors’ Code of Ethics. The Certified Accountant, 3rd quarter 2009 (39), pp. 102-105. Financial Reporting Council, 2010. Auditor Scepticism: Raising the Bar. [pdf] Available at: [Accessed 08 January 2013]. Financial Reporting Council, 2012. Professional Scepticism: Establishing a Common Understanding and Reaffirming Its Central Role in Delivering Audit Quality. [pdf] Available at: [Accessed 11 January 2013]. Financial Times, 2013. Auditor Independence. [online] Available at: [Accessed 08 January 2013]. Green, W., 2008. Does Repetition Impair Auditors' Judgments? Managerial Auditing Journal, 23 (8), pp. 724-743. Gupta, K., 2004. Contemporary Auditing. 6th ed. New York: McGraw-Hill Education. Hassink, H. F. D., Bollen, L. H., Meuwissen, R. H. G., and De Vries, M. J., 2009. Corporate Fraud and the Audit Expectations Gap: A Study among Business Managers. Journal of International Accounting, Auditing and Taxation, 18 (2009), pp. 85-100. Humphrey, C. G., Turley, W. S., and Moizer, P., 1993. The Audit Expectations Gap in Britain: An Empirical Investigation. Accounting and Business Research, 23, pp. 395–411. Kan, E., 2007. Audit and Assurance: Principles and Practices in Singapore. Chang Charn Road: CCH Asia Pte Ltd Kumar, R., and Sharma, V., 2006. Auditing: Principles and Practice. New Delhi: PHI Learning Pvt. Ltd. Martinov-Bennie, N., Cohen, J., and Simnett, R., 2011. Impact of the CFO’s affiliation on auditor independence. Managerial Auditing Journal, 26 (8), pp. 656-671. Miller, T. 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