Professional Skepticism - Essay Example

Name: .......................................................................................................xxxxx Institution: .............................................................................................xxxxx Title: ..................……………….Professional skepticism Course: ..................................................................................................xxxxx Tutor: ...................................................................................................xxxxx @2012 Professional Skepticism Introduction Professional skepticism simply equates skepticism with distrust and the opposite of trust. It can be defined as the propensity of an auditor to defer the conclusion of an audit until he or she gets enough evidence which will provide sufficient evidence to support his or her audit opinion. Skepticism on the other means that the auditor makes a critical assessment in the course of auditing with a questioning mind which will question the validity of audit evidence obtained (Nelson 2009). Skepticism enables the auditor to be alert of any audit evidence which contradicts or questions the reliability of the responses and documents and other information which is obtained from management and the all the members who are charged with corporate governance (Grenier 2010). A skeptical audit does not assume the honesty or dishonesty of the management. Professional skepticism is defined by Auditing Standards as the attitude of the auditor which includes a questioning mind and being alert of all the conditions which may indicate the possibility of material misstatement in the financial statements as a result of errors and frauds as well as a critical assessment of the audit evidence obtained. From the definition of professional skepticism, it is very clear that professional skepticism influences the auditor’s scope of work and therefore helps the auditor to evaluate all the audit findings and later conclude whether the audit evidence obtained was sufficient enough to enable a true and fair view opinion to be expressed on the financial statements. Auditors are supposed to have professional skepticism and it should be inconsistent with the client relationships that they try to preserve to keep the money flowing. That is, they should adopt a powerful and a simple philosophy of verifying to trust. This is because most clients are dishonesty and the only way to be effective in auditing for them is to be professionally skeptical (Nelson 2009). Nature of auditor skepticism Skeptical attitude in the mind of an auditor is very essential if an audit is to be rigorous and to be performed with due professional care. The degree of professional skepticism to be applied in auditing highly influences the efficiency and effectiveness of auditing (Grenier 2010). The less the degree of professional skepticism, the danger it has to the effectiveness and efficiency of auditing. It is important to explore the initial mindset of the auditor and how he or she reacts to evidence obtained during the process of auditing in order to understand how the conduct of audit is influenced y the professional skepticism. Initially, auditor’s approaches an audit with a strong believe that the financial statements may be misstated or the management is honest or dishonest. In the process of gathering audit evidence, the auditor may obtain information which may suggest the possibility of financial misstatements in the financial statements. At this point therefore, auditors become more intense in their inquires and end up seeking more information on the audit evidence obtained to resolve the issues at hand (Nelson 2009). The auditor will therefore have used his professional skepticism to enhance effectiveness in his auditing and in his audit opinion. Importance of professional skepticism Professional skepticism is very important to junior staff that had the best opportunity of identifying suspicious circumstances from their direct contact with the client management as well as the direct involvement with the management is testing and inspecting transactions. Professional skepticism is required by the auditors in order to challenge the management about the appropriateness of accounting estimates and whether the sufficient of audit evidence obtained is enough for the auditor to support the estimates (Nelson 2009). Skeptic minds enable the auditors to recognize all the circumstances which may exist and which may cause material misstatements in the financial statements and this calls for him to be alert and to remain cautious about such events and information which indicates the existence of material misstatement in the financial statements (Grenier 2010). Skepticism suggests to the auditor that he can accept the information obtained by him not unless he obtains any other information which may contradict the old information or expectation of the auditor. Maintaining professional skepticism is very important to auditors through out the audit as it helps in the reduction of risks of over generalization when drawing conclusions from the audit observations, overlooking the unusual circumstances and the use of inappropriate assumptions in determining the nature, extent and timing of the audit procedures and results evaluation thereof (Wright et.al 2011).. Current thinking on professional skepticism in UK There has been an ongoing debate on whether professional accounts are sufficiently skeptical in applying professional judgment. Different professional bodies and legislation have expressed their opinions on the current practice of the auditing profession in the UK. The Auditing Practice Board (APB) paper on “Auditor Skepticism: Raising the bar” which is dated 30 March 2012 has expressed the lack of consensus as to the role of professional skepticism in auditing (Nelson 2009). According to APB, there is the need for consistency in the nature of professional audit and that the opinion of auditors should demonstrate high degree of professional skepticism which should also be replicated in the course of auditing. The paper has therefore called for more professional skepticism in the auditors conduct in UK. The paper has also identified certain factors which may create disincentives for auditors making them to react in a way different from the application of high degree of professional skepticism. According to the Code of Ethics for Professional Accountants, auditors can act with integrity in order to exercise professional skepticism and objectivity in all areas where professional judgment is required (Wright et.al 2011).. According to this paper, though many appropriate safeguards may be implemented by the auditors, there are other parties whose inactions and actions create disincentives for the auditors to apply the required degree of professional skepticism. The paper therefore holds opinion that the degree of auditor skepticism in UK is highly influenced by the assessment of audit risk of material misstatement by the auditor and therefore the auditor will require more persuasive evidence to challenge the judgments of the management (Nelson 2009). The European Commission green paper in its report which was addressed to the House of Lords inquiry in the UK has also expressed its criticism on how the auditors have failed in exercising sufficient professional skepticism. The International Auditing and Assurance Standards Board has also emphasized in its recent communication on the application of professional skepticism in all auditing areas and especially in the areas of going concern and disclosure. The Financial Reporting Council (FRC) has been on the opinion that the responsibilities of the auditors should be increase since majority of the auditors are not doing what they are supposed to when it comes to professional skepticism (Wright et.al 2011).. FRC has then argued that professional skepticism is not likely to be achieved by the closer relationship between the directors of a company and the auditors hence calling for the auditors to exercise high level or degree of professional skepticism. In UK, the Financial Reporting Council (FRC) and the UK Financial Services Authority (FSA) have held the opinion that auditors should be properly examined to determine whether they apply professional skepticism to the latter (Nelson 2009). The two bodies think that UK auditors need to be highly challenged on the application of professional skepticism in their auditing. FSA in particular has heavily questioned whether the auditors in UK have always been sufficiently skeptical and whether the auditors usually pay attention to all indicators of management bias in their auditing. FSA therefore is concerned that the auditors portrays a worrying lack of professional skepticism in key areas. According to UKSA, auditors should report to the company owners as a requirement which should be taken in all considerations. There has been questioning on whether UK auditors exercise sufficient judgment when it comes to the disclosure of financial statements (Wright et.al 2011). In UK, there has been a perception that its auditors do not sufficiently challenge the management and all the members of corporate governance on the full disclosure of the financial statements. Other professional bodies have the perception tat auditors focus solely on completeness without ever applying judgment regarding whether all of those disclosures are necessary in the context of the specific entity (Bonner 2007). The United Kingdom Audit Inspection Unit found that firms in the country approach the audit involving highly judgmental balances by seeking or by obtaining audit evidence which will corroborate the judgments made by their clients (Bonner 2007). In it’s reporting on the recent inspections on accounting firms in Netherlands, 29 of the 46 audits reviewed indicated weaknesses and insufficient professional skepticism was the main cause of these weaknesses. Evaluation of the incentive which make auditors to act in a manner other than professional skepticism Several factors or incentives highly influence the degree of professional skepticism as reflected in the behavior of the auditor. The incentives may influence the behavior of the auditor to behave in a manner which reflects increased professional skepticism or in a manner other that the professional skepticism (Nelson 2009). Incentives which make auditors to behave in a manner different from professional skepticism are those incentives which pose threat to the independence of the auditor and they include: The relationship between the auditor and the client company Any close relationship which may exist between the client company and the auditor will be a threat to the independence of the auditor. For example, the auditor may be a beneficial shareholder in the client company. In this case, the auditor will have been allowed to purchase or acquire shares of the company. In this case, the relationship between the two may end up affecting the auditing of the books of accounts. The auditor in this case may also not practice professional skepticism to the latter hence unprofessional skeptical behavior. Regulatory inspection and threats to reputation Where there is no regulatory inspection, the auditor may fail to practice professional skepticism in his judgments (Wright et.al 2011). The auditor is also likely to exhibit less professional skepticism in his or her judgments if the concern for reputation and exposure to litigation is less than the concern for the firm revenue or the potential loss of the client. Opportunities for additional services and revenue generation This will pose a threat to the independence of the auditor. For example, the auditor may be offered the opportunity to provide accountancy, taxation and consultation services in addition to the auditing services to the company. This will result into a conflict of interest and the auditor will end up acting in a manner not similar to professional skepticism. Performance appraisal and recognition within the firm Any appraisal which the client may offer to the auditor becomes a threat to his or her independence (Bonner 2007). If this happens, the auditor may not practice professional skepticism making him or her to behave in a manner different from the professional skepticism. Evaluation of the measures introduced to respond to criticisms of professional skepticism Auditors need to approach and document the processes used in audit review and audit judgments in a manner which will facilitate and demonstrate the rigor of that challenge (Bonner 2007). Firms also need to develop and promote the application of professional skepticism in all of their partners and staff. It is also very important for the auditors to use audit methodologies which will allow for appropriate scope for use of informed professional judgment and audit skepticism like increase in the reliance of audit software and the proliferation of detailed requirements in the auditing standards (Nelson 2009). The audit methodologies used will foster professional skepticism and will encourage all the auditors to ask open questions to the management and to follow up on the responses. In this case, professional skepticism will have been enhanced. Several suggestions have been suggested by different legislation and professional bodies as the measures and means of ensuring consistency in the role and nature of professional skepticism in auditing: The process of risk assessment by the auditor should involve critical appraisal of the assertions by the management as a way of looking for material misstatements, the auditor should develop intense knowledge on the entity business and the environment in which it operates in order to enable it make its risk assessment through its own fresh and independent eyes rather than through the eyes of the management (Nelson 2009). This will enable the auditor to make informed challenge of consensus view as well as to consider any possible incidence of low probability of high impact events. Several ways have also been proposed on how to enhance professional skepticism in auditing and they include training the auditors on how to recognize and negotiate errors, recruitment process which will include the assessment of the relevant attributes, reviewing the processes which are structured in a way which favor professional skepticism, enhancing performance evaluation and promotion systems which will award the appropriate professional skepticism, improving on the decision aids like documentation and check lists and incentives which will promote the challenge in the process of auditing (Wright et.al 2011).. For auditors to become professionally skeptical, the following measures should be put in place: Do not reject any violated trust rather recons true or refute it, If the trust is experience and knowledge based the auditor should not quickly or readily accept an “adequate explanation”. The auditor should not succumb to cognitive inertia of seeking evidence to confirm rather than disconfirm a belief (Nelson 2009). The auditor should not fall a victim of self deception of believing something to be true if you w ant it to be. The auditor should not attribute untrustworthy behavior too easily to the situation. Conclusion The accounting profession has been under assault for the past years because of a seeming inability of the auditors to detect frauds prior to the issuance of company financial statements. The current focus on professional skepticism in terms of the elevated responsibility for the detection and prevention of errors and frauds calls for the investigation on how to enhance professional skepticism (Bonner 2007). It has been found that audit novices with practice and feedback in fraud detection indicated greater skepticism than the experienced auditors by assigning a higher initial likelihood that a material misstatement was due to fraud rather than error. Professional skepticism is very important in auditing as it enables the auditor to make a true and fair opinion. With professional skepticism, the auditor has to collect enough and sufficient audit evidence in order to make an audit opinion. However, for professional skepticism to be upheld in the process of auditing, it is important for the auditor to avoid all the circumstances which may pose a threat to his or her independence (Bonner 2007). That is, the auditor must avoid all incentives which may make him or her to behave in a manner which is not in accordance with professional skepticism. In general, it calls for lack of naivety if auditors are to practice professional skepticism to the latter. References AICPA. 2006. Code of Professional Conduct: AICPA, New York. Audit Inspection Unit of the UK’s Professional Oversight Board (AIU). 2010. Public Report on the 2009/10 Inspection of PKF (UK) LLP. (accessed April 2012) Bazerman, M. H., G. Loewenstein, and D. A. Moore. 2002. Why Good Accountants Do BadAudits. Harvard Business Review 80 (11):96-103. Beaulieu, P. R. 2001. The Effects of Judgments of New Clients' Integrity upon Risk Judgments, Audit Evidence, and Fees. Auditing: A Journal of Practice & Theory 20 (2):85-99. Beaulieu, P. R. 2001. The Effects of Judgments of New Clients' Integrity upon Risk Judgments,Audit Evidence, and Fees. Auditing: A Journal of Practice & Theory 20 (2):85-99. Blay, A. D. 2005. Independence Threats, Litigation Risk, and the Auditor's Decision Process. Contemporary Accounting Research 22 (4):759-789. Bonner, S. E. 2007. Judgment and Decision Making in Accounting Englewood, NJ: Prentice Hall. Buchman, T. A., P. E. Tetlock, and R. O. Reed. 1996. Accountability and Auditors' Judgments about Contingent Events. Journal of Business Finance & Accounting 23 (3):379-398. Buchman, T. A., P. E. Tetlock, and R. O. Reed. 1996. Accountability and Auditors' Judgments about Contingent Events. Journal of Business Finance & Accounting 23 (3):379-398. Bunge , M, 1991. A Skeptic’s Beliefs and Disbeliefs’, New Ideas in Psychology. Vol. 9, No. 2, pp. 131-149 Grenier, J.H. 2010. Encouraging professional skepticism in the industry specialization Era: A model and an experimental test. Paper presented at the 19th Symposium on Auditing Research, Champaign Illinois. Hackenbrack, K. 1992. Implications of seemingly irrelevant evidence in audit judgment. Hurtt, R. K., M. Eining, and R. D. Plumlee. 2008. An experimental examination of professional skepticism. Working Paper. Available at SSRN:http://ssrn.com/abstract=1140267 Journal of Accounting Research 30(1): 126-136 Nelson, M.W.2009. A model and literature review of professional skepticism in auditing. Auditing: Journal of Practice and Theory 28 (2):1-34 Quadackers, L. T, Groot and A. Wright, 2011. Auditor’s professional skepticism: Neutrality versus presumptive doubt. Paper presented at the 34th EAA Annual Congress, Rome. Read More