The Concept of Professional Scepticism in Financial Statement Auditing - Essay Example

Professional Scepticism College: Name: Students ID: Date: Course Name: Unit Code: Time: Instructor: Introduction Societies place high levels of confidence in financial statement auditors. This is because they need dependable financial information so as to make informed financial decisions that satisfy their interests. Financial statement auditors engage a key role in the course of financial reporting seeing as they present an independent opinion as to whether the prepared financial statements are presented fairly in all material aspects, or give ‘a true and fair view’ according to the relevant reporting standards. In recent times, there have come to pass several big financial scandals such as Adelphia, Enron, and WorldCom. Also reporting standards keep increasing as business transactions are becoming more complex (Hurtt et al 2008). Amid these developments, suspicion has emerged as to whether financial statement auditors improperly trust on the top management in carrying out financial statement auditing. To strengthen the auditing practice, international as well as national financial reporting regulatory bodies such as the IAASB, AUASB and others have published professional auditing standards auditors ought to adhere to while conducting financial statement auditing. Various aspects that have been considered keenly are the auditors’ attitude, mindset and action while conducting financial statement auditing. These are what have given rise to professional scepticism (Beasley et al 2000). In this paper I discuss the concept of professional scepticism and its importance in financial statement auditing. Professional Scepticism Scepticism by its own could as well be referred to as doubt or disbelief. Doubt or disbelief stimulates one to acquire more information or to inquire more so as to support a particular opinion. Each and every one of us, as human beings, is likely to be sceptic almost every day. Therefore, scepticism in manifest in almost everything we do. Therefore, it is to be expected that we will be sceptic even in carrying out our professional duties and this is where professional scepticism arises from (Beasley et al 2000). In general, professional scepticism is an attitude of the questioning mind. This is an attitude that involves asking questions that possibly will help to be on familiar terms with probable future consequences. They questions as well are intended to smooth the progress of making critical assessments of events supported by a strong deposit of data. The questions rivet around every aspect of the item under consideration with the objective of obtaining all information wished-for by the questioning mind. In auditing, professional scepticism more often than not will arise from obvious variance stuck between drivers existing in the broader environment within which a client operates (macro level) and the manner in which the client supposes to have acted depending on the circumstances of that environment (micro level). Basically, professional scepticism is a state of mind. This sceptical approach stimulates the auditor take on a questioning move towards judging financial statement information as well as in arriving at a formidable conclusion. In light of this, professional scepticism cannot be separated from the elemental ethical principles of impartiality along with auditor independence. Without a doubt, professional scepticism is bound to happen while exercising professional judgement. Therefore, reminiscent of professional judgment, professional scepticism is necessary while carrying out financial statement auditing (Hurtt et al 2008). According to the International Standards on Auditing (ISA) 200, professional scepticism does not just entail a questioning mind; it is ‘an attitude that incorporates a questioning mind, being watchful to conditions which may possibly be a sign of probable misstatement as a result of error or fraud, and a critical assessment of audit evidence.’ Moreover, the Canadian Institute of Chartered Accountants (CICA) calls for each one auditor ‘to plan and perform an audit with professional scepticism and be on familiar terms with those circumstances that can exist and that possibly will result to the financial statements to be considerably misstated’. The CICA instruction manual indicates that ‘a mind-set of professional scepticism points to the auditor to critically evaluate with a questioning attitude, of the adequacy and suitability of audit evidence collected and is ready to act on contradicting data or data that brings into question the dependability of documents or management submissions. It does not point out to the auditor being compulsively doubtful or mistrustful’ (Nelson, 2009). The United States’ Public Company Accounting Oversight Board (PCAOB), drawing upon the relevant United States Audit Standards, define professional scepticism as an attitude that incorporate a questioning mind along with a critical assessment of the suitability and adequacy of audit evidence. Moreover, it states that professional scepticism is required while conducting helpful audits under the Board’s standards (Hurtt et al 2008). In a bid to define what auditing professional scepticism entails, Hurtt et al (2008) developed a model that openly deals with the concept of professional scepticism from the perspective of financial statement audit. They made use of literature from the viewpoint of procedural scepticism to present a model of professional scepticism. Their model puts forward that professional scepticism comprises six features: a questioning mind, search for information, deferment of judgment, interpersonal understanding, self-assurance, as well as autonomy. Moreover, Hurtt et al (2008) imply that these features have to lead to four scepticism constructs: enhanced search for information, improved detection of contradiction, better generation of alternatives and amplified inspection of source reliability. Importance of Professional Scepticism in Financial Statement Auditing By and large, people may think that Auditing Standards are rules and requirements that auditors have got to tag along. However, this is not true; neither is it the purpose nor the auditor’s compulsion. Auditing is a profession like any other that calls for the auditors to use professional judgement in doling out vast numbers of circumstances. The AUASB continues to state that Auditing Standards are based on principles and are intended to be implemented across the exercise of professional judgement. The value of that auditor’s judgement, and as a result the worth of the audit, relies upon lots of factors including: the auditor’s level of education, training, knowledge, character, and more importantly, the element of professional scepticism – an ever watchful and inquisitive mind (International Auditing and Assurance Standards Board, 2012). Scepticism boosts the auditor’s capacity to put into effect professional judgement in discovering and taking action against conditions that may well designate probable misstatement. Professional scepticism supports a well thought-out contemplation of an alternative perspective. It makes possible the suitable application of professional judgement in audit assessment, for example, audit strategies plus meticulous plans, the consideration of evidence, the assessment of management’s resolutions and coming to formidable ending. Devoid of professional scepticism, the auditor cannot be able to dispute nor stay on the alert to variations and situations that point to actual or probable misstatements owing to error or fraud. Professional scepticism is a skill that many regard as the keystone of audit value. A high-value audit calls for the auditor to apply professional judgment together with an attitude of professional scepticism. In view of the fact that professional scepticism is part of the auditor’s way of thinking, it is drawn on their personal character traits and is influenced by such things as inspiration, proficiency, schooling, training and knowledge of each one auditor (International Auditing and Assurance Standards Board, 2012). The International Standards on Auditing (ISA) indicate that professional scepticism is required to critically evaluate audit evidence. This is particularly important in questioning conflicting audit evidence and the dependability of documents as well as reactions to inquiries plus erstwhile information relayed by the management as well as those in charge of running the business entity. Professional scepticism seeks to triumph over biases intrinsically formed by the structure of the auditor-client association. This may well be augmented by other characteristics of human character. For example, inherent unfairness may come to pass from the usual and unconscious trend to form associations. Also, clique preferential treatment which is the affinity to trust, rely upon or believe somebody because of the association or acting of kindly to those who have the ability to give benefits (Beasley et al 2000). Professional scepticism is also indicative of that fact the audit was designed and performed according to the International Standards on Auditing (IAS). In recent times, audit inspections all over the world suggest that professional scepticism may have not been applied as it should be in auditing financial statements. Some reports have indicated that a number of auditors failed to take the appropriate action in situations where there was contradictory or conflicting audit evidence. They too have been over-relying on the representations from the administration, hence, failed to search for audit evidence to back up rather than dispute the management’s statements. In other circumstances auditors acknowledged untrustworthy audit evidence as being satisfactory and correct (International Auditing and Assurance Standards Board, 2012). Beasley et al (2000) studied the fraud-related cases in which the SEC had instituted actions against auditors; they stumbled on a number of audit failures. Failure to exercise a proper level of professional deficiency was found to be the third most regular audit problem in these cases. This problem was found in 60 per cent of the cases. This confirms that auditors are obliged to apply an appropriate level of professional scepticism when carrying out financial statement audits. This will enable them to determine the correct view on behalf of all parties that rely on the financial statements to make decisions, but do not have the opening to directly get hold of appropriate evidence or they lack the knowledge to gauge the fairness of the information they obtain from the financial statements. It is for this reason that they expect financial statement auditors to uphold an approach of professional scepticism as they carry out of their assessment. A private report disclosed to the public in October 2011 by Deloitte for assessments of 2007 audits conducted in 2008 revealed that, “The character as well as the count of the reported insufficiency discovered through the inspection team (counting 9 of the 61 activities assessed, the Firm's failure to acquire satisfactory competent evidential substance, when the audit report was issued, to shore up its audit view) imply that pertinent matters may well be present as regards…The adequacy of the Firm's accent on the essential need to effect due care as well as professional scepticism when carrying out audits.” Also PwC conducted their private report disclosed to the public in March 2013 for assessments of 2009, 2008 audits conducted in 2010, 2009, they found the same deficiencies. Their report included 6 of the 50 activities assessed (Hurtt et al 2008). In the United States, audit standards thrash out auditors’ task to put into effect augmented professional scepticism while responding to particular circumstances. For example, an auditor is required to exercise a higher level of professional scepticism in confirmation procedures (AU 330.37). Failure to follow this has resulted in several misrepresentations and fraud such as Satyam, and Chinese reverse merger frauds. In the case of Satyam, it was found out that the client commanded the confirmation process. The auditors to a great extent relied on Satyam’s, for the reason that they assumed that Satyam’s ex-chairman along with the top management were truthful and that they did not think that Satyam was twisting audit documents. Clearly, the auditors failed to act in accordance with some PCAOB Standards such as AU 230.09 which requires auditors to exercise professional scepticism rather than being contented with inferior believable evidence due to a conviction that management is truthful (Hurtt et al 2008). Conclusion Today the world faces numerous complex situations arising from the interconnectedness of corporations and the high number of business dealings. This has bred a good ground for financial statement misstatement due to errors or frauds seeing as auditors fail to acquire satisfactory audit evidence to support their opinion. Professional scepticism is a questioning mindset. In auditing it also takes in a critical assessment of suitability and adequacy of the obtained audit evidence to support a particular opinion. In doing this auditors become more watchful and search for more information to support their opinion rather than relying on management assertions. This also considerably boosts the quality of auditing and ensures the users of financial statements use the correct information to make their financial decisions (Nelson, 2009). References Beasley, M.S. Carcello, J.V. Hermanson, D.R. and Lapides, P.D. (2000). Fraudulent financial reporting: consideration of industry traits and corporate governance mechanisms. Accounting Horizons, 14(4): 441-54. Hurtt, K. Eining, M.M. and Plumlee, R.D. (2008). An experimental examination of professional scepticism. Working Paper, Baylor University, Texas. International Auditing and Assurance Standards Board, (2012). Professional Scepticism in an Audit of Financial Statements: Staff Questions and Answers. Nelson, M. W. (2009). A Model and Literature Review of Professional Scepticism in Auditing. Auditing: A Journal of Practice and Theory. 28(2): 1-34. Read More