Why a Mindset of Professional Scepticism Is So Important When Undertaking Auditing - Assignment Example

Professional Scepticism and Auditing Name Institution Course Professor Date MEMO TO: STAFF MEMBERS FROM: (PUT YOUR NAME HERE) SUBJECT: PROFESSIONAL SCEPTICISM AND AUDITING DATE: 18th August 2014 Q1. What is professional scepticism? Auditors perform various audit functions and one of them pertains to audit evidence evaluation. This involves verification and synthesis of the evidence that the client provides. Additionally, at this point, an auditor checks whether he has enough competent evidence in supporting the assertions of the management. Professional judgement is used in making sure that the evidence gathered is sufficient, relevant and reliable (International Auditing and Assurance Standard Board 2012). Evaluation of the evidence is then performed after all the preliminary details are checked and conducted. This should be conducted in a thorough and unbiased manner. Unbiased attitude is important because it prevents one from acting unprofessionally due to personal factors such as having a soft spot for a client. Exercising scepticism and brainstorming ideas with other audit members are the other two key factors in evaluation of audit evidence. Together, both these factors constitute application of professional judgement to any auditing work. Adoption of professional scepticism attitude is increasingly becoming important in auditing these days. It is adopted when evaluation of audit evidence is undertaken. Professional scepticism means adoption of an attitude that includes critically assessing audit evidence and having a questioning mind without being obsessively sceptical or suspicious (Basu 2009, p. 3.39). In essence, a professional scepticism involves attitude that has a questioning mind and being alert to conditions that are associated with fraud or errors. Example of professional scepticism attitude include asking more questions than is normally usual, more probing questions by the auditor, and analysing answers in a critical manner. Additionally, analysis done is studiously compared with the other evidence gathered. Manifestation of professional scepticism is one of the concepts that are fundamental to auditors’ professional behaviour (Bik 2010, p. 30). Auditors are required to recognize that there exist circumstances that can cause financial statements to be misstated materially. In summary, professional scepticism include questioning, probing reflection, careful observation, suspension of belief and glancing beyond the obvious. It incorporates attitudes that require due diligence and standard of care in contexts of professional oversight and standards (Glower & Prawitt 2013). Q2. Why is it important for an auditor to adopt a mindset of professional scepticism? Auditors undertake their functions in an environment having significant litigation risk as well as existence of ample past frauds evidence involving auditors’ deception. Due to this, it seems that auditors will act with professional scepticism in an intuitive manner. However, the auditors’ difficulty lies in the inherent human condition that has been taught to accept assertions and information as the truth and to trust others (Rittenberg, Johnstone, & Gramling 2012, p. 102). Furthermore, if an auditor does not have the trust of the management, for example, it is therefore presumed that the auditor would cease to undertake the audit services for the client. Basu (2009, p. 3.39) explains that professional scepticism when adopted by the auditor evaluates the evidence bearing in mind that the evidence gathered may be misleading, incomplete or the person that is providing the evidence is either motivated to provide misleading or incomplete evidence or he is incompetent to provide such evidence. In the past, criticism has been levelled against external auditors for their lack of professional scepticism that results from fear of upsetting and a possible loss of a client. In any fraud investigation, the important qualities that an accountant brings are scepticism and an investigative mindset (Pedneault, Rudewicz, Silverstone, & Sheetz 2012, p. 95). Auditing has some inherent limitations. These limitations occur because of load of audit work, deadlines, nature of auditing procedures, and financial reporting issues. The limitations that arise from financial reporting issues refer to the manner in which financial statements are prepared. Financial statements have some degree of judgement and subjective decisions by the directors. Thus, financial statements will be subjected to inherent level of variability which cannot be eliminated through application of auditing procedures. Due to these, an auditor should have a mindset of professional scepticism when performing auditor work. Auditing procedures are designed to help auditors in performing their work. The auditor is required to follow professional auditing standards and demonstrate competency in doing so. As discussed earlier, auditing procedures have some limitations. Management can override a business internal control system meaning that information that will be obtained by an auditor is incomplete. In this case, fraud issues are difficult to detect due to nature of the fraud. Collings (2011) asserted that fraud is naturally designed to be concealed and therefore fraud can be organised in a sophisticated and careful manner. Thus, an auditor may not be able to identify a fraud. A mindset of professional scepticism becomes important to an auditor in detection of a fraud. Through it, an auditor will be able to identify a material fraud. Professional scepticism is also important because it enables auditors not to overlook unusual circumstances or use assumptions that are inappropriate in determination of nature, extent, and timing of audit procedures. A mindset of professional scepticism is important to an auditor because without it he or she is susceptible to accepting inaccurate or weak audit evidence (Rittenberg, Johnstone, & Gramling 2012, p. 102). Today, business operations and transactions have become complex and a mindset of professional scepticism becomes a necessity to an auditor in coping up with complexity of transactions. This mindset is also important in internalizing the essential fraud factors such as rationalization, opportunity and incentive (Pedneault et al., 2012, p. 95). Q3. Why has there been a recent increase in emphasis on professional scepticism? It is increasingly required that auditors should undertake their duties by using some degree of professional scepticism that was acquired through education, training and experience. Auditors have been found not to exercise professional scepticism which continues to concern regulators, standard setters and oversight bodies (Gong, Kim, & Harding 2014, p. 1). In the recent past, emphasis has been on professional scepticism apart from strict following of audit procedures and standards. The increase in this emphasis has been necessitated by various reasons. Auditing is a competitive business which is subjected to profit and return on capital demands like other businesses. Auditors are therefore constrained from detecting a fraud due to these economic demands which create a conflict for auditors (Makkawi & Schick 2003, p. 591). Due to the increased possibility of a fraud in financial reporting, auditors are needed to emphasized professional sceptical in their work. Fraud can have substantial negative impacts on investors’ money and therefore auditors should emphasized professional scepticism in detecting any form of fraud. In addition, Payne and Ramsay (2005, p.321) pointed out that financial community and judicial system have put pressure on auditors to improve detection of fraud. This can be achieved through the use of professional scepticism because of the complex nature that fraud has become. It is therefore being increasingly emphasized in achievement of this end. The International Standard on Auditing 240 (ISA 240) has placed an emphasis on adoption of professional scepticism and need to maintain it throughout auditing process. Accounting standards and business transactions continues to become more complex. There is an expanded use of subjective accounting measures and fair values hence requiring management to apply greater levels of judgement and discretion. Owing to increased complexity, subjectivity and continued emphasis on financial reports that are reliable, application of professional scepticism has been heightened. In a study by (Makkawi & Schick 2003, p.593), results indicated that auditors emphasize effectiveness in performing of audit procedures than efficiency. This means that auditors may overlook some details leading to the current increased on emphasis on professional scepticism. Regulators perform inspection of the auditors’ reports and there have been concerns about their work. In some cases, this is due to long audit tenure that threatens audit quality and undermines professional scepticism (Payne & Ramsay 2005, p. 323). In addition, management assertions and at times are accepted by an auditor without sufficient challenge. These have led to an intensified focus on exercise of professional scepticism by an auditor. Q4. What is the role of professional scepticism in undertaking an audit? In the process of auditing, professional scepticism is necessary and important. It forms an auditor’s integral part of his skill set. In auditing, a proper conduct should be maintained which have an effect on the audit quality. The core function of an auditor is to uncover any misstatements that are contained in the financial statements being reviewed by an auditor (Lessambo 2013, p. 164). For example, expenses can be underestimated or there can be overestimation of revenue accounts. The characteristics of professional scepticism perform various roles in undertaking an audit by an auditor. Provision of expert and independent assessment of financial reports that a company provides is the main function of an auditor. In doing these, an auditor must use set guidelines and professional scepticism. Auditors are helped by professional scepticism when they are considering and identifying fraud risks factors. Fraud risk factors influence the attention of the auditor while performing audit work or conducting auditing procedures (Jayalakshmy, Seetharaman & Khong 2005, p. 258-259). Professional scepticism facilitates professional judgement exercise hence impacting on the quality of the audit. Professional judgement is normally done after all relevant factors have been considered and all facts are known. Professional scepticism plays a part in making these decisions. Professional scepticism mindset is increasingly being adopted by auditors all over the world due to its role in undertaking an audit. Its role pertains to audit procedure, reduction of audit externalities and in making of certain decisions during an audit. It enhances effectiveness of audit procedures. Auditors are required to follow strict auditing procedures and its effectiveness is enhanced by professional scepticism. Professional scepticism reduces the possibility of misapplication of inappropriate audit procedures and overlooking of unusual circumstances in an audit exercise (IAASB 2012). In addition, it reduces possibility of misinterpretation of audit results and misapplication of inappropriate audit procedures. Professional scepticism also plays a role in making of some decisions in carrying out an audit. It assists in making decision on whether sufficient audit evidence has been achieved (Institute of Chartered Accountant in Australia 2013). Nature, timing and extent of audit procedures decisions are functions of an auditor. In undertaking these decisions, professional scepticism is used. Auditors, whether internal or external carry out their duties by using the financial statements and reports provided by a business entity. They are required to evaluate the management’s judgement (IAASB 2012). Professional scepticism is used in this case. Furthermore, it is the professional scepticism that is used in drawing conclusions bases pertaining to the audit evidence that is obtained. Investigation of inconsistencies and doubts about audit evidence authenticity is performed through a mindset of professional scepticism. Auditors work has become complex due to highly complex transactions hence decisions should be made with some degree of professional scepticism. Q5. Is the adoption of a mindset of professional scepticism something additional to the application of auditing standards: or is it subsumed within the broad concept of professional judgment? Auditing is not a routine process and it needs thorough understanding of an entity operations and exercising of high degree of professional judgement and expertise. Professional judgement is applying relevant knowledge and experience to certain facts and circumstances (Bagshaw 2013, p. 367). Professional scepticism is subsumed in professional judgement. Professional judgement should not be used in justification of decisions that are not supported by evidence but professional scepticism should be used instead. Example is the inappropriateness of discontinuation of an engagement with a client because of doubts with its integrity despite evidence pointing to it but opt to continue with engagement by using their professional judgement. Professional scepticism is one component that an auditor needs in exercising a sound professional judgement. A high quality professional judgement is achieved through the necessity of professional scepticism (IAASB 2012). For example, obtaining a high quality professional judgement by using professional scepticism is not enough without the requisite auditing industry expertise. References Bagshaw, K. 2013, Audit and assurance: essentials for professional accountancy. Wiley, Chichester, West Sussex.  Basu, SK. 2009, Fundamentals of auditing. Pearson Education India, New Delhi Bik, OPG 2010, The behavior of assurance professionals: a cross-cultural perspective. Delft, Euburon. Collings, S. 2011, Interpretation and application of international standards on auditing. Wiley, Chichester, West Sussex. Glower SM, & Prawitt DF 2013, Enhancing Auditor Profession Skepticism, Global Public Policy Committee, Washington, DC. Gong YF, Kim S, & Harding N 2014, ‘Elevating professional skepticism - An exploratory study into the impact of accountability pressure and knowledge of the superior's preferences’ Managerial Auditing Journal, vol. 29 issue 8 pp. 1-33. Institute of Chartered Accountants in Australia 2013, Practical Ways to Improve the Exercise and Documentation of Professional Scepticism in an ISA Audit. Institute of Chartered Accountants in Australia, Sydney. International Auditing and Assurance Standards Board 2012, Professional Scepticism in an Audit of Financial Statements: Staff Questions and Answers. International Auditing and Assurance Standards Board, New York. Jayalakshmy R, Seetharaman A, & Khong TW 2005, ‘The changing role of the auditors’, Managerial Auditing Journal, vol. 20, issue 3, pp. 249-271. Lessambo, FI 2013, The international corporate governance system: audit roles and board oversight. Palgrave Macmillan, Basingstoke. Makkawi B, & Schick A. 2003, ‘Are auditors sensitive enough to fraud?’, Managerial Auditing Journal, vol. 18, issue 6/7, pp. 591-598. Payne EA & Ramsay RJ. 2005, ‘Fraud risk assessments and auditors’ professional skepticism’, Managerial Auditing Journal, vol. 20, no. 3, pp. 321-330. Pedneault S, Rudewicz F, Silverstone, H, & Sheetz M. 2012, Forensic accounting and fraud investigation for non-experts. John Wiley & Sons, Hoboken, N.J. Rittenberg, LE, Johnstone, KM & Gramling, AA 2012, Auditing: A Business Risk Approach 8th edn.Cengage Learning, Mason, Ohio. Read More