Professional scepticism: Establishing a common understanding and reaffirming its central role in delivering audit quality

In March 2012, the Auditing Practices Board (APB) of the UK Financial Reporting Council (FRC) issued guidance on professional scepticism. The document builds on the August 2010 APB Discussion Paper, Auditor Scepticism: Raising the Bar, and the subsequent Feedback Paper published in March 2011, which summarized the Responses to the Discussion Paper and outlined the actions that the APB, and other parts of the FRC, intended to take in light of the responses received.

The guidance document is written in an unusual format for an APB document, being much more discursive than is customary and drawing analogies from a diverse group of areas. This is because scepticism needs to be more broadly understood and drawing these analogies will facilitate that understanding. The APB is also keen to stimulate and provide input to an international debate on the issue of scepticism. The document will provide valuable input to that debate.

With this objective in mind, the document: explores the roots of scepticism and identifies lessons for its role in the conduct of an audit; discusses scientific scepticism and the scientific method; reviews the origins of the modern audit; and offers conclusions about professional scepticism in the audit. It also discusses the conditions necessary for auditors to demonstrate the appropriate degree of professional scepticism and lists five proposals to take these matters forward. To learn more, read the 23-page guidance Professionalscepticism: Establishing a common understanding and reaffirming its centralrole in delivering audit quality.

IAASB – Guidance on Professional Skepticism in an Audit of Financial Statements

With regard to professional skepticism, a Questions & Answers (Q&A) publication developed by staff of the International Auditing and Assurance Standards Board (IAASB) was issued in February 2012. It states: “The public places value on the independent financial statement audit because it enhances the degree of confidence of intended users in the financial statements. A high-quality audit features the exercise of professional judgment by the auditor and, importantly, a mindset that includes professional skepticism throughout the planning and performance of the audit.”

The Q&A publication explains that: “The need for professional skepticism in an audit cannot be overemphasized. Professional skepticism is an essential attitude that enhances the auditor’s ability to identify and respond to conditions that may indicate possible misstatement. It includes a critical assessment of audit evidence. It also means being alert for audit evidence that contradicts other audit evidence or that brings into question the reliability of information obtained from management and those charged with governance. This critical assessment is necessary in order for the auditor to draw appropriate conclusions.”

The Q&A, published by the International Federation of Accountants (IFAC), contains 16 pages of guidance, including eight questions and answers about professional skepticism. It is not meant to be exhaustive and reference to the standards themselves should always be made. The IAASB’s International Standards on Auditing (ISAs) explicitly recognize the fundamental importance of professional skepticism. Nevertheless, adopting and applying a skeptical mindset is ultimately a personal and professional responsibility to be embraced by every auditor. It is an integral part of the auditor’s skill set and is closely interrelated to the fundamental concepts of auditor independence and professional judgment and contributes to audit quality.

Harvard Business Review - Making Smart Decisions

According to the research, bad decisions can often be traced back to the way the decisions were made. Perhaps the alternatives were not clearly defined, the right information was not collected or the costs and benefits were not accurately weighted. Sometimes, the fault lies in the mind of the decision maker rather than in the decision-making process.



The research has examined eight psychological traps that can affect the way that decisions are made. They include the anchoring trap, the status-quo trap, the sunk-cost trap and the confirming-evidence trap. They also include the framing trap, the overconfidence trap, the prudence trap and the recallability trap. The best way to avoid all of these traps is awareness. Forewarned is forearmed!

Learn more by reading the article “The Hidden Traps in Decision Making” by John S. Hammond, Ralph L. Keeney and Howard Raiffa in the Harvard Business Review on Making Smart Decisions.

Auditors' virtues and the exercise of professional judgment

One of many lessons learned from infamous audit failures (such as Enron, WorldCom and Nortel) is that rules cannot replace auditors' professional judgment. Transactions can be structured around rules and rules cannot be made to fit every situation. Professional judgment is fundamental to the auditor's ability to fulfill society's expectations, as it ensures that situations are appropriately handled where the rules are not appropriate or do not yet exist. Professional judgment requires not only technical competence but also depends on auditors' ethics and virtues.

While auditors' ethics are related to their formulation of professional judgment, auditors' virtues are related to their exercise of professional judgment. Much research has investigated the role of auditors' ethics in the formulation of professional judgment. For example, auditors' ethics are associated with the ability to detect fraud and to detect departures from GAAP and the Codes of Ethics. In addition, auditors' ethical reasoning is associated with gender, age, years of employment, political orientation and education.

To identify auditors' virtues as defined by the Canadian accounting community, in-depth interviews were done with nine CAs identified as experts in ethics and auditing, and exemplars of the accounting community. This resulted in an extensive inventory of virtues important to the auditor's role. In addition, a survey was undertaken to determine the relative importance of the auditor's virtues included in the inventory. More than 400 CAs participated from public practice and from private industry. Participants rated the importance of each virtue on a scale of one (not at all important) to five (highly important). The following exhibit presents the results of the survey.

Learn more by reading the CAmagazine article “Virtuous auditors” by Theresa Libby, PhD, CA and Linda Thorne, PhD, CA. Also, refer to the blog posting “Professional Judgment – Ethical Thinking by Chartered Accountants”.

Chinese accounting reform: Towards a principles-based global regime

The Institute of Chartered Accountants of Scotland (ICAS) has long advocated the benefits of principles-based accounting standards. The success of such standards relies on the ability of accountants to make "good quality" judgments, but to those new to the profession or new to principles-based standards, making judgments can be difficult.

The need for appropriate guidance to help those making judgments and the need to develop a professional judgment framework became evident from earlier ICAS projects on principles-based accounting standards, particularly while undertaking interviews for the report Chineseaccounting reform: Towards a principles-based global regime (also available in Chinese). The report provides insight into China’s adoption of IFRS-based standards and broadens the principles versus rules debate beyond Canada, Europe and the United States.

The main objectives of the research project were: (1) to identify and highlight the achievements in the implementation of IFRS principles-based standards in China; (2) to identify and consider the issues to be addressed in the implementation of principles-based standards, with a focus on the experience in China; and (3) to assess the degree of support for principles-based standards in China, in order to influence the future development of IFRS. This 32-page report, published in June 2010, is available on the ICAS website, along with other pertinent financial reporting guidance publications.