Professional Scepticism in an Audit of a Financial Report

In August 2012, the Australian Auditing and Assurances Standards Board (AUASB) issued a Bulletin called Professional Scepticism in an Audit of a Financial Report. The AUASB took this opportunity to emphasize to both auditors and others, the important and fundamental role that professional skepticism has to play in the audits of financial reports. It also reminded audit firms of their role in education, mentoring and inspiring partners and staff to cultivate a skeptical mindset, recognizing that it is a vital ingredient in performing high quality audit engagements.

According to the Bulletin, the inspection programs of the Australian Securities and Investments Commission (ASIC) have raised concerns about whether professional skepticism is being applied properly in practice. The findings question whether auditors: respond appropriately to unreliable audit evidence; seek to corroborate evidence rather than challenge it; and adequately demonstrate in the audit working papers how professional skepticism has been applied.

The ASIC refers to key areas of audit judgment where the level of professional skepticism exercized or evidenced in the audit files needs to be improved, particularly: fair value measurement of assets; impairment calculations; and going concern assessments. Importantly, audit committees play a significant influencing role and commonly seek to foster appropriate professional skepticism in the external audit. Auditors, in turn, should demonstrate the value of their audit by seeking to convince audit committees that they have properly exercized professional skepticism in the conduct of the audit.

In light of these concerns, this 8-page Bulletin, which is presented in Question and Answer format, encourages auditors to bring “professional skepticism” to front-of-mind in the conduct of their audit engagements. The test for auditors, especially in an uncertain economic environment, is to remain alert, to improve audit documentation and to continually and critically re-assess the application of professional judgment.

Mandatory audit rotation seen as a threat to skepticism

An Accountancy Age magazine article published July 2015 notes that forcing companies to change their auditors may put professional skepticism in jeopardy. That’s the conclusion of a number of US academics, who published their thoughts in the American Accounting Association’s journal The Accounting Review.

According to the study, Effects of Auditor Rotation, Professional Skepticism, and Interactions with Managers on Audit Quality, instead of elevating auditor skepticism of clients and raising audit quality, the intended “benefit disappears and even reverses when auditors rotate. Rotation and a skeptical mindset interact to the detriment of audit effort and financial reporting quality.”

Report authors, Kendall Bowlin of the University of Mississippi, Jessen Hobson of the University of Illinois at Urbana-Champaign, and David Piercey of the University of Massachusetts Amherst, said: “Rotating auditors, aware that they will not be in a long-term relationship, will... likely perceive themselves to be less competent in evaluating the honesty or dishonesty of the [corporate] manager relative to auditors who do not rotate.”

As a result, “rotating auditors would find it difficult to garner psychological support for the probability of manager dishonesty, leading them to be less likely to choose high levels of audit effort than non-rotating auditors.”