Strategies for efficient, effective audit documentation

An AICPA study found that the most common audit issue is a lack of adequate documentation. Although some auditors may think that documenting the nature, timing, extent and results of audit procedures will break the audit budget, many practitioners have found that this is not the case.

In fact, strong documentation will facilitate compliance with auditing standards and it usually leads to a more efficient engagement. The time spent documenting in accordance with the standards is an investment that will pay dividends later. Complying with the requirements while implementing the best practices will help auditors and audit firms perform high-quality work while increasing overall efficiency. In other words, take a smart approach to planning, embrace standardization, document now and save time later, and be prepared for what's ahead.

For more information, read the November 2017 article “4 strategies for efficient, effective audit documentation” in the Journal of Accountancy online. As well, review the additional AICPA guidance and resources at the end of that article. Further guidance on audit documentation in the context of exercising professional judgment is also available in previous posts on this blog.

Research and Guidance Resources by the Center for Audit Quality (CAQ)

Devoted to enhancing investor confidence and public trust in the global capital markets, the Center for Audit Quality (CAQ) is an autonomous, nonpartisan, and nonprofit public policy organization based in Washington, DC. Supported by a membership of U.S. accounting firms registered with the Public Company Accounting Oversight Board (PCAOB), the CAQ is led by a Governing Board made up of CEOs from leading public company auditing firms and the AICPA, as well as three members from outside the public company auditing profession. CAQ resources include guides, case studies, technical alerts, research reports, comment letters, amicus briefs, and videos. They are all publicly available and free of charge.

On August 7, 2016, top practitioners from the public company auditing profession gathered with leading academics at the CAQ’s Eighth Annual Symposium in New York, Research in Auditing – Insights from Academics and Practitioners. The event is a key part of the CAQ’s ongoing dialogue with the academic community on how research can help inform audit practice. As in past years, the 2016 Symposium included panel discussions on critical issues.

This Symposium panel focused on the advantages that can be gained when academics team up with members of the profession to inform their research. Behavioral and archival researchers working with the CAQ Research Advisory Board have benefited from conferring with auditors to better understand the challenges faced in practice, how those are addressed, and how changes in approach or audit methodology could impact the research question.

The Center for Audit Quality has also developed two video vignettes for use in the classroom (each approximately five minutes in length) that provide insights into the types of conversations that occur when auditors are assessing the internal controls used by management. In these scenarios, the focus is on a management review control over goodwill impairment estimates. The discussions captured in the videos can also be used in other teaching situations as they highlight communications and interviewing techniques, professional skepticism, and how to navigate conversations on difficult and sensitive issues. To learn more, refer to video Vignette 1: A Meeting between the Audit Manager and the Company Controller and video Vignette 2: A Meeting between the Audit Manager and the Engagement Partner.

Guidance on Professional Judgment for CPAs in China

At a China Press Conference in Beijing on February 15, 2006, Graham Ward, President, International Federation of Accountants remarked that: “The decision by China to converge towards international auditing standards sends a clear message to the world that both the Chinese people and the Chinese accountancy profession are committed to transparency, quality and high professional standards. Support of these standards will benefit not only the accountancy profession, but also, and even more importantly, all Chinese citizens and the Chinese economy as a whole. Why? Because following high, internationally accepted standards builds trust in the audit process; it builds credibility in the information provided by auditors; it builds investor confidence – all of which are vital to the development of your capital markets. As your economy continues to expand, you are far better positioned to improve the quality of life of your citizens.”

He concluded that: “I am proud that IFAC and the CICPA are working together. Through adherence to high professional standards we can, together, bring about social stability and good governance in business. Through convergence to international standards we can, together, deliver our promise of quality. And through acting in the public interest, we can, together, build public trust and sound economies that support a better quality of life for all. I firmly believe that China’s move toward convergence will go a long way towards improving the life and livelihoods of the people of the People’s Republic of China.”

In line with the convergence towards international auditing standards,  Guidance on Professional Judgment for CPAs (released by the Chinese Institute of Certified Public Accountants on March 26, 2015) states that: “the term professional judgment refers to the application of relevant training, knowledge and experience, within the context provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.” Accordingly, the guidance makes recommendations related to improvement of the quality of CPA’s professional judgment, recommendations for accounting firms, recommendations for CPAs, recommendations for regulators and recommendations for standard setters.

Learn more about the Chinese Institute of Certified Public Accountants – CICPA and the current situation in China by reading the Overview of the Accountancy Profession in China (released by the CICPA on January 21, 2016). The Overview explains that: “The accountancy profession was introduced to China in the early 20th century, mainly serving the booming national industry and commerce. After the founding of the PRC, the profession had played a vital role in the national economic recovery. It was suspended in the Mid-20th century when China adopted a planned economic system; along with China’s historical economic reform and opening up policies, the accountancy profession was revitalized and reconstructed and grew steadily. With over 30 years of development and growth, the accountancy profession in China is now a widely recognized and respectable profession. Accountants are an important link of integrity chain of the market economy and they are entrusted to safeguard the public interest.”

Promoting high ethical standards in the profession

As the first state society established in the United States, the New York State Society of Certified Public Accountants (“NYSSCPA” or “Society”) continues to play a leading role in the development and promotion of high ethical standards within the profession. The Society’s bylaws state that the membership shall be bound by the Society’s Code; however, it is advisable for Society members who are also members of the American Institute of Certified Public Accountants (“AICPA”) to apprise themselves of the applicable laws and related regulations of governmental agencies that regulate certified public accountants in the United States.

One of the cornerstones of the profession of public accountancy is the high ethical standards of its members. Such standards are set forth in the AICPA Code of Professional Conduct (the “Code”). While high ethical standards are essential in achieving public trust and confidence, such trust can be maintained only if the public is confident that the profession can regulate itself and discipline those members who violate or ignore the Code.

The AICPA adopted a revised Code that became effective December 15, 2014. The Conceptual Framework for Members in Business and the Conceptual Framework for Members in Public Practice became effective December 15, 2015. For updates to the Code, see the Table of Contents, Appendix C - Revision History Table.

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.”

The Role of Auditors’ Emotions and Moods on Audit Judgment

CPA Vision 2011 and Beyond: Focus on the Horizon, published by the American Institute of Certified Public Accountants (AICPA), states that emotional skills are extremely important and interpersonal skills are crucial for success as professional accountants. During the audit process, auditors may experience emotional reactions, such as liking or disliking toward client personnel, or anxiety about components of tasks. Auditors also may also experience different moods while conducting audits. Research reveals that an important consequence of auditors experiencing emotions and moods is that these reactions can influence their decision making and audit judgments.

A recently-published research article summarizes the results and practice implications associated with several studies in a stream of research that has examined the role of emotions and moods in auditing. Research illustrates that auditors can experience emotional reactions toward a client (e.g., likability) or an element of a task environment (e.g., anxiety from dealing with certain types of people or about being held accountable) or general moods unrelated to the judgment context (e.g., bad mood related to the weather), which can result in judgment errors.

The research summarized in this paper reveals the potential for auditors’ judgments to be susceptible to emotional reactions toward client personnel and components of a task, as well as general negative and positive moods. Given the fact that auditors’ emotional reactions and moods are pervasive in the audit environment, such effects appear to be somewhat inevitable. There is a potential for these effects to have significant negative consequences. Therefore, a critical first step is to make auditors aware of the potential for emotions and moods to inadvertently impact their judgments, and how the reactions could impact audit effectiveness and efficiency.

For more information, read the 17-page research paper “The Role of Auditors’ Emotions and Moods on Audit Judgment: A Research Summary with Suggested Practice Implications” by Sudip Bhattacharjee (Virginia Tech) and Kimberly K. Moreno (Northeastern University). A manuscript has been accepted for publication in an American Accounting Association (AAA) journal. This preliminary version of the manuscript was posted in the interest of making the information available for distribution and citation as quickly as possible following acceptance.

Auditor Judgment Under Uncertainty: Doctoral Dissertation 2013

A recent research paper investigates how experienced auditors recognize and respond to the degree of management’s evidentiary support and the level of estimate uncertainty when assessing management estimates. Drawing on information processing research, the paper predicts that auditors can be more comfortable with management estimates, and expect a lower adjustment, when there is alignment between the degree of estimate uncertainty and management’s evidentiary support (that is, high uncertainty and more support or low uncertainty and less support). The following diagram provides a graphical representation of the theoretical predictions.

This prediction is tested using an experiment where experienced auditors evaluate an uncertain warranty estimate. The level of uncertainty is manipulated by varying the range of potential costs as either two-times or eight-times materiality. The degree of management’s evidentiary support is manipulated by management either obtaining industry information, inquiring of technicians, or doing these two plus reviewing records, and performing field inspections.

The results support the prediction. In the higher uncertainty condition, auditors were more comfortable and expected a lower adjustment when management obtained more evidential support, but in the lower uncertainty condition auditors were more comfortable and expected a lower adjustment when management obtained less evidential support. In fact, the alignment between estimate uncertainty and management’s evidentiary support can make auditors more comfortable with management estimates supported by relatively less evidence.

These findings demonstrate how audit risk factors, such as the level of uncertainty and degree of management’s support can interact and cause auditors to more readily accept less supported financial statement estimates. More broadly, these findings reveal how providing more information can actually make recipients more uncomfortable with a proposition.

For more information, refer to the 93-page Dissertation, “Auditor Judgment Under Uncertainty” by Stephen P. Rowe, submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Accountancy in the Graduate College of the University of Illinois at Urbana-Champaign, 2013. The Doctoral Committee included: Professor Mark Peecher, Chair; Assistant Professor Bradley Pomeroy; Professor Ken Trotman, University of New South Wales; and Professor Michel Regenwetter.