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.

Exploring the Growing Use of Technology in the Audit, with a Focus on Data Analytics

In September 2016, the International Auditing and Assurance Standards Board (IAASB)’s Data Analytics Working Group (DAWG) released a Working Group Paper, Exploring the Growing Use of Technology in the Audit, with a Focus on Data Analytics. The Paper is open for comment until February 15, 2017. In addition, this publication is a call for nominations for a newly formed Project Advisory Panel to further advise the IAASB and the DAWG on developments relevant to standard setting.

The Paper provides insights into the opportunities and challenges with the use of data analytics in the audit of financial statements and outlines the insights gained from the activities to date. The purpose of the Request for Input is to:

• Inform stakeholders about the IAASB’s ongoing work to explore effective and appropriate use of technology, with a focus on data analytics, in the audit of financial statements; and 

• Obtain stakeholder input and perspectives on whether all the considerations relevant to the use of data analytics in a financial statement audit have been identified.

The DAWG paper (page 16) emphasizes that: “The use of data analytics in an audit of financial statements will not replace the need for the auditor to exercise appropriate professional judgment and professional skepticism. Strong views have been expressed by the IAASB CAG and at IAASB roundtables about the importance of the auditor having a thorough understanding of the entity and its environment in order to facilitate a high-quality audit in which professional skepticism is appropriately applied.”

For additional insights, refer to the June 2016 Audit Data Analytics Alert  issued by CPA Canada.

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.

Enhancing Auditor Professional Skepticism: The Professional Skepticism Continuum

A 2014 academic research paper published by the American Accounting Association notes that “Due to past high-profile audit failures, reported audit deficiencies in regulator inspection reports, and the growing number and size of complex estimates in the financial statements, there is a growing need for reliability and trust in financial reports and a corresponding increased demand for enhanced audit quality. Enhancing the level of professional skepticism applied in practice is one important means of improving audit quality, but there is a lack of practical guidance around the appropriate application and documentation of professional skepticism in the professional literature.”

The following graphic offers a proposed skepticism continuum. Such a continuum enables the auditor to take the perspective that is most appropriate considering the circumstances applicable to each audit area and assertion. Applying a continuum to a specific account and assertion takes place after a careful and rigorous initial risk assessment, and a continued re-evaluation of the risk throughout the audit to ensure that appropriate skepticism is applied to the collection and evaluation of audit evidence.

According to the paper, “A shared understanding would allow audit professionals to identify, communicate, and exercise a level of professional skepticism appropriate for the risks involved, and would enable regulators to fairly evaluate, after the fact, the level of skepticism applied. The skepticism continuum we propose represents a potential step forward in understanding the nature of professional skepticism and in applying it appropriately under varying circumstances.”

The paper concludes that, “In order to make the necessary changes, the profession, academics, regulators, and standard setters should work together to better understand the nature of professional skepticism, including how skepticism is threatened at various structural levels, current measures in place to mitigate those threats and, then, finally, how skepticism can be enhanced at the various structural levels. Our hope is that this paper will provide a conceptual foundation to facilitate a productive ongoing dialogue that will lead to specific actions to enhance auditor professional skepticism and, ultimately, audit quality.”

To learn more, read the full paper by Steven M. Glover and Douglas F. Prawitt, both Professors at Brigham Young University, “Enhancing Auditor Professional Skepticism: The Professional Skepticism Continuum” in Current Issues in Auditing: December 2014, Vol. 8, No. 2, pp. P1-P10.

Internal Audit - How to Develop Professional Skepticism

A recent research article notes that, to date, the Institute of Internal Auditors (IIA) standards regarding periodic internal and external quality assessments do not involve a formal and explicit evaluation of “professional skepticism” (see IIA Standard 1300). But, there is a trend afoot that asserts due professional care incorporates professional skepticism.

According to that article, “Professional skepticism can be thought of as having a reasoning of mind to question what has been presented for evaluative purposes—to look beyond the obvious in the search for revealing information and relationships. In essence, it is more than taking the easy way out. To do so, an individual must go beyond the face value.”

Furthermore, “Professional skepticism relies on the recognition that something is awry and needs to be addressed. As such, performance in the field should use this as the cornerstone for evaluation. ...At a truly effective level of professional skepticism, one is able to draw on one’s past work experiences and observations to make value-adding decisions about audit evidence.”

So, how do you produce highly regarded financial statements in the face of demands to minimize external audit costs? Many companies try to solve this problem by using their internal audit department more during the annual external audit. However, that can be tricky because the internal audit staff is required to remain independent. The solution, say the authors of this article, is to actively develop and maintain the internal auditors’ professional skepticism. And, the authors provide a detailed roadmap that shows how to do that.

To learn more, read the research article Internal Audit - How to Develop Professional Skepticism published in The Journal of Corporate Accounting & Finance, May/June 2011. The research was undertaken by Nicole McCoy, PhD, CPA, Louisiana Tech University; Royce D. Burnett, PhD, CPA, and Marc Morris, PhD, both at Southern Illinois University–Carbondale; along with Mark E. Friedman, PhD, CPA, University of Miami.

Further guidance on the exercise of professional skepticism is available in previous postings.

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.”

Professional Scepticism of Auditors: A Cross-Cultural Experiment

 In light of the growth in multinational business operations and the greater use of international sources of finance, there has been a global trend to increased uniformity in accounting and auditing standards. The research suggests that uniformity in auditing also requires uniformity in the application of those standards. One study attempts to determine whether there are differences in the application of auditing standards due to the influence of cultural differences on decision-making by auditors. In this regard, the study examines the effect of culture, the risk of fraud and errors, and accountability on auditors’ professional scepticism, which is necessary to assess the risk of material misstatements.

Data from a sample of auditors from the Big 4 audit firms in Egypt and Australia were collected. The subjects evaluated the risk of fraud and error at the planning stage. The findings provide evidence as to whether auditors from different cultural backgrounds react differently to audit evidence. The results show that there are significant differences between the two countries with respect to some audit decisions.

This paper makes an original contribution to the literature by providing evidence about whether auditor judgments, decisions and professional scepticism are consistent across cultures. The findings indicate that the exercise of professional judgment differs between cultures. Therefore, the researchers recommend that international auditing standards should consider these differences.

For more information, read the research paper (and the related Doctoral Thesis), Professional Scepticism of Auditors: A Cross-Cultural Experiment by Medhat Endrawes, Department of Accounting and Corporate Governance, Macquarie University and Gary S. Monroe, School of Accounting, University of New South Wales.