At a glance
Personal and professional barriers stand in the way of the scepticism required for an effective audit. “There is a fairly broad view that auditors are insufficiently sceptical when they’re doing their work,” says Noel Harding, associate professor at the School of Accounting, University of New South Wales Business School.
It’s a problem acknowledged globally, with a range of accounting standards and educational bodies combining to form a professional scepticism working group to improve the application of professional scepticism.
Professional scepticism is defined in Australian auditing standards as “an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence”.
The standards explicitly require the auditor to plan and perform an audit with professional scepticism, recognising that circumstances may exist that cause the financial report to be materially misstated.
Claire Grayston CPA, CPA Australia policy adviser – audit and assurance, says auditors need to guard against their own biases, which come in a variety of forms and can affect work quality.
One is overconfidence, where the auditor doesn’t question enough and believes their understanding and knowledge is better than that of others. There is also confirmation bias, where the auditor is just trying to corroborate what they’ve already been told, so they’re not looking for opposing evidence.
Another bias is anchoring, where the auditor assumes that because of evidence they’ve seen before, further evidence is going to support that view. Availability is also a key bias, which gives greater weight to evidence which is readily available.
“Auditors should be aware of these biases that might be unconsciously driving their behaviour and not assume that everything is the way the client presents it,” Grayston says.
“They should be looking at their own judgements and making sure they’re justified – that there’s actually evidence to support what they’re concluding, to avoid jumping to conclusions.”
Auditors should strive to suspend judgement until they have gathered all the evidence and not just seek evidence that backs up their assumptions. Instead, they need to look for evidence that might be contradictory as well. Seeking feedback from others and asking if they have come to the right conclusion is also important, Grayston says.
Unconscious bias: the challenge for accountants
The International Accounting Education Standards Board (IAESB) says that reducing unconscious bias is a challenge for professional accountants, particularly for those in large firms, where long working hours can lead to fatigue or cognitive overload. This can open the way for biases to occur.
IAESB notes that structured processes can reduce patterns of unconscious bias that take over when people “trust their gut” in informal procedures.
Training plays a key role in developing a questioning mind and giving auditors the skills to challenge a client, because the more junior or less knowledgeable the staff member, the harder it is for them to challenge someone they might see as more experienced or knowledgeable.
As staff gain experience, they pick up more knowledge of the industry and the management systems that should be in place, such as accounting standards and acceptable accounting treatments and methodologies. They can also draw on previous instances where they have experienced error or fraud, all of which heightens awareness of red flags.
However, Grayston warns that training and competence are not a panacea. “You can have a lot of knowledge and still not be sceptical enough. If you get too close to your client you can be too confident and assume everything is fine, because it was the previous year.”
The auditor-client relationship tightrope
The relationship with a client is also critical. An auditor walks a tightrope between relying on information and cooperation from a client and needing to question that information and apply critical thinking.
Auditors will derive more from a client if they have a good working relationship and Grayston says there is no reason why an auditor cannot question and be persistent about getting the evidence they need, while still retaining a perfectly amicable relationship with the client. Even so, the relationship should not be overly friendly or familiar.
Auditors also need the backing of their firm or partner, so they know they won’t be criticised for challenging the information they are given.
Terms of engagement
An effective audit starts with the terms of the initial engagement. It is important that partners do not underquote for the engagement and that they allow sufficient time and resources for auditors to pursue avenues where they’re not comfortable with evidence or the position the client has taken.
“Allowing opportunities to test the opposite scenario or a different explanation for the circumstances that present themselves is really important,” Grayston says, “as well as stepping back and trying to divorce themselves from time pressures, the need to get the job done and to get back to the office to start the next engagement, in order to adequately challenge management. Auditors must make sure they have properly justified their position by having the evidence to be satisfied with any particular balance, transaction or disclosure they are working on as part of the audit.”
Jeffrey Luckins, director, audit and assurance at William Buck, describes the engagement risk assessment as the most critical stage of audit scepticism, where leaders of the practice assess the risks of an engagement with a client and devise strategies and procedures to reduce assessed risks to acceptable levels.
This can involve refusing to engage or re-engage a client. Luckins says auditors may want to refine their client base, cutting back on high-risk clients that are unprofitable for the practice because, in order to apply professional scepticism, they require more work.
He also highlights the importance of brainstorming meetings, where the audit engagement team discusses what could go wrong and issues to be wary of.
Another driver of scepticism in the audit is the appointment of an engagement quality control review (EQCR) partner. This is already required for some entities, and Luckins says it is a good backstop check. The EQCR partner, who is not a member of the audit team, reviews key judgements, checks the completed work to determine if further procedures or any clarification is required and to point out any other risks that may not have been identified.
Scepticism requires that the tone be set from the top by the audit partner, who needs to make clear to the team why the engagement is important and gives them reasons to care and show care in their work, Luckins says.
He adds that the most highly technically skilled people will have in-built professional scepticism. They will be able to drill down into the accounts and be confident in challenging and asking questions.
For instance, if considering the valuation of goodwill on an acquisition, the auditor will test all the assumptions contained in the balance sheet valuation. They should compare it with other businesses in the same industry and performance against budgeted results, as well as consider the impact of an impairment. However, they should apply heightened professional scepticism if impairments could mean management miss out on bonuses.
“The best quality auditors will be people who understand the links between the different aspects of financial reports and how they interact with the performance of management and their reward systems,” Luckins says.
Like Grayston, he emphasises the role of education and competence. Auditors who display an appropriate level of professional scepticism will be able to understand the business they’re auditing and have a good understanding of the risks.
“It’s that focus on the greatest risk areas that allows you to really target the work and the procedures that you’re going to do to mitigate the risks of conducting the audit, and [not] potentially ending up with a material misstatement in the financial report,” he says.
This also leads to a more efficient audit because the effort is focused on the most important areas.
Audit education: the accounting school response
Given education is vital to auditor scepticism, how are accounting schools responding?
Harding says universities are trying to help accounting students develop their ability to consider a problem with a sceptical mind, but questions the extent to which an individual trait can be changed.
Regardless, he believes universities can help students activate a sceptical mindset by teaching them that scepticism is reflected in being open and receptive to different ideas and not closing off the decision-making process too early.
“We’re trying to foster a knowledge or ability [to the effect] that if we are able to activate this mindset, you’re likely to be looking for what are some alternate states of nature that might explain the phenomena you’re looking at.”
It reflects recent research that scepticism is a cognitive approach to a task, as much as it is an attitude of an individual, Harding says.
While there is general agreement that auditors need some degree of scepticism, there has been significant debate in the accounting profession and among standards setters about the extent to which other branches of the profession need to be sceptical. Should professional scepticism should be noted as characteristic of all professional accountants in ethical codes, for example?
The international position that is now emerging is that professional scepticism will be restricted to auditors. A sceptical mindset and behavioural characteristics are expected of professional accountants in business and in public practice.
Harding says all accountants need critical thinking skills, which he describes as a component of professional scepticism. However, he doubts broad scepticism would be useful in other settings.
“A sceptical approach to what management tells you and questioning management is something that we would certainly want to encourage in an audit setting, but probably not something we want to encourage in someone working in the financial accounting department of a major organisation,” he says.
As important as professional scepticism is for an auditor, Grayston says auditors don’t need the same level of “cynicism and mistrust” that a forensic accountant or liquidator brings to work.
“If you question and distrust every single thing you hear and see as an auditor, you will never get the job done,” she maintains. “You have to pick and choose, and that’s where experience comes into play to understand where the red flags are and which amounts or matters you need to pursue in greater detail.”
All of which means that debate around auditor scepticism and how to achieve it is unlikely to fade any time soon.