Audit Conduct

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"It is the mark of an educated mind to be able to entertain a thought without accepting it."

. . . Aristotle (384 - 322 BC)

Professional Skepticism: an attitude that involves a questioning mind, being alert to conditions that indicate possible fraud or errors, and critically assessing audit evidence. Without a questioning mind, there is no audit – the auditor should scrutinize management’s financial statements in opining on whether the company’s financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework.  Complexity and judgment are inherent in financial reporting and the possibility of fraud and deception is a perpetual concern, making the exercise of due care and professional skepticism in today’s audit environment even more critical.  

Standards-setters, regulators and others have speculated whether audit deficiencies that appear to result from a lack of professional skepticism are just that (and if so, why?), or whether a combination of other factors also may be at play. Some explanations include:    

  • Lack of time to perform a quality audit
  • Inadequate supervision 
  • Lack of due care or competence
  • Lack of fortitude (to stand up to management)
  • Pressures exerted by the client to meet their demands
  • Unreasonable deadlines for completing work
  • Poor audit firm tone at the top
  • Lax quality control at the audit firm
  • Catering to the client who pays their fees and may hire the firm to perform consulting or tax services
  • Personality traits, for example, some auditors are naturally more trusting or inquisitive than others
  • Cultural influences that may deter an auditor from challenging the client  
  • Situations or mindsets that lead an auditor to be overconfident, rely on easily obtainable data, support their own initial expectations, or fall prey to “groupthink”
  • Extended audit firm or audit partner/team member tenure which creates a familiarity threat
  • Firm incentives that reward pleasing the client over performing a quality audit


This article explores how the professional and regulatory community, audit firms, academics and others are working to address these complex issues and suggests ways that firms and auditors may enhance professional skepticism in audits and other attest engagements. 


Defining the Problem and Proposing Solutions

Advisory Committee on the Auditing Profession.  About a decade ago, the US Treasury Department’s Advisory Committee on the Auditing Profession (“ACAP”) was charged with examining the sustainability of a strong and vibrant audit profession.  The ACAP looked at a variety of issues, including the impact of independence and other professional standards on the markets and investor confidence.  In its 2008 Final Report, the committee emphasized several times the importance of healthy professional skepticism in audits, recommending (among many other things) that firms develop training materials to help foster and maintain the application of skepticism among public company auditors.  The Committee also suggested that the Public Company Accounting Oversight Board (“PCAOB”) review such training programs when they inspect audit firms. 


A Growing Concern.  The PCAOB periodically reports, without naming firms, its observations about significant or frequent deficiencies found in inspections of firms under the Board’s jurisdiction.  In the first report (dated October 2007), Report on the PCAOB'S 2004, 2005, 2006, and 2007 Inspections of Domestic Annually Inspected Firms (firms regularly auditing more than 100 issuers), the Board concluded by stressing the importance of due care and skepticism in public company audits.  In December 2008, the Board released Report on 2007-2010 Inspections of Domestic Firms that Audit 100 or Fewer Public Companies, citing concerns about a potential lack of due care, including professional skepticism, leading to deficiencies in audits. The report cited other possible causes, including lack of supervision and unreasonable workloads, and urged firms to analyze deficiencies in their firms to determine root causes and remedy them.  The Board issued another report on the inspections of triennially-inspected firms in 2013, with similar results, comments and exhortations to the firms. The Board’s criticisms persisted in reports summarizing inspection findings for broker-dealer audits released from 2012 through 2016. Excerpts from individual reports on firms that included public portions (expanded reports) included comments such as: 

The inspection results continue to provide cause for concern regarding the Firm's application of professional skepticism in the performance of audits. The inspection team identified eight audits with deficiencies… that appear to be caused, at least in part, by the failure to appropriately apply professional skepticism.


The inspection results provide cause for concern that the Firm's system of quality control may not do enough to assure that accounting and auditing issues are evaluated with the professional skepticism that is contemplated in the auditing standards.


In 2012, the PCAOB issued Staff Audit Practice Alert (“SAPA”) No. 10 amid concerns about a continued lack of professional skepticism in audits observed in the Board’s inspections program.   SAPA No. 10 acknowledged the complexity of professional skepticism in audits, and emphasized that, “it is important for auditors to be alert to unconscious human biases and other circumstances that can cause auditors to gather, evaluate, rationalize, and recall information in a way that is consistent with client preferences rather than the interests of external users”.  The SAPA also noted that incentives and pressures to maintain long-term audit engagements, avoid conflicts with management, please the client, keep costs low, and cross-sell other services can all play a part in weakening professional skepticism. 


Not Just a US Issue.  In recent years, the International Forum of Independent Audit Regulators (“IFIAR”) has issued annual Inspection Findings Reports for audit firms affiliated with the six largest international audit firm networks, also citing concerns about professional skepticism.  Its (latest) March 2016 report indicated a lack of professional skepticism related to all five (5) of its key deficiency findings: internal control testing; fair value measurement; risk assessment; revenue recognition; and group audits. Inspections of the firms’ quality control systems also revealed high frequencies of findings, including in the areas of independence and ethical requirements.  (Per its web site, IFIAR’s membership totals 52 audit regulators in jurisdictions around the world.)


Global Standard-Setters.  In February 2012, the International Auditing and Assurance Standards Board (“IAASB”), the audit standard-setting arm of the International Federation of Accountants (“IFAC”), issued Staff Questions and Answers, which re-emphasized to auditors and others the important role that professional skepticism plays in financial statement audits.  In 2015, the IAASB worked with academics to summarize research in auditor professional skepticism and update the academic literature.  Among other key findings, they believed that more research should be performed to determine how the wealth of information regarding impediments to professional skepticism and potential solutions can be translated into more effective training programs.  In 2016, the IAASB released an Invitation to Comment (“ITC”) addressing professional skepticism, quality control and group audits.  Other IFAC standard-setters, the International Ethics Standards Board for Accountants (“IESBA”) and the International Accounting Education Standards Board (“IAESB”), recently joined forces with the IAASB to address concerns about professional skepticism. 

In November 2013, the Global Public Policy Committee (“GPPC”), comprised of BDO, Deloitte, Ernst & Young, Grant Thornton, KPMG and PricewaterhouseCoopers, published Enhancing Auditor Professional Skepticism, written by Professors Steven M. Glover and Douglas F. Prawitt of Brigham Young University.  The publication discusses threats to professional skepticism and the safeguards that can mitigate those threats, and provides ideas and recommendations on how auditors might enhance their application of professional skepticism, which the GPPC suggests viewing in the context of a continuum related to risk and other factors. The publication notes that skepticism is a critical component of professional judgment and refers to and discusses professional skepticism in the context of applying a good judgment process (see also Elevating Professional Judgment in Accounting and Auditing: The KPMG Professional Judgment Framework).   


Suggestions for Enhancing Professional Skepticism

The previously-cited publications offer insights and solutions to the many factors and situations that may limit the auditor’s exercise of professional skepticism.  The following table pulls from those publications and the author’s discussions with audit firms and suggests, by category (Firm Level / Engagement Team Level / Individual Level), ways in which firms and auditors may boost skepticism in the performance of audits and other attest services.  


 



Other Resources

In 2014, the Center for Audit Quality (affiliated with the American Institute of CPAs) issued the Professional Judgment Resource, which firms may wish to use by: (i) adapting the resource to supplement the firm’s system of quality control through a decision-making process that strengthens audit and attest engagement performance, or (ii) enhancing consistency across the firm’s internal training materials, audit methodologies, and other internal processes related to audit and attest work.