Editorial - October 2009

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Scepticism in audit practice

The Auditing Practices Board (APB) of the Financial Reporting Council (FRC) is opening discussions about what needs to be done to ensure that the appropriate degree of scepticism is applied by auditors in practice.

'Auditor scepticism: Raising the bar' has been developed in close cooperation with the Professional Oversight Board (POB) and its Audit Inspection Unit (AIU), which monitors the conduct of audits of larger entities.

Richard Fleck, Chairman of the APB and a director of the FRC said, ‘We believe that the time is right for an informed discussion about the “right” level of scepticism to be applied by auditors and the conditions that foster appropriate sceptical behaviour. The Audit Inspection Unit emphasised that close attention must be applied to scepticism in its recent annual report. We hope this paper will lead to a full discussion within the profession about what audit firms need to do to ensure that auditors are appropriately sceptical in practice and how companies and others can facilitate this in the interests of investors and other company stakeholders.’

The discussion paper describes the issue as particularly timely as, in the wake of the banking crisis, regulators have challenged audit firms on whether sufficient scepticism was demonstrated. The need for audit firms to exercise greater professional scepticism was a key message in the Audit Inspection Unit (AIU) 2009/10 Annual Report.

The paper goes on to say that the application of an appropriate degree of professional scepticism is a crucial skill for auditors. 'Unless auditors are prepared to challenge management’s assertions they will not act as a deterrence to fraud nor be able to confirm, with confidence, that a company’s financial statements give a true and fair view. However, scepticism can be taken too far; challenging everything in a well run company will slow down the publication of its financial statements and risks unnecessary costs.'

The APB believes the role of regulation is also important. 'Auditors work to technical and ethical standards, including requirements on rotation of partners. These seek to achieve a balance between scepticism, knowledge and over familiarity. Furthermore, audits of listed companies are inspected by the AIU which looks for evidence that the right questions have been asked and the right judgements made. The challenge for regulators is to protect investors in ways that enable audit skills and judgement to flourish.'

Corporate behaviour also plays a significant role. According to the APB, audit firms and audit partners should not fear removal from their role if they challenge management strongly. Management and Audit Committees also have a responsibility for ensuring that the corporate culture and environment is one which encourages open dialogue with their auditors at all levels. The APB and POB welcome the views of those stakeholders and other parties interested in audit quality and in particular are asking for views on the following:

1. Agreement or otherwise on the emphasis placed by the paper on the importance of auditor scepticism.

2. The regulators recently challenged audit firms on whether sufficient scepticism was demonstrated on some audits. Is this problem widespread or limited to certain types of audits or circumstances? What factors do, or could, in practice create disincentives for auditors to apply an appropriate degree of professional scepticism and what might be done about them? What areas should auditors be more (or less) sceptical in their approach.

3. How should audit firms promote and develop professional scepticism in their partners and staff?

4. Should others, including companies, be doing more to promote, develop and support professional scepticism in auditors? If so, what?

The paper defines in fine detail the nature of auditor scepticism with reference to appropriate academic research on the subject and the history of the growth of auditor scepticism since the end of the 1990s.

Current suggestions to promote further auditor scepticism include:

· Consideration of whether Auditing Standards inadvertently lead auditors to place undue reliance on management’s work and whether there might be new requirements for fuller documentation of the rationale for key audit judgements, perhaps by mandating Audit Completion Memoranda.

· The retention of review notes as part of audit documentation,

· Meetings of the audit team after most of the work has been completed, but before the audit report is signed, to discuss findings,

· Ensuring that reviews are undertaken in person rather than remotely.

The discussion paper can be downloaded in full from the FRC website at www.frc.org.uk

Responses must be returned by 31 October 2010.

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