Skepticism Report
Skepticism Report
Auditor
Professional
Skepticism
BY
Professors Steven M. Glover
and Douglas F. Prawitt,
Brigham Young University
Contents
ii Executive Summary
23 Conclusion
The Standards Working Group (SWG) of the Global Public Policy Committee (GPPC) (comprising
BDO, Deloitte, Ernst & Young, Grant Thornton, KPMG and PricewaterhouseCoopers) has sought to
develop additional thinking and research that contributes to the dialogue on this important topic.
Accordingly, the SWG commissioned the enclosed publication “Enhancing Auditor Professional
Skepticism”, which was written by Professors Steven M. Glover and Douglas F. Prawitt of Brigham
Young University.
The publication considers the importance of developing a shared understanding of what professional
skepticism is, how it should be applied, the threats to professional skepticism and the safeguards
that may be cost effective. It provides some ideas and recommendations on how the application of
professional skepticism might be enhanced by auditors, as well as briefly indicating how other key
stakeholders can also contribute to its effective application.
The thoughts in the publication do not necessarily reflect the views of each network in the GPPC
and are not intended as recommendations or application guidance; rather, they are intended to
provoke further thought and discussion, with the objective of enhancing the consistent, appropriate
application of professional skepticism in practice, and, ultimately, improving audit quality. In particular,
the GPPC networks do not have a common view on all aspects of the EU audit market proposals.
We would be pleased to meet with you and your colleagues from your organization to discuss this
topic and consider how best to take forward further debate and careful consideration of this paper
and the general subject of enhancing auditor skepticism. Please contact the secretary of the SWG,
Angela Green ([email protected]) in the first instance and she will forward your inquiry
appropriately.
Yours sincerely,
T
he Standards Working Group (SWG) of the Global Public Policy
Committee of the six largest global accounting networks is committed
to improving the quality of financial statement audits and as such
has a keen interest in advancing the understanding and application of
professional skepticism. The SWG accordingly commissioned leading academics
to produce this thought leadership paper. The purpose of the paper is to facilitate
an ongoing discussion between the profession, standard setters, regulators,
investors, audit committees, and other interested stakeholders. While the SWG
believes this paper accomplishes that objective, not all of the views expressed in
this paper necessarily represent the views of individual networks represented in
The purpose of the the SWG.
paper is to facilitate
an ongoing discussion The application of professional skepticism by auditors is important to audit quality.
between the profession, However, various definitions of, and perspectives on, professional skepticism
exist in the auditing literature. To move the dialogue on improving the consistent
standard setters,
appropriate application of professional skepticism forward, it is important that a
regulators, investors, audit shared understanding be developed regarding what professional skepticism is,
committees, and other how it should be applied and documented in various situations, and how threats
interested stakeholders. to professional skepticism manifest themselves at different structural levels. It
is also important to take into account the efforts and safeguards already in place
to increase the likelihood that new initiatives will bring incremental improvement
and that their benefits will exceed their costs. We propose a “professional
skepticism continuum” that acknowledges that the appropriate application of
professional skepticism will depend on the risk characteristics of the account
and assertion. We also lay out the different structural levels at which professional
skepticism is applied and at which threats can arise. We propose that efforts to
mitigate threats to the appropriate application of professional skepticism are more
likely to be effective if they take into account the distinct nature of the different
structural levels. Finally, we provide some ideas and recommendations on how the
application of professional skepticism might be enhanced on the part of auditors as
well as how other key stakeholders can contribute to its effective application. The
thoughts presented for consideration in this paper are not intended as concrete
recommendations or specific application guidance; rather, they are intended
to provoke further thought and discussion, with the objective of enhancing the
consistent, appropriate application of professional skepticism in practice, and,
ultimately, improving audit quality.
R
eliable financial information is vital to investor confidence in the
capital markets. The financial reporting information chain involves
many stakeholders who have responsibilities that promote
reliable financial reporting. Independent, external financial
statement auditors play an important role in the financial reporting process
by providing an independent opinion that financial statements present fairly
in all material respects, or give a true and fair view of, the reporting entities’
financial position, results of operations, and cash flows, in accordance with
We propose a “professional
an applicable reporting framework. This paper contributes to an ongoing
discussion regarding enhancing the professional skepticism of auditors. skepticism continuum” that
recognizes that the appropriate
Auditors adhere to professional standards while performing financial application of professional
statement audits. Those standards require that appropriate professional
skepticism will depend on
skepticism be applied in the exercise of professional judgment. While
a responsibility for appropriate professional skepticism is not the sole the risk characteristics of the
domain of financial statement auditors, this paper focuses on professional particular account and assertion
skepticism applied by auditors in the conduct of a financial statement being audited.
audit. We note that while the concepts underlying professional skepticism
are relatively straightforward, there is a lack of common understanding or
practical guidance on what professional skepticism is and how it can be
demonstrated and documented. We discuss the reasons for a renewed
focus on auditor skepticism, as well as various definitions and meanings
of professional skepticism. We propose a “professional skepticism
continuum” that recognizes that the appropriate application of professional
skepticism will depend on the risk characteristics of the particular account
and assertion being audited. We also discuss threats to the consistent
application of professional skepticism at various structural levels and steps
that can mitigate these threats. Finally, we suggest that auditor professional
skepticism can be enhanced through the cooperative efforts of other
stakeholders in the financial reporting process, including directors and audit
committees, regulators, and standard setters, and we propose specific ideas
for advancing such cooperative efforts.
1
IAASB, ISA 200, Overall Objectives of the Independent Auditor
and the Conduct of an Audit in Accordance with International
Standards on Auditing. 2009. New York, NY: IFAC. PCAOB AU
230, Due Professional Care in the Performance of Work. 2010.
www.pcaobus.org.
SKEPTICISM CONTINUUM
PROFESSIONAL SKEPTICISM**
“An Attitude that Includes a Questioning Mind”
EXTENSIVE AUDIT
LESS AUDIT EVIDENCE
EVIDENCE AND
AND DOCUMENTATION
DOCUMENTATION
• Lower risk and susceptibility of material • Higher risk and susceptibility of material
misstatement misstatement
• No indicators of fraud • Fraud indicators present
• No errors detected • Errors detected
• Routine, little judgment required • Complex judgment
• Audit evidence consistent with initial • Audit evidence inconsistent or contrary
risk assessment to the initial risk assessment
The factors leading to the need for additional audit We illustrate four overlapping categories in the
evidence recognize that the complexity of business continuum and note that the two categories in the
transactions, expanded use of fair values and subjective middle are the two labels most commonly used in the
estimates, and the move to more principles-based prior literature. The categories are not used in equal
accounting standards all tend to heighten the degree proportion in a financial statement audit. We depict the
of professional judgment and skepticism auditors neutral perspective as covering a larger portion of the
need to apply. The boxes listing the factors indicate, continuum to recognize that a majority of assertions
as mentioned above, that the continuum focuses on will fall in this area and that there will be a substantial
audit strategy, procedures, and documentation after range of risk covered by this perspective. In other
an appropriate initial risk assessment for each account words, within the neutral range, the level of risk and
and relevant assertion is conducted in accordance with audit evidence increase moving from left to right.
applicable auditing standards. We also acknowledge Moving from left to right in the area of professional
that an initial risk assessment that leads to a particular skepticism increases the level of questioning in the
skepticism level should be reevaluated and challenged auditor’s mind. Evidence of increased questioning might
based on evidence obtained throughout the audit to involve a revision of the nature, timing, or extent of
determine if the original assessment is still appropriate. testing. For example, the timing of the testing may be
closer to period end, the nature of testing may involve
additional types of procedures to provide corroborating
The exhibit also illustrates that there are instances
evidence, or the extent of testing may be increased.
where the auditor’s risk assessment procedures will
Another aspect of an increase in questioning in the
lead the auditor to the determination that little to no
application of professional skepticism may be a greater
additional audit work, beyond the risk assessment
focus on potentially disconfirming evidence and when
procedures, for an account or assertion is necessary.
there are high-risk factors, such as the presence of
For example, an asset account balance that is
fraud-risk indicators, it may result in an active search
clearly immaterial and presents no risk of material
for evidence that has strong potential to contradict or
misstatement would not require additional audit work
disconfirm management’s assertions. An active search
beyond the initial risk assessment. As auditors consider
for disconfirming information may be facilitated by the
the extent of evidence needed, it is also important
auditor designing and carrying out audit procedures
to recognize that different forms and nature of audit
to specifically address questions such as “what
evidence vary in strength.
evidence might support the opposing arguments?”
or “what evidence might indicate that management’s
It should be noted that maintenance of a questioning
assumptions do not hold?”
mind is associated with the entire range of professional
skepticism. For example, for a material account or
The rightmost category, “complete doubt,” is a more
assertion that is assessed as lower risk, it may be
skeptical perspective than is “presumptive doubt” and
appropriate to apply a neutral perspective in determining
would be appropriate when, for example, audit tests
the audit evidence needed, but this does not mean
reveal known errors and/or fraud that will likely lead to a
that the auditor ceases to be alert for and follow up on
material misstatement. Accordingly, when audit testing
indicators of potential issues that may result in the need
reveals systematic errors that could lead to a material
for more persuasive evidence.
misstatement, the auditor would search for additional
errors or ask the entity to do so and appropriately
5
See, for example, Hurtt, K. 2010. “Development of a Scale to
Measure Professional Skepticism.” Auditing: A Journal of Practice
& Theory 29 (1): 149-171. The latter three traits may help ensure
that the auditor’s skeptical mindset will translate into actions by the
auditor that are consistent with that mindset. Consistent with the
argument for a role for personality traits in exercising skepticism,
a book titled Behind Closed Doors—What Company Audit is Really
About (published by the Institute of Chartered Accountants, 2001)
suggests that audit quality depends on audit partner personality
traits that have clear implications for skepticism.
6
For example, see Plumlee, D., B.A. Rixom, and A.J. Rosman.
Training Auditors to Think Skeptically. 2011. Working paper, University
of Utah.
7
Cultural differences around the world likely can affect the exercise
of professional skepticism through cultural personality traits or
through cultural norms regarding the application of knowledge
to question assertions. It is important that cultural characteristics
or patterns that have potential to undermine the application of
appropriate professional skepticism be identified and addressed so
that professional skepticism can enhanced through training, and
encouraged in the field through supervision, mentoring, and review
of work performed.
I
n this section, we address potential threats to professional skepticism
as well as factors that are already in place to foster the consistent,
appropriate application of professional skepticism. We also discuss
potential opportunities for audit firms and the profession to consider as A key to understanding,
they work to enhance professional skepticism. Given the scope of this paper,
evaluating, and appropriately
the ideas we offer for enhancing professional skepticism are illustrative—
they do not constitute an effort to propose a comprehensive set of solutions addressing factors that may
nor do we provide in-depth discussion of the appropriateness or potential either threaten or enhance
value of each proposal. professional skepticism is
to recognize that different
Some regulators have suggested that more appropriate levels of professional
skepticism might have avoided alleged audit deficiencies that they have factors come into play at
identified, and have conducted outreach and suggested possible measures different structural levels of
intended to enhance auditor skepticism.8 Our observation regarding efforts the professional setting.
to enhance professional skepticism is that before moving ahead with such
proposals, stakeholders should take time to fully understand the various
factors that influence the application of professional skepticism, including
potential threats and measures already in place, and should engage in a
full consideration of potential ways to effectively enhance professional
skepticism. Any such analysis should consider the full context in which
professional skepticism is applied. Otherwise, proposed solutions may have
8
For example, one suggested solution is mandatory audit firm rotation. Both the 2010
European Commission Green Paper “Audit Policy: Lessons from the Crisis” and a 2011 U.S.
Public Company Accounting Oversight Board (PCAOB) concept release include discussion
of mandatory audit firm rotation. In response to requests to provide feedback as to whether
mandatory audit firm rotation would enhance professional skepticism and if so, if it would do
so in a cost effective manner, the significant majority of responses (including analyses that
exclude responses from the audit profession) were not in favor of mandatory rotation.
Threats − Some of the potential threats to professional skepticism that may exist at the Individual
Auditor level include:
• Judgment traps and biases, lack of knowledge and expertise
• Deadline pressure, inherited preferences and expectations
• Auditor character, and personal and cultural attributes
• Performance and compensation metrics and incentives that do not appropriately encourage professional skepticism
Mitigating Factors − Some of the measures in place to foster and encourage the appropriate application of professional
skepticism at the individual auditor level include:
• Professional licensing and continuing education requirements
• Supervision, mentoring, review, and inspection of work and performance evaluations
• Effective planning and audit programs, including expectation setting
• Performance metrics that reward people for high quality work
• Stringent recruiting requirements
• Effective engagement partner and leadership messaging
• Training on core competencies, professional judgment, and other subjects
Threats − Some of the potential threats to professional skepticism that exist at the engagement team level include:
• Client service and business development goals that create conflict of interest
• Inadequate time management, limited resources, ineffective utilization of specialists and experts
• Misaligned inspection influence (e.g., expanded requirements)
• Preferences of management and partner, tone or practices of engagement leadership that do not adequately
emphasize professional skepticism
• Apprenticeship model
• Client characteristics (governance structure, tone at the top)
• Familiarity linked to audit tenure
• Potential bias stemming from dysfunctional group decision tendencies
Mitigating Factors − Some of the measures in place to foster and encourage the appropriate application of professional
skepticism at the engagement team level include:
• Planning with involvement of engagement leadership
• Industry and client experience
• Fraud brainstorming meetings
• Internal quality performance review programs
• Required upward consultation
• HR and independence policies, including limitations on provision of certain nonaudit services and restrictions on
compensation based on such services
• Ethics and compliance hotlines
• Partner rotation requirements
• Engagement quality control review and external inspection programs
Profession/Audit Firm − Pertains to the external auditing profession; encompasses public accounting firms and the
economic and regulatory environment in which they operate.
Threats − Some of the potential threats to professional skepticism that exist at the profession and firm level include:
• Conflicts of interest stemming from payor/selector model
• Insufficient resources devoted to the audit, or competition primarily based on audit fees
• Incentives created by office/regional performance measures and consequences
• Dependency by local office on large client
• Nature or volume of nonaudit services
• Inspection focus that does not fully align with relevant audit risks.
• Audit committees that do not understand oversight role or are aligned too closely with management
Mitigating Factors − Some of the measures in place to foster and encourage the appropriate application of professional
skepticism at the profession and firm level include (may differ by jurisdiction):
• Tone at the top encouraging high quality auditing and professional skepticism
• Independence requirements including prohibition on providing certain nonaudit services
• Licensing exams, experience, and continuing education requirements
• Professional accounting and auditing standards
• Audit methodology, templates, tools, and policies, including linkage between assertions and audit procedures
• Quality control policies and procedures, including internal and peer inspections, and independence policies, tracking
and enforcement
• Independent regulatory oversight and inspection, and appropriate public reporting of inspection results
• Required upward consultations
• Threat of litigation, sanction, fine
• Quality control, quality reviews, and independence standards
• Required communication with audit committee, audit committee selecting and appointing the auditor, and audit
committee approval of nonaudit services
Individual Auditor Level: Threats However, because they are shortcuts, situations can
arise where they systematically and predictably lead
to the Appropriate Application of to suboptimal judgments and potentially inhibit the
Professional Skepticism. application of appropriate professional skepticism.
Research has found that auditors’ judgments can be Bias-inducing tendencies can lead even the brightest,
flawed because, like all people, sometimes they do not most experienced professionals, including auditors, to
consistently follow a sound judgment process and they make suboptimal judgments. Understanding where
fall prey to systematic, predictable traps and biases. auditors tend to unknowingly take judgment shortcuts
People, including experienced professionals such as and where their motives can subconsciously affect them
doctors, attorneys, and accountants, often unknowingly can facilitate the identification of when the quality of
use mental “shortcuts” and simplifying strategies auditor judgments and the application of professional
to efficiently navigate complexity. These simplifying skepticism can be affected by systematic bias. While
shortcuts and tendencies generally serve us very well. a complete discussion of unconscious judgment traps
Exhibit 3: Common Judgment Tendencies that Can Lead to Bias and Weaken Skepticism
Overconfidence — The tendency of decision makers to overestimate their own abilities to perform tasks or make
accurate assessments of risk or other judgments and decisions. Overconfidence can lead to underinvesting in
understanding issues and audit objectives; insufficient challenging of management’s preferences, views, and reporting
choices; limited consideration of the nature of the audit procedure and potential alternatives; or truncating evidence
search, all of which can manifest themselves in terms of a suboptimal level of professional skepticism.
Confirmation — The tendency to seek and overweight confirming information in the information-gathering and evaluation
steps, and to favor conclusions that are consistent with initial beliefs or preferences. The confirmation tendency can bias
a wide variety of auditor judgments, ranging from an auditor only seeking evidence that is consistent with a supervisor’s
or client’s explanation for an unusual pattern in financial data, to placing disproportionate weight on audit evidence that is
consistent with a preferred outcome.
Anchoring — The tendency to make assessments in gathering and evaluating information by starting from an initial value
and then adjusting insufficiently away from that initial value in forming a final judgment. Anchoring is commonly exhibited
when auditors begin the audit of a specific account by viewing the account details from the previous year or by examining
unaudited balances. The auditor may be inappropriately influenced by those numbers or the auditor may unknowingly
fail to sufficiently adjust away from an initial starting point, resulting in a lack of objectivity in assessing transactions,
estimates, and account balances.
Availability —The tendency for decision makers to consider information that is more readily available from memory as
being more likely, relevant, or more important for a judgment. The tendency limits alternatives considered or information
gathered to those alternatives or information that readily come to mind. Availability can be especially common as auditors
typically work with several clients. Information from recent events and audits may be fresh in the mind, and an auditor
may unconsciously attempt to apply less relevant information or conclusions from prior situations to the current audit.
10
Nelson, M.W. 2009. “A model and literature review of professional
skepticism in auditing.” Auditing: A Journal of Practice & Theory 28
2: 1–34.
11
IAASB, ISA 240, The Auditor’s Responsibility Relating to Fraud in an
Audit of Financial Statements. 2009. New York, NY: IFAC. PCAOB 12
See Brazel, J., Carpenter T., and Jenkins, G. 2010. “Auditors’ Use
AU Section 316, Consideration of Fraud in a Financial Statement of Brainstorming in the Consideration of Fraud: Reports from the
Audit. 2010. www.pcaobus.org. Field.” The Accounting Review 85 4: 1273–1301.
E
xternal auditors clearly have the responsibility to apply appropriate
Understanding the professional skepticism throughout an audit. Understanding the
determinants of and threats determinants of and threats to professional skepticism at different
structural levels will facilitate the formulation of solutions that
to professional skepticism at can foster more consistently appropriate levels of professional skepticism.
different structural levels will While auditors can and must do better in their central role, we believe
facilitate the formulation of that a complete solution to the problem of enhancing auditor professional
solutions that can foster more skepticism requires an approach that addresses threats at all structural
levels and that involves all of the key stakeholders that share responsibility in
consistently appropriate levels
enhancing the reliability of the financial reporting process. In the context of
of professional skepticism. this section, we focus on how other key stakeholders can contribute to the
improved application of professional skepticism by auditors.
15
See Auditing Practices Board, 2012, “Professional Skepticism: Establishing a Common
Understanding and Reaffirming its Central Role in Delivering Audit Quality,” www.frc.org.uk.
Also see KPMG, Glover, and Prawitt, 2012, COSO Monograph: Enhancing Board Oversight:
Avoiding Judgment Traps and Biases.
16
A recent paper by the U.S. National Association of Corporate
Directors (NACD), dated January 2013, titled “Honing Skepticism,”
notes the importance of exercising skepticism by those in the
corporate boardroom, both in itself and for its role in enhancing the
professional skepticism of external auditors. Also see KPMG, Glover, 18
See the FRC’s Auditing Practices Board publication, Auditor
and Prawitt, 2012, COSO Monograph: Enhancing Board Oversight: Scepticism: Raising the Bar, March 2011. Clarified guidelines
Avoiding Judgment Traps and Biases. and requirements around achieving appropriate audit committee
independence from management, in appearance and fact, may also
17
For example, PCAOB Auditing Standard No. 16, Communications be an area that could improve the ability of audit committees to
with Audit Committees. 2012. www.pcaob.us.org. enhance auditors’ professional skepticism.
20
An example of such a judgment framework can be found in 21
Maksymov, E., M. Nelson, and W. Kinney, 2012. Effects of
Glover, S.M., D.F. Prawitt, and KPMG, 2011, Elevating Professional Procedure Frame, Procedure Verifiability, and Audit Efficiency
Judgment in Accounting and Auditing: The KPMG Professional Pressure on Planning Audits of Fair Values. Working paper, Cornell
Judgment Framework. University.
I
n light of the changing environment of financial reporting and demands for
enhanced audit quality and relevance, an understanding of and an ability
to exercise proper professional skepticism is increasingly important for
all stakeholders who participate in the financial reporting process. Audit
professionals must be able to identify and exercise a sufficient level of professional
skepticism—one that is appropriate for the risks involved. There is currently a lack
of practical guidance around the appropriate application and documentation of
professional skepticism in auditing standards and in the professional literature. We
believe this represents an important opportunity for the profession, academics,
standard setters, and regulators. The skepticism continuum we provide represents
a potential step forward in understanding the nature of professional skepticism Our hope is that this paper
and in applying, documenting, and evaluating an appropriate level of skepticism will provide a conceptual
in varying circumstances. In order to make changes that have the potential to foundation for a productive
enhance professional skepticism in the financial reporting process, auditors and ongoing dialogue that will
others involved must understand the nature of professional skepticism, including
how skepticism is threatened and how it can be enhanced at the various structural
lead to specific actions
levels (Individual Auditor, Engagement Team, Profession/Audit Firm). An increased to enhance auditor
capacity to understand and identify threats to professional skepticism at particular professional skepticism
structural levels and in the context of measures already in place will assist the and, ultimately, audit
profession in taking appropriate steps to mitigate such threats and will assist
quality.
others in evaluating relevant costs and trade-offs that are explicit or implicit in
alternatives considered.