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Through this essay a critical evaluation will be presented on whether auditor scepticism is consider to be an increasing concern for the audit profession and stakeholders of companies in the UK. In doing so, examples will explain how accounting profession highlight auditor scepticism into UK. Furthermore, various recommendations will be stated that will help auditor scepticism to be reduced from auditors prospective.
Firstly, it would be wise to define what audit and auditor scepticism is. As indicated by Woolf, "in its modern sense, an audit is a process (carried out by suitably qualified auditors) whereby the accounts of business entities, including limited companies, charities, trusts and professional firms, are subjected to scrutiny in such detail as will enable the auditors to form an opinion as to their truth and fairness. This opinion is then embodied in an 'audit report', addressed to those parties who commissioned the audit, or to whom the auditors are responsible under statute." (Woolf, 1997) Auditor scepticism as defined by Nelson consists of "auditor judgments and decisions that reflect a heightened assessment of risk that an assertion is incorrect, conditional on the information available to the auditor" (Nelson, 2009). From this definition we comprehend that scepticism somehow influences the scope of the auditor's work and helps him or her to evaluate their findings. Also, it helps the auditor to decide whether he/she has obtained a 'true and fair view' on the business financial statements.
In terms of scepticism the auditors and the stakeholders have concerns, some of which are explained briefly below. The crucial event which had a major effect on the audit profession was the financial crisis and the recession. When financial crisis hit the UK economy, the role of auditors was reviewed, especially from the UK government. Stakeholders accused the auditors of not performing as they should when it comes to scepticism, especially in the banking sector. Now stakeholders are more demanding towards auditors and try to force them to be more sceptical (Welch, 2010). The Agency theory states that agents of the company are considered to be the managers, whereas owners are the shareholders. Owners and agents must have a parallel opinion when it comes to company's revenue. By forcing the auditors to be more sceptical it would not help solving the agency problem, instead it would give a boost on increasing it. (Dunn, 1996)
When it comes to the profession, being too sceptical will lead to over-auditing. From over-auditing, there will be a communication gap between management and auditors. This will result to the breakdown of communication such as luck of evidence or no evidence. Another problem is that if there is any lack of evidence it would cause a delay in meeting deadlines. This would lead the auditors to charge a higher fee for their services. So, in order to reduce the communication gap, they need to have an equal sceptical attitude (Murray, 2012). As previously mentioned, audit profession was affected from the events of financial crisis and recession. After questioning the scepticism of the profession, accounting bodies and committees had to take actions in order to prevent any similar issues in the future. The regulators are in a position to challenge the audit firms if there was sufficient scepticism demonstrated from their part and the Audit Inspection Unit tried to pass a massage through their annual report that firms had to exercise a bigger professional scepticism (Auditing Practises Board, online). Many parameters had been put on the table on how to enhance the appropriate professional scepticism without affecting the communication gap.
Now, I would be looking at how the audit profession addresses the scepticism. The framework defines auditor independence as "freedom from those factors that compromise, or can reasonably be expected to compromise, an auditor's ability to make unbiased audit decisions". (McGrath, 2001) The advantage of being independent for an auditor point of view is to make auditor report more reliable so users can easily rely on it. It makes the report unbiased because the decision of auditor will be more accurate. The issue with independence is that it can be only applied if there are standards been followed, otherwise the independence is useless. (McGrath, S., Siegel, A., Dunfee, T., et.al.)
Threats are posed by a wide range of dealings and circumstances. If a thread is created by a relationship or a circumstance, then this could jeopardize, or could be seen as endangering the compliance of a professional accountant with the fundamental principles. There may be more than one threats created by a single circumstance or a relationship. Also, a threat may have an effect on compliance with more than one basic principle. Threats can be found in one or more of the following categories. (ICAEW, 100.12)
Self-interest threat: It is considered of being the threat that an auditor's judgment or manners will be inappropriately influenced by having a financial or any other interest. (ICAEW, 200.4)
Self-review threat: Is the threat where an auditor will shape a judgment instead of providing an existing service since it will not duly estimate the results of any prior examination performed or judgments made by himself or any other individual auditor of his firm or other. (ICAEW, 200.5)
Advocacy: The threat that arises from advocacy is that the auditor will negotiate his objectivity to the point that he will uphold the position of his clients. (ICAEW, 200.6)
Familiarity: In this situation, the auditor will be sensitive towards the client's interest or accept client's work due to the close and long relationship that was established through time. (ICAEW, 200.7)
Intimidation: Perceived pressure, including any attempts to exercise or even excessive influence over the auditor are considered intimidation threats since it will discourage the auditor from acting objectively. (ICAEW, 200.8)
If there are threats towards auditors' independence, there are also safeguards, which need to be addressed. Safeguards are used in order to remove or diminish any threats to a satisfactory level. Safeguards fall in two different categories. Firstly, there are those safeguards, which are formed by the profession, legislation or regulation. Secondly, there are safeguards through the work surroundings. (ICAEW, 300.13) Safeguards that have been created by the profession, regulation or legislation include professional standards, regulation concerning corporate governance. Education is considered another safeguard along with training and experience requirements in order to enter the profession. Another safeguard is considered regulatory or qualified monitoring and disciplinary actions (ICAEW, 100.14)
There are some other factors than need to be considered whilst performing audit process, which will help the auditor scepticism to increase. Below are mentioned examples of professional principles and their critical evaluation as to the strengths and weaknesses of the audit profession. Firstly, auditors need to have Integrity. This principle obliges the auditor to be direct and honest in all of his professional and business relationships. It also implies truthfulness and fair dealing. An auditor's advice and work should be unaffected by any selfishness and not be subjected to any other parties interests. (ICAEW, 110.1) The advantage of using integrity in a profession is that it will increase further the chances of scepticism and would make the audit reports more reliable, efficient and trustworthy. On the other hand having too much integrity will mean loss of position as an agent because the management might not be satisfied with the auditor interest of being too sceptical towards them. The Libor scandal is a recent one as to the integrity of auditors. (Wilson, H., Richard, T.)
Secondly, the auditor needs to show Objectivity. Auditors are obliged by the principle of Objectivity not to compromise any of their judgment because of clash of interest, bias on any excessive influence from others. Objectivity is considered the state of mind, which observes any relevant consideration to the task in hand. (ICAEW, 120.1) The strength through achieving objectivity is that the auditor's judgment will not have any clash of interest and it would not be bias while performing his professional services. In the failing of meeting the principle of objectivity, the auditor will face lack of independence and firm will face unbiased auditor report. This might lead the firm's reputation to fall. Similar example was PNC case. (Reuters, 2012)
The third principle is Professional Competence and Due Care. The objective of professional competence and due care highlights that in order to provide professional service to the client, the auditor itself needs to have professional knowledge and sufficient skills. Additionally, the auditor needs to perform its services diligently in agreement with any professional or technical standards while providing professional services. (ICAEW, 130.1) The advantage of this is that while the auditor is performing the appropriate procedures there will be a less chances of errors since the auditor will have sufficient knowledge of what he is doing. With his action it can meet client satisfaction which considers being the most significant consideration. The disadvantage is that if the auditor does not have any sufficient knowledge the validity of the audit report can be questioned. (Colson, 2004)
Another principle, which is considered very important, is for the auditor to show confidentiality. This is one of the most important principles. An auditor should not only maintain information confidential but ought to take all reasonable measures to protect the confidentiality. If any information is considered confidential or not it would mainly depend on its nature. One of the safest and suitable approaches an auditor could take is to presume that any unpublished information regarding a client's business is considered confidential. (ICAEW, 140.1) If the client is aware that the auditor practices the confidentiality principal, it will feel more secure to provide any personal or even sensitive information towards his auditor. If the auditor fails to meet this criteria of confidentiality then the client will might hesitate to provide sufficient information. Also, it would have negative impact on his opinion towards the firms.
Finally, the auditor needs to have professional behaviour. An auditor, under this principle, must act in accordance with any related rules and laws and avoid any action that it could dishonour the profession. Auditors should not excessively state about the service that they are capable to give neither the experience nor qualifications they possess. Auditors should express themselves with courtesy and thoughtfulness with any party they come into contact while they carry out their work. (ICAEW, 150.1) The advantage of this would be that rules and regulations, which are made by the IAS, would be followed and due to that, audit report quality will meet the criteria of stakeholders. The negative impact is that if the auditor does not behave in a professional manner this will bring him in conflict while risking of losing the client (Falk H., Lynn, B., Mestelman, S., et.al., 1999)
In the following paragraphs, recommendations will be given on how the profession could try to create professional scepticism. A firm policy, ethics and culture is mainly based from their top ranked management. The firm needs to establish procedures or policies that will help promote the internal culture and lead to understand that audit quality is essential (IASSB). The firm has to promote this culture by addressing performance, evaluation systems, compensation or rewards systems, which will promote the incentive scheme (IASSB). Another way would be that the firm develops and implements the culture by educational programmes, in all levels of personnel, which will take place regularly. This can be achieved through work examples or work experience from experienced staff, on the job training and by independent training (IASSB). A different option that will be helpful in the long term is to innate that in the recruitment policy; it would be beneficial to hire new staff with the right attitude (Auditing Practises Board, online). This can be achieved through psychometric tests which results will suggest if the candidate has the appropriate abilities or attitude when it comes to professional scepticism. (Jenkins, 2001)
Auditing standards, which are applied in the United Kingdom and Ireland require from auditors, before supporting application material, to plan and also perform audit with the appropriate scepticism (Auditing Practises Board, online). In order for something like that to be met, certain procedures must be performed by the auditors. Firstly, the audit team must have mandatory meetings in order to discuss the sensitiveness of the entity when it comes to fraud (ISA, 240), misstatements (ISA, 315) or errors from relationships by a related party (ISA, 550). Secondly, the team should make random checks of journal adjustments (ISA, 240) and review any outcome from opening provisions (ISA, 540). Another example is to evaluate, based on the presumption of risk or fraud, when it comes to revenue identification (ISA, 240). Last but not least, to investigate any related party transactions that the entity is having, which are outside the entity's scope of business (ISA, 550 and Auditing Practises Board, online).
The Auditing Practice Board supports the opinion that summaries must been issued, about audit failures, from investigations that were learned from the past (Auditing Practises Board, online). Another huge impact on auditing profession was the Enron scandal (Chaney, P.; Philipich, K., 2002). Under ethical standards, UK auditing and accounting was questioned by many as to whether audit firms create a relationship with customers. Due to this relationship auditor with auditor client could turn to be more familiar which will override any professional scepticism (Auditing Practises Board, online). Different actions should take place in order to avoid that. Such actions are the rotation between the firm's, staff and even partners, forbiddance of stated non audit services and prohibition of employing any staff from the audited team, by the audited entity (Auditing Practises Board, online). Also, the rotation period of firms was reduced, from seven years to five, due to Enron scandal (Prosser, 2011)
It is the responsibility of the Audit Inspection Unit to monitor the audits of all listed entities. One of the challenges that inspectors face is whether there is a sceptical thinking from the auditor and if he took sceptical action (Auditing Practises Board, online). Accounting bodies believe that training the staff through videos provided by them will help create scepticism in an auditor's culture. (Auditing Practises Board, online).