Comments from ACCA to the Financial Reporting Council (FRC), 31 October 2010.
ACCA welcomes the opportunity to respond to the above Discussion Paper. We have structured our comments as answers to the questions set out in the paper.
The topic of auditor scepticism is important and timely and our comments below should be read in conjunction with those we made in September 2010 in response to the discussion paper Enhancing the auditor's contribution to prudential regulation issued by the Financial Services Authority (FSA) and Financial Reporting Council (FRC).
In ACCA's recent written evidence to the Economic Affairs Committee inquiry into Auditors: market concentration and their role, we noted that professional scepticism is a fundamental concept that is enshrined in the ACCA Rulebook, which is mandatory for our members. We concluded, in that evidence, that audit firms and the audit profession needed to take the criticisms reported in the above FSA/FRC discussion paper very seriously and consider remedial steps as a matter of urgency.
Question 1
Do you agree with the emphasis that this paper places on the importance of auditor scepticism? Are there aspects of the analysis, including the summary of academic research in Appendix 1, with which you particularly agree, or disagree? If so, what are they?
We agree that auditor scepticism is deserving of emphasis as it is of vital importance to audit quality. As the discussion paper points out, the degree of scepticism can be regarded as being on a sliding scale, the exact position is an important determination of the way the audit is carried out and hence of its cost.
The academic research summarised in Appendix 1 of the paper provides a useful, albeit not entirely current, picture of the nature of auditor scepticism and, importantly, the factors that influence it. There is a subtle interplay between the role of the standard setter, the professional judgement of the auditor, and professional scepticism - which may be exercised in assurance engagements including audit. ACCA is currently funding research commissioned by the International Association for Accounting Education and Research to support the work of the International Auditing and Assurance Standards Board (IAASB). That includes research on the nature of professional judgement in auditing (by Ian Dennis, Oxford Brookes University). We anticipate that the outcome of enquiries into the nature of professional judgement and auditor scepticism will inform the work of the IAASB. It is for the standard setter to determine the extent to which prescription is necessary and hence what remains a matter for professional judgement. Conceptually, there are questions as to whether auditor scepticism influences auditor judgement, whether auditor judgement determines the degree of auditor scepticism, or whether the two concepts can be considered to be independent of each other.
Clearly, while a firm conceptual basis is preferable, it is the degree to which auditor scepticism is exercised in practice that is of direct importance to audit quality and this is considered further in our answers below.
Question 2
Regulators have recently challenged audit firms on whether sufficient scepticism was demonstrated on some audits:
Evidence is available to the FRC that includes the outcomes of the work of the Audit Inspection Unit and its oversight of the monitoring of auditors carried out by the ACCA itself. We do not comment here, therefore, on whether this problem is widespread or limited to certain types of audits or circumstances.
The paper identifies factors that could create disincentives for auditors to apply an appropriate degree of professional scepticism. As set out in The Code of Ethics for Professional Accountants (the IESBA Code) issued by the International Ethics Standards Board for Accountants, an individual can act with integrity and exercise objectivity and professional scepticism only where influences do not compromise professional judgment. There is considerable overlap, therefore, between factors relating to independence and those that could impact auditor scepticism. While many of the appropriate safeguards may be implemented by auditors themselves, there are undoubtedly other parties whose actions, or inactions, could create disincentives for auditors to apply an appropriate degree of professional scepticism. We deal with this matter further in our answer to question four.
We do not have any further evidence to offer in answer to the question in the third bullet point above. As a general observation, we believe that the degree of auditor scepticism exercised is influenced by the auditor's assessment of the risk of material misstatement. Where there is significant risk, the auditor will require more persuasive evidence and be more inclined to challenge management's judgements. This is so much so that it is recognized through the requirements of auditing standards. In addition, certain aspects of an audit are highlighted, for example where there are accounting estimates, complex valuations or indicators of potential fraud.
Question 3
How do you think audit firms should promote and develop professional scepticism in their partners and staff? Do they need to do more and, if so,what?
The mechanisms available to audit firms to promote and develop professional scepticism in their partners and staff vary from establishing an appropriate 'tone at the top' down to making sure that junior staff are coach individually on the importance of professional scepticism in their work.
It is important that audit methodologies allow appropriate scope for the use of informed professional judgement and auditor scepticism as, anecdotally, increasing reliance on audit software and the proliferation of detailed requirements in auditing standards do not, in themselves, promote the exercise of auditor scepticism.
As to whether firms need to do more, we believe that auditors and the audit profession take criticism very seriously and will already be undertaking remedial steps as a matter of urgency.
Question 4
Do you think that others, including companies, should be doing more to promote, develop and support professional scepticism in auditors? If so,what?
It is important that all components of the financial reporting chain are prepared to play their part. For example, as we suggested in our response to the discussion paper Enhancing the auditor's contribution to prudential regulation, the role of the regulator is important because sharing with auditors both relevant general industry information and any matters specific to the regulated entity in question will inform and enhance the auditor's professional scepticism.
The criticisms of the AIU and others and the recent discussion papers themselves are important as they provide strong incentives for doing more to promote, develop and support auditor scepticism.
Standard setters have a vital role to play through taking decisions as to where and to what extent professional scepticism is required to be exercised in particular aspects of an audit. We note in this regard that the 'clarity' International Standards on Auditing are introducing more-rigorous approaches in areas such as the audit of groups and the benefits of this will be felt in future financial reporting.
ACCA has a continuing role, both through the supervision of the firms that carry out audit engagements and in relation to the education, learning and development of auditors. In all such aspects, professional scepticism is considered to be very important and receives an appropriate degree of emphasis. However, we are not complacent and we take notice of the criticism of auditors in relation to professional scepticism, for example when reviewing the relevance of our examination syllabus and continuing professional education. The FRC will also be aware of the further actions being taken as set out in the July 2009 report of the Steering Committee of the CCAB Audit Conduct and Training Project.
Management and those charged with governance of companies and other entities being audited can do much to create a climate where auditor scepticism is accepted in a non-confrontational fashion. A willingness to engage in candid dialogue between those charged with governance and auditors and, where relevant, regulators can do much to ensure that the ultimate beneficiaries of the auditor's work: the shareholders and credit and capital markets, are well served.