Professional Scepticism
Misstatements in financial statements originate from errors or fraud. The risks of these occurring can only be appropriately determined with a thorough understanding of circumstances, systems and the industry. When applying knowledge and risk assessment in the audit, trends and transactions which do not correlate should raise concerns with the auditor, i.e. lead to professional scepticism.
 The importance of applying professional scepticism
When performing an audit, the engagement team must plan and perform the audit with professional scepticism, recognising that there may be circumstances and incentives by management causing the financial statements to be materially misstated. Professional scepticism must be exercised through all stages of the audit.
Auditors are required to exercise professional judgment when planning and performing audits. To make appropriate judgments, the auditors must maintain their independence and apply the necessary level of professional scepticism. Applying an appropriate level of professional scepticism supports the quality of judgments made by the engagement team, which, in turn, supports the achievement of quality at the engagement level.
Maintaining professional scepticism throughout the audit reduces the risk of overlooking unusual circumstances, drawing overly general conclusions from audit observations, and making inappropriate assumptions in determining the nature, timing and extent of audit procedures, and evaluating the results. Audit evidence must be critically assessed, in order to draw appropriate conclusions.
Examples of applying professional scepticism
Professional scepticism includes being alert to:
- The types of fraud and incentives which may exist, in respect of management and employees
- Audit evidence contradicting other audit evidence obtained
- Information bringing into question the reliability of other documents, responses or information to be used as audit evidence
- Conditions indicating possible fraud
- Circumstances suggesting the need for additional audit procedures.
The auditor must question contradictory audit evidence, and the reliability of documents and management responses. The sufficiency and appropriateness of audit evidence should also be considered in light of the circumstances, such as where fraud risk factors exist, and a single document, of a nature that is susceptible to fraud, is the only supporting evidence for a material financial statement amount.
The reliability of information to be used as evidence must always be considered. If there are doubts about the reliability of information or indications of possible fraud, which cause the auditor to believe that a document may not be authentic, they must investigate further and determine the necessary modifications or additions to audit procedures to resolve the matter.
It is important to remember that, even if a client has a good track record of honesty and integrity, the auditor must still maintain professional scepticism and must not accept less than persuasive audit evidence. The auditor must still evaluate the business rationale for journal entries based on supporting documentation and knowledge of the operations, challenge management estimates and judgments, and corroborate management representations.
Common deficiencies
In the latest IRBA Public Inspections Report on Audit Quality, the IRBA still considered lack of professional scepticism and professional judgment as underlying causes of common audit deficiencies.
Areas where lack of professional scepticism and professional judgment is detected, and the audit documentation does not support the conclusion reached, include the following:
- Identifying and assessing risks of material misstatements
- Responding to fraud risks
- Determining materiality and the revision of materiality
- Concluding on the audit approach and reliance on controls (including information system controls)
- Determining the extent of testing required for transactions and balances audited
- Evaluating estimates and judgments made by management, including significant accounting estimates and judgments, e.g. fair-value determination
- Evaluating the effect of unadjusted audit misstatements identified.
Conclusion
The documentation on the audit file should clearly demonstrate how the auditor applied professional scepticism and professional judgment. This enables the auditor to conclude that sufficient and appropriate audit evidence was obtained, in response to the audit risks identified. It also avoids unnecessary doubt whether issues were appropriately considered. When this is not evidenced on the audit file, it is difficult for a quality reviewer or audit regulator to reasonably conclude that a proper audit was performed, and the financial statements are not materially misstated.
LEAF can assist with identifying deficiencies and areas for improvement on your audit files.
References
- ISA 200, Overall objectives of the independent auditor and the conduct of an audit in accordance with International Standards on Auditing
- ISA 220 (Revised), Quality management for an audit of financial statements
- 2024 IRBA Public Inspections Report on Audit Quality.
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