Auditors told to be more sceptical when reviewing company accountsby
Efforts to improve the quality of auditing have arrived in the form of a new document on professional scepticism drafted by the Financial Reporting Council.
The UK’s accounting watchdog wants auditors to be more sceptical and ask tougher questions when carrying out their work.
The Financial Reporting Council (FRC) recently published what it called comprehensive professional judgement guidance to tackle the poor quality of auditing it has found during industry benchmarking.
While professional judgement is key to high quality audit, the FRC said a lack of scepticism is of the most significant issues plaguing the trade.
"Unfortunately, the FRC’s supervision and enforcement work regularly finds professional judgement has not been exercised effectively and consistently, undermining audit quality and trust in audited accounts,” said FRC executive director of regulatory standards, Mark Babington. “The new guidance, which is the first of its kind by a regulator, sets out a clear framework for how auditors should exercise professional judgement to enhance audit quality."
If applied widely, the guidance “will improve audit quality by enhancing the consistency and quality of professional judgement exercised by auditors”, the FRC said.
“It is unusual for the FRC to issue guidance in areas such as this. However, given the effort by the FRC to improve audit quality, it is a positive step,” said Steve Collings, partner, LWA Chartered Certified Accountants and Statutory Auditors. “The guidance itself is not authoritative but is intended to be persuasive and contains some useful examples to help firms interpret it.”
A matter of mindset
The FRC focuses on the mindset of the auditor, and outlines clearly how important the job is in the wider context of the economy, benefiting the public by virtue of having clean financial markets.
Professional scepticism means having a questioning mind and being alert to conditions which may indicate possible error or fraud, the FRC said. It is one of the key pillars of audit quality, said Andrew Likierman, professor of management practice and former dean of the London Business School.
One of the most controversial corporate collapses in recent history, government outsourcer Carillion, stemmed from such basic failures, according to UK lawmakers who said “in failing to exercise – and voice – professional scepticism towards Carillion’s aggressive accounting judgments, KPMG was complicit in them”.
“Carillion and Patisserie Valerie are the most notorious, Galliford Try and Keir the most recent firms where the audit, one way or another, has gone wrong. This rightly encourages rigorous questioning of information provided by management,” said Likierman.
Earlier this month, PwC was fined multiple millions of pounds and reprimanded twice in a single day by the FRC over separate audit failures at London-listed construction groups Kier and Galliford Try.
The Big Four firm and a former partner who led both audits, Jonathan Hook, were rebuked by the regulator for exercising poor professional judgement and failing to gather enough evidence.
The FRC wants to see more evidence of auditors using these critical skills, pulling together data and using analytics when challenging management.
Revisit technical skills, perform more tests
Auditors will not be short of challenges over the coming months, but key personal and practical technical skills, from to-do lists and delegation to communication can help lay the groundwork for improved professional judgement, said ICAEW Financial Reporting Faculty board member Simon Kettlewell.
“Anyone associated with audit will have noticed the term ‘professional scepticism’ being used more frequently,” he said. The ICAEW’s own research has found the underlying issues behind many botched audits involve weak professional scepticism and challenge of management, he said.
“Seniors need to be skilled in identifying audit risks as part of the audit planning process and designing appropriate tests to respond to those risks,” Kettlewell said. “Testing performed, results obtained and conclusions drawn should be sufficiently well documented to enable understanding by an experienced auditor with no previous connection to the audit – such as a cold file reviewer.”
Firms without their own such framework are advised to either develop one or adopt the FRCs, as how effectively the principles are carried out will form part of future inspections.
“Auditors are required to exercise professional judgement during the course of an audit, particularly in areas where there is a higher risk of material misstatement, such as a complex accounting estimate,” Collings told AccountingWEB. “Professional scepticism is frequently cited by professional bodies as lacking during the course of reviews of audit work so this guidance by the FRC should prove helpful to auditors.”