STAFF QUESTIONS AND ANSWERS

Transcription

1 STAFF QUESTIONS AND ANSWERS PROFESSIONAL SKEPTICISM IN AN AUDIT OF FINANCIAL STATEMENTS The public places value n the independent financial statement audit because it enhances the degree f cnfidence f intended users in the financial statements. A high-quality audit features the exercise f prfessinal judgment by the auditr and, imprtantly, a mindset that includes prfessinal skepticism thrughut the planning and perfrmance f the audit. The need fr prfessinal skepticism in an audit cannt be veremphasized. Prfessinal skepticism is an essential attitude that enhances the auditr s ability t identify and respnd t cnditins that may indicate pssible misstatement. It includes a critical assessment f audit evidence. It als means being alert fr audit evidence that cntradicts ther audit evidence r that brings int questin the reliability f infrmatin btained frm management and thse charged with gvernance (TCWG). This critical assessment is necessary in rder fr the auditr t draw apprpriate cnclusins. The IAASB s Internatinal Standards n Auditing (ISAs) explicitly recgnize the fundamental imprtance f prfessinal skepticism. Nevertheless, adpting and applying a skeptical mindset is ultimately a persnal and prfessinal respnsibility t be embraced by every auditr. It is an integral part f the auditr s skill set and is clsely interrelated t the fundamental cncepts f auditr independence and prfessinal judgment and cntributes t audit quality. Prfessinal skepticism is als influenced by persnal behaviral traits, including mtivatin, and cmpetencies. Thus auditr educatin, training and experience are imprtant. Audit firms themselves therefre have an imprtant rle t play in cultivating a skeptical mindset in auditrs. This includes designing and implementing plicies and prcedures that prmte an internal culture recgnizing that skepticism is essential in perfrming audit engagements. Frewrd frm IAASB Chairman Tday s financial reprting seeks t address infrmatin that is mre relevant t users. As a result, mre judgment and increased subjectivity is invlved in management s accunting and reprting decisins (fr example in relatin t sme fair value measurements). Als, many entities tday face difficult ecnmic cnditins that give rise t unique financial reprting and auditing challenges. These develpments heighten the imprtance f prfessinal skepticism by auditrs, especially in areas f financial reprting that are cmplex r highly judgmental. In the aftermath f the glbal financial crisis, recent audit inspectin reprts in varius jurisdictins have nted areas, such as fair values, related party transactins, and ging cncern assessments, where regulatrs and versight bdies believe that auditrs shuld have mre clearly demnstrated prfessinal skepticism. It is therefre in the public interest t re-emphasize t bth auditrs and thers the imprtant rle that prfessinal skepticism has t play in audits f financial statements. The attached IAASB Staff Questins & Answers (Q&A) publicatin has been develped fr this purpse. The fllwing Q&A fcus n cnsideratins in the ISAs and the IAASB s quality cntrl standard that are f particular relevance t the prper understanding and applicatin f prfessinal skepticism during an audit f financial statements. I trust that firms and auditrs f entities f all sizes will find these Q&A helpful. They may als be useful t users f financial statements, in particular TCWG and regulatrs and versight bdies, in their effrts t challenge and questin the applicatin f prfessinal skepticism in audits. Prf. Arnld Schilder, IAASB Chairman This dcument has been prepared by IAASB staff. It is a nn-authritative dcument issued fr infrmatin purpses nly.

2 The Internatinal Auditing and Assurance Standards Bard (IAASB) ( develps auditing and assurance standards and guidance fr use by all prfessinal accuntants under a shared standardsetting prcess invlving the Public Interest Oversight Bard, which versees the activities f the IAASB, and the IAASB Cnsultative Advisry Grup, which prvides public interest input int the develpment f the standards and guidance. The bjective f the IAASB is t serve the public interest by setting high-quality auditing, assurance, and ther related standards and by facilitating the cnvergence f internatinal and natinal auditing and assurance standards, thereby enhancing the quality and cnsistency f practice thrughut the wrld and strengthening public cnfidence in the glbal auditing and assurance prfessin The structures and prcesses that supprt the peratins f the IAASB are facilitated by the Internatinal Federatin f Accuntants (IFAC). The missin f the Internatinal Federatin f Accuntants (IFAC) is t serve the public interest by: cntributing t the develpment, adptin and implementatin f high-quality internatinal standards and guidance; cntributing t the develpment f strng prfessinal accuntancy rganizatins and accunting firms, and t high-quality practices by prfessinal accuntants; prmting the value f prfessinal accuntants wrldwide; speaking ut n public interest issues where the accuntancy prfessin s expertise is mst relevant. Internatinal Standards n Auditing, Internatinal Standards n Assurance Engagements, Internatinal Standards n Review Engagements, Internatinal Standards n Related Services, Internatinal Standards n Quality Cntrl, Internatinal Auditing Practice Ntes, Expsure Drafts, Cnsultatin Papers, and ther IAASB publicatins are published by, and cpyright f, IFAC. The IAASB and IFAC d nt accept respnsibility fr lss caused t any persn wh acts r refrains frm acting in reliance n the material in this publicatin, whether such lss is caused by negligence r therwise. The IAASB lg, Internatinal Auditing and Assurance Standards Bard, IAASB, Internatinal Standard n Auditing, ISA, Internatinal Standard n Assurance Engagements, ISAE, Internatinal Standards n Review Engagements, ISRE, Internatinal Standards n Related Services, ISRS, Internatinal Standards n Quality Cntrl, ISQC, Internatinal Auditing Practice Nte, IAPN, the IFAC lg, Internatinal Federatin f Accuntants, and IFAC are trademarks and service marks f IFAC. Cpyright February 2012 by the Internatinal Federatin f Accuntants (IFAC). All rights reserved. Permissin is granted t make cpies f this wrk t achieve maximum expsure and feedback prvided that each cpy bears the fllwing credit line: Cpyright February 2012 by the Internatinal Federatin f Accuntants (IFAC). All rights reserved. Used with permissin f IFAC. Permissin is granted t make cpies f this wrk t achieve maximum expsure and feedback. Published by:

3 This Questins & Answers (Q&A) publicatin has been develped by staff f the Internatinal Auditing and Assurance Standards Bard (IAASB). The publicatin des nt amend r verride the Internatinal Standards n Auditing (ISAs) r Internatinal Standard n Quality Cntrl (ISQC) 1, 1 the texts f which alne are authritative. Reading this Q&A publicatin is nt a substitute fr reading the standards. The Q&A are nt meant t be exhaustive 2 and reference t the standards themselves shuld always be made. This publicatin des nt cnstitute an authritative r fficial prnuncement f the IAASB. Questins and Answers Q1. What is prfessinal skepticism? The ISAs define prfessinal skepticism as an attitude that includes a questining mind, being alert t cnditins which may indicate pssible misstatement due t errr r fraud, and a critical assessment f audit evidence. 3 They explicitly require the auditr t plan and perfrm an audit with prfessinal skepticism recgnizing that circumstances may exist that cause the financial statements t be materially misstated. 4 Like ther cncepts fundamental t auditing, it is difficult fr a single definitin t capture fully the meaning f prfessinal skepticism. Further, there is n single way in which prfessinal skepticism can be demnstrated. Nevertheless, the ISA definitin describes imprtant elements that help in the understanding f what prfessinal skepticism means. As an attitude, prfessinal skepticism is fundamentally a mindset. A skeptical mindset drives auditr behavir t adpt a questining apprach when cnsidering infrmatin and in frming cnclusins. In this regard, prfessinal skepticism is inseparably linked t the fundamental ethical principles f bjectivity and auditr independence. 5 The auditr s independence enhances the auditr s ability t act with integrity, be bjective and maintain an attitude f prfessinal skepticism. 6 Prfessinal skepticism als includes being alert t, fr example, audit evidence that cntradicts ther audit evidence btained, r infrmatin that brings int questin the reliability f dcuments r respnses t inquiries t be used as audit evidence. Further, it includes being alert t cnditins 1 ISQC 1, Quality Cntrl fr Firms that Perfrm Audits and Reviews f Financial Statements, and Other Assurance and Related Services Engagements 2 While certain ISA and ISQC 1 requirements and applicatin and ther explanatry material are highlighted, this publicatin des nt reprduce all f the ISA and ISQC 1 prvisins that are relevant t the auditr s respnsibility t plan and perfrm an audit with prfessinal skepticism. 3 ISA 200, Overall Objectives f the Independent Auditr and the Cnduct f an Audit in Accrdance with Internatinal Standards n Auditing, paragraph 13(l) 4 ISA 200, paragraph 15 5 The Internatinal Ethics Standards Bard fr Accuntants Cde f Ethics fr Prfessinal Accuntants (IESBA Cde), paragraph 290.6, explains that independence cmprises bth independence f mind and independence in appearance. In relatin t independence f mind, it is the state f mind that permits the expressin f a cnclusin withut being affected by influences that cmprmise prfessinal judgment, thereby allwing an individual t act with integrity and exercise bjectivity and prfessinal skepticism. 6 ISA 200, paragraph A1 3

4 that may indicate pssible fraud, and circumstances that suggest the need fr audit prcedures in additin t thse required by the ISAs. 7 Prfessinal skepticism als includes a critical assessment f audit evidence, which cmprises bth infrmatin that supprts and crrbrates management s assertins, and any infrmatin that cntradicts such assertins. Applying prfessinal skepticism in this regard means questining and cnsidering the sufficiency and apprpriateness f audit evidence btained in the light f the circumstances, fr example, in the case where fraud risk factrs exist and a single dcument, f a nature that is susceptible t fraud, is the sle supprting evidence fr a material financial statement amunt. 8 In cases f dubt abut the reliability f infrmatin r indicatins f pssible fraud, the ISAs require that the auditr investigate further and determine what mdificatins r additins t audit prcedures are necessary t reslve the matter. 9 The matter f difficulty, time, r cst invlved is nt in itself a valid basis fr the auditr t mit an audit prcedure fr which there is n alternative r t be satisfied with audit evidence that is less than persuasive. 10 While the auditr cannt be expected t disregard past experience with management and thse charged with gvernance (TCWG), a belief that they are hnest and have integrity des nt relieve the auditr f the need t maintain prfessinal skepticism r be satisfied with less than persuasive audit evidence when btaining reasnable assurance. 11 Q2. Why is prfessinal skepticism imprtant in audits f financial statements? Prfessinal skepticism plays a fundamentally imprtant rle in the audit and frms an integral part f the auditr s skill set. 12 Prfessinal skepticism is clsely interrelated with prfessinal judgment. 13 Bth are essential t the prper cnduct f the audit and are key inputs t audit quality. Prfessinal skepticism facilitates the apprpriate exercise f prfessinal judgment by the auditr, particularly regarding decisins abut, fr example: The nature, timing and extent f audit prcedures t be perfrmed. 7 ISA 200, paragraph A18 8 ISA 200, paragraph A20 9 ISA 240, The Auditr s Respnsibilities Relating t Fraud in an Audit f Financial Statements, paragraph 13 and ISA 500, Audit Evidence, paragraph ISA 200, paragraph A48 11 ISA 200, paragraph A22 12 The Internatinal Accunting Educatin Standards Bard s Internatinal Educatin Standard 8, Cmpetence Requirements fr Audit Prfessinals, paragraph 42, in particular requires the skills requirement within the educatin and develpment prgram fr audit prfessinals t include, amngst ther matters, develping prfessinal skills at an advanced level in an audit envirnment. These skills include applying relevant audit standards and guidance; evaluating applicatins f relevant financial reprting standards; demnstrating capacity fr inquiry, abstract lgical thught, and critical analysis; demnstrating prfessinal skepticism; applying prfessinal judgment; and withstanding and reslving cnflicts. 13 ISA 200, paragraph 13 (k), defines prfessinal judgment as the applicatin f relevant training, knwledge and experience, within the cntext prvided by auditing, accunting and ethical standards, in making infrmed decisins abut the curses f actin that are apprpriate in the circumstances f the audit engagement. 4

5 Whether sufficient apprpriate audit evidence has been btained and whether mre needs t be dne t achieve the bjectives f the ISAs. The evaluatin f management s judgments in applying the entity s applicable financial reprting framewrk. The drawing f cnclusins based n the audit evidence btained, fr example, assessing the reasnableness f the estimates made by management in preparing the financial statements. 14 The applicatin f prfessinal skepticism enhances the effectiveness f an audit prcedure and f its applicatin and reduces the pssibility that the auditr might select an inapprpriate audit prcedure, misapply an apprpriate audit prcedure, r misinterpret the audit results. 15 Q3. What can be dne by audit firms and auditrs t enhance the awareness f the imprtance f prfessinal skepticism and its applicatin? Prfessinal skepticism is influenced by persnal behaviral traits (i.e., attitudes and ethical values) as well as the cmpetence level (i.e., knwledge) f the individuals undertaking the audit. These, in turn, are influenced by educatin, training and experience. Prfessinal skepticism within the engagement team is als influenced bth by the actins f the firm s leadership and the engagement partner, and by the culture and business envirnment f the firm. The ISAs and ISQC 1 include requirements and guidance designed t help create an envirnment at bth the firm and engagement levels in which the auditr can cultivate apprpriate prfessinal skepticism. Firm Level The firm s leadership and the examples it sets significantly influence the internal culture f the firm. 16 Accrdingly, the tne at the tp and cntinual reinfrcement f the imprtance f prfessinal skepticism n audit engagements are imprtant influences n individuals behavir. Opprtunities fr the firm t set expectatins regarding, and t emphasize the imprtance f, prfessinal skepticism include, fr example, when: Establishing plicies and prcedures designed t prmte an internal culture recgnizing that quality is essential in perfrming engagements. 17 Prmting a quality-riented internal culture thrugh clear, cnsistent and frequent actins and messages frm all levels f the firm s management. This may be cmmunicated by, but nt limited t, training seminars, meetings, frmal r infrmal dialgue, missin statements, newsletters, r briefing memranda. Such actins and messages encurage a culture that recgnizes and rewards high-quality wrk, and may be incrprated, fr example, in the firm s internal dcumentatin and training materials and in partner and staff appraisal prcedures 14 See ISA 200, paragraph A See ISA 200, paragraph A ISQC 1, paragraph A4 17 ISQC 1, paragraph 18 5

6 such that they supprt and reinfrce the firm s view n the imprtance f quality and hw, practically, it is t be achieved. 18 Establishing plicies and prcedures designed t prvide the firm with reasnable assurance that it has sufficient persnnel with the necessary cmpetence, capabilities and cmmitment t ethical principles. 19 In this regard, prmting an internal culture based n quality may be achieved thrugh the establishment f plicies and prcedures that address perfrmance, evaluatin, cmpensatin, and prmtin (including incentive systems), that give due recgnitin and reward t the develpment and maintenance f cmpetence. 20 Develping and implementing internal training and cntinuing educatin prgrams fr all levels f the firm s persnnel. This may be achieved thrugh, fr example, wrk experience, n the jb training, caching by mre experienced staff (fr example, ther members f the engagement team), and independence educatin. It is nted that the cntinuing cmpetence f firm persnnel depends t a significant extent n an apprpriate level f cntinuing prfessinal develpment. 21 Engagement Level At the engagement level, the engagement partner is required t take respnsibility fr the verall quality n each audit engagement t which that partner is assigned. 22 The actins f the engagement partner and apprpriate messages t the ther members f the engagement team emphasize that quality is essential in perfrming audit engagements and the imprtance t audit quality f, fr example, the engagement team s ability t raise cncerns withut fear f reprisals and in issuing auditr s reprts that are apprpriate in the circumstances. 23 An ideal pprtunity t address and emphasize with the engagement team the imprtance f maintaining prfessinal skepticism thrughut the audit is during the discussin by the engagement partner and ther key engagement team members f the susceptibility f the entity s financial statements t material misstatement. This discussin includes the applicatin f the applicable financial reprting framewrk t the entity s facts and circumstances, and places particular emphasis n hw and where the financial statements may be susceptible t material misstatement due t fraud, including hw fraud might ccur (setting aside beliefs that the engagement team members may have that management and TCWG are hnest and have integrity). This discussin als prvides a basis upn which engagement team members cmmunicate and share new infrmatin that may affect risk assessments r the audit prcedures perfrmed See ISQC 1, paragraph A4. 19 See ISQC 1, paragraph See ISQC 1, paragraphs A5 and A25-A See ISQC 1, paragraphs 29 and A25-A ISA 220, Quality Cntrl fr an Audit f Financial Statements, paragraph 8 23 See ISA 220, paragraph A3. 24 See ISA 315, Identifying and Assessing the Risks f Material Misstatement thrugh Understanding the Entity and Its Envirnment, paragraphs 10 and A14, and ISA 240, paragraph 15. 6

7 Further pprtunities fr the engagement partner t set expectatins regarding, and t emphasize the imprtance f, prfessinal skepticism include, fr example, when taking respnsibility fr: The directin, supervisin and perfrmance f the audit engagement. 25 Reviews f wrk perfrmed. In this regard, the engagement partner, in particular, has much knwledge and experience t impart in helping less experienced team members develp a critical and questining mind thrugh review f, amng ther matters, critical areas f judgment and significant risks. Timely reviews als allw significant matters (fr example, critical areas f judgment, especially thse relating t difficult r cntentius matters identified during the curse f the engagement) t be reslved n r befre the date f the auditr s reprt. 26 The engagement team undertaking apprpriate cnsultatin n difficult r cntentius matters and that the cnclusins reached frm such cnsultatins have been implemented. 27 While activities at the firm level and engagement level cntribute t the mindset f prfessinal skepticism, it is nevertheless the respnsibility f each individual auditr t maintain an attitude f prfessinal skepticism. Like prfessinal judgment, prfessinal skepticism needs t be exercised thrughut the audit. Maintaining prfessinal skepticism thrughut the audit enables the auditr t reduce the risks f verlking unusual circumstances, ver generalizing when drawing cnclusins frm audit bservatins, r using inapprpriate assumptins in determining the nature, timing and extent f the audit prcedures and evaluating the results theref. 28 Q4. At what stage in the audit prcess is prfessinal skepticism necessary? Prfessinal skepticism is relevant and necessary thrughut the audit, even thugh reference t it is nt repeated within each ISA. 29 Fr instance: Engagement acceptance Fr example, when cnsidering matters such as the integrity f principal wners and management. 30 Identifying and assessing risks f material misstatement Fr example, when: Perfrming risks assessment prcedures (including the engagement team discussin n the susceptibility f the entity s financial statements t material misstatement, as discussed in Q3 abve). Revising the auditr s assessment f the risks f material misstatement and mdifying the further planned audit prcedures accrdingly as apprpriate, fr example, as a 25 See ISA 220, paragraph See ISA 220, paragraphs 16 and A ISA 220, paragraph ISA 200, paragraph A19 29 See ISA 200, paragraph A ISA 220, paragraph A8 7

8 result f new infrmatin that is incnsistent with the audit evidence n which the auditr riginally based the assessment, r thrugh being alert t changes in circumstances, new infrmatin, r a change in the auditr s understanding f the entity and its peratins as a result f perfrming further audit prcedures. 31 Designing the nature, timing and extent f further audit prcedures that are respnsive t assessed risks f material misstatement, and evaluating audit evidence Fr example, when: Cnsidering, fr areas f higher assessed risks, the need t increase the quantity f evidence r btain evidence that is mre relevant r reliable, fr example, by placing mre emphasis n btaining third party evidence r btaining crrbrating evidence frm a number f independent surces. 32 Designing and perfrming substantive analytical prcedures, including when evaluating the reliability f data frm which the auditr s expectatin is develped, and when identifying and investigating fluctuatins r relatinships that are incnsistent with ther relevant infrmatin r that differ frm expected values by a significant amunt. 33 The auditr s expectatins serve an imprtant rle when evaluating the results f analytical prcedures and challenging management s explanatins fr deviatins frm expected results. Addressing circumstances such as when management refuses t allw the auditr t send a cnfirmatin request. 34 Frming an pinin n whether the financial statements are prepared, in all material respects, in accrdance with the applicable financial reprting framewrk Fr example, when: Cncluding abut whether reasnable assurance was btained and whether sufficient apprpriate audit evidence was btained t supprt such cnclusin. 35 Cnsidering the implicatins fr the pinin where the auditr is unable t gather necessary audit evidence. 36 Evaluating whether financial statements that are prepared in accrdance with a fair presentatin framewrk achieve fair presentatin, cnsidering bth (i) the verall presentatin, structure and cntent f the financial statements and (ii) whether the financial statements, including the related ntes, represent the underlying transactins and events in a manner that achieve fair presentatin See ISA 315, paragraph 31, and ISA 320, Materiality in Planning and Perfrming an Audit, paragraphs 12 and A See ISA 330, The Auditr s Respnses t Assessed Risks, paragraphs 7 and A See ISA 520, Analytical Prcedures, paragraphs 5 and See ISA 505, External Cnfirmatins, paragraph See ISA 700, Frming an Opinin and Reprting n Financial Statements, paragraph See ISA 540, Auditing Accunting Estimates, Including Fair Value Accunting Estimates, and Related Disclsures, paragraph A See ISA 700, paragraph 14. 8

9 Q5. Hw des prfessinal skepticism relate t the auditr s respnsibilities with respect t fraud? Due t the characteristics f fraud, including the fact that fraud may include sphisticated and carefully rganized schemes designed t cnceal it r may invlve cllusin, the auditr s prfessinal skepticism is particularly imprtant when cnsidering the risks f material misstatement due t fraud. ISA 240 places special emphasis n prfessinal skepticism. Amng ther matters, it includes requirements specifically addressing the need t maintain prfessinal skepticism thrughut the audit, recgnizing the pssibility that a material misstatement due t fraud culd exist, ntwithstanding the auditr s past experience f the hnesty and integrity f the entity s management and TCWG. 38 It als requires the auditr t investigate further where cnditins identified during the audit cause the auditr t believe that a dcument may nt be authentic r that terms in a dcument have been mdified but nt disclsed t the auditr. 39 ISA 240 ntes that maintaining prfessinal skepticism in audits requires an nging questining f whether the infrmatin and audit evidence btained by the auditr suggests that a material misstatement due t fraud may exist. This includes cnsidering the reliability f the infrmatin t be used as audit evidence and the cntrls ver its preparatin and maintenance where relevant. 40 ISA 240 als recgnizes the fact that audit prcedures that are effective fr detecting errr may nt be effective in detecting fraud. Accrdingly, the requirements f ISA 240 are designed t assist the auditr in identifying and assessing the risks f material misstatement due t fraud and in designing further prcedures. 41 In sme cases, the ISAs require the auditr t make presumptins abut risks f fraud, the assessment f risks f material misstatement, r specify prcedures that are required t be perfrmed. They d s recgnizing the imprtance f prfessinal skepticism in areas where it has been demnstrated that they are mre susceptible t misstatement, including misstatement due t fraud. Examples include the required presumptin that there are risks f fraud in revenue recgnitin, 42 the treatment f risks f management verride as a risk f material misstatement due t fraud and thus a significant risk, 43 and required prcedures addressing the review f accunting estimates fr biases ISA 240, paragraph ISA 240, paragraph ISA 240, paragraph A7 41 ISA 240, paragraph 8 42 See ISA 240, paragraphs See ISA 240, paragraph See ISA 240, paragraph 32(b). 9

10 Determining verall respnses t address assessed risks f material misstatement due t fraud generally includes the cnsideratin f hw the verall cnduct f the audit can reflect increased prfessinal skepticism. ISA 240, fr example, includes specific examples f hw the cnduct f the audit might reflect increased prfessinal skepticism, including: Increased sensitivity in the selectin f the nature and extent f entity dcumentatin t be examined in supprt f material transactins. Increased recgnitin f the need t crrbrate management explanatins r representatins cncerning material matters. 45 The ISAs nte that the risk f the auditr nt detecting a material misstatement resulting frm management fraud is greater than fr emplyee fraud, because management is frequently in a psitin t directly r indirectly manipulate accunting recrds, present fraudulent financial infrmatin r verride cntrl prcedures designed t prevent similar frauds by ther emplyees. 46 In this regard, the ISAs: Indicate that evaluating management s respnses t inquiries with an attitude f prfessinal skepticism may need t include crrbratin f management s respnses t inquiries with ther infrmatin. 47 Where respnses t inquiries f management r TCWG are incnsistent, require the auditr t investigate the incnsistencies. 48 Require the auditr t reevaluate the prir assessment f the risks f material misstatement due t fraud, the cnsequential impact n the nature, timing and extent f audit prcedures, and the reliability f evidence previusly btained if a misstatement cmes t light that it is r may be the result f fraud and that invlves management (in particular, senir management) r where circumstances r cnditins indicate pssible cllusin invlving emplyees, management r third parties. 49 Q6. In additin t fraud, are there ther aspects f an audit where prfessinal skepticism may be particularly imprtant? Prfessinal skepticism is imprtant and necessary thrughut the entire audit prcess. The auditr s prfessinal skepticism becmes particularly imprtant when addressing areas f the audit that are mre cmplex, significant r highly judgmental such as: Accunting estimates, including fair value accunting estimates, and related disclsures Fr example, when: 45 ISA 240, paragraph A33 46 ISA 240, paragraph 7 47 ISA 240, paragraph A17 48 ISA 240, paragraph See ISA 240, paragraphs

11 Evaluating the reasnableness f the significant assumptins used by management fr accunting estimates that give rise t risks t significant risks. 50 Determining whether changes in accunting estimates r in the methd fr making them frm the prir perid are apprpriate in the circumstances. 51 Reviewing the judgments and decisins made by management in the making f accunting estimates t identify whether there are indicatrs f pssible management bias. 52 Ging cncern Fr example, when evaluating management s plans fr future actins in relatin t its ging cncern assessment, whether the utcme f these plans is likely t imprve the situatin and whether management s plans are feasible in the circumstances. 53 The December 2011 IAASB release, Ecnmic Cnditins Cntinue t Challenge Preparers and Auditrs Alike; Fcus Must Include Ging Cncern Assumptin and Adequacy f Disclsures, stresses the imprtance f prfessinal skepticism and judgment in evaluating financial statement disclsures and the implicatins fr the auditr s reprt when a material uncertainty exists relating t events r cnditins that, individually r cllectively, may cast dubt n the entity s ability t cntinue as a ging cncern. It als references the 2009 IAASB Staff Audit Practice Alert, Audit Cnsideratins in Respect f Ging Cncern in the Current Ecnmic Envirnment, which highlights matters relevant t the cnsideratin f the ging cncern assumptin in the preparatin f financial statements. Related party relatinships and transactins Fr example, when remaining alert during the audit fr infrmatin that may indicate previusly unidentified r undisclsed related party relatinships r transactins; 54 and in the cntext f identified significant transactins utside the entity s nrmal curse f business, when evaluating whether the business ratinale (r lack theref) f the transactins suggests that they may have been entered int t engage in fraudulent financial reprting r t cnceal misapprpriatin f assets r the reliability f external cnfirmatin requests. 55 Cnsideratin f laws and regulatins Fr example, when remaining alert while perfrming ther audit prcedures fr instances f nn-cmpliance r suspected nn-cmpliance with thse laws r regulatins that may have a material effect n the financial statements r that have a fundamental effect n the peratins f the entity causing it t cease peratins, r call int questin its cntinuance as a ging cncern. 56 This may als be relevant in the 50 See ISA 540, paragraph See ISA 540, paragraph ISA 540, paragraph ISA 570, paragraph 16(b) 54 ISA 550, Related Parties, paragraphs and See ISA 550, paragraphs 16, A24 and A See ISA 250, Cnsideratin f Laws and Regulatins in an Audit f Financial Statements, paragraphs 14, 15 and A9. 11

12 cntext f a grup audit, fr instance, due t business practices and cultures in different jurisdictins. 57 Anther example where prfessinal skepticism is particularly imprtant is in relatin t auditing significant unusual r highly cmplex transactins. The 2010 IAASB Staff Q&A publicatin, Auditr Cnsideratins Regarding Significant Unusual r Highly Cmplex Transactins, highlights cnsideratins in the ISAs that are relevant t auditing such transactins, nting that their nature may give rise t risks f material misstatement f the financial statements and, accrdingly, may merit heightened attentin by auditrs. In additin, in relatin t auditing financial instruments, firms and auditrs attentin is drawn t the IAASB s recently released Internatinal Auditing Practice Nte (IAPN) Amng ther matters, the IAPN re-emphasizes the imprtance f prfessinal skepticism, in particular in relatin t the risks and cnsequences f management bias. 59 Q7. Hw can the applicatin f prfessinal skepticism be evidenced? Prfessinal skepticism is ften demnstrated in the varius discussins held by the auditr during the curse f an audit. Fr example, the auditr s cmmunicatin with TCWG includes, where applicable, why the auditr cnsiders a significant accunting practice, that is acceptable under the applicable financial reprting framewrk, nt t be mst apprpriate t the particular circumstances f the entity. 60 Nevertheless, audit dcumentatin remains critical in evidencing prfessinal skepticism because it prvides evidence that the audit was planned and perfrmed in accrdance with ISAs and applicable legal and regulatry requirements. 61 The ISAs require the auditr t prepare sufficient audit dcumentatin t enable an experienced auditr, having n previus cnnectin with the audit, t understand, amng ther things, the significant decisins made regarding significant matters arising during the audit, the cnclusins reached theren, and significant judgments made in reaching thse cnclusins. 62 The ISAs als require auditrs t dcument discussins f significant matters with management, TCWG, and thers, including the nature f the significant matters discussed and when and with whm the discussins tk place. 63 Such dcumentatin helps the auditr demnstrate hw significant judgments and key audit issues were addressed and hw the auditr has evaluated whether sufficient and apprpriate audit evidence has been btained. 57 See ISA 600,Special Cnsideratins Audits f Grup Financial Statements (Including the Wrk f Cmpnent Auditrs), paragraphs 19 and IAPN 1000, Special Cnsideratins in Auditing Financial Instruments 59 IAPN 1000, paragraph ISA 260, Cmmunicatin with Thse Charged with Gvernance, paragraph ISA 230, Audit Dcumentatin, paragraph 5 62 See ISA 230, paragraph See ISA 230, paragraph

13 Examples f circumstances in which it is imprtant t prepare audit dcumentatin where the matters and judgments are significant include: Significant decisins reached during the discussin amng the engagement team regarding the susceptibility f the entity s financial statements t material misstatement due t fraud, and cmmunicatins abut fraud made t management, TCWG, regulatrs and thers. 64 Identified r suspected nn-cmpliance with laws and regulatins and the results f discussin with management and, where applicable, TCWG and ther parties utside the entity. 65 The basis fr the auditr s cnclusins abut the reasnableness f accunting estimates, and their disclsures that give rise t significant risks, and any indicatrs f pssible management bias. 66 Identified infrmatin that is incnsistent with the auditr s final cnclusin regarding a significant matter, including hw such incnsistency was addressed. 67 The basis fr the auditr s cnclusins n the reasnableness f areas f subjective judgments. The basis fr the auditr s cnclusin abut the authenticity f a dcument when further investigatin (such as making apprpriate use f an expert r f cnfirmatin prcedures) is undertaken in respnse t cnditins identified during the audit that caused the auditr t believe that the dcument may nt be authentic. 68 Given that prfessinal skepticism is a state f mind, it is smetimes difficult fr the auditr s dcumentatin t fully capture hw the auditr applied prfessinal skepticism thrughut the audit. The ISAs nte that there may be n single way in which the auditr s prfessinal skepticism is dcumented. Nevertheless, audit dcumentatin may prvide evidence f the auditr s exercise f prfessinal skepticism in accrdance with the ISAs. Such evidence may include specific prcedures perfrmed t crrbrate management s respnses t the auditr s inquiries. 69 Q8. D regulatrs and versight bdies f audit firms and thse charged with gvernance have a rle t play in supprting skeptical behavir amng auditrs? The ISAs d nt set frth requirements fr regulatrs and versight bdies f the audit firms, nr fr TCWG. Hwever because f the critical rle that thse stakehlders serve in achieving audit 64 ISA 240, paragraphs 44(a) and ISA 250, paragraph ISA 540, paragraph ISA 230, paragraph See ISA 230, paragraph A ISA 230, paragraph A7 13

14 quality, 70 they are in a psitin t further challenge auditrs t be skeptical thrugh adequate twway cmmunicatin and effective versight and inspectin f audits. Adequate tw-way cmmunicatin between the auditr and TCWG is an essential part f the audit prcess. The ISAs require the auditr t cmmunicate certain matters abut the audit, including the planned scpe and timing f the audit as well as significant findings and difficulties encuntered during the audit. Fr example, the required cmmunicatins include the auditr s views abut significant qualitative aspects f the entity s accunting practices, including accunting plicies, accunting estimates and financial statement disclsures. 71 Rbust dialgue between the auditr and TCWG abut areas f higher assessed risk f material misstatement, particularly critical accunting estimates, and hw the auditr respnded t thse assessed risks, may prvide TCWG an pprtunity t challenge hw the auditr applied prfessinal skepticism in the apprach t thse areas. TCWG are in a psitin t influence and stimulate auditr skepticism by prviding feedback n imprtant matters pertaining t the audit. Fr example, in receiving cmmunicatins abut the planned scpe and timing f the audit, TCWG may: Discuss issues f risk and the cncept f materiality with the auditr; Identify any areas in which they may request the auditr t undertake additinal prcedures; and Assist the auditr t better understand the entity and its envirnment. 72 Thrugh their mnitring and audit inspectins, versight bdies can als facilitate effective dialgue that cntributes t fcusing auditrs n the imprtance f prfessinal skepticism and hw it can be apprpriately applied in financial statements audits. The auditr s dcumentatin is particularly imprtant as it serves, amng ther purpses, t enable the cnduct f external inspectins in accrdance with applicable legal, regulatry r ther requirements. 73 Auditrs ften are required t cmmunicate directly with regulatrs r prudential supervisrs, in additin t TCWG. 74 Even in the absence f a requirement, in exceptinal circumstances, the 70 The IAASB s publicatin, Audit Quality, An IAASB Perspective, discusses the many imprtant influences that cntribute t achieving audit quality and the rles that the external auditr and thers play in achieving quality financial reprting. 71 See ISA 260, paragraph 16(a), which als ntes that, when applicable, the auditr is als required t explain t TCWG why the auditr cnsiders a significant accunting practice, that is acceptable under the applicable financial reprting framewrk, nt t be the mst apprpriate t the particular circumstances f the entity. 72 See ISA 260, paragraph A See ISA 230, paragraph Fr example, ISA 250 requires auditrs t determine whether there is a respnsibility t reprt identified r suspected nncmpliance with laws and regulatins t parties utside the entity. If the auditr identifies r suspects a fraud, ISA 240 requires the auditr t determine whether there is a respnsibility t reprt the ccurrence r suspicin t a party utside the entity. Althugh the auditr's prfessinal duty t maintain the cnfidentiality f client infrmatin may preclude such reprting, the auditr's legal respnsibilities may verride the duty f cnfidentiality in sme circumstances. Requirements cncerning the auditr s cmmunicatin t banking supervisrs and thers may be established in many cuntries either by law, by supervisry requirement, r by frmal agreement r prtcl. 14

15 auditr may judge it necessary t cmmunicate certain matters directly with regulatrs r prudential supervisrs. Hwever, the auditr s prfessinal duty t maintain the cnfidentiality f client infrmatin may preclude such reprting. Accrdingly, the auditr may cnsider it apprpriate t btain legal advice t determine the apprpriate curse f actin in the circumstances. There als may be situatins fr which cmmunicatin with regulatrs r prudential supervisrs may be useful thrughut the audit. Fr example, in sme jurisdictins, banking regulatrs seek t cperate with auditrs t share infrmatin abut the peratin and applicatin f cntrls ver financial instrument activities, challenges in valuing financial instruments in inactive markets, and cmpliance with regulatins. This crdinatin may be helpful t the auditr in identifying risks f material misstatement. 75 It als prvides an pprtunity fr cnstructive dialgue between the auditr and regulatrs abut matters pertinent t the apprpriate applicatin f prfessinal skepticism. Key Cntacts14 James Gunn, IAASB Technical Directr (jamesgunn@iaasb.rg) Diane Jules, IAASB Technical Manager (dianejules@iaasb.rg) 75 See IAPN 1000, paragraph

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