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1041 Applying Professional Skepticism
Apr-2018

Overview

This section explains:

  • The concept of professional skepticism
  • Why applying professional skepticism throughout the audit is necessary
  • Documenting professional skepticism

CPA Canada Assurance Standards

Office

Annual Audit

Performance Audit, Special Examination, and Other Assurance Engagements

CAS 200.15 The auditor shall plan and perform an audit with professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated. (Ref: Para. A20-A24)

CAS 200.A20 Professional skepticism includes being alert to, for example:

  • Audit evidence that contradicts other audit evidence obtained.
  • Information that brings into question the reliability of documents and responses to inquiries to be used as audit evidence.
  • Conditions that may indicate possible fraud.
  • Circumstances that suggest the need for audit procedures in addition to those required by the CASs.

CAS 200.A21 Maintaining professional skepticism throughout the audit is necessary if the auditor is, for example, to reduce the risks of:

  • Overlooking unusual circumstances.
  • Over generalizing when drawing conclusions from audit observations.
  • Using inappropriate assumptions in determining the nature, timing and extent of the audit procedures and evaluating the results thereof.

CAS 200.A22 Professional skepticism is necessary to the critical assessment of audit evidence. This includes questioning contradictory audit evidence and the reliability of documents and responses to inquiries and other information obtained from management and those charged with governance. It also includes consideration of the sufficiency and appropriateness of audit evidence obtained in the light of the circumstances, for example, in the case where fraud risk factors exist and a single document, of a nature that is susceptible to fraud, is the sole supporting evidence for a material financial statement amount.

CAS 200.A23 The auditor may accept records and documents as genuine unless the auditor has reason to believe the contrary. Nevertheless, the auditor is required to consider the reliability of information to be used as audit evidence. In cases of doubt about the reliability of information or indications of possible fraud (for example, if conditions identified during the audit cause the auditor to believe that a document may not be authentic or that terms in a document may have been falsified), the CASs require that the auditor investigate further and determine what modifications or additions to audit procedures are necessary to resolve the matter.

CAS 200.A24 The auditor cannot be expected to disregard past experience of the honesty and integrity of the entity's management and those charged with governance. Nevertheless, a belief that management and those charged with governance are honest and have integrity does not relieve the auditor of the need to maintain professional skepticism or allow the auditor to be satisfied with less-than-persuasive audit evidence when obtaining reasonable assurance.

CSAE 3001.41 The practitioner shall plan and perform an engagement with professional skepticism, recognizing that circumstances may exist that cause the underlying subject matter to deviate from the applicable criteria. (Ref: Para. A75-A79)

Professional Skepticism and Professional Judgment

Professional Skepticism (Ref: Para. 41)

CSAE 3001.A75 Professional skepticism is an attitude that includes being alert to, for example:

  • Evidence that is inconsistent with other evidence obtained.
  • Information that calls into question the reliability of documents and responses to inquiries to be used as evidence.
  • Circumstances that suggest the need for procedures in addition to those required by relevant CSAEs.
  • Conditions that may indicate likely deviation.

CSAE 3001.A76 Maintaining professional skepticism throughout the engagement is necessary if the practitioner is, for example, to reduce the risks of:

  • Overlooking unusual circumstances.
  • Overgeneralizing when drawing conclusions from observations.
  • Using inappropriate assumptions in determining the nature, timing and extent of the procedures, and evaluating the results thereof.

CSAE 3001.A77 Professional skepticism is necessary to the critical assessment of evidence. This includes questioning inconsistent evidence and the reliability of documents and responses to inquiries. It also includes consideration of the sufficiency and appropriateness of evidence obtained in the light of the circumstances.

CSAE 3001.A78 Unless the engagement involves assurance about whether documents are genuine, the practitioner may accept records and documents as genuine unless the practitioner has reason to believe the contrary. Nevertheless, the practitioner is required by paragraph 55 to consider the reliability of information to be used as evidence.

CSAE 3001.A79 The practitioner cannot be expected to disregard past experience of the honesty and integrity of those who provide evidence. Nevertheless, a belief that those who provide evidence are honest and have integrity does not relieve the practitioner of the need to maintain professional skepticism.

OAG Policy

Auditors shall plan and perform audit engagements with professional skepticism. [Nov-2011]

OAG Guidance

Professional skepticism is an attitude that includes a questioning mind, being alert to conditions that may indicate a possible deviation or misstatement due to error or fraud, and a critical assessment of evidence. (CAS 200.13(l) and CSAE 3001.14(t))

Applying professional skepticism

All assurance engagements

Professional skepticism is relevant and necessary throughout all assurance engagements. The following table provides examples of the areas where professional skepticism is particularly important:

Area

Examples

Acceptance and continuance
  • Considering integrity of management

Risk assessment
  • Questioning responses to inquiries and other information obtained from management and those charged with governance
  • Revising risk assessment as a result of identified material or significant inconsistent information

Developing an audit plan
  • Incorporating unpredictability in our audit plan
  • Increasing the extent of use of external confirmations or obtaining additional corroborative evidence from third parties in the areas of higher risk
  • Planning for sufficient procedures to evaluate the reliability of data to be used during the audit

Laws and regulations
  • Remaining alert for instances of non-compliance when performing other audit procedures

Significant and unusual transactions
  • Considering the rationale for such transactions and corroborating management's explanations with further evidence, including review of related contracts

Annual audits

In addition to the examples identified for all assurance engagements above, the following are other examples of areas where professional skepticism is particularly important when performing annual audits:

Area

Examples

Risk assessment
  • Identifying specific Financial Statement Line Items (FSLIs) that are susceptible to the risk of material misstatement due to fraud or error

Accounting estimates
  • Evaluating reasonableness of management assumptions and challenging those assumptions
  • Determining whether changes in the estimates or in the method for making them from the prior period are appropriate
  • Reviewing judgments made by management to identify bias indicators (including results of retrospective reviews)

Going concern
  • Evaluating management plans for future actions

Related parties
  • Remaining alert for information that may indicate previously unidentified or undisclosed relationships or transactions, e.g., as part of review of minutes
  • Investigating an unusual transaction to understand if the counterparty involved is related to the entity

Why professional skepticism is important

Professional skepticism plays a fundamentally important role in the audit, and forms an integral part of the auditor’s skill set. It facilitates the appropriate exercise of professional judgment, particularly regarding decisions about:

  • the nature, timing and extent of audit procedures to be performed to reduce the risk to an appropriate level;
  • whether sufficient appropriate audit evidence has been obtained and whether more needs to be done to achieve the objectives of the relevant assurance standards;
  • the evaluation of management’s judgments (particularly regarding the application of the entity’s applicable financial reporting framework in the context of an annual audit);
  • the drawing of conclusions based on the audit evidence obtained.

The application of professional skepticism enhances the effectiveness of an audit procedure and of its application and reduces the possibility that we might select an inappropriate audit procedure, misapply an appropriate audit procedure, or misinterpret the audit results.

Emphasizing importance of professional skepticism

Professional skepticism within the engagement team is influenced both by the actions of the engagement leader and other members of the engagement team.

The actions of the engagement leader and appropriate messages to other members of the engagement team need to emphasize that quality is essential in performing audit engagements and the importance to audit quality of, for example, the engagement team’s ability to raise concerns without fear of reprisals and in issuing auditor’s reports that are appropriate in the circumstances.

An ideal opportunity to address and emphasize with the engagement team the importance of maintaining professional skepticism throughout the audit is at a team meeting early on in the planning of the engagement.

The engagement leader may further emphasize the importance of professional skepticism when taking responsibility for:

  • the direction, supervision and performance of the audit engagement;
  • review of work performed and discussion;
    In this regard, the engagement leader, in particular, has much knowledge and experience to impart in helping less experienced team members develop a critical and questioning mind through review of, among other matters, critical areas of judgment and significant risks.
  • the engagement team undertaking appropriate consultation on difficult or contentious matters and the implementation of the conclusions reached from such consultations.

While activities at the firm level and engagement level contribute to the mindset of professional skepticism, it is nevertheless the responsibility of each individual auditor to maintain an attitude of professional skepticism.

Documenting professional skepticism

Given that professional skepticism is a state of mind, we may not document every aspect of how we applied skepticism throughout the audit. Nevertheless, audit documentation remains critical in evidencing professional skepticism because it provides evidence that the audit was planned and performed in accordance with relevant assurance standards. As explained above, it is important to apply professional skepticism throughout the audit and document this accordingly, including when considering significant matters.

Professional skepticism is often demonstrated in the various discussions held with the audit team, management, and those charged with governance. That is why it is important that we properly document such discussions to demonstrate how professional skepticism was applied. Examples of circumstances where documentation is particularly important include:

  • probing questions and management responses as part of normal audit procedures, e.g., understanding controls;
  • identified or suspected non-compliance with laws and regulations, and the results of discussions with management;
  • basis for conclusions regarding the reasonableness of accounting estimates, including consideration of subjective and objective factors;
  • identified information that is inconsistent with the final conclusion regarding a significant matter;
  • basis for conclusions on the reasonableness of areas of subjective judgments;
  • basis for adequacy of disclosures;
  • basis for conclusions about the authenticity of a document when further investigation is undertaken.

Examples of how professional skepticism can be effectively documented at each stage of the audit include, but are not limited to the following:

  • Document the thought process, alternative views considered, and changes to our approach in the course of the audit, not just the evidence supporting the final conclusion.
  • Document how we challenged management views, assumptions, not just how we accepted them.
  • Document the basis for unusual, one-time transactions and related business rationale.
  • Include a complete and comprehensive record of discussions with management, particularly in areas of uncertainty.
  • Document how we assessed the reliability of the source of documents, specifically those prepared by the entity.
  • Document professional skepticism in the significant matters.

Documentation in specific areas

Examples of how professional skepticism can be demonstrated in specific areas:

All assurance engagements

Entity and team meetings
  • Have we included professional skepticism on the agenda of our team meetings?
  • Have all important professional skepticism conversations with the entity been documented in the engagement file?

Use of experts
  • Have we documented any follow up discussions with the experts or specialists?
  • Have the specialists received clearly defined instructions for the scope for their work, do they understand the related audit objectives and how their output will be used or assessed by the engagement team?

Contradictory or conflicting evidence
  • Have we documented how we addressed contradictory or conflicting evidence and obtained audit comfort to support our final conclusions?
Fax, email, or entity copies of key audit documents
  • Have we critically assessed the reliability of the documentary evidence?

Engagement leader and quality reviewer
  • Have any important professional skepticism considerations by senior members of the team been documented in the audit file?

Annual audits

In addition to the examples identified for all assurance engagements above, the following are other examples of how professional skepticism can be demonstrated in specific areas of an annual audit:

Entity and team meetings
  • Have we documented the team discussions about “what can go wrong” with respect to an entity’s financial statements?

Estimates, impairment,  and complex accounting judgements
  • Have we documented how we assessed the estimation uncertainty and the inherent lack of precision in the measurement of affected FSLIs?
  • Is our assessment of the likelihood of unexpected outcomes in the file?
  • Have we documented our conclusion about indicators of possible management bias?
  • Have we considered and recorded a wide range of alternatives, not just those considered by the entity?
  • Have we documented how we generated and evaluated the possible alternative views?

Areas with history of prior year errors
  • Have we demonstrated how we critically assessed these areas during the current year’s audit?
  • If no errors have been identified this year, have we considered whether and evidenced/corroborated how root causes of errors in previous years have been rectified/addressed by the entity throughout the current year to minimize the risk of misstatement?

Use of experts
  • Has the expert provided a conclusion on the entity’s valuations, not just memoranda on their views on valuations?

Related-party transactions
  • Have we documented our understanding of the business rationale for significant related-party transactions?
  • Have we skeptically assessed the economic substance of related-party business transactions, any complex business practices or organizational structures that may enhance the ability of management to mask the economic substance?

Deferred tax assets
  • Have we challenged the expected future profits and assumptions regarding future earnings, e.g. by comparing to the industry trends in the same business sector?

Financial statements disclosures
  • Have we documented our conclusions and how we challenged management  in relation to adequacy of disclosures for areas such as non-GAAP measures, key sources of estimation uncertainty, changes in assumptions used in fair value and impairment assessments, current versus non-current classifications, working capital deficiency, loss-making segments, appropriateness of going concern assumptions, breaches of banking covenants, financial support by related and other parties, contingent liabilities, offsetting (GAAP: (Generally Accepted Accounting Principles).

Related Sections

OAG Annual Audit 4010 Team Planning Meetings

OAG Audit 7030 Drafting the chapter