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Students
Current issues in auditing: part 4
Students must be familiar with professional practice issues and pronouncements as part of their understanding of professional auditing.
The International Federation of Accountants (IFAC) framework ‘A framework for audit quality: Key elements that create an environment for audit quality’ (bit.ly/2Z3JK6O) provides a comprehensive overview of the factors driving audit quality at an engagement, firm and national level. It reiterates much of the previous guidance but contextualises the ideas within the debate around the increasing focus on public interest.
The problems in ensuring audit quality in audit firms are clearly not easy to resolve as the regulatory review into audit firms in the UK routinely highlight areas of weakness. The spate of recent high profile audit scandals in public interest entities would support the idea that these problems result in poor quality in practice. It is therefore vital that students understand how audit quality is promoted and safeguarded in audit firms. This is an area that is frequently examined in this paper. In the UK, there is evidence that audit firm quality procedures are not as robust as the regulator might prefer. There is also evidence that the audit firms have a tendency to underestimate problems with their own work. This is not entirely unexpected, as subconscious bias will tend to mean that auditors who work within a specific audit culture will not be able to appreciate its weaknesses. It is very difficult for an audit firm to be objective about its own quality. However, there is an increased focus from IFAC and national regulators on firm audit quality policies and the monitoring of such.
IES 8 Professional Competence for Engagement Partners responsible for statutory audits of financial statements (revised) has applied since July 2016. This responds to the risk that as engagement partner work becomes more specialised, it is possible that they are not up to date in all aspects of current technical developments. As their practice administrative duties increase, it is also tempting to delegate the specialist CPD to other members of the firm. This then renders their knowledge insufficient to support the complex evaluation of audit evidence to come to an appropriate audit opinion.
© istockphoto/Visual Generation
As the engagement partner review supporting the development of this opinion is a critical function of the audit, audit quality can only be assured where professional competence is assured. This becomes a specific issue where the audit partner is rotated as part of the maintenance of independence or as a client business becomes increasingly specialised. As part of the firm’s policies on audit quality, there must be safeguards to ensure the professional competence of the firm’s partners.
Professional judgment
Professional judgment remains a key area of concern to regulators. The 2019 Brydon Review recommends that: “ARGA (the new UK Regulator) should revisit the existing definition of professional judgment with a view to strengthening, and demonstrating better, the use of judgment in audit.”
The developing ideas in “ED Proposed Revisions to the Code to Promote the Role and Mindset Expected of Professional Accountants” (2019) articulate key areas that all professional accountants should consider to ensure that professional judgment is robust. This includes the following: ● Obtain and understand information relevant for making reliable judgments based on facts and circumstances known to them. ● Make informed challenges of views developed by others. ● Be sensitive to the integrity of information, including the source of the information and the appropriateness of its presentation.
Audit quality policies in audit firms
“Audit is vital to investor confidence in UK companies. Poor quality audit work remains unacceptably common.
“The latest audit inspections for 2018/19, which relate principally to audits of companies’ December 2017 year ends, found 75% of FTSE 350 audits reviewed were good or required no more than limited improvements, compared to 73% in 2017/18. No firms achieved the FRC’s audit quality target for 90% of FTSE 350 audits to meet this standard. Looking across all audit reviews completed at the largest seven firms, the outcome was 75% compared to 74% in 2017/18. In the reports published today, each firm has committed to specific actions to enhance audit quality including, for the worst performers, detailed audit quality improvement plans. The FRC will assess the success of these initiatives and secure further action if necessary. “The FRC found cases in all seven firms where auditors had failed to challenge management sufficiently on judgmental issues. This has been a recurring finding over a number of years and it can have many contributory factors. These include the mindset of audit teams, especially an absence of professional scepticism in evaluating evidence presented by company management, tight reporting deadlines and the complexity of the judgments involved. Familiarity is also a factor arising from longstanding audit relationships, particularly if the company comes to be considered as ‘the client’ for the auditor, rather than the shareholder or investor.” “Firms’ Audit Quality Monitoring” Financial Reporting Council (2019)
Withhold judgment pending thoughtful consideration of all known and relevant available information.
The ideas around acting with integrity have also been further developed to expand from the idea of fair dealing and truthfulness and the requirement to be straightforward and honest in all professional and business relationships. Integrity also requires having the determination to act appropriately when confronting dilemmas and can include: ● standing one’s ground when facing pressure to do otherwise during the course of performing professional activities; and ● challenging others as and when appropriate, even when doing so creates potential adverse personal or organisational consequences.
Emphasis on understanding facts andcircumstances
The issues raised above are consistent with the ideas I highlighted from IFAC Exposure Draft 17: Professional Judgment – Emphasis on Understanding Facts and Circumstances. This is a key area of understanding for students at paper 15. The paper is concerned with the application of understanding and judgment to scenarios raised in the questions, and students are expected to show that they are applying professional judgment robustly.
“Professional judgment involves the application of training, knowledge and experience, taking into account the nature and scope of the professional activity being undertaken. When exercising professional
judgment, it is important that the professional accountant obtains a sufficient understanding of the facts and circumstances known to the accountant to identify, evaluate and address threats to compliance with the fundamental principles.”
Students should ensure that they are familiar with the debate around professional judgment and the ED 17 in their wider reading to contextualise the emerging debates around auditor conduct.
Professional scepticism
Professional scepticism continues to be an ongoing issue. The FRC in the UK regards the poor application of professional scepticism as core to compromising the ability of the auditor to robustly challenge management judgment and therefore a significant contributor to recent audit failures. These include Carillion Plc, Thomas Cook Plc, Patisserie Valerie Plc and others.
IFAC is currently reviewing its guidance on professional scepticism in order to meet public expectations and ICAEW has recently published a really helpful and practical insight into professional scepticism in the practice. This highlights some of the core challenges that compromise the ability of an auditor to maintain a sceptical mindset, including time pressure and a lack of situational context.
As boards strive to achieve faster reporting deadlines, time pressure is increasing. As audit clients become more complex and audit teams work against deadlines without really becoming immersed in the business, commercial factors seem to be conspiring to make being sceptical more difficult. An understanding and appreciation of the developing debate around scepticism is important to ensure that this final paper in audit embeds this critical skill area in students. See bit.ly/3gHtui1 and bit.ly/3faUpSP.
Developments in international ethicalstandards
As all student accountants will be aware, the last few years have not been easy for the reputation of the profession. In the United Kingdom, the collapse of Carillion Plc was followed by months of media comment and a government Select Committee Report into the corporate failure. This lack of confidence in the ethics of accounting firms has driven the review of the functioning of the audit market and may see some substantial
changes to audit practices over the next few years. This focus on the conduct of auditing firms is by no means limited to isolated cases of Big Four audits of PIE’s causing concern – and the problems relate to audits throughout the world. It is against this evidence of concerns over the quality of accounting ethics that the new International Code of Ethics for Professional Accountants was published last year, coming into force on 15 June 2019 came into force. And in December 2019, the Brydon Review – Assess, Assure and Inform was published (see bit.ly/2BOAFWL).
There are a number of very important developments to the new 2018 Code which, if adopted correctly, should do much to resolve some of the problems in ethics evidenced in recent scandals and to help to re-establish the reputation of the accounting profession. The IESBA launched the Code in April 2018 with the statement: “While the fundamental principles of ethics have not changed, major revisions have been made to the unifying conceptual framework – the approach used by all professional accountants to identify, evaluate and address threats to compliance with the fundamental principles and, where applicable, independence.”
The substantive revisions to the Code are summarised: ● an enhanced conceptual framework, which includes extensive revisions to “safeguards” throughout the Code that are better aligned to threats; ● strengthened independence provisions regarding long association of personnel with audit clients; ● strengthened provisions relating to offering and accepting of inducements, including gifts and hospitality that apply to both professional accountants in business (PAIBs) and professional accountants in public practice (PAPPs); ● strengthened provisions dedicated to PAIBs, including: ● a new section relating to pressure to breach the fundamental principles; and ● revised provisions relating to the preparation and presentation of information; ● clarifications about the applicability of PAIB provisions to PAPPs; ● new material to emphasise the importance of understanding facts and circumstances when exercising professional judgment; and ● new material to explain how compliance with the fundamental principles supports the exercise of professional scepticism in an audit or other assurance engagements.
Students are reminded that three articles regarding issues raised by the Code were published by AIA in the Student Accounting in July, August and September 2019.
Exercise of Professional Judgment 120.5
A1 Professional judgment involves the application of training, knowledge and experience, taking into account the nature and scope of the professional activity being undertaken. When exercising professional judgment, it is important that the professional accountant obtains a sufficient understanding of the facts and circumstances known to the accountant to identify, evaluate and address threats to compliance with the fundamental principles.
In obtaining this understanding, the accountant might consider, among other matters, whether: ● there is an inconsistency between the known facts and circumstances and the accountant’s expectations; ● the information provides a reasonable basis on which to reach a conclusion; ● other reasonable conclusions could be drawn from the information being considered; ● the accountant’s own preconception or bias might be affecting the accountant’s judgment; and ● the accountant’s own expertise and experience are sufficient, or whether there is a need to consult with others with relevant expertise or experience.
Reasonable and Informed Third Party 120.5
A2A1 The reasonable and informed third party test is a consideration by the professional accountant about whether the same conclusions would likely be reached by another party. Such consideration is made from the perspective of a reasonable and informed third party, who weighs all the relevant facts and circumstances that the accountant knows, or could reasonably be expected to know, at the time the conclusions are made. The reasonable and informed third party does not need to be an accountant but would possess the relevant knowledge and experience to understand and evaluate the appropriateness of the accountant’s conclusions in an impartial manner.
Proposed Application Material Relating to: (a) Professional Skepticism – Linkage with the Fundamental Principles; and (b) Professional Judgment – Emphasis on Understanding Facts and
Circumstances. Exposure Draft 17. International Federation of Accountants (IFAC) May 2017
Other issues
The Brydon Review has proposed a wide range of reform ideas to resolve the ongoing issue with audit and include: ● the inclusion of fraud analysis in the audit remit; ● a replacement of true and fair with present fairly in all material matters; ● a greater focus on going concern; ● a change to audit committee composition to include a wider range of members, not only those from the accounting profession, but also including those with “an enquiring mind and able to make robust independent decisions”; ● an alteration in audit scope to extend to the directors’ statements regarding their discharge to the public interest; and ● the development of a new professional corporate auditing body.
Whilst the detailed recommendations may be beyond the content of Paper 15, the issues that they debate represent the very real concerns and challenges facing the global profession and students should be familiar with these. ●
