Documenting significant professional judgements in an ISA (UK) audit

Why is it important?

Why is professional judgement so important in an audit?

ISA 200 requires the auditor to exercise professional judgement in planning and performing an audit of financial statements [ISA 200.16]. The exercise of professional judgement is an explicit requirement which highlights its importance and makes clear that it is essential to the proper conduct of an audit.

The distinguishing feature of the professional judgement expected of the auditor is that it is exercised by a professional whose training, knowledge and experience have contributed to developing the necessary competencies. A doctor could not make a judgement on the most appropriate treatment to cure a disease without relevant training and practical experience. Similarly, without applying knowledge and expertise to the relevant facts and circumstances, the auditor could neither make the informed decisions required throughout the audit nor interpret and apply relevant ISAs appropriately. The auditor’s ability to make reasonable judgements is therefore an indispensable prerequisite to achieving the objective of an audit.

Professional judgement is defined as the application of relevant training, knowledge and experience, in the context of auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement [ISA 200.13(k)]. Professional judgement needs to be applied throughout the audit, particularly to:

• materiality and audit risk;
• determining the nature, timing and extent of audit procedures;
• evaluating whether sufficient appropriate audit evidence has been obtained;
• evaluating management’s judgements on significant accounting estimates, for example; and
• drawing conclusions based on the audit evidence obtained.

What is the purpose of documenting professional judgement?

ISA 200 makes it clear that professional judgement is not to be used as the justification for decisions that are not otherwise supported by the facts and circumstances of the engagement or sufficient appropriate audit evidence [ISA 200.A29]. Accordingly, the ISA emphasises that the auditor is responsible for the exercise of judgement in a transparent and justifiable manner.

Documentation of significant professional judgements serves to explain the auditor’s conclusions, thereby enabling the auditor to demonstrate that judgements made are justifiable. This also reinforces the quality of judgements. Such documentation is particularly important to those responsible for reviewing an audit engagement, or carrying out subsequent audits when reviewing matters of continuing significance. It is also relevant, for example, when performing a retrospective review of accounting estimates.

The application of professional judgement is also likely to be the focus of any external reviewers, such as lawyers or external regulators reviewing an engagement file. Reviewers will expect that they will be able to understand the auditor’s thought processes when applying professional judgement. It is essential for the auditor to document:

• the facts and circumstances that were known when applying professional judgement;
• the reasoning supporting the decision taken; and
• the results of any consultations that were undertaken when forming a view on significant or contentious matters.

Requirements and challenges

When and to what extent do auditors need to document professional judgement?

Audit documentation is important because it provides evidence that the audit complies with ISAs. However, it is neither necessary nor practicable for the auditor to document every matter considered or professional judgement made in an audit [ISA 230.A7].

Accordingly, documentation of professional judgement is only required when it is important for a proper understanding of an audit. It is worthwhile considering carefully the wording used in ISAs to describe when and how to document professional judgement. The auditor is required to prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand the significant professional judgements made in reaching conclusions on significant matters arising during the audit [ISA 200.A29].

The requirement to document professional judgement is restricted to cases in which both the extent of professional judgement required and the subject matter are significant. The application material in ISA 230 discusses both of these conditions in more detail.

ISA 230.A8 gives the following examples of significant matters:

• matters that give rise to significant risks;
• findings indicating either material misstatements or a need to revise previous risk assessments and responses;
• significant difficulties in applying necessary audit procedures;
• findings that could trigger a modified audit opinion or an emphasis of matter paragraph in the auditor’s report; or
• concerns about the entity’s ability to continue as a going concern.

If the consideration of such significant matters by the auditor also involves significant professional judgement, it would be appropriate to prepare audit documentation relating to the use of judgement. A practical example of this would be the basis for the auditor’s conclusion about the reasonableness of a subjective management judgement regarding a significant accounting estimate. Also, the auditor’s considerations and conclusions in response to serious doubts regarding the authenticity of a document relevant to the audit would most likely require documentation of the use of professional judgement [ISA 230.A10].

Further, ISA 230 emphasises that the documentation of the use of professional judgement is tailored to the information needs of an experienced auditor. As defined in ISA 230.6(c), an experienced auditor would have practical audit experience and a reasonable understanding of both the business environment of the audited entity and the auditing and financial reporting issues relevant to that entity.

There is no need, therefore, for auditors to document in detail instances of applying professional judgement that may not be transparent to less experienced reviewers due to their lack of industry specific audit or accounting knowledge. Similarly, in cases where the documentation of professional judgement is regarded as appropriate, it can be restricted to information that an experienced auditor would need to understand the underlying thought process.

What constitutes proper documentation of professional judgement?

The need to document the use of professional judgement when performing a particular audit may be restricted to the significant matters identified during that audit and the extent of professional judgement applied. It may nevertheless be a challenge to identify all cases in which the exercise of judgement should be documented. Professional judgement may need to be applied during all phases of an audit, from assessing risk to drawing final conclusions. A need to document a significant professional judgement can therefore arise at any time.

One practical way of dealing with the need to document significant professional judgements is to raise the awareness of the documentation requirement within the audit team. For example, discussing examples of significant matters in ISA 230.A8 at an early stage of the audit, in the context of the risk assessment discussion required under ISA 315 (Revised) Identifying and assessing risks of material misstatement through understanding the entity and its environment [ISA 315 (Revised).10] would increase the team’s alertness to the documentation requirement should the need arise.

The routine review of working papers could also be used to identify significant matters that may need additional documentation explaining the application of professional judgement. This would be particularly relevant when reviewing a completion memorandum summarising the significant matters identified during the audit, if prepared as suggested by ISA 230.A11.

Are there any other ISA requirements on documenting professional judgement?

In addition to the general documentation requirement regarding significant professional judgements contained in ISA 230.8, there are several specific audit documentation requirements in other ISAs that involve the documentation of professional judgement. Examples include requirements to document:

• the factors considered when determining or revising materiality for the financial statements as a whole, materiality for particular classes of transactions, account balances or disclosures, and performance materiality [ISA 320 Materiality in planning and performing an audit (ISA 320.14)]. In explaining the thought process when setting such materiality levels, the auditor may document the benchmarks and percentages selected for determining materiality levels, and the reasons for selecting them;
• the reasons for any significant changes made during the audit engagement to the overall audit strategy or the audit plan. This explains, in the auditor’s view, why the changes were made and why the audit strategy and audit plan that are finally adopted represent an appropriate response to the significant changes occurring during the audit [ISA 300 Planning an audit of financial statements (ISA 300.12(c) and ISA 300.A20)];
• the basis for the auditor’s conclusions as to whether uncorrected misstatements are material, individually or in aggregate [ISA 450 Evaluation of misstatements identified during the audit (ISA 450.15(c))]. Documenting the size and the nature of the misstatement and the particular circumstances of its occurrence would, for example, explain the auditor’s considerations when assessing the materiality of any uncorrected misstatement identified; and
• an analysis of group components, indicating those that are significant [ISA 600 Special considerations – audits of group financial statements (ISA 600.50(a))]. In order to support the auditor’s judgement regarding the significance of individual components, appropriate documentation could include, benchmarks and percentages selected when determining components of individual financial significance, significant risks to the group financial statements, and an explanation of which components are affected by those risks.

Finally, ISA 200.24 requires the auditor to evaluate whether the overall objective of the auditor can still be achieved if the objective of an individual ISA cannot be achieved. The failure to achieve an objective represents a significant matter. Considering its effect on the overall objective would typically involve the exercise of significant professional judgement and, accordingly, would need to be documented under ISA 230.8(c).