All auditors want to apply professional judgement with scepticism and appropriate management challenge, but which key attributes and elements should be the focus of this never-ending quest?
Perspectives on professional scepticism vary and are constantly evolving, inside the audit profession and among those in and around the audit ecosystem. There is, however, widespread agreement on the fundamental importance of scepticism, challenge and judgement in audit, and ways to enhance and strengthen their development and application is increasingly a focus for audit firms, networks, regulators and ICAEW. This has recently resulted in some valuable insights and recommendations that all auditors may want to consider.
“The application of professional judgement with scepticism and appropriate challenge of management is critical to high-quality audits,” says Trevor Smith, Director, Quality Assurance, ICAEW. ICAEW’s Quality Assurance Department (QAD) finds that lack of these skills is a factor in many weaker audits. It also sees good practices, where auditors have applied robust challenge of an audited entity’s management to explain and justify key judgements underlying the information in their financial statements.
Supporting good practices
The Audit Monitoring Report 2021/22 notes lack of scepticism and challenge in key judgement areas, including asset valuation and going concern, with firms doing insufficient work to evaluate and challenge material uncertainties over audited entities’ assumptions and forecasts. QAD has been encouraging firms to dig down into root causes behind such findings and, after analysing results, it shared learnings in its 2020/21 monitoring report, using case studies and good practice examples. More good practice examples of scepticism and challenge are in Audit Monitoring Report 2020.
Towards the close of 2022, the Financial Reporting Council (FRC) published What Makes a Good Environment for Auditor Scepticism and Challenge, summarising its views and sharing examples to encourage the spread of good practices and support continual improvement in audit quality. “It is vital that a good audit recognises the need for an audit team to not only have the necessary skills and experience but that it also approaches the engagement with the right behaviours and mindset,” states the FRC, as behaviours and mindsets form the foundation of a high-quality audit.
In this paper, the FRC sets out key attributes of a high-quality audit environment that enables professional scepticism and challenge, linking to factors outlined in its June 2022 Professional Judgement Guidance (which is available with a framework, examples and expectations paper). The judgement guidance outlines environmental factors and psychological factors and biases that can impact how easy or difficult it is to exercise appropriate scepticism and challenge and although it is not prescriptive, the FRC expects all firms to consider it, as Audit & Beyond has previously highlighted.
What good looks like
What Makes a Good Environment for Auditor Scepticism and Challenge also references FRC analysis of information provided to it by firms, plus independent findings based on research with focus groups of auditors. This was combined to inform the good practice highlights shared in this paper and framed by the FRC using four key elements:
- learning environment;
- audit firm operating mode; and
- interactions with parties in the wider ecosystem including the audit committee and management at the audited entity.
Here are just a few of the FRC examples of good practices that may assist firms to create a good environment for scepticism and challenge:
- Defining desired audit-specific behaviours – for each audit role/grade to be assessed against annually – and including professional scepticism and challenge.
- Psychometric assessment to help partners identify how their personality may lead to or inhibit audit quality and understand how their behaviour may change under pressure.
- Prompts during audits for certain behaviours, such as meeting agenda items, ‘step-back’ meetings and ad-hoc prompts throughout an engagement to assess critical audit behaviours.
- Annual 360 degree-feedback for audit managers and above, with anonymous feedback on the firm’s values (including integrity and quality), used in appraisal and promotion processes.
- Mandatory full team discussions at set points during the audit to drive timely debate of key judgements.
- Hot reviews on focus areas such as management estimates, to identify themes and concerns.
There is an overview for each of the FRC’s four key elements, which are considered in more depth in dedicated sections. Some of these sections feature good practice case studies on matters including: training and coaching; governance; leadership, communication; reward and recognition; working environment; people engagement; resource and project management; audit firm processes; and interactions with audit committees and management. There is plenty to assist auditors to understand what good looks like to the FRC.
By far the largest of the four sections in What Makes a Good Environment for Auditor Scepticism and Challenge focuses on culture. It draws on insights from the FRC’s 2021 conference on Audit Firm Culture: Challenge. Trust. Transformation (now available as recordings). This explores links between culture and high-quality audit, such as behaviours that can promote or inhibit what the FRC sees as appropriate audit firm culture, and the role of culture in the development and application of robust professional scepticism and management challenge.
These matters are reflected in a 2022 Audit and Assurance Faculty report Sharpening the Focus on Corporate Fraud: an Audit Firm Perspective, which makes recommendations for government and audit regulators, executive and non-executive directors and audit firms. This report also shows how large audit firms are shaping and reshaping their culture and cultivating the sort of environment that strengthens development and application of professional scepticism and challenge, and the research for the report informs an Audit & Beyond article offering practical tips that may assist other firms.
The role of culture in audit also looms large in some 2023 outputs from ICAEW. In Building a culture that cultivates professional judgement, Sir Andrew Likierman, Professor of Management Practice at the London Business School, explains how his work on professional judgement from a more general management perspective can be applied to professional judgement in the audit profession – explaining his six elements of judgement. He’s spent a lot of time talking to large and smaller audit firms, and he offers some recommendations that all firms may find helpful.
An ICAEW Insights podcast, Carillion five years on: can we regulate ‘good’ judgement?, will also offer auditors food for thought. Sir Andrew, Mark Babington, Executive Director of Regulatory Standards at the FRC, Andrew Ratcliffe, Non-Executive Director, Barclays Bank (and an ex-audit partner) and ICAEW’s Iain Wright, Managing Director, Reputation and Influence, consider the UK government’s proposed audit reforms. Mainly, however, they focus on audit judgement and the importance of challenging management not just in audited entities, but in and across audit teams and firms.
The podcast also includes an anecdote that audit firms and teams may want to consider on their quest to enhance professional judgement, scepticism and challenge. Apparently, when one past UK Prime Minister arrived in a new government department he would get the civil servants together, then ask this standard question: “Who’s the hold-on-a-minute guy? When we’ve taken a decision and we’re getting really enthusiastic, who has the bravery and intellect to say ‘Hold on a minute, I don’t understand…’” Then, if their faces looked blank, he’d say: “Go and find one. We need one.”