Demonstrating professional scepticism
Prominence of professional scepticism is growing among standard-setters and other stakeholders in all types of assurance engagement, says Katharine Bagshaw.
Demonstrating professional scepticism, like good governance, can be hard. But doing this is increasingly important in all forms of assurance engagements, not just in audit and not just among auditors. It’s important for standard-setters to show that they too are giving it appropriate prominence in developing new projects, such as the International Auditing and Assurance Standards Board (IAASB) project on emerging forms of external reporting (EER) assurance and the July/August 2019 edition of Audit & Beyond.
As often happens, adapting old concepts to new situations gives the concepts a new lease of life – in this case, as new examples of scepticism are developed. These will in due course be usefully tweaked and retrofitted to the original audit context.
The original EER – which is now fairly well established – is reporting on greenhouse gas (GHG) statements. IAASB issued the International Standard on Assurance Engagements (ISAE) 3410 Assurance Engagements on Greenhouse Gas Statements back in 2013. That was based on the ‘mother’ standard ISAE 3000 Assurance Engagements Other than Audits or Reviews of Historical Financial Information, which is a good place to start.
ISAE 3000 defines professional scepticism in the same way as it is defined in International Standards in Auditing (ISAs): an attitude, a questioning mind, being alert to matters that may indicate possible misstatement and a critical assessment of audit evidence. Planning and performing an assurance engagement therefore involves being alert to inconsistencies in evidence, to evidence that casts doubt on the reliability of documents or responses to inquiries, and to the implications of circumstances suggesting that additional procedures may be needed, beyond those required by standards.
This helps ensure that practitioners do not overlook unusual circumstances, overgeneralise when drawing conclusions, or use inappropriate assumptions when determining the procedures to be performed or when evaluating results.
As in an audit, while practitioners cannot be expected to disregard experience of management’s past honesty and integrity, such experience doesn’t relieve practitioners of the need to exercise professional scepticism. Also, as with an audit, practitioners may accept records and documents as genuine unless there is any reason to believe otherwise.
Now, let’s go back to the original EER, and explore how all of this translated into ISAE 3410 on reporting on GHG statements.
It is perhaps important to note that competence is paramount in these cases. It is impossible to exercise professional scepticism effectively from a position of ignorance. ISAE 3410 notes that when considering potential causes of material misstatements, to demonstrate scepticism practitioners need to show that they have considered the possibility of intentional misstatements. They also need to consider the likelihood of non-compliance (intentional or otherwise) with laws and regulations – particularly those affecting operations, such as licensing regulations and those involving significant penalties – even if there is no direct effect on amounts and disclosures in the GHG statement.
Practitioners need to show that they have considered the likelihood of the omission of potentially significant emissions, which demands an understanding of concepts such as ‘fugitive’ accidental emissions. Practitioners must also show that they have considered the degree of complexity in determining organisational boundaries, which is particularly important where reporting on scope 3 emissions.
To provide some context, scope 1 emissions are owned or controlled, scope 2 are indirect emissions arising from purchased energy, and scope 3 emissions are all other indirect emissions which extend further up and down the supply chain. The level of subjectivity in the quantification of omissions and the inclusion of scope 3 emissions both challenge practitioners technically when it comes to demonstrating scepticism. ISAE 3410 has a useful supplement outlining the basics of GHG measurement, reporting requirements and trading schemes.
The much newer EER consultation draft (published by the IAASB in February 2019) has yet to develop the subject of professional scepticism and judgement in detail. A whole chapter is to be devoted to the subject in Phase 2 of the project, but the current draft does note that considerable professional scepticism may be needed in determining suitable criteria for EER assurance engagements, particularly where the criteria are developed by the entity. Professional scepticism is needed to evaluate neutrality in such cases because of the inherent risk of management bias.
Where well-established reporting criteria are modified – resulting in criteria that are different to those commonly used in the sector – significant scepticism may be needed in determining the appropriateness of the revised criteria and the reasonableness of the change, including whether it has been adequately explained and disclosed. The more mature the reporting framework, the less likely it is that changes to criteria will be suitable. Scepticism is also needed in evaluating judgements and in focusing on what the preparer chose to exclude and why. This last example in particular has a modern feel to it and the principles as they develop in this project seem likely to be applied to audit.
Dealing with complexity
One of the main reasons the development of the issue of scepticism in the IAASB’s EER project has been deferred is because the IAASB has a separate project investigating the issue. The IAASB published a communiqué on professional scepticism and quality management in February 2019, summarising its activities in the area, including its work with the International Ethics Standards Board for Accountants. A previous edition of this communiqué was published in October 2018.
As noted earlier, professional scepticism is not a straightforward issue. Cultural assumptions about appropriate boundaries when challenging authority, and cultural and economic considerations when the issue is extended into reporting suspicions of fraud and non-compliance with laws and regulation, cannot be glossed over in an international context; the differences are deep rooted. But it is encouraging to note that everyone has moved beyond simply paying lip service to the subject.
Standard-setters recognise that they can no longer simply exhort practitioners to be and be seen to be sceptical, and then leave it to them to work out how. Examples have to be provided. And practitioners increasingly recognise that simply writing in a file the words “we will maintain an attitude of professional scepticism at all times” is not enough to demonstrate that professional scepticism has been exercised. Simply saying that something should be done does not make it happen, and simply saying that something has been done does not mean that it has.