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New Alert Calls on Auditors to Get Skeptical

Tammy Whitehouse | December 4, 2012

It's not an auditing standard, but the Public Company Accounting Oversight Board has issued new guidance making a stern new call for greater skepticism and objectivity on the part of public company auditors.

Chief Auditor Martin Baumann published a new practice alert to remind auditors of requirements that already exist for auditors to approach their work with an independent, skeptical mindset. The PCAOB released the practice alert at a year-end national regulatory conference of the American Institute of Certified Public Accountants to encourage audit firms to heed the guidance as they get ready for the year-end audit cycle. “I consider it essential reading for all auditors,” Baumann said.

The alert says PCAOB standards define professional skepticism as an attitude that includes a questioning mindset and a critical assessment of audit evidence. Standards also indicate it is required of all auditors on an engagement team. “Professional skepticism is required in every aspect of every audit by every auditor working on the audit,” said Baumann. “If an audit is conducted without professional skepticism, the value of that audit to investors or other is seriously impaired.”

The PCAOB first called attention to the need for greater skepticism when it published a controversial concept release proposing that perhaps a system of mandatory firm rotation would help auditors to become more independent and objective of management, and more skeptical of management assertions. PCAOB Member Jeannette Franzel said the board is “taking a pause” from the idea of a new auditing standard as it pursues other avenues to rattle more skepticism out of auditors.

In addition to the staff alert, the board recently published a final standard on auditor communications with audit committees as well as guidance to audit committees intended to help them make better use of inspection reports in their management of external auditors. The auditing standard is awaiting approval by the Securities and Exchange Commission before it can become final. “Right now we are really focusing on areas where practice can be improved,” Franzel said. She said the board will decide its next steps on a possible standard, whether to require audit firm rotation or something else, in 2013.

Baumann offered some examples the board has seen through its inspection process and disciplinary proceedings where professional skepticism was sorely lacking. In one case, an engagement team failed to get an understanding of how an outside pricing service valued some hard-to-value financial instruments, even ignoring audit evidence that would suggest the price was issuer friendly. In another, he said, an engagement team didn't evaluate the effects of a determination by management that it didn't need to test plant, property or equipment for impairment, despite plenty of evidence that they might be impaired, like operating losses, goodwill and intangible asset impairments, a projected loss for the upcoming year, and reduced or delayed customer orders.

“As a practical matter, auditors are often challenged in meeting this fundamental requirement, but it's important for auditors to be alert to unconscious human bias,” Baumann said. He said auditors often operate in an environment where there are numerous impediments to skepticism. He called on audit firms to take a closer look at their compensations and incentives, marketing materials, and professional terminology that encourage auditors to think of the entities they audit as clients.