Firms ‘doubt’ FRC’s audit direction

“GUILTY UNTIL proven innocent?” This phrase is probably more commonplace in audit circles than it has been in the past.

Accounting’s regulator the Financial Reporting Council (FRC) and the Financial Services Authority (FSA), in a joint paper last autumn on considering how to enhance auditor scepticism, flagged up introducing a “presumptive doubt” way of thinking for auditors when doing their job.

The phrase was used a total of four times throughout the discussion paper, to illustrate where the regulators believed the audit profession could aim for in doing their work.

The regulators also plainly declare that new auditing standards intended to enhance audit rigour are aligned with “presumptive doubt”. “The recently updated Auditing Standards can be characterised as reflecting a presumptive doubt approach,” stated the discussion paper.

To suggest that the firms disagree with this point is putting it mildly. In their repsonses to the paper, they point to the term “questioning mind” as set out in auditing standards – plus UK case law that refers to the “enquiring mind” – as more appropriate markers for their attitude towards their work.

“The term ‘presumptive doubt’ is not used in the ISAs. Having an initial mindset of ‘presumptive doubt’ as expressed in the discussion paper reflects an approach that assumes management is dishonest,” argued PwC in its response. “This would result in procedures far beyond a ‘questioning mind’ as set out in the ISA definition of professional scepticism and the established concept of an ‘enquiring mind’.”

Such a level of doubt would greatly increase auditors’ workload, they warn, which will simply add unneeded cost for clients.

Despite the strong reaction to the FRC and FSA’s assumptions on scepticism, the firms agree that making some of the audit processes and discussions more transparent is important. They generally believe their work is valued by company CFOs and audit committees, but providing details of how they question and push them remains out of the public domain – for now.

Demonstrating scepticism is difficult to quantify and explain, say the firms, but agree that more should be done to illustrate their efforts.

“…Scepticism is more of a behavioural trait, and given this inherent quality it is difficult to demonstrate fully via documentation or indeed to measure objectively,” said E&Y in its response.

“There is a need to improve the visibility of the challenges made by auditors of management and audit committees, and for audit committees to provide information in their reporting about the key areas discussed with auditors during the course of the year,” E&Y added.

Investors are less forgiving about auditors’ stance on the scepticism issue.

They claim that auditors spend too much time gathering evidence that backs up management, rather than question them on their decisions. In particular they are concerned that international financial reporting standards (IFRS) allows companies to make their own judgments of their financial position in certain circumstances. Because of this, auditors must be more strident in pushing clients to explain how they have reached their valuations.

The Investment Management Association wants auditors to be more consistent in their application of accounting policies across different clients, and where possible coordinate with each other.

Predictably investors want auditors to be more open about clients’ unusual transactions, or flag up where a client has taken a valuation at the extreme end of estimates.

However many auditors would argue that this would be a step too far: flagging up an auditors’ ‘concerns’ over their clients’ accounting could prove to be self-fulfilling, destroying its share price and sending the company into meltdown – an issue that was raised during the banking crisis.

Some argue that auditors are more concerned about not losing their clients.

It is yet to be proved whether such audit hurdles are insurmountable.

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