You are the audit manager in charge of the audit of Vulnerable Company Limited which has been making losses in its operations owing to many factors including competition, impairment of some of its non-current assets and losses incurred on derivatives in its hedging activities as well as problems of complying with many laws and regulations governing its operations.
During your briefing meeting with the Engagement Partner, he drew your attention to the Question and Answer paper on Professional Skepticism issued by the International Auditing and Assurance Standards Board (IAASB) and requested you to discuss its contents with the audit team before commencement of the field work.
Required:
i) Discuss the concept of Professional Skepticism and its importance in audit. (4 marks)
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Professional Skepticism is hard to define but is “fundamentally a mindset” which is linked to the ethical principles of objectivity and independence. It means being alert to evidence that contradicts evidence already obtained or which casts doubt on the reliability of documents or explanations, provided or which may indicate fraud.
It is important in audits because it is part of the auditor’s “skill set” and it is part of professional judgement. It affects decisions about the procedures to be performed, the sufficiency and appropriateness of evidence obtained, the validity of management’s financial reporting judgments.
ii) Assess and evaluate the areas in an audit of your client where the audit team members need to exercise a high level of professional skepticism. (6 marks)
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- Fraud
Where management is involved in fraudulent financial reporting, they could provide the auditor with representations which may mislead the auditor or contradict evidence obtained elsewhere - Accounting estimates
Auditors must ensure that the assumptions used by management are reasonable. Since making accounting estimates require exercise of judgement by management, an opportunity is provided for bias and fraud. - Going Concern
Auditors must ensure whether management plans are really feasible and the assessment of going concern by management was done objectively. - Related Party Transactions
Related Party relationships and transactions where transactions may not be conducted at arm’s length or be outside the normal course of business. This is another area for manipulation by management. - Laws and Regulations
For example, where non-compliance may call into question going concern and determination whether an act of omission or commission amounts to non-compliance which may require the services of legal experts. (4 points @ 1.5 marks each)