ACT501 Chap.3 Auditor Liability, Independence and Professional Skepticism
Auditor Liability, Independence and Professional Skepticism
Where the register changes
Everything earlier in the opening lecture explains what an audit is. This part explains what happens to the practitioner when the work goes wrong, and what the standards positively demand in order to make that less likely.
It also maps onto a stated learning outcome of the course, which asks students to identify and evaluate situations that could threaten compliance with the fundamental principles of the professional code and to apply safeguards that eliminate or reduce the threat.
Criminal exposure requires participation
Six situations are listed in which the practitioner personally commits an offence, and what they share is involvement rather than carelessness.
Inciting a client or anyone else to commit an offence. Helping or encouraging the planning or execution of one, the example given being the production of false financial statements. Agreeing to pervert or obstruct justice by destroying, hiding or manufacturing evidence, or by telling the police things the auditor knows to be false.
Getting in the way of the arrest or trial of a client guilty of a serious offence, with tax evasion given as the example. Taking a payment in return for withholding information that would materially help a prosecution. And knowingly or recklessly dropping from an audit report a statement the law requires it to carry, attributed in the lecture to section 408(1) of the Companies Ordinance.
Only the last can be reached without an agreement with someone else, and even that requires knowledge or recklessness.
Civil exposure requires neither
The negligence standard the lecture quotes comes from a nineteenth-century English waterworks case of 1856, and it has survived because it is symmetrical.
Negligence is leaving undone what a reasonable person, guided by the considerations that ordinarily regulate everyday conduct, would have done, or doing something a prudent and reasonable person would avoid. The defendants might have been liable if, unintentionally, they omitted what a reasonable person would have done. Two features matter. Unintentionally reaches conduct nobody planned.
And the symmetry means a practitioner can be negligent by performing an unnecessary procedure badly as easily as by skipping a necessary one. The lecture adds that a company's audit report is written to its shareholders, and that the courts settled long ago that a negligent auditor answers to them for the loss.
Three positive requirements
Alongside those exposures sit three obligations.
Comply with relevant ethical requirements, including independence, in relation to the engagement. Plan and perform the audit with professional scepticism, recognising that circumstances may exist that cause the statements to be materially misstated. And exercise professional judgement in planning and performing the audit.
Examination questions frequently describe a failure and ask which of the three it breaches, so learning them as three separable items pays.
Independence has two tests
Independence in fact is independence in mental attitude, the condition that lets an opinion be formed without being affected by influences that would compromise it.
Independence in appearance concerns users' perceptions of the auditor's independence.
The second exists because the first is unobservable: a reader cannot inspect a state of mind, so the profession protects the value of the opinion by regulating the relationships that would make a reasonable reader doubt it.
Scepticism is a set of alerts
Professional scepticism is a frame of mind marked by proper questioning and a critical weighing of what the evidence shows, held across the whole engagement.
The reason given is structural: the auditor and the managers under examination are always potentially in conflict, because management wants the position shown in the best possible light while the auditor has to see it shown fairly. Four alerts are named. Evidence that contradicts other evidence obtained. Information calling into question the reliability of documents or of responses to inquiries.
Conditions that may indicate possible fraud. And circumstances suggesting that procedures beyond those the standards require are needed. Each describes something visible in the file rather than a feeling.
What this chapter covers
- 01
Six situations creating criminal exposure, and what they share
- 02
The statutory offence of omitting a required report statement
- 03
The 1856 negligence formula, and the word unintentionally
- 04
Symmetry between omission and commission in that formula
- 05
Who the report is addressed to, and who may sue
- 06
Ethics and independence, scepticism, judgement as three separate duties
- 07
Independence in fact against independence in appearance
- 08
The four alerts that make scepticism operational
- 09
Five decisions in which professional judgement is expressly required
Find the failure, then write the sceptical version of the same step
- 3Say what the file actually contains as evidence, and what it does not.
- 3Name the requirement breached and why the other two are not the answer.
- 3Rewrite the step so that it could have found the dispute.
Key terms
- Professional Skepticism
- A frame of mind marked by proper questioning and a critical weighing of what the evidence shows, held from the first day of an engagement to the last.
- Professional Judgment
- Bringing training, knowledge and experience to bear, inside the frame set by auditing, accounting and ethical standards, when deciding what to do next on an engagement.
- Independence in Fact
- Independence of mind, which lets an opinion be formed without being swayed by anything that would compromise it.
- Independence in Appearance
- How independent the auditor looks to users, which a reader can judge from relationships and interests that are out in the open.
- Negligence
- Leaving undone what a reasonable person would have done, or doing what a prudent and reasonable person would avoid, whether or not anybody meant it.
Auditor Liability, Independence and Professional Skepticism FAQ
Can an auditor be prosecuted for missing a fraud?
Not on those facts alone. The criminal situations listed in this course all involve the practitioner joining in: inciting, helping or encouraging, agreeing to conceal or fabricate, impeding a prosecution, taking payment for silence, or knowingly or recklessly causing a required statement to be omitted from the report. Every one except the last needs an agreement with somebody, and the last needs knowledge or recklessness.
A description of work that was simply careless belongs in the civil column instead, where no intent is required.
What does a reasonable person mean when the defendant is a professional?
It means a competent member of that profession rather than an ordinary member of the public. The 1856 formula was written about a burst water main, and read out of context it invites an answer about common sense.
In a professional setting the standard is set by what a competent practitioner would have done, which is why auditing standards and the firm's own methodology end up being the measure of the duty, and why the working papers of the auditor who was there become the evidence of whether it was met.
Why does independence in appearance matter if the auditor really is objective?
Because nobody outside can check the first condition. A state of mind is unobservable, so if the value of the opinion depended on taking the auditor's word for it, the opinion would reduce no information risk at all.
Regulating the relationships a reader can see is what makes independence something a reader can rely on, which is also why a shareholding, a contingent fee or a close family connection produces an answer even when no one has behaved badly.
Exam move
Build a two-column table of situations. On the left put anything involving an agreement, an inducement or knowledge; on the right put anything involving an omission, a shortcut or a missed step. Then add a third column naming which of the three positive requirements a right-hand item breaches.
Most questions on this topic are answered by putting the scenario in the right column and naming the requirement in one clause, and the table makes that automatic.
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