Professional Skepticism Essay
During an audit, Professional Skepticism and Auditor Independence are two of the most important topics. Regardless of the relationship between the client and auditor, the auditor has to maintain neutrality and professionalism throughout the audit. In each of the cases presented in this paper, the personal relationship between the auditor and client jeopardizes their Professional Skepticism and Auditor Independence. The “If You Need Love, Get A Puppy” case successfully displays a high level of Professional Skepticism and Auditor Independence. The “Ernst & Young” case highlights the lack of these elements, resulting in a failed audit and consequences within the organization.
“If You Need Love, Get a Puppy” Case
According to the PCAOB, describes the professional skepticism needs to be applied throughout the duration of the audit engagement by the auditor as a general duty of care (Frazel, 2013). Professional skepticism involves the auditor having a clear and questioning mind when regarding the assertions that are presented by management or other client personnel. The auditor is instructed to not take the words or data presented by management as sufficient and appropriate audit evidence. Instead, the auditor needs to thoroughly audit the evidence with a questioning mind to achieve reasonable assurance about the persuasiveness of the evidence.
Skepticism is composed of three elements; auditor attributes, mindset and actions (Dimitrova and Sorova, 2016). Attributes are the knowledge, skills and abilities that an auditor uses to perform an audit. A person who qualifies for this position has adequate technical training and proficiency as an auditor. Auditors should be assigned to tasks that fit with their level of knowledge, skills, and abilities so that they can evaluate the audit evidence they are examining. Mindset is an attitude in which the auditor doesn’t assumethat management is dishonest. When an auditor exercises professional skepticism, they should not be content with anything less than persuasive evidence because of the belief that management is honest. The auditor should conduct the engagement with a mindset that recognizes the possibility that a material misstatement due to fraud could be present, regardless of any past experience with the entity. Actions are the gathering and neutral evaluation of audit evidence. Actions require the auditor to consider the competency and sufficiency of the evidence presented. Since evidence is gathered and evaluated throughout the audit, professional skepticism should be exercised throughout the audit process.The PCAOB alwaysinstructs the auditor to question evidence presented by the auditor for the probability of loss, fraud or financial misstatement.
In “If You Need Love, Get a Puppy” Will, the auditor, exercised professional skepticism in this case regarding to the mysterious cash ticket payments purchased on November 16, 2005. Due to his personal relationshipwith Jessica, Will needed to exhibit a higher level of skepticism in order to eradicate any misjudgment regarding the issue at hand. When Jessica made the deposit slip for the $320 ticket and asserted that the deposit slip had probably fallen in between two cabinets in the vault, Will was given the opportunity to take Jessica’s assertion as sufficient and valid evidence but rather decided to investigate further into the situation. He noticed that the year on the bills and the ticket were different as well as the ink on the deposit slip. After discovering these red flags, Willwiden the sample size to see if this was a singularity or evidence of an ongoing issue/fraud.
The two main conditions affecting Will’s skepticism were his relationship with the process owner he audited, who happened to be Jessica Randle, the wife of Will’s best friend. This presents an issue in that skepticism can sometimes be influenced by the relationships auditors have made with the people they are auditing. An auditor is more likely to believe the assertions by someone that they know and trust, creating an unfair advantage. The other main condition that affects skepticism is the materiality levels set forth for the audit. Will could have also have decided to not pursue further with his investigation of cash deposits that are missing their deposit slip up due to the amount of $320 being less than the materiality benchmark of $5,000.
This, in addition to the fact that he felt as if he was irritating his superiors by asking them many questions, might have caused Will to simply abandon further investigation of the area. If Will had not been exercising professional skepticism, he would have simply taken Jessica’s assertion as to why the deposit slip was missing as sufficient and appropriate evidence while moving on to another audit area. Jessica would have never gotten caught, and the fraud could have continued.
2. The Generally Accepted Auditing Standards requires that the auditor must maintain independence that is required of auditors (AICPA,2014). There are two types of audits that auditors are required to follow. Independence in appearance relates to others’ perceptions of auditors’ independence. It is held in the highest regard that the users of the financial statement believe that the auditor is independent. For example, if an auditor were to own even one share in a company that he or she was auditing, third party users would see this, as the auditor lacking independence even if the auditor considered was truly unbiased and considered that share irrelevant.
The Code of Professional Conduct addresses the issue of personal client relationships. The familiarity threat states that auditors “having a close or long standing relationship with an attest client or knowing individuals or entities (including by reputation) who performed non-attest services for the client” lack independence (AICPA, 2014). In Part E of the Code of Professional Conduct, it is stated that a member of the attest engagement team whose close friend is in a key position with the client is prohibited. Will’s independence in this case was in question.
His best friend’s wife, Jessica, worked for the client, but did not hold a key position. Will’s independence in mind seemed to be impaired in this case. He was clearly uncomfortable accusing his best friend’s wife of fraud. Some cases may exist where auditors in similar situations would be so uncomfortable that they would look past the fact that fraud was committed.
The factor that plays the greatest role in determining auditor independence is independence in mind. Auditors may or may not appear to be independent. However, if the auditor is truly in mind, then the auditor can remain neutral and unbiased. The profession should consider tightening the Code of Professional Conduct in order to address the issue of an audit team member knowing a close friend that holds any position at the audit client. If this scenario arises, the firm can still audit the client, but the audit member with the close relationship won’t be able to be on the audit team.
3. The evidence in the case is presented in a manner that leads to a stronger refute to Jessica’s claim that the money had fallen between the cabinets as opposed to supporting her claim. The evidence that would lead to support her claim would be her statement that there could be several possible explanations as to why the ticket was missing. She originally suggested that the ticket most likely was included with the other cash. After finding the ticket, Jessica talks about a story of what must have happened. She claimed that the assistant clerks were working late one night and must have decided to include the deposit with the following day’s bank deposit. Thus, when the ticket was missing, no one noticed. All of these explanations mentioned are all considered responses to inquiries of client.
This type of evidence is not conclusive and could be biased in the client’s favor; hence, why this is the only evidence that is in favor of Jessica’s statement. When Will went back to his desk and counted the money he made sure the money on the slip was all there. The amount Will counted was $320, which is much less than the set amount of $5,000 for materiality on the job. However, he noticed that the bills were crisp and had been printed in 2006. He checked this back to the bank deposit slip where he reconfirmed that the deposit was dated November 16, 2005. He then traced it back to the cash receipt to find that it was indeed recorded on November 16, 2005.
This document tracing is important evidence that clearly shows a discrepancy in the documentation, which lead to the first real line of evidence towards fraud. Another discrepancy that caught Will’s eye was the entry in the in receipt book that was recorded in black ink even though the writing on the envelope was in blue ink. Although this is not a strong form of evidence, it is valid enough to bring question the evidence that has been traced back to recorded items.
4. Effective controls that if installed would have prevented or detected this theft include: Segregation of Duties (SoDs), daily payment and bank deposit reconciliations. The first area of controls deals with the Receipt books and proper SoDs. The receipt of cash payments should be different from the individual that records that cash payments into the Sheriff’s computer records as paid. The other control deals with reconciliations. The morning after the daily payment vouchers are processed and deposited, a reconciliation by someone who was not a recipient of cash payments the previous day needs to be done in order to reconcile that the total amount deposited into the bank matches the bank statement of amounts deposited by check, cash and money order. A monthly reconciliation needs to be performed for all payments done by credit card.
5. After Will presented Vince with the evidence that he had found after Jessica showed him the missing deposit slip along with the cash, the two decided to test eight more cash paid tickets. When five of the eight tickets were also not included in the bank deposit of the day, Will and Vance decided to have a meeting to discuss how they were going to proceed. With the evidence leading to fraudulent activity, the auditors could have decided to proceed in one of two ways. The first being to assess the level of materiality and decide if the amounts were immaterial; if so they could leave the report as was. The other route the auditors could have taken was to further examine revenue, specifically the tickets paid in cash. If the decision is to proceed even further with the audit, there are multiple steps the auditors would have taken to reach reasonable assurance.
First, they could examine internal controls to see if there was any other person who could have been using Jessica’s name fraudulently, since she was not the only assistant Clerk of Court. Next, they could examine every cash transaction for 2006. If the trend was consistent, they could examine through previous years. In addition to further testing of the transactions, the statements to verify that the cash tickets aren’t being put with other cash deposits in the department. Ultimately, the auditors would have to contact the police department to report their findings.
6. In pursuing the matter, Will faced a number of pressures. At first he was concerned because Jessica was his best friend’s wife and he did not feel comfortable working in the situation. However, Vince Huston, the partner that he had usually worked with, assured him that knowing Jessica was not such a bad thing. When Will was completing the audit and found that a cash receipt had not been deposited, he did not want to believe that Jessica was responsible so he double- checked his work and then asked her about it. After receiving the bank deposit from Jessica, he was still skeptical because he had noticed a few minor things. The pen ink was two different colors in the receipt book and on the envelope. Afterwards, Will noticed that it was impossible for a 2005 cash receipt to be paid for with a bill marked 2006.
When Will asked Jessica about the matter, she brushed it off. Will was forced to report what he found out to Vince. In dealing with the misappropriation of assets of fraudulent financial reporting, auditors are to maintain professional skepticism throughout the engagement. The reasoning behind this is that fraud usually occurs by a person that the auditor least expects. In this case, it was Jessica. Will maintained his professional skepticism and did not let the fact that Jessica is his best friend’s wife. It was important that Will did not budge in his stance and made Jessica speak honestly about what she doing with the money. In many similar cases, there have been times where with close affiliation between separate parties in an audit is toxic, as this relationship causes independence to be disrupted. In general, auditors must also be aware of the basics of fraud awareness. Auditors should be able to notice any signs or signals of fraud and then be able to trace the documents back to anything that may help to uncover fraudulent activity.
7. When most people make ethical decisions, one of the things they do is try to find an alternative to the problem or situation and ask themselves what the consequences of those alternatives would be. In Will’s situation, after finding out that Jess was involved in misappropriating the cash associated with the ticket he had many options in what he could have done. First, Will could have let what he had found out slide because Jessica was his best friend’s wife. Second, Will could have confronted Jessica about the situation and reported her, or could have let Jessica report herself.
Will ignoring the blatant signs that Jessica was stealing money would only lead to her continue her fraudulent behavior. If Will were to ignore Jessica’s acts, he would be putting his career in jeopardy. It would be highly unethical of Will to act in this way because he has a responsibility to maintain professional skepticism throughout the audit process. The other alternatives of reporting Jessica or letting her report herself to the authorities would be the right and ethical alternative to the situation. The consequences would basically be the same as they had turned out to be. If this alternative were to happen Jessica would still get punished for her crimes. On a more personal level, Will reporting Jessica would lead to Will losing his best friend.
Ernst ; Young Case
There have been many real life cases that are similar to Will’s. One of these cases occurred in 2016 when Ernst & Young (SEC, September 19, 2016) had two of their firm’s audit partners get too close to their clients on a personal level, which caused them to violate rules that ensure firms to maintain their neutrality and impartiality during audits. These violations not only cost these partners their job, it also caused Ernst ; Young’s reputation to be damaged and forced them to pay a $9.3 million fine to the SEC. The SEC found out that Ernst & Young was lying about the company’s independence throughout these audits.
The first partner who was found guilty, Gregory S. Bednar, was found to be committing auditor independence rule violations at Ernst ; Young from January 2012 to March 2015. Bednar was specifically asked by the firm to help improve the firm’s relationship with a New York based client, as the client’s account seemed to be in trouble. Bednar and the company’s CFO started to have a relationship that affected Bednar’s independence, as he stayed overnight at the CFO’s house multiple times. He even managed to have a relationship with the CFO’s son. Even though certain members of the audit team found out about what was going on, they did nothing to stop it from happening. Eventually, the SEC caught Bednar’s wrongdoing and made Ernst & Young pay $4.975 million to the SEC. The SEC made Bednar pay a fine of $45,000 and prohibited him from doing work in front of the SEC as an accountant for a minimum of three years. As a result of his actions, Bednar was let go by Ernst & Young.
Another finding the SEC had during its investigation was an auditor independence rule violation committed by Pamela Hartford. Ms. Hartford violated auditor independence rules by having a romantic relationship with financial executive Robert Brehl, dating from March 2012 to June 2014. While this improper relationship was going on, partner Michael Kamienski, who was supervising Ms. Hartford on the audit, became aware of the improper relationship yet failed to conduct a reasonable inquiry about the issue or report the issue to someone within the firm. As a result of the violations committed, Ernst & Young had to pay a fine of 4.399 million to the SEC. In addition, Mr. Brehl, and Ms. Hartford had to pay a fine of $25,000 each. They also were suspended from appearing in front of the SEC as accountants. Mr. Brehl’s suspension lasted one year while Ms. Hartford’s lasted three years. While he was not fined for his wrongdoings, Mr. Kamienskiwas suspended from appearing in front of the SEC as an accountant for at least three years. Due to the violations they committed, Ms. Hartford and Mr. Kamienski are no longer employed by Ernst & Young.
Ernst & Young was forced to sever ties with their employees who violated the rules of
After looking at both cases, it is important to understand why it is important for all parties involved in an audit to be honest and neutral, despite what relationship members of the different parties have. If members of different parties aren’t cooperating within the rules of professional skepticism, it will not only affect the validity of the audit, it could result in punishment for these members. This is why it is important for clients and auditors to throw away any feelings they might have for each other, when they are working on the audit. Will did a great job of throwing his the feeling of affection he had for Jessica when he was auditing her company. While many people would crack in his situation, Will did a great job of keeping his neutrality and his actions ended up paying major dividends in the end. He did not break any laws and ended up helping Jessica out with her gambling addition. His behavior is a great example of how an auditor performs an audit involving a client who employees someone who is very close to the auditor. The Ernst ; Young case is a very good example of what an auditor should not do. Having a personal relationship with a company CFO who is one of your clients is not a good idea. This relationship was bound to violate independence from the start and only got worse as time went on. It got to the point where the auditing wasn’t even relevant in terms of the respective individuals relationship with each other. That should never happen. While this behavior seems like it would only happen once in a blue moon at a prestigious company like Ernst & Young, there was more chaos going on. An employee having a romantic relationship with a financial executive is never a good look. This is a distraction and can lead to the lack of validity in one’s work. As expected, the relationship was a violation of independence. While Mr. Kamienski could have intervened with what was going on between the employee and the financial executive, he decided to do nothing. As a result, all three received punishments from the SEC and Mr. Kamienski as well as Ms. Hartford were let go by Ernst ; Young. It is a valuable lesson that anyone from any profession can learn. If one breaks the rules, they are probably going to get into trouble. In addition, the punishment for breaking the rules is usually heavier than the reward for breaking them.
Frazel, J. M. (2013, August 5). Auditor Objectivity and Skepticism- What’s next? Speech presented at American Accounting Association Annual Meeting, Anaheim, CA.
Dimitrova, J., & Sorova, A. (2016, December 27). The Role OF Professional Skepticism in Financial Statement Audit and its Appropriate Application Scholarly project. Retrieved November 1, 2017, from js.ugd.edu.mk/index.php/JE/article/download/1596/1420/
Generally Accepted Auditing Standard, AICPA § AU Section 150 (2001).
AICPA Code of Professional Conduct, AICPA Code of Professional Conduct § 100-1.16 (2014).
Ernst & Young, Former Partners Charged With Violating Auditor Independence Rules. (2016, September 19). Retrieved November 1, 2017, from https://www.sec.gov/news/pressrelease/2016-187.html