Key Auditing Concepts for Professional Scepticism-myassignmenthelp

Question: Write about theKey Auditing Concepts for Professional Scepticism. Answer: Auditors while performing an audit engagement, are required to exercise certain approaches such as professional judgement and professional scepticism in their work since audit is conducted to enable the auditor to express an opinion about the true and fair view of the financial statements of an entity. Professional scepticism requires the auditors to remain alert to anything unusual indicating the possibility of material misstatements in the financial statements of the company, which they come across during the audit process. The approach to keep a questioning mind throughout the audit process is necessary to critically assess the audit evidences which assists them in drawing a conclusion based on which audit opinion is formed. Although it is not the statutory duty of auditor to detect the frauds and errors in the financial statements but still they are supposed to follow the concept of professional scepticism if they find any information that casts doubt about the reliability of nec essary documents and the inquiry responses of the relevant parties. Even if there are contradictory evidences on a particular audit matter the auditor must apply professional scepticism to determine the genuineness of the audit evidences. There are 3 main elements of professional scepticism which interact whenever auditor encounters the unusual situations (Hurtt et al., 2013). These are attributes mind-set and the action. First one is the Attributes includes the auditors knowledge and skills. Second element is Mind-set includes the auditors behavioural approach towards the audit i.e. the auditor cannot start his work of audit with suspicious framework of mind about the entitys management. Therefore, the auditors should not be influenced by the evidences that are less persuasive by nature. Actions is the third element which involves gathering and critically examining the audit evidences to assess the genuineness of the entitys books of accounts. For the purpose of critical assessment auditors must the sufficient and appropriate audit evidences. While pursuing the approach of professional scepticism auditors must extend the audit procedures whenever they find anything unreasonable. Moreover, auditor is also required to assess the appropriateness of going concern assumption adopted by the company and if during the audit engagement he identifies certain indicators which affects the reasonability of going concern assumption he must extent his audit procedures.(Quadackers, Groot Wright, 2014). Auditors are the external parties appointed by an entity for the purpose of conducting audit so as to raise the level of confidence of the investors and other stakeholders of the company. Therefore, to ensure their independence auditors are required to apply professional scepticism in the audit planning and while performing the audit procedures. Earnings Management It is the practice where the business managers manipulates the financial reports of the entity in order to deceive the stakeholders about the companys financial position so as to ultimately attain the economic benefits. As the value of firm is influenced by the level of earnings reported by it, the managers tends to manipulate the earnings with the motive of attaining the economic incentives (Cohen Zarowin, 2010). It is therefore difficult to determine whether these practices of earnings management are acceptable or they form part of fraud done by the management to mislead the investors. Financial reports are considered as the most effective way of communication of information between the company and the stakeholders about the financial performance of the company. The critical nature and usefulness of financial reports necessitates the need of audit of financial statements by an independent party (auditors) so as to increase the creditability of financial statements in the eyes of t he shareholders. Therefore, the auditors are required to maintain the highest degree of independence while conducting an audit and at the same time auditors are also required to apply professional scepticism and professional judgement during the entire audit process. The exercises of earnings management can either be for the purpose of showing higher income or for showing the lower income in the financial statements of the company (Badertscher, 2011). For example, the managerial remuneration system of a company requires the managers to generate a certain level of earnings so as to earn incentives and bonuses and in order to gain the incentives the managers engage themselves in the earnings management exercises. The company may be suffering losses which is affecting the reasonability of its going concern assumption then to raise funds from financial institutions the management may increase the earnings in the reports as going concern assumption is based on companys viability to conti nue business in the future. Also, to gain the governmental subsidies and assistances management adopts the practice of earnings manipulation (Gunny, 2010). Discretionary Accruals: Accruals are one of the two components of total earnings of the company. The other component is the direct cash flows from the operations of an entity. The total accruals are the estimates and judgements made by the management to reflect better economic performance through improved earnings accounting. Accruals can be either discretionary accruals or non-discretionary accruals (Linck, Netter Shu, 2013). Discretionary accruals is the component that the managers can select on their own, within the accounting regulations flexibility, to adjust the cash flows of the company (Badertscher, Collins Lys, 2012). Discretionary accruals offers the business managers with the flexibility to manipulate the companys earnings so as to influence the stakeholders. Due to the involvement of extensive managerial judgement this component is more subjective than the other components of earnings. The audit of the entities with more discretionary accruals is difficult than the audit of entities with lesse r amount of discretionary accruals (Kent, Routledge Stewart, 2010). This type of accruals at times holds two elements that are, the disturbance caused by the unethical and aggressive reporting done by the managers for their personal benefits and the information element which enables the managers to share their inside information. Since the highly skilled auditors have greater experience and knowledge to separate the information element from noise, they are capable of enhancing the informative quality of discretionary accrual by restricting the unethical and unreasonable reporting practice. List of References: Badertscher, B.A., 2011. Overvaluation and the choice of alternative earnings management mechanisms.The Accounting Review,86(5), pp.1491-1518. Badertscher, B.A., Collins, D.W. and Lys, T.Z., 2012. Discretionary accounting choices and the predictive ability of accruals with respect to future cash flows.Journal of Accounting and Economics,53(1), pp.330-352. Cohen, D.A. and Zarowin, P., 2010. Accrual-based and real earnings management activities around seasoned equity offerings.Journal of accounting and Economics,50(1), pp.2-19. Gunny, K.A., 2010. The relation between earnings management using real activities manipulation and future performance: Evidence from meeting earnings benchmarks.Contemporary Accounting Research,27(3), pp.855-888. Hurtt, R.K., Brown-Liburd, H., Earley, C.E. and Krishnamoorthy, G., 2013. Research on auditor professional skepticism: Literature synthesis and opportunities for future research.Auditing: A Journal of Practice Theory,32(sp1), pp.45-97. Kent, P., Routledge, J. and Stewart, J., 2010. Innate and discretionary accruals quality and corporate governance.Accounting Finance,50(1), pp.171-195. Linck, J.S., Netter, J. and Shu, T., 2013. Can managers use discretionary accruals to ease financial constraints? Evidence from discretionary accruals prior to investment.The Accounting Review,88(6), pp.2117-2143. Quadackers, L., Groot, T. and Wright, A., 2014. Auditors professional skepticism: Neutrality versus presumptive doubt.Contemporary Accounting Research,31(3), pp.639-657. Kindly use the references in case any follow up is required on any of the above explained topics. Yours Sincerely, Students Name