Overview

First of all, we have explained the definition of professional skepticism based on

Institute of Chartered Accountants in England and Wales (ICAEW), Association of Chartered
Certified Accountants (ACCA), and International Federation of Accountant (IFAC). In general,
professional skepticism means an attitude that includes a questioning mind, being alert to
conditions which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence. Furthermore, we have explained 4 various stage the auditor may
apply professional skepticism from client’s acceptance during the audit process. The 4 various
stage are when the auditor assessing engagement acceptance, at the time when performing risk
assessment procedures, when obtaining audit evidence and during evaluating evidence.

For further understanding, we have included Satyam Computer Service Limited

Accounting Scandal as our real case example to describe professional skepticism. In this case,
the auditor relied on Satyam’s representations because they believed that Satyam’s former
chairman and senior management were honest and that they did not suspect that Satyam was
counterfeiting the audit documents. As a results, PwC has violated its most fundamental duty
as a public watchdog by failing to comply with the requirement of most elementary auditing
standards and procedures in conducting the Satyam audits. After that, we give our own opinion
about the Satyam case. In addition, we also include a case which is about the auditor have
perform her duties with professional scepticism. In this case, during the audit, the auditor does
not just reliance on the evidence provided by the client although she already talked with the
clerk who is in charge of the sale ledger. In order to verify whether the clerk is giving correct
explanation, the auditor had find additional evidence from related third party.

Lastly, we conclude that it is important to foster professional scepticism among the

auditors so that the audit quality is guaranteed and maintained in high level. The auditor shall
always having a questioning mind over the possibility that a material misstatement due to fraud
could exist, notwithstanding the auditor’s past working experience with the honesty and
integrity of the management and those charged with governance.

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Definition

Professional scepticism is an attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a critical assessment of
audit evidence. These professional scepticism videos highlight the regulator's concerns and
help audit firms respond to these issues.

by ICAEW

An attitude that includes a questioning mind, being alert to conditions which may indicate
possible misstatement due to error or fraud, and a critical assessment of evidence.

ISA 200 requires the use of professional scepticism as a means of enhancing the auditor’s
ability to identify risks of material misstatement and to respond to the risks identified.
Professional scepticism is closely related to fundamental ethical considerations of auditor
objectivity and independence. Professional scepticism is also linked to the application of
professional judgment by the auditor. An audit performed without an attitude of professional
scepticism is not likely to be a high quality audit. At its core the application of professional
scepticism should help to ensure that the auditor does not neglect unusual circumstances,
oversimplify the results from audit procedures or adopt inappropriate assumptions when
determining the audit response required to address identified risks, all of which should improve
audit quality.

by ACCA

The International Auditing and Assurance Standards Board (IAASB), International Ethics
Standards Board for Accountants (IESBA), and the International Accounting Education
Standards Board (IAESB) to formulate views on whether and how each of the three boards’
sets of international standards could further contribute to consider what actions may be
appropriate within their collective Standards and other potential outputs to enhance
professional scepticism and to explore the topic of professional scepticism as it applies to an
audit. The importance of professional skepticism is underscored by the increasing complexity
of business and financial reporting, including the greater use of estimates and management
judgment, business model changes due to technological developments, and the fundamental
reliance of the public on dependable financial reporting.

by IFAC

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Introduction

Professional scepticism is the fundamental foundation for the auditing profession which
all the auditors need to maintain and evolve in order to support the audit of the future. It is also
an essential concept in auditing practice and theory as well. For your information, the
regulatory bodies for example, International Auditing and Assurance Standards Board (IAASB)
and the UK Financial Reporting Council (FRC) have already issued documents regarding the
importance of professional scepticism in audit field in recent years. This had proven that
professional scepticism is becoming increasingly important towards the auditors.

By the way, how does the auditor apply professional scepticism in their audit work?
The auditor may apply professional scepticism at various stages from client's acceptance and
during the audit process. For instances:
1. When assessing engagement acceptance- in this particular stage, the auditor should
concern whether the management acts with integrity and whether there is any matters
which may deter the auditor from being able to perform their task with professional
scepticism if they enter into the engagement.
2. At the time when performing risk assessment procedures- risk assessment is normally
perform at the planning stage of audit. The auditors should be sceptical in the risk
assessment procedures through obtaining audit evidence in every aspect and not just
rely on the explanation given by the management which might be inaccurate or biased.
3. When obtaining audit evidence- this stage is the key area which requires the
professional scepticism to the most. The auditor should be prepared to challenge the
management particularly on complex and subjective matters. The reliability and the
adequacy of the evidence obtained from management should be considered especially
when there is an indication of risk of misstatements.
4. During evaluating evidence- the auditor should critically evaluate the audit evidence
and be aware for contradictory evidence that would cause damage to the adequacy and
appropriateness of evidence.
Moreover, the auditor should apply professional scepticism in forming audit opinion on the
financial statements. The auditor needs to identify whether the overall financial statement
presented fairly, in accordance with relevant regulations and standards, and whether the
evidence obtained is considered sufficient and appropriate before expressing audit opinion
in the financial statements.

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 ISA state a specific requirement for the auditor which is ‘The auditor shall maintain
professional scepticism throughout the audit, recognising the possibility that a material
misstatement due to fraud could exist, notwithstanding the auditor’s past experience of the
honesty and integrity of the entity’s management and those charged with governance’. This
paragraph required that the auditors shall perform their statutory duties thoroughly even the
overall reputation of the entities or companies are good based on the past experiences.
Management is most probably the one who perpetrate fraud due to their position and power in
the entity. So, the auditor shall form independent opinion and not to depend on the management
information which may have intention to perpetrate fraud.

Auditors shall also perform professional scepticism in providing information about

accounting estimates, going concern, related party relationships and consideration of laws and
regulation. The auditor should review the method use by management in developing accounting
estimates to prevent overestimate or underestimate from happening. Besides, the auditors have
to question in mind whether the entities are able to continue operating for a forseable future in
determining the going concern issue. Related party relationship is difficult to identify so it is
fraud in nature. The auditor should also be sceptical when assessing the business rationale
behind related party transactions. Lastly, the auditor should pay attention to the issue of non-
compliance with laws and regulations during auditing of financial statements. Non-compliance
indicates that the overall financial statements are not fairly and truthfully presented.

The scenario which could related to professional scepticism is when the auditor ask the
client to obtain addition evidence from the related party but the client refuse to do so and
explain that there is no necessary to take the action. This situation may indicate that the client
has something to hide and there is a risk of misstatements or fraud. The auditor should not just
refer to the evidence provided by the client but insist to find more reliable resources from third
parties.

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Content: Real Case Example
Satyam Computer Services Limited Accounting Scandal

Satyam Computer Services Limited, a global IT company based in India which was
formed in 1987 by Mr. Ramalinga Raju. It offered IT and business process outsourcing services
spanning various sectors globally. Satyam was as an example of India’s growing success and
previously known as “rising-star” in the Indian outsourced IT-services industry. However,
Satyam has been added to a notorious list of companies due to involvement in a massive
accounting fraud.

From year 2003 through September 2008, Satyam Computer Services Limited had
deceived investors by falsifying the company's revenue, income, earnings per share, and
interest bearing deposits in the public filed financial statement. Mr. Ramalinga Raju (Founder
and Chairman of Satyam) who has been arrested and has admitted that he overstated assets on
Satyam’s balance sheet by $1.47 billion (or Rs 7800 crore). On 7 January 2009, Mr. Raju
disclosed in a letter to Satyam Computers Limited Board of Directors that he had been
manipulating the company’s accounting data over the years. Nearly $1.04 billion in bank loans
and cash that the company claimed to himself was non-existent and the amount was just being
manipulated.

In addition, Satyam also underreported liabilities on its balance sheet. Satyam

overstated income almost every quarter over period of several years, in order to meet analyst
and investors’ expectations. Mr. Raju created numerous bank statements to advance the fraud
and deceive the investors’ expectation. He falsified the bank accounts as a mean to inflate the
balance sheet with balances that did not exist. He also manipulated the income statement by
claiming interest income from these fake bank accounts. Mr. Raju revealed that he created 6000
fake salary accounts over the past few years and appropriated the money after the company
deposited it.

Other than that, the company’s global head of internal audit created fake customer
identities and generated fake invoices against their names to inflate revenue. With the
assistance of the company’s global head of audit, Mr. Raju succeed in perpetrating the fraud
by using a number of different fraudulent accounting techniques. The Satyam scandal is a
classic fraud case due to negligence of fiduciary duties, total collapse of ethical standards, and
a lack of professional skepticism by the external auditors.

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 One of the best global auditing firm, PricewaterhouseCoopers (PwC), was the external
auditor of Satyam Computer Services Limited. This auditing firm has audited Satyam book of
accounts since year of June 2000 until the discovery of the fraud in 2009. After the fraud was
uncovered, several accounting and audit experts criticized that PwC was harshly failed to detect
the fraud. This is because PwC audited the company for nearly 9 years but did not detect any
financial scam, whereas the investment banker, Merrill Lynch discovered the fraud as part of
its due diligence in merely 10 days period.

One most concerned part was the $1.04 billion that Satyam claimed to have on its
balance sheet in non-interest bearing deposits. The large amount of non-existence cash should
have been a ‘red-flag’ for the auditors that further verification and confirmation was indeed a
necessary audit procedure to be done. Besides that, whenever Satyam needed more income to
meet analyst and investor expectations, it simply created “fictitious” sources with numerous
times repeatedly. However, these fraudulent manipulation was being made without the auditors
ever discovering the fraud. Suspiciously, Satyam also paid PwC the audit fees on twice what
other firms would charge for the audit, which raises questions about whether PwC was
complicit in the fraud. Missing these “red-flags” gives implied meaning that either the auditors
were grossly incapable of performing audit or in collusion with Mr. Raju and the company in
committing the fraud.

In the case of Satyam, the external auditors over-relied on Satyam’s financial

representations, in large part, because they believed that Satyam’s former chairman and senior
management were honest and that they did not suspect that Satyam was counterfeiting the audit
documents. As to the external auditors, they relied wholly on the forged fixed deposit receipts
and the computerized accounting system while verifying the bank balances. PwC did not
independently verify bank statements and fixed deposit receipts nor disclose the lack of such
verification in the audit report. PwC argued that it had undertaken verification and that the
fixed deposit receipts appeared to be genuine. However, the auditors ignored the first set of
confirmations received directly from the banks and relied exclusively only on those received
from the company, showing deposit balances which were tallying with what was shown in the
books.

The reason of this audit failure was mainly that the external auditors were lack of
independence, and they were not able to maintain sufficient professional cautiousness and
professional skepticism. In the audit procedure, the auditor was completely lack of sufficient

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cautiousness and professional skepticism, and was credulous to the explanation of manager. It
is clear that they had carried out verification of current account balances and fixed deposits in
total disregard for the mandated procedures. As a results, PwC has violated its most
fundamental duty as a public watchdog by failing to comply with the requirement of most
elementary auditing standards and procedures in conducting the Satyam audits.

Maintaining an attitude of professional skepticism requires an ongoing questioning of

whether the information and audit evidence obtained suggests that a material misstatement due
to fraud may exist. The independent auditor need to consider the reliability of the information
to be used as audit evidence and the controls over its preparation and maintenance where
relevant. According to AS 1015 of PCAOB standards, states that “Due professional care
requires the auditor to exercise professional skepticism. Professional skepticism is an attitude
which including a questioning mind and a critical assessment of audit evidence. The auditor
uses the knowledge, skill, and ability at the required profession level of public accounting to
diligently perform in good faith and with integrity, the gathering and objective evaluation of
evidence.”

For instances, confirmation procedures are one circumstances where an auditor has to
exercise a heightened degree of professional skepticism. The auditors are supposed to have
independent bank confirmation in the form of a bank statement and should have obtained
certificates from the banks on the tax deducted on the interest accruing on the deposits. The
auditor needs to demonstrate that he exercised ‘due professional diligence’ and have an attitude
of ‘professional skepticism’ in discharging his duties. This can prove that he is not been grossly
negligent in performing the audit works. External evidence, such as confirmation received from
a third party or banks is usually more reliable than internal evidence. Examining corroborative
evidence, such as interest earned on bank deposits and proof of bank statement, provide
increased assurance to the auditor.

In accordance with principle of professionalism, the auditor shall maintain an attitude

of professional skepticism throughout the audit. The auditor shall always having a questioning
mind over the possibility that a material misstatement due to fraud could exist, notwithstanding
the auditor’s past working experience with the honesty and integrity of the management and
those charged with governance. Auditing standards state that, an auditor should neither
assumes that management is dishonest nor assumes unquestioned honesty, in exercising
professional skepticism. In exercising professional skepticism, the auditor should not be

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satisfied with less than persuasive evidence because of a belief that management is honest and
integrity. Although the auditor cannot be expected to disregard past working experience with
the honesty and integrity of the management and those charged with governance, the auditor’s
attitude of professional skepticism plays an important role when considering the risks of
material misstatement due to fraud.

Relating to Satyam case, PwC claimed that it relied on misleading information provided
by Satyam management to make professional judgement is a weak defense for their failure to
follow established auditing criteria and basic standards. The external auditor should ensure
high level of professional skepticism and responsibility in detecting unusual activities that have
the potential of leading to massive fraud. The primary responsibility of the professional auditor
is to conduct substantive test and assess the company past and current earnings potential, as
well as verifying bank balances versus book balances, invoices versus book balances, and most
necessarily a comprehensive payroll verification.

The primary responsibility of auditors is to attest to management’s assertion as to all

material facts fairly represent the organization’s financial position and economic events. As a
result of doing so, the auditor is able to examine the righteousness and virtue of management’s
assertions and conducting independent confirmation from sources. An easy example of audit
procedures related to this is with the bank reconciliation. With the client’s consent, the auditor
can do reconciliation with the bank to review and check for bank and book balance. As to the
Satyam accounting fraud scandal, PwC failed to perform procedures to confirm Satyam cash
and cash equivalent balances, which would result in the nation’s largest accounting financial
scam to being undetected for as long as 9 years period.

As a conclusion, PwC is equally responsible for the financial scandal since there is lack
of professional skepticism and totally failed in due diligence of their duties. External auditing
firms must facilitate adequate training programs for its staffs in practicing the profession on
security laws that are specifically designed to guide auditors’ performance, follow to auditing
rules and regulations set by the auditing standards (PCAOB), and compliance with GAAS
when conducting audit engagements. These proper training is beneficial and necessary to
ensure quality of audit done by the auditors. In addition, the auditing firm should implement
new pre-opinion review controls, and also revise its audit policies and procedures. Above all,
the need for independence by the auditors themselves is integral to the entire engagement
process. The auditing firm should make cleared to its staffs the level of independence in mind

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and in appearance that need to be maintained when performing audit works. As such, their
close relationship with the client can potentially hinder or not being influence any professional
judgement. With all of these professional behaviour, the possibility of fraud may happen can
be minimized. In nutshell, we can arrived at a conclusion that if PwC firm work with due
diligence and professional skepticism, the Satyam fraud case may not occurred.

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Example

MSA Leo & Co, a medium sized audit firm was engaged to audit London Sdn Bhd.
London Sdn Bhd is a biscuit manufacturing unit producing high quality biscuits and crackers
distributing all over the country. During the audit, Lily who was the auditor discovered mistake
about sale ledger in the book of London Sdn Bhd.

In order to provide good quality audit, Lily had talk the clerk who is in charge of the
sale ledger. The question asked by Lily are regarding to the sales ledger control such as how
London Sdn Bhd control over the cash receipt and whether there have any different between
the cheque value and associated value. The clerk who is in charge of the sales ledger had gave
a good explanation when answering Lily question. In order to verify whether the clerk is giving
correct explanation, Lily had find additional evidence from related third party and not just
reliance on evidence provide by the client.

In this situation, Lily are able to detect misstatement with the confirmation procedure
from related third parties with professional skepticims. In addition, Lily also included an
attitude of the questioning mind. In this attitude Lily ask the questions which will be helpful
for knowing the future consequences. The question asked by Lily also help her to make critical
assessment of the financial event with a strong set of evidence. However, if Lily just only
reliance on the information provided by London Sdn Bhd and does not find additional evidence
from third parties means that she does not provide audit with professional skepticims.

In the nutshell, auditor should have the skeptic mind which will make his or her alert
for the situations to avoid material misstatement. He or she should be cautious of the chances
of errors. Auditor with professional scepticism will make the financial statement more
transparent because they will guard the statement from all type of misstatements. Professional
skepticism is also the skill which is obtained by continuous training and experience.

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Conclusion

Professional scepticism is not just the heart of auditing, it is in the heart of most auditors
because without it, the audit has little value. Each of the auditors has to apply their professional
scepticism in every engagement they involved. As the IAASB states that ‘the need for
professional scepticism cannot be overemphasised’ and that ‘adopting and applying a sceptical
mindset is ultimately a personal and professional responsibility to be embraced by every
auditor’. In the view of the increasing complexity and subjectivity of IFRS requirements,
auditors must be well prepared to challenge management on various issues related to the
preparation of the financial statements. IAASB and national bodies such as the FRC (Financial
Reporting Council) are keen to support auditors in the application and implantation of
professional scepticism. They believe that this is the basic element to ensure the quality control,
and also safeguard the credibility of the audit opinion. It is also important to foster professional
scepticism among the auditors so that the audit quality is guaranteed and maintained in high
level.

The real case mentioned above “Satyam Computer Services Limited Accounting
Scandal”, had proven that PwC, one of the best global auditing firms failed to apply
professional scepticism when auditing the firm’s financial statements. The chairman of Satyam
(Mr. Raju) was able to exploit this weakness and lead to the serious accounting scandal by
falsifying company’s revenue, manipulating accounting disclosures, underreporting liabilities
and overstating income in Satyam Computer Services. PwC was unable to detect any financial
scam even they audited the company for nearly nine years, and this also raises questions about
whether PwC was complicit in the fraud. The critical reason of this audit failure was the lack
of independence, professional scepticism and unable to maintain sufficient professional
cautiousness by the external auditor. This is evidenced when the external auditor disregard
mandatory procedures but only verify the current account balances and fixed deposits in total.
Moreover, the external auditors were over reliance to the financial representation by the Satyam
due to the previous experience that the former chairman and senior management were honest.
They should obtain external evidence from third parties or bank as those evidences are usually
more reliable resources. As defined in professional scepticism, the auditor shall always having
a questioning mind over the possibility that a material misstatement due to fraud could exist,
notwithstanding the auditor’s past working experience with the honesty and integrity of the
management and those charged with governance. In a nutshell, PwC is likely responsible for

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the Satyam’s financial scandal because the external auditors failed to exercise professional
scepticism and due diligence of their duties.

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Reference

Acca. (n.d.). Professional scepticism. Retrieved from

https://www.accaglobal.com/ie/en/student/exam-support-resources/professional-exams-study-
resources/p7/technical-articles/scepticism.html

Madan, Lal & Bhasin, Madan. (2016). Revisiting the Satyam Accounting Scam: A Case
Study. International Journal of Management and Social Sciences Research. 5. 31-46.

Morris, A. B., & Morris, A. B. (n.d.). PWC AUDIT SCANDAL AND FRAUD. Retrieved
from https://www.academia.edu/26663968/PWC_AUDIT_SCANDAL_AND_FRAUD

Professional Skepticism | IFAC. (n.d.). Retrieved from

http://www.iaasb.org/ projects/professional-skepticism

Professional scepticism and other key audit issues. (n.d.). Retrieved from
https://www.icaew.com/technical/audit-and-assurance/professional-scepticism/professional-
scepticism-videos

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