There doesn't seem to be a week that goes by without one of the large firms being hit with a huge fine by the Financial Reporting Council for carrying out deficient audit work.
In this particular case, senior BT Italy executives were alleged to have manipulated the financial position of the subsidiary in order to protect their bonuses. The PwC partner in Italy is also alleged by local prosecutors to have falsified findings.
An unnamed accountancy firm was appointed by BT Italy to carry out an investigation over the irregularities and the firm found significant breakdowns in the controls which had also resulted in fraud. Following this discovery, BT Italy had to adjust its financial statements by some £530m resulting in a 20% drop in its share price in one day.
PwC failed to apply professional scepticism over two receivable balance adjustments worth £72m. While members of the PwC audit engagement team did question these receivables adjustments, PwC agreed with management that the errors were immaterial in prior periods hence the adjustments could be reported as revisions in the current year as opposed to restatements.
It would seem that a lack of professional scepticism was the main culprit which resulted in audit work failing to meet professional standards. Had professional scepticism been appropriately applied in this case, it would have enabled the auditor to maintain a questioning mind and challenge management over its conclusions, especially where transactions had been manipulated to achieve a desired outcome.
ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing defines 'professional skepticism' [spelt 'skepticism' in ISA 200] as:
'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.'
Audit firms must demonstrate the application of professional scepticism throughout the audit. For example, challenging management's accounting estimates, questioning unusual transactions and performing adequate audit procedures over inordinate fluctuations in figures when undertaking analytical review.
Professional bodies and regulators are keen to ensure that professional scepticism is correctly applied as well as adherence to all the provisions of relevant ISAs. Failing to ensure an appropriate level of professional scepticism and compliance with ISAs and other regulation will invariably lead to a deficient audit being carried out. This puts the audit firm at significant risk of sanctions.
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