This document discusses financial reporting, professional judgment, and professional skepticism. It provides principles for preparers and auditors when exercising professional judgment in financial reporting. Preparers and auditors must gather and analyze all relevant information, assess accounting guidance, and properly document their judgments. Auditors must also appropriately assess and challenge the client's judgments. Regulators review financial statements and auditor documentation to evaluate the professional judgments made. The document concludes with case studies that illustrate issues like a lack of management assumptions verification, risk of management override of controls, and unreliable evidence provided by management.

1. Professional Scepticism
and Judgment in
Financial Reporting
Nik Mohd Hasyudeen Yusoff
6 May 2016
UIA

2. What we will explore?
• Financial reporting
• Professional judgment
• Professional scepticism
• Cases

3. Financial reporting
• Financial reporting is part of the accountability
process where reports are prepared by
management and sanctioned by the board for the
shareholders and stakeholders to assess the
performance and financial position of a reporting
entity.
• As the management and ownership of the entity are
separated, especially for publicly listed companies,
there is an inherent risk of bias in the part of
management is preparing the report.

4. Financial reporting
• Complexity of business models, structures and
operations make financial reporting more challenging.
• Fair value accounting is the main stream principles
behind International Financial Reporting Standards
(IFRS).
• IFRS requires assets and liabilities to be marked to
market values and in instances where markets for
those assets and liabilities are not active, complex
valuation models would be used as proxies.

5. Financial reporting
• Revenue and cost recognitions are also challenging as business
operations are becoming more complex e.g. telecommunication
industry.
• Reliance on external experts is becoming a norm when dealing with
complex assets e.g. retirement liabilities and intellectual properties.
• Even for typical assets such as properties, plants and equipments, the
valuation is based on the income streams expected out of those
assets.
• Disclosures are also important in the present financial reporting
framework to compensate for situations where recognition and
measurement may not be adequate.

6. Financial reports
Reviewed by
regulators
Prepared by
management
Approved by the
board
Audited by
auditors
Tabled to
shareholders

7. Professional judgment
FOR PREPARERS
PRINCIPLE 1 - Knowledge gathering and analysis
A professional accounting judgement can only be made once all
relevant information has been collected and analysed.
PRINCIPLE 2 – Assessment of accounting guidance
A professional accounting judgement can only be made in the context of
the applicable accounting framework, accounting standards and other
literature where relevant.
PRINCIPLE 3 - Process for making judgment
A professional accounting judgement can only be made after
undertaking appropriate due process.
PRINCIPLE 4 – Documentation of judgment
A professional accounting judgement must be suitably documented.

8. Professional judgment
FOR AUDITORS
PRINCIPLE 1 - Knowledge gathering analysis
A professional auditing judgement can only be made once all relevant
information has been collected and analysed.
PRINCIPLE 2 – Assessment of accounting and auditing guidance
A professional auditing judgement can only be made in the context of the
applicable accounting framework, accounting standards and other literature
where relevant, as well as the appropriate auditing standards and guidance.
PRINCIPLE 3 - Process for assessing and challenging client’s judgment
A professional auditing judgement can only be made after undertaking
appropriate due process to assess and challenge the client’s judgement.
PRINCIPLE 4 – Documentation of judgment
A professional auditing judgement and the assessment and challenge of the
preparers’ judgement must be suitably documented.

9. Professional judgment
FOR REGULATORS
PRINCIPLE 1 - Review of financial statements
The regulator should assess whether the professional accounting judgement has
been appropriately disclosed in the financial statements or other document.
PRINCIPLE 2 - Review of auditor and preparer documentation
The regulator should assess whether the professional accounting judgement has
been suitably documented.
PRINCIPLE 3 - Decision
The regulator should assess the judgement based on the facts and
circumstances available at the time the judgement was made.

10. PRINCIPLE 1 - KNOWLEDGE
GATHERING AND ANALYSIS
(PREPARER)
A professional accounting judgement can
only be made once all relevant
information has been collected and
analysed.
Understand the purpose, legal terms and
economic substance of the transaction(s):
• Read all relevant documentation,
including contracts, agreements,
correspondence, etc.
• Consider the expected cash flows from
the transaction and the impact on the
entity’s cash position.
• Consider why each party is
undertaking the transaction in order to
understand its commercial reality.
• Identify if there are any related or
linked transactions which need to
reconsidered in determining the economic
substance.
• Consider the uncertainties and range
of possible outcomes of the transaction.
• Consider the effect of the
transaction,once completed,on the
entity’s assets,liabilities and operational
capabilities.
• Prepare a risk and reward analysis.
Consider who bears the risk and who
receives the benefits under a range of
scenarios governed by the transaction.
• Ask probing questions of those parties
who setup the transaction–apply
appropriate scepticism.

11. PRINCIPLE 3 - PROCESS FOR
ASSESSING AND CHALLENGING THE
CLIENT’S JUDGEMENT
A professional auditing judgement can
only be made after undertaking
appropriate due process to assess and
challenge the client’s judgement.
Consider the uncertainties and range of
possible outcomes of the transaction
and compare with the client’s
assessment of these.
Review the client’s assessment of
alternative treatments and the reasons
for rejection. Evaluate whether
significant assumptions made by the
client are reasonable.
Assess the client’s proposed accounting
treatment. If the transaction is covered
by existing standards, is the proposed
treatment in accordance with the
appropriate standard?
If there is an element of judgement,
refer to IAS 8 (paras 10-12), as
appropriate, and assess the client’s
proposed treatment, as follows:
• Is there resulting financial
information both relevant and reliable
and does it give a fair presentation of
the transaction?
• Is it consistent with the treatment of
similar transactions under the relevant
accounting framework?
• Is it consistent with the conceptual
framework for broad principles on
definition, recognition and measurement
of assets, liabilities, income and
expenses?

12. PRINCIPLE 3 - PROCESS FOR
ASSESSING AND CHALLENGING
THE CLIENT’S JUDGEMENT
• Is it consistent with a authoritative
accounting texts?
• Is it consistent with generally
accepted accounting practice in either
the home or other countries?
• Is it consistent with accepted
industry practice?
• Is it consistent with
pronouncements of other standard-
setting bodies with similar conceptual
frameworks?
• Is there any evidence which
would contradict the client’s proposed
treatment?
Obtain appropriate advice from
experts within the audit firm or
externally, where necessary.
Identify any client conflicts of interest or
bias to ensure the objectivity of
judgements. If there are possible conflicts
of interest or bias, reassess the above
considerations with a greater degree of
scepticism.
Be aware of any undue pressures from
the client or audit firm and maintain your
objectivity.
Make your own judgement on the
appropriate accounting treatment.

13. PRINCIPLE 3 - PROCESS FOR
ASSESSING AND
CHALLENGING THE CLIENT’S
JUDGEMENT
Assess whether the client’s
judgement on the accounting
treatment is similar to your own or
within acceptable limits. If not,
discuss with your client and
consider the implications for the
audit and audit report (refer to
appropriate ISAs).
Consider whether your decision is
one which you would be happy to
defend against any possible
reputational risk.
Ensure approval/escalation
procedure for key judgements
have been followed to ensure that
material judgements have been
endorsed, where appropriate.
Check the resultant accounting
treatment and entries and ensure
they make sense. Check the
resultant note disclosures.
Identify points in time where
reassessment of judgement will
be required – for example period
ends or trigger points in the initial
contract.

14. Professional scepticism
• The word scepticism is formed from the root “skeptic,” which comes
from the Greek word “skeptikos,” meaning “inquiring or reflective.” To
inquire is “to seek information by questioning; to ask.” The
characteristics commonly associated with being a sceptic include
questioning and careful observation, probing reflection, looking
beyond the obvious, and suspension of belief.
• Professional scepticism incorporates the attributes commonly
associated with being a sceptic in a professional setting that requires
a standard of care and due diligence in the context of professional
standards, regulation, oversight, litigation, negotiation, evidence
collection and evaluation, professional judgment, complex business
transactions, varying incentives and motives, rationalisation, and so
forth.

16. Are Professional Judgment and Professional Scepticism the
Same Thing? Professional scepticism is necessary for high-quality
professional judgment, but it is only one component of what is
necessary for the auditor to exercise sound professional judgment.
For example, scepticism without requisite accounting and auditing
industry expertise is not sufficient to obtain high-quality judgment.
Attributes, Skills, Personality. Another aspect of defining
scepticism is whether it fundamentally consists of a set of skills and
behaviours, or whether it also involves knowledge and expertise or
personality traits. While some scholars lean more toward skill and
others toward personality trait, we believe ongoing dialogue is best
served by considering professional scepticism in terms of a
combination of personal traits, knowledge, and skill.

17. CASES
17

18. 18
Case Study : Assets Impairment
Common Observations:
[Next Slide]
 Lack of verification and challenge of management’s assumptions
 No basis to support conclusion made by management
 Inappropriate determination of recoverable amount and incorrect
comparison of recoverable amount with carrying amount
 Undue reliance of and lack of professional skepticism on management
representation

19. 19
Case Study : Assets Impairment (cont.)
[BACK] 3
350
Forecast
2014
Forecast
2015
Forecast
2016
Forecast
2017
Revenue
(270)
424 466 512
Projection
2013
Cost of sales
Actual
2012
150
(135)
Gross Profit 15
(245)
105
Admin and
other cost
(65)
(LBT) / PBT (50)
Tax (20%) -
(LAT) / PAT (50)
(85)
20
16
(4)
Terminal
value
115
(94)
21
17
(4)
(296)
128
(10)
25
20
(5)
(326)
140
(11)
27
22
(5)
(359)
153
GP Margin 10% 30% 30% 30% 30% 30%
(12)
29
23
(6)
Value in Use = NPV =
1,300
773
Carrying amount of Sub A
Goodwill
100
500
600
173
AUDIT CONCLUSION:
NO IMPAIRMENT ON ASSETS
AND GOODWILL
Key assumption 1:
Increase in revenue
in FYE 2013 due to
one new customer
Key assumption 2:
Constant growth rate
(g) of 10% year on
year
Key assumption 4:
WACC (r) of 13%
Supported by a
mere “Letter of
Intent”
Historical growth of
company last 5
years = 5%,
Forecasted for
next 2 years – 7%
Entire group’s average
WACC, not specific to
Sub A which actual cost
of capital = 16%
Key assumption 3:
Calculated based on a growth
rate of 11%
Basis to higher growth rate?
IMPAIRMENT =
If r = 16%, g = 7%
401 429 459
(262) (281) (300) (329)
112 120 129 138
(97)(91) (104) (111)
21 23 25 27
(4) (5) (5) (5)
17 18 20 22 249
178
(422)
385
Example: Investment in a subsidiary which has been loss-making and in net current liabilities position

20. Case Study: Risk of Management Override of Controls
20
PLC A
Board of Directors (6 members)
Independent Non-
Executive
Directors
(Audit Committee)
Executive
Directors
(Run day to day
operations)
Collectively
holds 42%
interest in the
PLC
Father,
daughter and
son
+
+
Risk of
Management
Override of
Controls
AOB’s identified deficiencies
• Risk of management override not
identified [ISA 200.15 & ISA 315.14]
 Did not apply appropriate
professional skepticism
• Risk of management override was
identified and considered a risk,
however no additional procedures
[ISA 240.33]
 Journal entry testing – nature,[BACK]

21. 21
Case Study: Reliability of evidence provided by management
Leasehold Land B (vacant) 15
Total 18
PPE:
(lease expiring: Year 2025)
Factory and office building A 3
Statement of Financial Position as at 31
December 2012 (in RM’ million)
Freehold Land D 20
Total 50
Land held for development:
Freehold Land C 30
Management’s basis to support valuation
and accepted by auditor
Valuation Report
Full valuation report for a
condominium unit belonged to
another subsidiary
Ascribed Value: RM3.2 million
AUDIT CONCLUSION:
“Higher than Carrying
Amount,
Hence No Impairment”
BUT
1. No evaluation to support the basis of comparison, ie. comparing a
factory cum office to condominium
Example: Valuation of properties

22. 22
Case Study: Reliability of evidence provided by management (cont.)
6
Leasehold Land B (vacant) 15
Total 18
PPE:
(lease expiring: Year 2025)
Freehold Land and building A (use as
office and factory)
3
Statement of Financial Position as at 31
December 2012 (in RM’ million)
Freehold Land D 20
Total 50
Land held for development:
Freehold Land C 30
Management’s basis to support valuation
and accepted by auditor
One page fax letter from the
valuer’s offices
Ascribed Value: RM16 million
AUDIT CONCLUSION:
“Higher than Carrying
Amount,
Hence, no Impairment”
BUT
1. Fax copy signed by a clerk from the valuer’s office but not evaluated
by the auditor as to the quality and reliability
2. Contained limitation clause stating that “…provided lease term is
extended another 50 years…”.
Example: Valuation of properties

23. 23
Case Study: Reliability of evidence provided by management (cont.)
7
Leasehold Land B (vacant) 15
Total 18
PPE:
(lease expiring: Year 2025)
Freehold Land and building A (use as
office and factory)
3
Statement of Financial Position as at 31
December 2012 (in RM’ million)
Freehold Land D 20
Total 50
Land held for development:
Freehold Land C 30
Management’s basis to support valuation
and accepted by auditor
iProperty website
Asking price for a
similar land:
RM45 million
BUT
1. No justification of using iProperty to support the valuation for
Freehold Land C, particularly on the reliability of the “asking price”
2. No evaluation if the property in iProperty was comparable to
Freehold Land C, for example, the physical condition and hence, no
considering of adjusting the value to reflect such differences
AUDIT CONCLUSION:
“Higher than Carrying
Amount,
Hence No Impairment”
Example: Valuation of properties

24. 24
Case Study: Reliability of evidence provided by management (cont.)
8
Leasehold Land B (vacant) 15
Total 18
PPE:
(lease expiring: Year 2025)
Freehold Land and building A (use as
office and factory)
3
Statement of Financial Position as at 31
December 2012 (in RM’ million)
Freehold Land D 20
Total 50
Land held for development:
Freehold Land C 30
Management’s basis to support valuation
and accepted by auditor
Valuation report specific to this land
Date of report: 31.12. 2010
Abscribed value: RM22 million
BUT
1. No evaluation of the continue relevance of the outdated valuation
report
Example: Valuation of properties
Valuation Report
AUDIT CONCLUSION:
“Higher than Carrying
Amount,
Hence, no Impairment”
2. Contained limitation clause stating that “…commercial land free
from encumbrances…”, however Freehold Land D is an agriculture
land
[BACK]

25. Case study: Conflicting audit evidence
Included in the PIE’s cash and bank as at 29 February 2012 YE is a FD of RM25.7 million
15 June’129 April’12
FYE
1 - 14 Feb’12 1 - 14 Mar’12
Vouched on 23
Mar’12
Conflicting Evidence
GL Balance
29 Feb’12
Placement
dates
Maturity
dates
FD Certs
Audit report
sign-off
Bank
confirmation
Receive 1st
Confirmation
What Could go wrong
=RM20.0m?
FD uplifted at FYE??
4 May’12
Receive 2nd
Confirmation
Fax Bank
confirmation
Receive 3rd
Confirmation
Unknown
Fax Bank
confirmation
=
Balance as at
29 January 2012
Balance as at
29 February 2012
RM25.7m RM25.7m
Balance as at
29 February 2012
RM5.7m= RM25.7m RM25.7m
WRONG DATE,
NOT
ACCEPTABLE
NOT PUT IN FILE
AS AUDIT
EVIDENCE

26. References
• A professional judgment framework for financial
reporting, Institute of Chartered Accountants of
Scotland, August 2012
• Enhancing auditor professional skepticism, by
Professors Steven M. Glover and Douglas F.
Prawitt, Brigham Young University for the Global
Public Policy Committee, November 2013
• Cases provided by the Audit Oversight Board,
Securities Commission Malaysia