## Professional Skepticism in Audit

### Definition

Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. The auditor is alert to:

Conditions that may indicate possible misstatement due to error or fraud
Circumstances suggesting the need for audit procedures beyond the usual

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### Why Professional Skepticism is Essential

Without it, auditors risk:

Overlooking unusual circumstances that signal problems
Using inappropriate assumptions when determining nature, timing, and extent of audit procedures
Incorrectly evaluating audit results

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### When to Heighten Skepticism — Red Flags

Red Flag	Implication
Revenue grows despite adverse operational events	Possible overstatement of revenue or understatement of losses
Profit margins improve despite significant losses	Inconsistency requiring investigation
Management reluctant to provide documentation	Possible concealment
Prior-year procedures seem adequate despite changed circumstances	Risk of overlooking new risks

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### Auditor's Response When Skepticism is Triggered

1. Do NOT simply repeat prior-year procedures — changed circumstances require modified procedures

2. Include substantive analytical procedures to analyse variations

3. Seek explanations from management for unusual results

4. If fraud is suspected: determine what modifications or additions to audit procedures are necessary

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### Documentation Requirement (Listed Companies)

The auditor of a listed company must document:

Overall audit strategy
Audit plan
Any significant changes made during the audit and reasons for those changes

Worked example

### Example 1

Scenario (MD 5 – 4 Marks): Truthful Products Pvt. Ltd. suffered a ₹5 crore fire loss in 2023-24, had operations disrupted for approximately 2 months, and its insurance claim was rejected. Despite this, the company's financial statements show: Revenue increased from ₹80 crore (FY23) to ₹100 crore (FY24), and net profit before tax increased from ₹6 crore (FY23) to ₹10 crore (FY24). CA D, auditor for the past 3 years, decided to rely on the same tests of detail as performed in prior years. What is lacking on the part of CA D?

Answer: CA D lacks professional skepticism.

The unusual circumstances demand a questioning approach:

Revenue grew by ₹20 crore despite ~2 months of operational disruption — this is counter-intuitive
Net profit margin improved from 7.5% (₹6/₹80) to 10% (₹10/₹100) despite a ₹5 crore fire loss — also counter-intuitive

Despite these red flags, CA D continued with the same procedures as prior years. The nature and extent of audit procedures must be altered to reflect changed circumstances. He should:

1. Apply substantive analytical procedures to analyse and explain the variations

2. Seek explanations from management for the unexpected results

3. Consider whether fraud indicators are present

4. Determine if modifications to audit procedures are needed

Maintaining professional skepticism throughout the audit is necessary to reduce the risk of overlooking unusual circumstances and using inappropriate assumptions.

⚠️ Common exam mistakes

Defining professional skepticism as 'distrust of management' — it is a questioning mind and critical assessment of evidence, not blanket suspicion
Assuming prior-year procedures are always adequate for recurring audits — changed circumstances require reconsidering the nature and extent of procedures
Missing the profit margin calculation: ₹6cr/₹80cr = 7.5% vs ₹10cr/₹100cr = 10% — improved margins despite adverse events is the key red flag to identify
Not connecting the operational disruption (2-month shutdown + ₹5 crore loss) to the implausibility of improved revenue AND margins simultaneously

Reference:

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