7 ways companies can impede conflicting audit evidence
EDITOR'S NOTE: In part two of this two-part series on contradictory audit evidence, Thomas Ray, distinguished lecturer at Baruch College and former Chief Auditor of the PCAOB, details matters companies should consider when preparing and evaluating the fairness of financial statement amounts and disclosures.
Auditors are still under pressure from the PCAOB to properly evaluate and consider the effects of contradictory audit evidence. Here are seven ways management can reduce incidents involving conflicting audit evidence, help the company’s auditors meet their requirements and improve processes:
- Consider alternatives, and document why one was selected over the others. For example, different valuation models may apply to the valuation of a financial instrument. Document why the one selected is most appropriate in the circumstances. Explain why the ones not selected would not have resulted in a better valuation.
- When conditions change, assumptions may need to change. Recognize that when economic or environmental conditions change, inputs and assumptions also may need to change. This is also true if management’s intent changes—for example, on how it will use its assets.
- Consider assumptions used in other areas. Actively consider whether the assumptions and inputs used in different financial statement accounts and disclosures should be consistent with each other. For example, assumptions used when evaluating possible impairment of long-lived assets may be relevant to the going concern evaluation and disclosures about risks and uncertainties. Should the assumptions used be the same, or is there justification for using different ones?
- Is the supporting information reliable? Consider whether there are appropriate controls over the completeness and accuracy of entity information used. Check the sources of inputs from outside the entity.
- Document your evaluation, conclusions, evidence considered, and the reasons your conclusions are appropriate. Take the time to prepare contemporaneous documentation. As time passes, it becomes difficult to reconstruct the thought processes and evidence considered.
- Do not ignore inconsistencies or contradictions. For an auditor to be criticized for not sufficiently evaluating contradictory evidence, there must have been some. Don’t turn a blind eye to inconsistencies or contradictions, hoping that no one will notice. Evaluate the information, make appropriate adjustments, if necessary, and document your conclusions regarding its effect on your financial statements.
- Reviewers should be skeptical. Personnel who review the work prepared by others may benefit by taking a cue from the auditing literature and adopt a skeptical mindset. Read How to Thrive in the New Era of Professional Skepticism by myself and Joe Howell.
Management’s evaluation and documentation of these matters can help its auditor’s evaluation. Incorporating these considerations into a company’s processes also can help to improve its reliability.