Professional scepticism is your best friend in corporate reporting exams. It’s a skill that brings in crucial marks and keeps your thinking sharp.

It is an active approach to the exam.

You need to look critically at financial information. Pay particular attention to where management’s assumptions or estimates distort reality. The CR examiner is also interested in presenting a scenario, where you are expected to practice professional scepticism not only against the management but also against the work of someone else from the audit team or component auditor. Such scenarios are found within all three questions of corporate reporting.

Professional scepticism has three key elements: “AIM High in Scepticism”

A =  Apply Curiosity

I   =  Identify Red Flags

M =  Meaningfully Challenge Accounting Treatments & Assumptions

Let’s break those down. We will use actual exam question examples. This way you can see how they work. You will also learn how to master them.

1. Don’t Say It – Apply Curiosity

Just stating that you need to be sceptical or defining scepticism does not win marks. You need to actually raise some doubt about the information being presented to you. You should raise the ‘right’ type of question only.

This is similar to asking questions in the case of the valuation of development costs for Jupiter Ltd. Management estimated high value for intangible assets. Where this would extend into scepticism are questions such as: “How were these future cash flows estimated?” or “Is this useful life realistic given the uncertainty?”

Your line of questioning shows that you will not take the figures at face value. You go in-depth into the matter. This proves that you understand there is more than meets the eye.

Professional scepticism within the internal audit function at Jupiter Ltd will help you recognise the potential biases. To illustrate this, management will filter reports coming out of internal audits, thereby rendering them less effective. Here, you are sceptical by taking into account as to whether the conclusion is supported by the evidence.

Ask yourself, “Are these conclusions supported by unbiased audit evidence?” Be inquisitive in this way. It ensures that internal audit work can be relied upon only, if it’s devoid of managerial bias.

2. Identifying Red Flags-Onset of Creative Accounting

Being able to identify overly optimistic numbers or convenient accounting choices forms another facet of professional scepticism. Knowing what these are will prevent you from making mistakes and enhance the quality of your response.

Take for instance the expansion of AP Ltd in Asia.

Some of the issues to be concerned with include questionable cash flows and poor documentation. The above question will serve as a very good example. It highlights the importance of being alert to the risks of fraud, money laundering, or incorrect revenue recognition.

In your response, explain how you would examine the consistency of cash flows. Also, confirm documentation is complete. This would show you are alert to potential creative accounting or misrepresentation.

The management of the MegaB case would wish to see their materiality threshold increased. They want auditors to consider this change. The effect is less detail required during audit work.

This is an intimidation threat because scrutiny of critical figures would be reduced by it. Emphasizing it would show awareness of attempts at shaping financial reality and approach it with heightened scepticism.

Another good example would be expected credit loss on lease receivables for AP Ltd., management has not set an impairment allowance, even when rental payments are in arrears. That is a classic red flag: It can mean that some defaults are likely. To be appropriately sceptical, verify whether management’s forecasted collectability matches the actual probability of collection.

Challenge those assumptions that reduce the credit risk, and you will show that you are thinking critically.

3. Meaningfully Challenge the existing and suggestive Accounting Treatments/ assumptions

Challenging accounting treatments and estimates show effort and critical thinking. They can also provide indications of willingness to go the extra mile beyond what has been given. Questions in examinations sometimes contain estimates or judgments that demand critical evaluation. Are they in conformity with financial reporting standards? Do they portray reality?

Consider the case of Jupiter Ltd.

If there is a requirement for the valuation of an intangible asset, challenge it. If management has given a long useful life, assess this carefully. The same should be compared with industry norms and market trends. Ask yourself, “Does this match how similar assets are valued?” or “Is the time frame reasonable given the economic context?” These questions show you won’t accept numbers just because they’re there.

You will realise that, from the estimate of the credit loss on lease receivables for AP Ltd., management has made no provisions for credit risk, despite the fact even though payments are overdue. You would challenge this by asking that recognition of an allowance for bad debts be done. This shows that you understand the need. It reflects your critical thinking as you identify missing elements. You also examine the assumptions of those who make the results appear far better than they actually are.

There is, of course, the really exciting audit procedure for trade payables and accruals. Great time to properly figure out how much we owe. Here, healthy scepticism makes us check whether the procedures are adequate to obtain sufficient evidence.

The question perhaps would be: Does the audit cover all material liabilities successfully? Or we can frame it this way: Was additional testing necessary? This perspective shows our commitment to identifying any problem that may exist. It ensures we remain vigilant for improvement in every respect.