Professional Skepticism Richard Fleck, IESBA WG Chair IESBA Meeting New York December 12-15, 2016

Objective To consider a project proposal to respond to stakeholder calls for greater emphasis on PS in the Code To consider and possibly approve for exposure, proposed text to emphasize PS in the restructured Code To consider and possibly approve for exposure, proposed text to introduce “critical mindset” as a requirement To receive an update on the activities of the tripartite PSWG and discussions at various meetings

Activities Since Sept 2016 IESBA Meeting (1) October 2016 PSWG Meetings Initial draft proposals considered by PSWG, unanimous support for approach Some comments and drafting suggestions received IESBA Project Update at SMPC and Forum of Firms Meetings IESBA considering feasibility of ST initiative for restructured Code Emphasize application of PS for audit and assurance engagements LT initiative to explore extension of concept of PS to all PAs SMPC Feedback: No specific comments, but general concern about further changes to the Code and what will explicitly be required in terms of documentation of ST intitiative. For FoFs Ken Presented and indicated the following: Joint PSWG coordinating SSBs’ response to common issues Explore feasibility of short term response for restructured Code To emphasize application of PS for audit and assurance engagements IESBA consideration Dec 2016 Longer term initiative to explore applicability of PS to all PAs Support from IAASB CAG, IESBA CAG and other stakeholders Possible reconsideration of ISA definition of PS? Articulation of PS linkages with fundamental principles and independence FOF Feedback: Strong support for coordinated effort among all three SSBs. PS has a specific meaning in the context of audit and assurance. Strong caution about potentially watering down the meaning of PS if it is extended to all PAs for non-audit and assurance. Temper expectations of what can be achieved with standard-setting. Human/ psychological dimension – some people are naturally skeptical, while others are not. James clarified that IESBA has heard similar views from IAASB and its CAG. Cautioned about how to take CAG input into account given that many on the CAG are not auditors. It was suggested that before taking action to extent PS to all PAs, consider field testing what it would mean for each type of non-assurance service.

Activities Since Sept 2016 IESBA Meeting (2) Planning Committee Meeting – October 2016 Received report back on PSWG meeting Agreed approach involving separate project proposal and early 2017 ED October 2016 Structure and Safeguards TF Meetings General support for proposals, but calls for better alignment with the CF (i.e., S120) and questions raised about the level of detail in AM Chairs and Staff of PS, Structure and Safeguards Teleconference to discuss updated draft, which was later circulated to Structure and Safeguards Task Forces

Activities Since Sept 2016 IESBA Meeting (3) Feedback from IAASB PSWG Reps on Updated Proposals Continued unanimous support for new AM with description of linkage b/w PS and FPs/ independence Concerns raised about change from “..shall critically consider…” to “…shall apply a critical mindset…” Input from IESBA CAG and IAASB Meeting (both on Dec 7) SMPC Comment letter on IESBA Agenda Materials

Recap of How PS is Addressed in Standards PS is defined in IAASB’s standards Applies to PAs who perform audits and other assurance engagements only Code only refers to PS as part of description of independence Independence applies to audits and other assurance engagements only IAESB standards refer to PS definition in the IAASB’s standards PS applies to all PAs, including PAIBs who prepare financial statements

Overview of Feedback to IESBA about PS (1) Information underpinning ethical decisions should be assessed with PS PS is an attitude of mind and public expects all PAs to have it Code should emphasize PS in the same way it does independence Code should address how PS applies to PAIBs Linkage between PS and the FPs/ independence should be clarified Drivers and impediments to applying PS and complying with the FPs/ independence requirements are the same

Overview of Feedback to IESBA about PS (2) Important that a coordinated approach be adopted by all SSBs Concern that extending PS to all PAs would dilute/conflict with IAASB’s standards and its objective to enhance audit quality Concern that to extend PS to all accountants might have unintended consequences

IESBA WG Proposals Short term proposals aimed enhancing robustness of the Code include New application material to explain the linkage between PS and the FPs/ independence (for audits and assurance only) New requirement in the conceptual framework for all PAs to apply a critical mindset to achieve compliance with the FPs Step forward in advance of longer-term discussion about whether PS should apply to all PAs, and whether the IAASB definition of PS should be changed

New AM – Clarifying Linkage to FPs/ Independence Restructured Code Opportunity to expand on reference to PS in the Code and explain the linkage between PS and the FPs/ independence of mind New AM (applicable for audits and assurance only) explain How compliance with each FP, other than confidentiality, might reinforce PS when performing audits, reviews and other assurance engagements That threats to compliance with FPs and threats to applying PS are the same

New Requirement – Applying A Critical Mindset (1) Key element of the process by which PA applies the conceptual framework (CF) to achieve compliance with the fundamental principles Not a euphemism for professional skepticism Has the same standing as, and complements req’ts to: Exercise professional judgment Use the reasonable and informed third party test Remain alert for changes in the information available Further enhances the CF (i.e., the process for identifying, evaluating and addressing threats)

New Requirement – Applying A Critical Mindset (2) Intended to add a degree of rigor to judgments and conclusions made, because PAs will be required Not to take information at face value, but rather apply a critical mindset to understand facts and circumstances when identifying, evaluating and addressing threats to compliance with the FPs Think critically when considering compliance with the FPs while undertaking professional activities Does not use term “professional skepticism” (or components of definition) to avoid confusion with IAASB standards

Why Consider Public Exposure Now? Opportunity for input on LT project Proposal is a ST measure to enhance restructured Code, but might also inform longer term SSBs’ discussions ED questions might seek to understand: Whether proposed new AM to clarify linkage is helpful Implications of proposed req’t for all PAs to “apply a critical mindset” Whether there are some professional activities for which “critical mindset” should not be applied Whether and how PS should be applied by all PAs

IESBA CAG Dec 7 Teleconference Support for proposal and for exposure (if approved by IESBA) Advised to provide more contextual information about project in PP Clarify whether consideration of “preconceptions” is the PA’s or others’ Explain how ST project fits in with LT initiatives Indicate that proposals are not intended to preempt LT/ change current PS defn Refine impact analysis section of PP – if no change in cost, is there value? Clarify the problem that proposals seek to fix with new “critical mindset” req’t

Feedback from IAASB Dec 7 Meeting Strong support for coordinated efforts of SSBs Acknowledgement of responsiveness in proposing “critical mindset” (as opposed to PS) requirement for all Pas Questions raised included: Difference between term “critical mindset” and PS Whether “critical mindset” is a component of professional judgment Whether PAIBs understand what is meant by PS Whether time needed to “flesh out” the link between PS and FPs

Specific Suggestions from IAASB Consider different terminology “shall critically think” vs “shall apply a critical mindset” Clarify: Meaning of “critical mindset” Expectations of PAs How PAs should document application of “critical mindset”

Action Points/Questions Arising From Consultations Refinements needed to project proposal to address feedback from IESBA CAG Is the terminology –“critical mindset”– appropriate? Is there a better term? Can more be done to distinguish “critical mind-set” from PS? Is there more to be said about the way PAs should apply/document critical mind-set? Can application material be improved?

Matters for IESBA Consideration (1) Three questions for the Board Do IESBA members support a project to introduce: The requirement of a “critical mindset” to enhance compliance with the FPs (for all professional accountants) New application material to explain the linkage between PS and the FPs/ independence (for audits and assurance only)

Matters for IESBA Consideration (2) If so, do IESBA members support the project proposal (2-C) If so, what comments do IESBA members have on the proposed text (2-B)