Normally when you record system audio using iShowU HD, the default system output is switched to Soundflower 2ch and iShowU HD records that.
Some applications (and Skype is one of them) don't use the "Default" set in System Preferences. Instead, you have to tell them where the audio should go. So to setup Skype such that you can both hear the audio and record it, you need to do the following:


If like me you use a headset in Skype, then you'll find that Skype is now playing the other parties through your speakers (or whatever default sound output you had selected).
The way around this is to get iShowU to output there as well.
To do this:


Sound will now be played back through your headset when you're in a Skype conversation (and recorded!).