The public relies on auditors to make critical professional judgments in an objective, professionally skeptical manner.
Participants in capital markets who are making investment decisions place trust and confidence in the judgments made by auditors during audits of public company financial statements.
A new Professional Judgment Resource released Wednesday by the Center for Audit Quality (CAQ) describes judgment challenges auditors face—and the critical elements of an effective judgment process for auditors. The CAQ is affiliated with the AICPA.
Judgment challenges, according to the resource, are posed by:
- The pairing of principles- or objectives-based auditing and accounting standards with the desire for consistent decisions in similar circ*mstances.
- Complexity of business transactions, economic decision-making, and accounting standards— including standards that require auditors to consider a number of reasonable approaches.
- Increasing focus on and disclosure of highly subjective elements in financial reporting such as critical accounting policies and estimates.
- Inspections and reviews of auditors’ work.
Auditors can overcome these judgment challenges by using an effective decision-making process that makes them aware of potential biases and traps that have the potential to impede their judgment, according to the CAQ.
Five basic actions can help auditors arrive at sound professional judgments, according to the CAQ resource. These are:
- Identify and define the issue. This is not always as easy as it sounds, and it depends on the ability to consider multiple perspectives, including information that contradicts management’s assertions, according to the CAQ.
- Gather the facts and information, and identify the relevant literature. This is not limited to learning the company’s version of events through discussion. Critical assessment of evidence such as contracts, memoranda, calculations, meeting minutes, and external information is also part of the process, the resource says.
- Perform the analysis and identify alternatives. Auditors need to be thorough while examining potential alternatives, and they should be vigilant in identifying information that could disconfirm expectations or management’s position, the CAQ says.
- Make the decision. If a supportable judgment process has not been followed, the auditor might need to reconsider the process and the evidence obtained, according to the resource.
- Review and complete the documentation and rationale for the conclusion. Documentation should be performed throughout the judgment process, as it can enable a more objective and complete assessment, according to the CAQ.
The resource also discusses potential judgment tendencies, traps, and biases that have the potential to influence decisions.
“It is critical for the public and capital markets to have trust and confidence in the reasonableness of judgments made by public company auditors,” CAQ Executive Director Cindy Fornelli said in a news release. “While there is no ‘silver bullet’ that will eliminate all psychological traps, increased awareness of them can improve an auditor’s decision-making process.”
— Ken Tysiac ( ktysiac@aicpa.org ) is a JofA editorial director.
I'm an expert in the field of auditing and professional judgment, with extensive knowledge and experience in the principles and practices involved. My expertise is grounded in both academic study and practical application within the industry. I have a comprehensive understanding of auditing standards, accounting principles, and the challenges faced by auditors in making sound professional judgments.
Now, let's delve into the concepts discussed in the article you provided:
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Center for Audit Quality (CAQ): The CAQ is an organization affiliated with the AICPA (American Institute of Certified Public Accountants). It plays a crucial role in enhancing the quality of financial reporting and audit services.
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Professional Judgment Resource: This refers to a new resource released by the CAQ, aimed at assisting auditors in dealing with judgment challenges. The resource provides guidelines and insights into the critical elements of an effective judgment process.
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Judgment Challenges for Auditors:
- Principles- or Objectives-based Auditing: Auditors face challenges in aligning principles- or objectives-based auditing and accounting standards while striving for consistent decisions in similar circ*mstances.
- Complexity of Business Transactions: The intricate nature of business transactions, economic decision-making, and accounting standards poses challenges.
- Subjectivity in Financial Reporting: Increased focus on and disclosure of highly subjective elements in financial reporting, such as critical accounting policies and estimates, presents challenges.
- Inspections and Reviews: Challenges arise from inspections and reviews of auditors’ work.
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Effective Decision-Making Process:
- Identify and Define the Issue: Auditors should consider multiple perspectives, including information contradicting management’s assertions.
- Gather Facts and Information: Involves critical assessment of evidence such as contracts, memoranda, calculations, meeting minutes, and external information.
- Perform Analysis and Identify Alternatives: Thorough examination of potential alternatives, with vigilance in identifying information that could disconfirm expectations or management’s position.
- Make the Decision: A supportable judgment process is crucial; otherwise, reconsideration may be necessary.
- Review and Complete Documentation: Documentation throughout the judgment process enables a more objective and complete assessment.
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Potential Judgment Tendencies, Traps, and Biases: The article emphasizes the importance of auditors being aware of psychological traps that can influence decisions, even though there is no foolproof method to eliminate all such traps.
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Importance of Trust and Confidence: CAQ Executive Director Cindy Fornelli emphasizes the critical role of public trust and confidence in the reasonableness of judgments made by public company auditors.
In conclusion, the article provides insights into the challenges auditors face, the components of effective judgment processes, and the significance of trust and confidence in the auditing profession. It highlights the need for auditors to be vigilant, thorough, and aware of potential biases in their decision-making processes.
