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 circumstances.
- 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 (email@example.com) is a JofA editorial director.