CPAs pride themselves on performing their duties with ethics, integrity, and due professional care. But even the most conscientious preparers and auditors need to be aware of hidden biases to which humans are susceptible. Could the financial statements you prepare or audit be affected by unconscious biases even if there is no intentional manipulation? Before you continue reading this article, the authors suggest you complete the decision-making quiz.
FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information, discusses important characteristics of accounting information, including relevance, reliability, neutrality, and comparability. FASB defines reliability as “[t]he quality of information that assures that information is reasonably free from error and bias and faithfully represents what it purports to represent.” In accounting, the term “bias” is often equated with intentional manipulation of the financial statements, yet FASB’s discussion of reliability includes the possibility that accounting information may be affected by bias that is “not necessarily intended.” This concept is also incorporated into AU-C Section 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, which states that “accounting estimates are imprecise and can be influenced by management judgment. Such judgment may involve unintentional or intentional management bias.” To what type of unintentional bias could these standards be referring?
In its Professional Judgment Framework published in 2011, KPMG identified five frequently occurring biases that can affect business judgments—availability, anchoring and adjustment, overconfidence, confirmation, and rush to solve. The following year, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) incorporated this list of biases into its white paper Enhancing Board Oversight, which provided suggestions for improving decisions made by boards of directors.
Many of the biases referenced in these papers are based on a type of decision-making process known as a heuristic. Heuristics, or mental shortcuts, allow people to make decisions quickly and efficiently. This type of decision-making is often beneficial, saving individuals the time and effort of thoroughly evaluating each point of data in the world around them. Many times, the heuristic process results in a high-quality decision. The problem arises when individuals rely on these shortcuts unwittingly or when the shortcuts lead individuals astray. In those cases, decisions may be systematically biased. Each of the five biases identified by KPMG and COSO may affect decisions CPAs make, both personally and professionally.
The availability bias occurs when individuals’ decisions are unduly influenced by information that is most memorable or easily accessible. This occurs when accountants are influenced by the most easily retrieved data as they generate hypotheses for account fluctuations, seek information, evaluate evidence, and assess risks. For example, when hypothesizing the cause of account fluctuations, managers may readily recall the types of events they have personally experienced but will have a harder time generating new ideas. Similarly, auditors may be tempted to easily consider the explanation provided by management, but it may be more challenging for them to generate additional possibilities. Likewise, tax professionals may form judgments regarding the defensibility of tax positions based on the ease with which they recall similar cases, without fully considering the outcome of the cases.
This tendency may also bias analysts’ forecasts and investors’ predictive earnings judgments. Interestingly, the availability bias can also contribute to members of a team feeling as though they have done more work than others since individuals often find their own contributions more accessible and memorable than those of their teammates. This observation can have important implications for accountants working as part of a team.
Anchoring and adjustment
When estimating a value, individuals often anchor on a preliminary amount and then make adjustments to arrive at their final estimate; however, they often make insufficient judgments to arrive at the true value. For accountants, this type of bias may occur during the budgeting process, when making capital allocation decisions, or when conducting a cost-variance analysis. It may also affect analytical review procedures and sample assessments. Auditors are particularly vulnerable to this bias since they typically begin their process with management-provided anchors (i.e., financial statements).
The overconfidence bias occurs when individuals overestimate their abilities to perform tasks or make accurate decisions. Accountants may overestimate their ability to prepare and audit fair value estimates, assess risks in enterprise resource planning systems, and evaluate the accuracy of their performance as well as the performance of others. As discussed by Jason Smith, John Keyser, and Douglas Prawitt last year in a webinar offered by the American Accounting Association (see tinyurl.com/mw9sj9j), overconfidence can also manifest in other ways such as taking on too many projects, overpromising on deadlines, considering just one possibility when problem-solving, truncating or skipping information searches, and making snap judgments.
Confirmation bias is the tendency for decision-makers to seek or interpret evidence in ways that support preexisting beliefs or expectations. Accountants may exhibit this tendency when evaluating the strength of internal controls, selecting accounting standards, or estimating the probability of successfully defending a tax position in court. In reality, for an individual to know something is true, he or she must test to see how it may be false. If accountants want to increase their professional skepticism, it is important for them to change their mindsets to seek or interpret evidence in ways that disconfirm prior beliefs or expectations.
Rush to solve
The rush-to-solve bias occurs when decision-makers form a judgment without fully considering all available data. This may occur if a management team reaches an early consensus without deliberating on an issue, or if auditors rely heavily on the perceived trustworthiness of a client when evaluating the likelihood of fraud. The rush-to-solve tendency may be exacerbated by external factors, such as time and budgetary pressures, and may inadvertently lead decision-makers to fall into other biases such as those listed above.
If accounting judgments are subject to these frequently occurring biases, how can individuals safeguard their decisions against them? After decades researching this topic, Daniel Kahneman, a professor at Princeton University, suggests individuals learn to recognize the signs that their decisions are susceptible to bias, slow down, and employ a more deliberate thought process. Similarly, COSO proposes using a professional judgment framework and refers to the work published by KPMG. While each Big Four accounting firm has developed a framework and the Center for Audit Quality (CAQ) recently released its own, the basic content of these frameworks is similar.
The professional judgment framework developed by the CAQ, which is affiliated with the AICPA, includes five steps: (1) Identify and define the issue; (2) gather the facts and information and identify the relevant literature; (3) perform the analysis and identify potential alternatives; (4) make the decision; and (5) review and complete the documentation and rationale for the conclusion. The five common judgment biases summarized in this article can manifest across any of the five steps in the judgment process. To mitigate bias in judgments, consider each step of the framework and maintain an awareness of the potential biases and an attitude of professional skepticism. Professional skepticism, which is defined in AU Section 316, Consideration of Fraud in a Financial Statement Audit, as “an attitude that includes a questioning mind and a critical assessment of audit evidence,” is embedded in auditing standards, but it is also essential for evaluating data used in the decisions of managers, accountants, and tax professionals.
To enhance your decisions, the attitude of professional skepticism should be directed at your own judgments as well. Often you can improve your decisions by “considering the opposite” or explaining why your initial assessment could be incorrect. This exercise forces you to take the time and mental effort to thoughtfully consider the limitations of your chosen solution. For critical decisions it may be beneficial to bring in an outside party to obtain a truly independent assessment.
Increased emphasis on the use of judgment in accounting makes a high-quality decision-making process critical to the success of the profession. By reading this article and completing the decision-making quiz, you have taken the first step toward improving your decisions by developing an awareness of the biases that may affect your decision-making process. For additional guidance, see the materials listed in the resources box.
Five common judgment biases have the potential to influence financial statement preparers and auditors in their work. Learning how to spot and short-circuit these biases can help CPAs maintain their objectivity.
Decisions can be influenced by: (1) relying on information that is most readily accessible (availability); (2) focusing on a preliminary amount and making an adjustment (anchoring and adjustment); (3) overestimating abilities (overconfidence); (4) making interpretations that support preexisting beliefs (confirmation); and (5) failing to consider all available data (rush to solve).
Using a professional judgment framework can help CPAs prevent biases from creeping into their work. Decisions also can be improved by “considering the opposite” or explaining why an initial assessment may be incorrect.
Rebecca Fay (firstname.lastname@example.org) is an assistant professor of accounting at East Carolina University in Greenville, N.C. Norma R. Montague (email@example.com) is an assistant professor of accounting at Wake Forest University in Winston-Salem, N.C.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at firstname.lastname@example.org or 919-402-2112.
- "5 ways to overcome confirmation bias," Feb. 2015, page 30
- “Professional Liability Spotlight: Independence Is in the Eye of the Beholder,” June 2013, page 18
- “Highlights of Audit Research,” July 2012, page 32