Eliminating biases that jeopardize audit quality

Certain cognitive biases pose threats to audit work, but it’s possible to recognize and overcome them.
By Billy E. Brewster, CPA, Ph.D.; Janet B. Butler, CPA (inactive)/CITP, CGMA, Ph.D.; and Ann L. Watkins, CPA, Ph.D.

Eliminating biases that jeopardize audit quality
Image by marrio31/iStock

Auditing standards state that inquiry alone does not provide sufficient evidence regarding the lack of material misstatement (AU-C §500, Audit Evidence, ¶.A2), yet regulatory inspections and laboratory findings indicate that even experienced auditors often simply accept management's explanations without further corroboration. In its staff inspection brief issued in August 2017, the PCAOB staff stated that reviews of audit inspections have continued to raise concerns about whether some auditors apply professional skepticism, particularly in areas that involve management judgment. The brief stated that inspectors observed that some auditors sought to obtain only evidence that would support judgments or representations made by management. The auditors failed to critically take into account all relevant evidence, regardless of whether it confirmed or contradicted management's assertions.

Why does this problem persist despite the authoritative guidance and its overall importance to the audit process? The PCAOB (2012) offers some insights when stating that auditor skepticism can be hindered by cognitive biases. By expanding on these insights, this article aims to show auditors of both private and public companies how they can improve their judgment and enhance their professional skepticism. We begin by briefly examining the factors likely to influence an auditor's decision to investigate management's representations. We then examine common cognitive biases that can make auditors more vulnerable to flawed decision-making, and describe how auditors can learn to apply mental modeling to combat cognitive biases (without the need for specific firm training), thus improving auditor judgment and professional skepticism.


AICPA Professional Standards stress that while client inquiry is an important source of evidence, typically such discussion alone does not provide evidence of the absence of a material misstatement or the effectiveness of internal controls (AU-C §500, ¶.A2). The required corroboration can include comparing the explanation to the auditor's preexisting understanding "of the entity and its environment, and other audit evidence obtained during the course of the audit" (AU-C §520, Analytical Procedures, ¶.A28).

When an unexpected material issue arises, most auditors will seek additional information from the client, but as noted in "The World Has Changed: Have Analytical Procedure Practices?" by Greg Trompeter and Arnold Wright, Contemporary Accounting Research, Vol. 27, Issue 2, page 669 (2010), as many as one-third of auditors may not always follow up to corroborate the client-provided explanations. Additionally, "Two Decades of Behavioral Research on Analytical Procedures: What Have We Learned?" by William F. Messier Jr., Chad A. Simon, and Jason L. Smith, Auditing: A Journal of Practice & Theory, Vol. 32, Issue 1, page 139 (February 2013), finds that when performing analytical procedures, even experienced auditors fail to follow through with additional evidence when a client explanation appears plausible, and are likely to overweight a client's explanation, compared to other pieces of evidence, when forming conclusions. Corroborating management estimates and fair value measurements also has been a challenge for auditors for many years, as PCAOB inspectors cited this as one of the three most common areas of audit deficiencies identified in 2016 audits.


Research in psychology suggests that factors in the audit setting create cognitive biases that can reduce the auditor's likelihood of following up on client explanations with additional evidence. Cognitive biases represent often unconscious, systemic influences affecting how individuals gather and interpret information when forming judgments and decisions. Identifying these unconscious biases can aid professionals in counteracting the potential "pitfalls" arising during the explanation-corroboration process of the audit. While auditors are susceptible to many types of unconscious bias, we specifically focus on three that regulators and researchers suggest are common influences, increasing the likelihood that the auditor accepts an explanation without additional corroborating evidence.

Motivated reasoning

Many audit judgments are made with significant uncertainty, and research indicates that auditors who evaluate management explanations for "reasonableness" may be less likely to follow up and corroborate with additional information. The answers are not always in a stark black-and-white format. Psychology research finds that these types of judgments open the door for motivated reasoning bias that can sway the auditor toward accepting the client's preferred conclusions.

Motivated reasoning bias is a well-documented phenomenon describing an unconscious bias in which individuals interpret information in a manner that is consistent with their own goals. For an auditor, these goals can include improving client relations as well as trying to meet budget objectives. Suppose that an auditor is over budget in a particular area and asks a client for an explanation regarding an account fluctuation. Motivated reasoning theory suggests that in the absence of supporting evidence, auditors are more likely to convince themselves that the client's explanation is reasonable without actually finding supporting evidence. Further, the unstructured benchmark of the auditor reasonableness judgments opens the door for other factors like source credibility of the client, complex business environments, and the nature of auditors' listening activity to influence auditor judgment.

Source credibility and complex business environments

If an auditor considers the client highly credible, then he or she is more likely to rely on the client's explanations. In their book chapter titled "Attitude Change: Multiple Roles for Persuasion Variables," pages 323—390 found in Handbook of Social Psychology (1998), Richard Petty and Duane Wegener explain that source credibility has two components — expertise and trustworthiness — and each component has a different effect on the auditors' likelihood of accepting an explanation. Expertise relates to the messengers' level of knowledge about a particular subject. Not surprisingly, when a message source is considered trustworthy, the message becomes more persuasive.

The auditor's vulnerability to source credibility bias may increase when the client's business environment is complex. In accordance with Professional Standards (e.g., AU-C §330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained), auditors are required to understand the operational aspects of their client's business and how these operations interact with the industry and the overall economy. This includes understanding how these industry and macroeconomic forces interact and flow down to the client level to affect the risk of material misstatement.

While gaining this understanding may seem straightforward, understanding the sometimes complex interactions can be challenging. Consider, for example, a client that is a fast-growing franchising company specializing in pastries. This client often assists its franchisees with the purchase of a franchise by extending a note receivable. Further, suppose that the client's pastries become so popular that the market becomes saturated with outlets selling its products. This market oversaturation, particularly when combined with changing customer preferences, creates risk to the client as the franchisees begin to struggle to sell their product and perhaps default on loans made by the client. The financial statement impact becomes apparent as the franchisee-related notes receivable may be impaired. Additionally, rapid growth can lead to other qualitative factors, such as a decline in product quality, that also affect sales. While the risks associated with this type of growth may seem intuitive when spelled out clearly in a narrative, in the real world, the auditors would have to gather this operational information themselves and understand these risks as well as recognize how the risks affect the likelihood of material misstatement.

The nature of the auditors' listening activity

In "The Effect of Client Lies on Auditor Memory Resistance and False Memory Acceptance," Auditing: A Journal of Practice & Theory, Vol. 35, Issue 3, page 33 (August 2016), Billy E. Brewster (who is also a co-author of this article) finds evidence suggesting that the very nature of the audit experience can increase the auditors' susceptibility to persuasive client explanations. When auditors are trained to interview their clients, they are naturally expected to listen carefully to the explanation.

Listening closely and carefully is taught in the classroom and suggested in Professional Standards. However, Brewster finds that when auditors do not have a well-developed understanding of the client and its operating environment, the careful listening process may actually embed client lies in the auditor's memory. Hence, not only are these auditors less likely to identify client lies when evaluating client explanations, when subsequently prompted to recall the related information, they will recall the embedded client lies instead of their own previously constructed accurate facts.


Fortunately, mental modeling and simulation activities can help auditors reduce the impact of cognitive biases and improve audit judgments. In another article, Brewster suggests that the auditor must develop a "mental model" of the client operating environment and how it interacts with the outside economy (see "How a Systems Perspective Improves Knowledge Acquisition and Performance in Analytical Procedures," The Accounting Review, Vol. 86, Issue 3, page 915 (May 2011)). A mental model is a cognitive representation of a particular phenomenon. The quality and detail of an individual's mental model depends on both the individual's understanding and his or her information processing ability. Think of the mental model as a "mental picture" that an individual has in his or her head regarding how something works. In an auditing scenario, mental models help auditors develop the expectations that serve as the benchmark against which they can evaluate management explanations. Brewster finds that when auditors do not develop accurate mental models, they are less likely to identify the client's erroneous explanations.

To illustrate, imagine an auditor asking a client about a decline in gross profit percentage. According to Professional Standards (AU-C §315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, ¶.12), before talking to the client, the auditor should obtain an understanding (i.e., mental model) of the macroeconomic and industry forces that combine to affect the input variables in the gross profit percentage. For example, the gross profit of a fast-food chain would be influenced by changes in beef prices. Many auditors will immediately ask the client about significant fluctuations. A better approach is for the auditor to develop expectations on how beef prices would change over time depending on how the interacting variables move. The auditor can then compare the client explanation to his or her own mental simulations and follow up on any disagreement between the two.

Psychologist Gary Klein, in his book Sources of Power, provides criteria auditors can use to evaluate the accuracy and sufficiency of their mental models. First, do the causal relationships in the mental model make sense? In other words, is the model consistent with the auditor's prior understanding of the industry and economy? Second, how much accuracy should be incorporated into the mental model? If the auditor assesses a higher risk of material misstatement, and therefore requires more precise expectations, the model should be more accurate. Finally, is the model missing any important facts? If so, the auditor may have to make too many unknown assumptions when evaluating management's explanations.

A more accurate mental model will ultimately result in the development of more accurate expectations — an integral part of audit testing. Ideally, auditors will attempt to draw or graph out their own mental models focusing on causal linkages, interactions, and the directional (positive versus negative) effect of these interactions before soliciting management explanations. For simple models, this can be done easily with paper and pencil. More complex models can be devised with a variety of software programs.

The benefit of drawing the model is that the auditor is forced to evaluate whether he or she truly understands the processes and relationships among the variables. To illustrate, consider an auditor who is evaluating the adequacy of a client's warranty reserve liability. In the last year, the client implemented major cost-saving and efficiency initiatives throughout the company. Initial production line changes have resulted in more efficient, cost-effective operations, and the client recently laid off 10% of its production workforce. If future production efficiency and cost-saving measures are effective, the intent is to lay off an additional 10% to 15% of the production line workers in two years. The client has also decreased the warranty reserve liability relative to sales when compared to prior years, citing a gradual drop in warranty claims over the last three years. Although the client's rationale for reducing the warranty reserve may hinge on past trends, an accurate mental model considers the potential unintended consequences of the layoffs on the warranty reserve. A complete mental model would include consideration of factors (such as reduced employee morale resulting from the current and planned layoffs) that may lower the quality of the product produced, leading to increases in warranty claims and the need to also increase the warranty reserve.

To fully examine these factors, the auditor will need to graph out the causal forces that affect the quality of the product (see the graphic, "Sample Product Quality Causal Diagram"). The result of the modeling process will be a causal diagram showing any positive or negative effects. The causal diagram can be used to simulate different conditions and determine the impact on the client's operations. Based on the model, the auditor can then try to understand how the account being tested would fluctuate over time.

Sample product quality causal diagram

A mental model illustrates the impact of employee layoffs on a company’s warranty reserve.

Sample product quality causal diagram

A more advanced simulation could use software techniques to create a more mathematical what-if analysis to compare against management's explanations. However, this process can be challenging and often has a significant learning curve that may take some time to overcome. Some of the previously mentioned laboratory studies find evidence that decision-makers have been able to temporarily develop complex graphical mental models even with only a brief tutorial. For further instruction on how to develop mental models and causal diagrams, free resources on mental model diagraming are available at thesystemsthinker.com and donellameadows.org.


Cognitive biases can negatively influence auditor judgments about the need to substantiate management's assertions and can potentially lead to costly audit failures that damage an audit firm's reputation. An awareness of the biases described in this article is an important first step in reducing their impact on auditor judgment. Development of robust mental models and simulating business conditions using the models can also be effective tools in combating cognitive biases. It takes commitment and a diligent effort for auditors to properly evaluate their mental models and use them for simulation, but it is reasonable to expect that such efforts can result in professionals' experiencing improved judgment and decision-making with enhanced professional skepticism over time.

About the authors

Billy E. Brewster, CPA, Ph.D., is an assistant professor; Janet B. Butler, CPA (inactive)/CITP, CGMA, Ph.D., is a professor and assistant chair; and Ann L. Watkins, CPA, Ph.D., is a professor and chair, all at the Department of Accounting at the McCoy College of Business Administration at Texas State University.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA's editorial director, at Kenneth.Tysiac@aicpa-cima.com or 919-402-2112.

AICPA resources


CPE self-study

  • Applying Professional Skepticism in an Audit (#166020, online access)
  • Experienced Staff/New In-Charge — Engagement Management and Supervision (#161220, online access)

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