Professional scepticism and other key audit issues

There is an ongoing debate about whether professional accountants are sufficiently sceptical in applying professional judgment. For example, the concerns of regulators and others have been highlighted in the media and form part of the discussions on the future of the accounting profession. In this regard, the Institute of Chartered Accountants in England and Wales (ICAEW) (Audit and Assurance Faculty) is exploring the possibility of conveying key messages on the issues and has discussed this possibility with the UK Professional Oversight Board (POB).

The result is a new set of videos Professional scepticism and other key audit issues now available on the ICAEW website. The purpose of the videos is to highlight some of the concerns of the POB (and other regulators around the world) and to be constructive about how audit firms respond to the issues. In total, there are ten videos with one compilation video (about 40 minutes long). It is hoped that, in addition to individual auditors watching them, some firms will play the videos as part of training activities and team meetings.

The longest video (about 17 minutes) highlights the fundamental importance of professional scepticism. The video provides key messages on the issues that will be of interest to firms at the current time. Martyn Jones (ICAEW Vice-President) speaks about how auditors should be dealing with the challenges and the need to understand that scepticism is a behavioural issue for the entire audit team. John Kellas (POB Chairman) talks about what the Audit Inspection Unit (AIU) has been looking at in the current climate and describes the ways a lack of scepticism can be apparent. Myles Thompson (Chairman of the faculty’s Technical and Practical Auditing Committee) outlines the personality traits that auditors need to have and gives tips on how to produce documentation that demonstrates scepticism.

The messages are relevant to auditors from firms of all sizes and the personal qualities that are spoken about are needed for all types and sizes of audit. The key points also apply internationally, not just in the UK. Other subjects covered in the videos are group audits, quality control, audit committee reporting, audit documentation, ethical matters and concluding remarks.

Enhancing Board Oversight by Challenging Traps and Biases in Professional Judgment - Part 3 of 3

As previously mentioned (see Part 1 and Part 2), the Committee of Sponsoring Organizations of the Treadway Commission (COSO) has released a thought paper called Enhancing Board Oversight: Avoiding Judgment Traps and Biases. COSO recognizes the vital role of consistent, high-quality professional judgment as management and boards of directors execute and oversee an entity’s enterprise risk management, internal control and fraud deterrence efforts.

COSO stresses that “Professional judgment is increasingly important as board members fulfill their responsibilities related to effective oversight of management’s strategic planning, execution, fraud prevention and risk management processes. Even seasoned board members can improve the consistency and soundness of their judgment by being aware of common judgment traps and by following a good judgment process.” Such a process can help avoid threats to good judgment and mitigate the biases associated with common judgment tendencies (see Exhibit 3 below, drawn from page 16 of the COSO Paper).

Exhibit 2 (on page 14 of the Paper) summarizes the traps and tendencies. Exhibit 4 (on page 18 of the Paper) outlines actions that boards can consider at each of the five steps of the judgment process presented in Exhibit 1 (see Part 2).

Many board-level judgments are made in group settings and, although group judgments are often better than individual judgment, group judgments can fall victim to narrow thinking; suppression of divergent views; and, consequently, shallow judgment processes. Some common tendencies in individual judgment that can lead to bias in board-level decisions are the overconfidence tendency, the confirmation tendency, the anchoring tendency and the availability tendency.

Awareness of the common threats to good judgment is the key initial step in improving judgment. Board members can use the insights summarized in this thought paper to test and improve the consistency and quality of management’s judgment processes and outcomes by rigorously challenging perspectives and assumptions via open and frank discussions. Such discussions can include consideration of judgment traps, simplifying tendencies and alternative viewpoints. Board members who are aware of traps and tendencies that limit the quality of judgment can use these insights to challenge management’s judgments and more effectively fulfill their oversight role.

Enhancing Board Oversight by Challenging Traps and Biases in Professional Judgment - Part 2 of 3

As previously mentioned (see Part 1), COSO has released a thought paper called Enhancing Board Oversight: Avoiding Judgment Traps and Biases. According to this thought paper, “judgment is the process of reaching a decision or drawing a conclusion when there are a number of possible alternative solutions. An effective judgment process will be logical, flexible, unbiased, objective and consistent. It will utilize an appropriate amount of relevant information, and it will properly balance experience, knowledge, intuition and emotion.”

The paper notes that: “we often do not follow a sound process due to common judgment traps and tendencies that can lead to bias. Some of these tendencies are judgment shortcuts that help simplify a complex world and facilitate more efficient judgments. However, these shortcuts sometimes can lead to suboptimal judgments. The judgment traps and tendencies are systematic—in other words, they are common to most people, and they are predictable.”

It also points out that: “By consistently following a sound judgment process, understanding where directors and management are vulnerable to predictable traps, and appropriately challenging their own judgments and the judgments of those they are charged with overseeing, directors can improve their oversight and monitoring of the organization’s strategies and risks, including the risk of fraud. Following a better judgment process translates to improved risk management and better business outcomes.”

Exhibit 1 (on page 3 of the Paper) illustrates a model of a good judgment process. The steps in this process are simple to understand. Although the steps are a representation of the process to follow, the Exhibit does not depict how people actually make judgments. It provides a helpful context to illustrate where judgments can go wrong. The reality is that in a world of high-stake decisions, deadlines and limited capacity, the judgments of even highly educated, capable people are vulnerable to common, systematic traps and predictable biases.

This thought paper highlights some of the common pitfalls and biases in judgments to which decision makers are vulnerable and provides an overview of actions and steps that boards can take to avoid falling prey to them. For additional insight, read the COSO Paper and the article “COSO explores common judgement traps, lays out five-step decision-making process”at CGMA Magazine online.

Enhancing Board Oversight by Challenging Traps and Biases in Professional Judgment - Part 1 of 3

Recently, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) commissioned a paper on Enhancing Board Oversight: Avoiding Judgment Traps and Biases. Originally formed in 1985, COSO is a joint initiative of five private sector organizations and is dedicated to providing thought leadership through the development of frameworks and guidance on enterprise risk management (ERM), internal control and fraud deterrence. COSO’s supporting organizations are the Institute of Internal Auditors (IIA), the American Accounting Association (AAA), the American Institute of Certified Public Accountants (AICPA), Financial Executives International (FEI) and the Institute of Management Accountants (IMA).

The paper was authored by Steven M. Glover, CPA, Ph.D., and Douglas F. Prawitt, CPA, Ph.D., as well as contributing authors from KPMG LLP including Sam Ranzilla, National Managing Partner, Audit Quality and Professional Practice; George Herrmann, National Office Partner; and Rob Chevalier, National Office Partner. It provides a five-step judgment process that board members and others can use to overcome common pitfalls and mitigate the effects of judgment bias. The judgment process is based on KPMG’s Professional Judgment Framework, which enables individuals to identify where and when the quality of judgments tends to be threatened by predictable, systematic judgment traps and biases.

The authors note that: “Consistently making high-quality professional judgments in a constantly changing environment has never been more important or challenging. The growing complexities of the global business environment and demands for effective corporate governance and oversight have placed a premium on sound judgment and decision making by all key players in the marketplace: management, boards of directors, auditors, and others. Our hope is that this collaboration—incorporating insights from academic research and reflecting KPMG’s commitment to consistent and incisive professional judgment in all aspects of its work—will be useful to board members in appropriately evaluating and challenging judgments and in encouraging sound decision making and solid performance.”

To learn more, view the COSO press release “COSO Releases Thought Paper on Enhancing Board Oversight by Avoiding and Challenging Traps and Biases in Professional Judgment” and read the paper Enhancing Board Oversight: Avoiding Judgment Traps and Biases.

Ethical Dilemmas: Case Studies for Professional Accountants – Part 4 of 4

As previously noted (see Part 1, Part 2 and Part 3), the Consultative Committee of Accountancy Bodies (CCAB) has published case studies on ethical issues encountered by professional accountants in business, in public practice, working as non-executive directors and working in the voluntary sector. These case studies provide guidance for resolving ethical problems and encourage debate. CCAB welcomes feedback on the case studies and other ethics related issues.

The December 2011 CCAB guidance on Ethical Dilemmas Case Studies for Professional Accountants Working in the Voluntary Sector illustrates how the ethical codes of the CCAB bodies can be applied by professional accountants working in the voluntary (or ‘third’) sector. These scenarios are not intended to cover every possible circumstance, but instead to outline key principles and processes that could be considered when attempting to identify, assess and resolve ethical problems in line with the ethical codes.

Six case studies address the following matters:

Case Study 1 - Disclosure of malpractice – unauthorised payments;

Case Study 2 - School governor – fair tender policy;

Case Study 3 - Disclosure of malpractice – grant claim;

Case Study 4 - Personal reference;

Case Study 5 - Undisclosed employee benefits;

Case Study 6 - Persuading others to tell the truth.

The guidance states that: “An accountant in the voluntary sector carries a great deal of responsibility, and may be subject to scrutiny by the staff and members of the local community.” It further states that: “A professional accountant working in the voluntary sector has a responsibility to further the legitimate aims of the organisation for which he or she works. The ethical codes of the CCAB bodies do not seek to hinder the fulfilment of that responsibility, but address circumstances in which compliance with the fundamental principles may be compromised. The professional accountant is required to act in the public interest, which requires objectivity to be exercised at all times. On occasions, it may be difficult to reconcile this requirement with the duty to act in the interests of the voluntary sector organisation. Therefore, it is important to understand the conceptual framework approach to resolving ethical dilemmas.”

Ethical Dilemmas: Case Studies for Professional Accountants – Part 3 of 4

As previously noted (see Part 1 and Part 2), the Consultative Committee of Accountancy Bodies (CCAB) has published case studies on ethical issues encountered by professional accountants in business, in public practice, working as non-executive directors and working in the voluntary sector. These case studies provide guidance for resolving ethical problems and encourage debate. CCAB welcomes feedback on the case studies and other ethics related issues.

The December 2011 CCAB guidance on Ethical Dilemmas Case Studies for Professional Accountants Working as Non-Executive Directors illustrates how the ethical codes of the CCAB bodies can be applied by professional accountants working as non-executive directors. These scenarios are not intended to cover every possible circumstance, but instead to outline key principles and processes that could be considered when attempting to identify, assess and resolve ethical problems in line with the ethical codes.

Six case studies address the following matters:

·       Case Study 1 - To be or not to be a non-executive director;

·       Case Study 2 - Formal governance procedures not being followed;

·       Case Study 3 - Confidentiality and conflict of interest in non-executive roles;

·       Case Study 4 - Non-executive director being used as a sounding board by an employee;

·       Case Study 5 - Pressure on a non-executive director to make a decision without adequate information;

·       Case Study 6 - Withholding information from the non-executive directors.

The guidance states that: “When acting as a non-executive director in a voluntary capacity, for example for a small charity or school, your responsibility to behave professionally and demonstrate strong ethics is in no way lessened by the fact that the position is unpaid.” It further states that: “Non-executive directors have a broad role that goes beyond operational matters. They contribute to the development of a clear mission and strategy for the company and to helping to ensure that the strategic objectives are fulfilled. Non-executive directors are encouraged to demonstrate their objectivity and, where appropriate, to challenge decisions of the executive directors. The duties of non-executive directors cannot be easily reconciled. On the one hand, they are expected to work closely with the executive directors as part of a team; on the other hand, they are expected to monitor the executive directors’ behaviour and to challenge their decisions.”

Furthermore: “It is important to consider the wider requirements of your role as a non-executive director, whether in the public, private or charity sector, and to ensure that you comply with all relevant governance standards and regulations. The role of the non-executive director is coming under increasing scrutiny in the corporate sector. With this growing focus can come a greater risk of personal liability should things go wrong.”