Summary of the KPMG Professional Judgment Framework

KPMG LLP, one of the four largest international public accounting firms, launched an initiative in 2009 to enhance the professional judgment and professional skepticism of its people and teams. KPMG collaborated with two professors at Brigham Young University, Professors Steve Glover and Doug Prawitt, to emphasize these skills in its training. The result of this effort is refreshed professional judgment content throughout KPMG's audit training curriculum for all levels of audit professionals.

KPMG took the additional step of sharing and leveraging its professional judgment training content to create, again in collaboration with Brigham Young University Professors Glover and Prawitt, a monograph to help students accelerate the development of their professional judgment while still in college. The previously-posted monograph is titled Elevating Professional Judgment in Auditing and Accounting: The KPMG Professional Judgment Framework.

The monograph is only available in electronic form, with live Internet links and audio files embedded. In addition, there are video files and an instructor’s manual available separately to professors who register on KPMG University Connection. To learn more, see the 2013 Summary of the KPMG Professional Judgment Framework— Understanding and DevelopingProfessional Judgment in Auditing and Accounting, available online.

Good judgment requires discipline and awareness of traps and biases

It used to be that exercising good judgment largely meant "using common sense." But today, while common sense is still essential, exercising good judgment -- consistently -- in a business environment that is increasingly complex and dynamic, volatile and uncertain, and under high pressure requires a disciplined process. It also requires an understanding of common traps and biases, like "groupthink," that can undermine the judgments of even seasoned professionals and boards.

This article highlights the main recommendations in Enhancing Board Oversight: Avoiding Judgment Traps and Biases, a COSO paper co-authored by KPMG and Brigham Young University professors Steven M. Glover and Douglas F. Prawitt. The paper discusses the keys to a robust professional judgment process, including “where things can go wrong.” Read the article “Good Judgment Requires Discipline, Awareness of Traps and Biases” by Dennis T. Whalen and George Herrmann.

The Future of Ethics

In light of the financial crisis and the ongoing turbulence in the world economies, there has never been a more important time to address the issues concerning ethics and ethical behaviour within organizations around the world. To discuss the pressures faced by organizations and the subsequent CGMA report Managing Responsible Business – A global survey on business ethics, CIMA and AICPA held a webcast debate in association with The Accountant.

In the Video: The Future of Ethics, hosted by Nicola Maher, Editor, The Accountant, the panel of experts discuss ethical culture, accounting for ethics, dilemmas, pressures and business issues. The panel includes: Jeff Kaye, FCMA, CGMA, Chief Executive, Willow Foundation; Simon Webley, Research Director, Institute of Business Ethics; Brian Walsh, FCMA, CGMA, Deputy-chair, IESBA; Nina Barakzai, FCMA, CGMA, EMEA Privacy & Ethics Counsel, Dell Corporation Ltd; Margaret Fowler, CIMA Adv Dip MA, Assistant Manager, Transport Advisory Team, KPMG; Professor Colin Fisher, Professor of Managerial Ethics and Values, Nottingham Trent University; and Tanya Barman, Head of Ethics, CIMA.

For guidance and additional resources, refer to previous postings about ethics.

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.

Using frameworks for the application and evaluation of auditors’ professional judgments

In response to concerns that a transition towards less precise accounting standards in the United States will increase auditor litigation exposure, regulators and accounting firms have developed and implemented frameworks for the application and evaluation of auditors’ professional judgments. Regulatory frameworks include, for example, the 2008 US Securities and Exchange Commission (SEC) Committee on Improvements to Financial Reporting (see previous posts on August 17, August 24 and August 30). Accounting firm frameworks include, for example, the 2011 KPMG monograph, Elevating Professional Judgment in Auditing: The KPMG Professional Judgment Framework (see previous posts on September 7, September 14 and September 20).

Recent research predicts and provides experimental evidence that such frameworks provide clarity to evaluators about the quality of auditors’ judgments. The research found that, when no direct signals of judgment quality are available, only auditors with recognized technical expertise in specific judgment tasks (an indirect signal of judgment quality) are insulated from the increase in litigation exposure arising from less precise standards.

When a direct signal of judgment quality is available (e.g., the auditor used a judgment framework when making specific judgments), there is no longer a relative increase in litigation exposure for auditors with general expertise compared to technical expertise. Nonetheless, when accounting standards are precise, the research found that the use of judgment frameworks may result in dysfunctional outcomes by reducing litigation exposure more for auditors with general expertise, not by improving the perceived quality of their judgments relative to auditors with technical expertise, but by signaling their lack of control over the events leading to the alleged material misstatement.

It is important to note that this research examines the signaling aspects of auditors’ use of a judgment framework, not whether and how professional judgment frameworks actually improve the quality of auditors’ professional judgments. Future research could examine auditors’ willingness and ability to use judgment frameworks and the downstream effects on their professional judgments, which preliminary evidence finds to be positive but to also depend on the economic substance of the transactions.

To learn more, read the April 2011 research article “Signaling the Quality of Auditors’ Professional Judgments: The Joint Effects of Accounting Standard Precision and Auditor Task Expertise” by Jonathan H. Grenier, PhD (Miami University), Bradley Pomeroy, PhD and Matthew Stern (both at University of Illinois at Urbana-Champaign). The paper is also available online at the Social Sciences Research Network.

Learning about Professional Skepticism – Part 1 of 3

With the move toward a more principles-based financial reporting framework and increased emphasis on fair value measurement, along with increased expectations from stakeholders and regulators, the ability to consistently make high quality professional judgments is increasingly important. In response, KPMG has launched a professional judgment initiative, which includes development of a Professional Judgment Framework and training all assurance professionals on a good judgment process, as well as common threats to good judgment. This Framework and training are intended to elevate judgment quality and professional skepticism across the firm and to provide a common vocabulary that facilitates implementation and mentoring on professional judgment.

“Professional scepticism” may be defined as an attitude that includes a questioning mind and a critical assessment of the supporting evidence. Professional skepticism helps to frame the professional accountant’s mindset. If that mindset is aligned with the objectives of the accounting profession and the duty to the public trust, professional judgments are also likely to be appropriately aligned with those objectives.

According to the KPMG monograph (on page 16): “Professional skepticism refers to the ability of the auditor to approach issues in an objective, balanced way, with a questioning mind and an appropriate level of critical evaluation. Accordingly, it is important that you learn what professional skepticism is and how to develop and improve your own sense of professional skepticism. It is important to understand that professional skepticism does not mean that auditors should adopt a cynical attitude toward client management. To the contrary, professional standards indicate that auditors should neither assume that management is dishonest nor assume unquestioned honesty.”

The accompanying exhibit sets out six characteristics of scepticism, summarized from the current research, as follows:

·       Questioning Mind - A disposition to inquiry, with some sense of doubt;

·       Suspension of Judgment - Withholding judgment until appropriate evidence is obtained;

·       Search for Knowledge - A desire to investigate beyond the obvious, with a desire to corroborate;

·       Interpersonal Understanding - Recognition that people's motivations and perceptions can lead them to provide biased or misleading information;

·       Autonomy - The self-direction, moral independence and conviction to decide for oneself, rather than accepting the claims of others;

·       Self-Esteem - The self-confidence to resist persuasion and to challenge assumptions or conclusions.

To learn more, read the research article “Development of a Scale to Measure Professional Skepticism” by R. Kathy Hurtt, PhD, CPA, in Auditing: A Journal of Practice &Theory, Vol. 29, No. 1, May 2010, pp. 149–171.

Can you really teach good judgment? (Part 3 of 3)

Research in the areas of judgment and decision making over the last few decades indicates that additional knowledge about common threats to good judgment, together with processes and tools for making good judgments, can improve the professional judgment abilities of both new and seasoned professionals. The research also confirms that professional judgment in the context of teams or groups is crucial because many important judgments are made in groups.

In learning about group judgments and decisions, three key themes should be kept in mind. First, the same judgment process, such as that illustrated in the KPMG Professional Judgment Framework (available at the KPMG University Connection) applies to both individual and group judgments. Second, it is important to be aware of the judgment traps and biases, and to take steps to mitigate them in group settings. Third, successful group leaders manage group judgment processes by properly structuring the group’s interaction and by effectively managing conflict.

With the movement in financial reporting toward more principles-based standards and more fair value measurements, exercising good professional judgment is increasingly important. It is clear that professionals will be required to apply more and better professional judgment on a consistent basis. As the accompanying exhibit shows, the more critical the judgment, the more rigorous the process and the more time it will take to make good judgments.

Can you really teach good judgment? (Part 2 of 3)

The KPMG monograph, Elevating Professional Judgment in Auditing: The KPMG Professional Judgment Framework (available at the KPMG University Connection) offers a judgment framework. That framework depicts constraints, influences and biases that threaten good judgment, with the box on the outer rim of the framework labeled “Environment” and the triangle at the top labeled “Influences/Biases.” At the bottom are Knowledge and Professional Standards, as these factors provide the foundation for quality judgments. The framework includes a number of components, such as mindset, consultation, reflection and coaching. At the core, there is a five-step judgment process.

The monograph presents simple, but powerful, principles that help overcome common threats to good judgment and that enhance professional skepticism. In addition, it covers several common judgment tendencies and how they can lead to biased judgments, and offers techniques to overcome or reduce the potential impact of these biases. After laying a foundation for individual judgments, the monograph discusses common threats to good judgment in groups, and the techniques that can improve the quality of group judgments.

According to KPMG, the mindset, skills and techniques behind good judgment begin to form at a young age and can be taught and improved with experience and practice. It is critical that accounting and auditing students receive a strong foundation in the fundamentals of professional judgment. KPMG is committed to sustaining an ongoing dialogue about professional judgment. Therefore, it is now taking the important step of sharing and leveraging the content with the key stakeholder groups, including the academic community.

Can you really teach good judgment? (Part 1 of 3)

According to a recent publication, Elevating Professional Judgment in Auditing: The KPMG Professional Judgment Framework, a common question people have is, “Can you really teach good judgment?” Many believe that it is a gift; either you have it or you do not. Others would say you cannot teach good judgment; rather, it must be developed through the “school of hard knocks” after many years of experience. There is no question that talent and experience are important components of effective professional judgment, but it is possible to enhance your professional judgment skills through learning and applying some key concepts. As with other important skills, the sooner you start learning how to make good professional judgments, the better.

The KPMG monograph and related training materials (available at the KPMG University Connection) were developed with the help of two professors from Brigham Young University, Steven Glover and Douglas Prawitt. Their research focuses on the judgment and decision making of accounting and auditing professionals. They have taught graduate (MBA) courses on effective judgment and decision making for many years.

Graduate courses in professional judgment are also being offered at selected Canadian universities, For example, Professor Efrim Boritz teaches a course on Professional Judgment (ACC 690 on pages 90-91) at the University of Waterloo. The course covers a variety of topics, such as: Introduction to Professionalism and Professional Judgment; Being a Trusted Adviser; Methods of Studying Professional Judgment; Bounded Rationality; Heuristics, Framing and Biases; Knowledge, Expertise, Specialization; Ethics, Skepticism and Rules of Professional Conduct; Multi-person Tasks and Professional Judgment; Role of Decision Aids in Professional Judgment; and, Conflicts and Negotiations.