Guidance for Teaching Professional Judgment and Ethics

In 2015, Pearson Canada published the textbook Auditing: The Art and Science of Assurance Engagements,Thirteenth Canadian Edition by Professor Alvin A. Arens (Michigan State University), Randal J. Elder (Syracuse University), Mark S. Beasley (North Carolina State University) and Joanne C. Jones (York University). Chapter 4 (on pages 63-91) covers Professional Judgment and Ethics. The Chapter presents A Framework for Professional Judgment, discusses the Auditor’s Mindset and Judgment Tendencies, presents A Framework for Ethical Reasoning, and offers Professional Guidance on Ethical Conduct.

The authors note (see page 65) that “In its research report, Professional Judgment and the Auditor, the Canadian Institute of Chartered Accountants (now CPA Canada) said: Professional judgment in auditing is the application of relevant knowledge and experience, within the context provided by auditing and accounting standards and Rules of Professional Conduct, in reaching decisions where a choice must be made between alternative possible courses of action.”

The report further explained that professional judgment is analytical and systematic, objective, prudent, and carried out with integrity and recognition of responsibility to those affected by its consequences. This means that auditors must be able to justify a decision on the basis that it:

• Is well thought out;

• Is objective;

• Meets the underlying principles of GAAP and GAAS;

• Has evidence to support the decision;

• Maximizes the likelihood of “good” consequences;

• Is carried out with truthfulness and forthrightness; and

• Considers the impact on the financial statement users.

Accordingly, this type of decision making can be both complex and difficult. To assist auditors and firms, several professional associations such as CPA Canada, the Institute of Chartered Accountants of Australia, and the Institute of Chartered Accountants of Scotland, as well as the American Center for Audit Quality, have issued professional judgment and professional skepticism frameworks that provide auditors with a methodical approach.

The approach depicted in Figure 4-1 above (see page 66) is based on those various frameworks. Although the framework may seem to be simple, such frameworks are considered effective tools in guiding thinking and encouraging auditors to be aware of their own judgment biases and traps and what can go wrong. Judgment biases and traps are considered in more detail as part of the auditor mindset component of the framework (see page 67).

Ernst & Young Foundation - Introducing the Professional Judgment Framework to Students

A 2017 brochure prepared by the Ernst & Young Foundation (US) states that “Professional judgment skills have never been more important for professionals to operate successfully in an environment of increasing risk and complexity.” In this regard, the Ernst & Young Academic Resource Center (EYARC) is providing free, leading-edge resources to prepare students for the fast-changing, global marketplace.

Professional Judgment Framework (click to enlarge)

As the above graphic illustrates, the EYARC has developed curriculum materials to introduce the professional judgment framework to students. According to the accompanying User Guide, lecture notes and supplemental curriculum materials allow students to apply the professional judgment framework to a variety of accounting and auditing scenarios. The supplemental materials include an “application template” which serves as a tool to track, organize and evaluate considerations of the judgment framework. For each application scenario provided, this template can be used by the students to support their judgment.

Documenting the rationale and support for important judgments made during the course of the audit is generally required by professional standards. In addition, for preparers, documentation helps support assertions made in the financial statements and supports an effective system of internal control. As such, requiring students to develop a written memorandum will assist in reinforcing the concepts included in the judgment framework and the development of effective writing skills.

Finally, the lecture notes discuss that the overarching considerations for the professional judgment framework are to be continually readdressed throughout the overall judgment process. However, in completing the application scenarios, for simplicity purposes, students will only address the overarching considerations at the beginning of the judgment process.

Why do controllers compromise on their fiduciary duties?

A new research paper notes that, “Business controllers play a fiduciary role to ensure the integrity of financial reporting.” So, what makes these financial professionals bend or break the rules under pressure? It may result from being too sensitive to the feelings of others and mirroring their emotions. In other words, empathetic accountants may have a tendency to be less ethical.

The paper’s researchers found a correlation between the subjects’ emotional sensitivity and their willingness to flout the rules. The findings also suggest why the stereotypical reserved accountant remains controlled amidst an ocean of emotional pressures. For more information, read the research paper, Why Controllers Compromise on Their Fiduciary Duties: EEG Evidence on the Role of the Human Mirror Neuron System, to be published in the journal Accounting, Organizations and Society.

Do auditor judgment frameworks help in constraining aggressive reporting?

A 2016 research paper investigates whether alternative judgment frameworks help Big 4 audit managers and partners constrain management’s aggressive financial reporting under accounting standards that differ in their precision. The authors found that a framework based on the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR) recommendation that auditors critically evaluate the pros and cons of alternative accounting methods helps auditors constrain aggressive reporting under less precise standards.

Although the results highlight a limitation of counterfactual reasoning on its own at enhancing auditor constraint of aggressive reporting, this study provides evidence on how structured thinking can overcome this limitation. In particular, combining this consideration of the alternatives with a structured thought process that encourages auditors to think about the issue at increasing levels of abstraction effectively shifts auditor focus away from client considerations and towards substance-over-form considerations, thereby incrementally enhancing auditor constraint of aggressive reporting across different levels of accounting standard precision.

These research findings should be of interest to academics, regulators, standard-setters and auditors as they continue to contemplate ways to improve auditor professional judgment under different levels of accounting standard precision. For more information, read the research paper, Do Auditor Judgment Frameworks Help in Constraining Aggressive Reporting? Evidence under More Precise and Less Precise Accounting Standards by Ann G. Backof (University of Virginia - McIntire School of Commerce), E. Michael Bamber (University of Georgia) and Tina Carpenter (University of Georgia - C. Herman and Mary Virginia Terry College of Business) published in the journal, Accounting, Organizations and Society, Volume 51, May 2016, Pages 1–11.

Research and Guidance Resources by the Center for Audit Quality (CAQ)

Devoted to enhancing investor confidence and public trust in the global capital markets, the Center for Audit Quality (CAQ) is an autonomous, nonpartisan, and nonprofit public policy organization based in Washington, DC. Supported by a membership of U.S. accounting firms registered with the Public Company Accounting Oversight Board (PCAOB), the CAQ is led by a Governing Board made up of CEOs from leading public company auditing firms and the AICPA, as well as three members from outside the public company auditing profession. CAQ resources include guides, case studies, technical alerts, research reports, comment letters, amicus briefs, and videos. They are all publicly available and free of charge.

On August 7, 2016, top practitioners from the public company auditing profession gathered with leading academics at the CAQ’s Eighth Annual Symposium in New York, Research in Auditing – Insights from Academics and Practitioners. The event is a key part of the CAQ’s ongoing dialogue with the academic community on how research can help inform audit practice. As in past years, the 2016 Symposium included panel discussions on critical issues.

This Symposium panel focused on the advantages that can be gained when academics team up with members of the profession to inform their research. Behavioral and archival researchers working with the CAQ Research Advisory Board have benefited from conferring with auditors to better understand the challenges faced in practice, how those are addressed, and how changes in approach or audit methodology could impact the research question.

The Center for Audit Quality has also developed two video vignettes for use in the classroom (each approximately five minutes in length) that provide insights into the types of conversations that occur when auditors are assessing the internal controls used by management. In these scenarios, the focus is on a management review control over goodwill impairment estimates. The discussions captured in the videos can also be used in other teaching situations as they highlight communications and interviewing techniques, professional skepticism, and how to navigate conversations on difficult and sensitive issues. To learn more, refer to video Vignette 1: A Meeting between the Audit Manager and the Company Controller and video Vignette 2: A Meeting between the Audit Manager and the Engagement Partner.

Enhancing Auditor Professional Skepticism: The Professional Skepticism Continuum

A 2014 academic research paper published by the American Accounting Association notes that “Due to past high-profile audit failures, reported audit deficiencies in regulator inspection reports, and the growing number and size of complex estimates in the financial statements, there is a growing need for reliability and trust in financial reports and a corresponding increased demand for enhanced audit quality. Enhancing the level of professional skepticism applied in practice is one important means of improving audit quality, but there is a lack of practical guidance around the appropriate application and documentation of professional skepticism in the professional literature.”

The following graphic offers a proposed skepticism continuum. Such a continuum enables the auditor to take the perspective that is most appropriate considering the circumstances applicable to each audit area and assertion. Applying a continuum to a specific account and assertion takes place after a careful and rigorous initial risk assessment, and a continued re-evaluation of the risk throughout the audit to ensure that appropriate skepticism is applied to the collection and evaluation of audit evidence.

According to the paper, “A shared understanding would allow audit professionals to identify, communicate, and exercise a level of professional skepticism appropriate for the risks involved, and would enable regulators to fairly evaluate, after the fact, the level of skepticism applied. The skepticism continuum we propose represents a potential step forward in understanding the nature of professional skepticism and in applying it appropriately under varying circumstances.”

The paper concludes that, “In order to make the necessary changes, the profession, academics, regulators, and standard setters should work together to better understand the nature of professional skepticism, including how skepticism is threatened at various structural levels, current measures in place to mitigate those threats and, then, finally, how skepticism can be enhanced at the various structural levels. Our hope is that this paper will provide a conceptual foundation to facilitate a productive ongoing dialogue that will lead to specific actions to enhance auditor professional skepticism and, ultimately, audit quality.”

To learn more, read the full paper by Steven M. Glover and Douglas F. Prawitt, both Professors at Brigham Young University, “Enhancing Auditor Professional Skepticism: The Professional Skepticism Continuum” in Current Issues in Auditing: December 2014, Vol. 8, No. 2, pp. P1-P10.

Enhancing Public Trust in the Accounting Profession Using Professional Judgment

A 2004 dissertation empirically examined the impact of ethics instruction and ability on student propensity to use professional judgment in resolving accounting ethics dilemmas. The literature has supported the need for increased ethics instruction in accounting programs as a vehicle to improve ethical decision making in the accounting profession. The significance of the American Institute of Certified Public Accountants (AICPA; 2004) Code of Professional Conduct as the profession’s source of authority relative to ethical decision making was documented.

The Code emphasizes three trust characteristics (ability, benevolence, and integrity) identified in the literature that are important relative to enhancing public trust in the accounting profession. Ability is important to ethics instruction as it determines the extent to which students acquire a working knowledge of the provisions of the AICPA Code of Professional Conduct. The ethical norms contained in the Code’s provisions are derived from the underlying ethical decision-making characteristics inherent in the accounting profession’s organizational culture. These characteristics relate to an individual’s ethics system, ethics application perspective, moral reasoning perspective and level of moral reasoning.

The literature has supported a deontological ethics system, holistic ethics application perspective, orthodox moral reasoning perspective, and conventional level of moral reasoning as appropriate for ethical decision making in the accounting profession. All of these characteristics point to the use of professional judgment rather than personal judgment in the resolution of accounting ethics dilemmas.

According to the author, there are several avenues for future research efforts relative to increasing the use of professional judgment in present and future accounting leaders and ultimately enhancing public trust in the accounting profession. They are (a) replicating the study’s repeated measures experiment to other sample frames within the sample population, (b) extending the repeated measures experiment to other sample populations, (c) conducting a longitudinal study involving student use of professional judgment, (d) preparing and conducting repeated measures experiments that evaluate the impact of the other important trust characteristics of benevolence and integrity on student use of professional judgment, and (e) developing and testing a comprehensive model of professional judgment that incorporates all three of the important characteristics that enhance public trust.

This 100-page dissertation is available online. For more information, read, Enhancing Public Trust in the Accounting Profession Using Professional Judgment Rather Than Personal Judgment in Resolving Accounting Ethics Dilemmas, by Gene R. Sullivan submitted in April 2004 to Regent University School of Leadership Studies in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Organizational Leadership.

Expertise Management by Public Accounting Firms

Research suggests that professional expertise may be viewed as an attribute of an accounting firm rather than just an attribute of individual experts. One research paper constructs a model that leads to the identification of three strategies applicable to accounting firms. A Knowledge firm develops and sells proprietary knowledge to a selective clientele, whereas a Full Service firm develops and sells general professional knowledge to a broad clientele. A Relationship firm is in-between the other two firm types. 

Associations are hypothesized between these strategies and a variety of firm activities such as client selection, diffusion (or concentration) of expertise within the firm, sharing of expertise within the firm, and formalization of quality control processes. A questionnaire was completed by 219 audit and tax partners and consulting, insolvency and forensic accounting principals in 15 public accounting firms.

The results are consistent with the existence of three distinct types of firms. The results also indicate that partners are aware of local pressures that they personally face (such as the need to sell more services to clients) and less aware of the effect of broad structural features of the firm (such as size and decision aids). The key structural features that are salient to partners involve the need for selectivity in choosing clients and the need for the firm to develop specialized proprietary technical knowledge.

To learn more about this research on expertise, read the paper “Expertise Management by Public Accounting Firms” by Michael Gibbins and Karim Jamal, University of Alberta (February 6, 2001 Version).

Educating Professionals: Ethics and Judgment in a Changing Learning Environment

According to Gordon Beal, Vice President of the Research, Guidance & Support Department at CPA Canada: “Ethics and professional judgment are key attributes that distinguish professionals from others.” With this in mind, “The profession continues to refine the framework for the new single, unified designation and business credential and define the criteria for the qualities required to be recognized as a Chartered Professional Accountant (CPA). The challenge is to effectively embed, in the fabric of every professional accountant’s decision-making process, the essential principles of ethics and foster their ability to apply professional judgment while balancing this with the task of acquiring the ever-increasing technical knowledge.”

As previously reported, CPA Canada partnered with the University of Toronto in March 2014 to create a forum for exploring best practices with respect to teaching the principles of ethics and professional judgment. As the need for these skills is common to all professions, a one-day Educating Professionals Symposium was organized which included participation of five professions: education, health care, engineering, law and accounting. Leading academics from the identified professions were asked to prepare thought papers prior to the symposium. The dialogue that ensued on the day highlighted similarities, differences and opportunities. It was the beginning of new conversations across the professions.

The Educating Professionals: Ethics and Judgment in a Changing Learning Environment project is a joint initiative between the Chartered Professional Accountants and University of Toronto. Its objective is to explore possible strategies to effectively refine the approaches to teaching ethics and professional judgment in a changing learning environment.

Internal Audit - How to Develop Professional Skepticism

A recent research article notes that, to date, the Institute of Internal Auditors (IIA) standards regarding periodic internal and external quality assessments do not involve a formal and explicit evaluation of “professional skepticism” (see IIA Standard 1300). But, there is a trend afoot that asserts due professional care incorporates professional skepticism.

According to that article, “Professional skepticism can be thought of as having a reasoning of mind to question what has been presented for evaluative purposes—to look beyond the obvious in the search for revealing information and relationships. In essence, it is more than taking the easy way out. To do so, an individual must go beyond the face value.”

Furthermore, “Professional skepticism relies on the recognition that something is awry and needs to be addressed. As such, performance in the field should use this as the cornerstone for evaluation. ...At a truly effective level of professional skepticism, one is able to draw on one’s past work experiences and observations to make value-adding decisions about audit evidence.”

So, how do you produce highly regarded financial statements in the face of demands to minimize external audit costs? Many companies try to solve this problem by using their internal audit department more during the annual external audit. However, that can be tricky because the internal audit staff is required to remain independent. The solution, say the authors of this article, is to actively develop and maintain the internal auditors’ professional skepticism. And, the authors provide a detailed roadmap that shows how to do that.

To learn more, read the research article Internal Audit - How to Develop Professional Skepticism published in The Journal of Corporate Accounting & Finance, May/June 2011. The research was undertaken by Nicole McCoy, PhD, CPA, Louisiana Tech University; Royce D. Burnett, PhD, CPA, and Marc Morris, PhD, both at Southern Illinois University–Carbondale; along with Mark E. Friedman, PhD, CPA, University of Miami.

Further guidance on the exercise of professional skepticism is available in previous postings.