Guidance for Applying a Professional Judgment Framework

Enhanced Communication and Collaboration
on Professional Judgment Matters

In 2011, the Institute of Chartered Accountants of Scotland (ICAS) sponsored the research report Professional Judgment Matters: Assessing the Need for Enhanced Communication and Collaboration. This guidance blog is an integral part of that research report which is available on Google Docs and on the Social Science Research Network (SSRN). The ICAS then published A Professional Judgement Framework for Financial Reporting in 2012. It was primarily targeted at accountants (both preparers and auditors) determining the appropriate accounting treatment for particular transactions.

In 2016, the ICAS released a new, up-to-date publication  A Professional Judgement Framework for Financial Reporting Decision Making to replaces the 2012 edition. It offers practical guidance for decision makers involved in narrative and financial reporting. The new edition has been broadened to make it more universally applicable to decision makers involved in financial reporting, whether accountants or nonaccountants, in the private or not-for-profit sectors. It also includes a new section on audit committees and further context on ethical decision making. Furthermore, the 2016 edition is shorter and more interactive for online readers.

The ICAS firmly believes that a principles-based approach to standard setting is a key driver of quality reporting. Therefore, the guidance includes recommendations for standard setters to ensure that standards provide the appropriate scope for professional judgment.

In this regard, it is entirely consistent with the 1995 Research Report Professional Judgment and the Auditor prepared by staff of the Canadian Institute of Chartered Accountants (CICA), Research Studies Department (J. Paul-Emile Roy, CA) under the direction of an 8-member Study Group of professionals. The 1995 Report identified many sources of information regarding the issues surrounding professional judgment. It developed a framework for professional judgment and discussed key factors that influence the judgment process. In addition, it provided valuable guidance to practitioners regarding their professional obligations when exercising professional judgment. Other blog postings regarding a “professional judgment framework” may also be useful for improving decision-making.

Addressing Unconscious Bias in Decision Making

According to a recent article in the American Institute of Certified Public Accountants (AICPA) Journal of Accountancy, many professionals, without realizing it, make “unconscious” choices regarding those who are different in terms of race, gender, geographic origin, college education and other factors. This “unconscious bias” is a hidden bias that can significantly undermine good decision making and impacts both personal and business decisions.

How much do you know about unconscious bias? Try a short, 10-question, online quiz to help test your knowledge on the subject. To learn more, watch the following AICPA Unconscious Bias webcast series of three information videos:

• “Help Me in the Heart - Understanding Unconscious Bias”: This session will help participants understand the full scope of what unconscious bias entails, where it comes from, and the areas of business it impacts. 
• “Look Me in the Brain – Identifying Unconscious Bias”: This session will help participants identify personal biases which might be holding us back from true inclusiveness.
• “Fix Me in the Act – Managing Unconscious Bias”: This session will help participants manage biases in a constructive manner to obtain the highest level of inclusiveness and performance. 

In addition, review previous blog postings on “bias” and how it affects the exercise of professional judgment.

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.

ICAS – Ethical Decision-Making Framework

According to the Institute of Chartered Accountants of Scotland (ICAS), “There has been a lot in the media recently about Artificial Intelligence (AI). One of the most difficult tasks for any AI designer will be to replicate the ability to place ethical considerations into the decision-making process. Whilst this might be easier for certain aspects, such as determining compliance with a set of rules on auditor independence, it will be much trickier in other areas where a real understanding of the circumstances, and possible available courses of action, is required.”

The ICAS has prepared guidance for those faced with such dilemmas by publishing a Discussion Paper on Ethics Principles and an Ethical Decision-Making Framework. To learn more, read the ICAS discussion paper, The Five Fundamental Ethics Principles: Time for Evaluation? and the ICAS guidance on an Ethical Decision-Making Framework. In addition, review the guidance entitled, What Do You Do Now? Ethical Issues Encountered by Chartered Accountants, and the ICAS ethical dilemmas series called Shades of Grey.

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.

Using Good Decision Making to Drive Value

EY - The Future of Decision Making

Making the right decision is hard. Companies have to frame the questions properly, find the right data to support the analysis, and do all this in a way that is transparent and repeatable. In 2012, Ernst & Young LLP (EY) commissioned a survey of 285 senior executives globally from across the consumer products sector. 81% of participants indicated that they needed to improve their decision-making speed and level of insight.

Survey respondents suggested that their people spent too much time making decisions based on intuition, working on mechanical tasks and focusing on unnecessary detail. Instead, they wanted their people to be adding more value through better use of leading indicators, conducting root cause analysis of issues, and linking strategy with resource allocation, planning and reporting.

To improve their performance management capabilities and drive profitable growth, companies need to take a more encompassing approach that not only implements driver analytics, but also uses the analytics to mathematically link business strategies with the market, competitor, operational and financial forces that drive value and, by extension, good decision making. Learn more from the EY guidance, The future of decision making: 5 Insights for Executives.

PwC - Using Data and Analytics to Re-Imagine Forecasting

According to PwC (United States), we are always forecasting - thinking about what will happen, assessing its likelihood, and contemplating the implications. But for CFOs, the stakes are much higher. The cost of being off the mark can be huge, not just in perception but also in dollars. A company’s cost of capital can be impacted by their assumptions and forecasts, and failure to accurately forecast demand fluctuations can result in too much, or not enough, inventory. In each of these situations, the cost of being wrong today can become extremely costly in the future.

This paper talks about the steps and factors a CFO may consider as they re-imagine forecasting in a way that allows themselves and their counterparts in the C-Suite to tease out signals that matter and deliver more value to their organizations in the short and long term. Learn more from the 2016 PwC guidance, Reimagine forecasting: High stakes decision making for CFOs.

Guidance on Professional Judgment for CPAs in China

At a China Press Conference in Beijing on February 15, 2006, Graham Ward, President, International Federation of Accountants remarked that: “The decision by China to converge towards international auditing standards sends a clear message to the world that both the Chinese people and the Chinese accountancy profession are committed to transparency, quality and high professional standards. Support of these standards will benefit not only the accountancy profession, but also, and even more importantly, all Chinese citizens and the Chinese economy as a whole. Why? Because following high, internationally accepted standards builds trust in the audit process; it builds credibility in the information provided by auditors; it builds investor confidence – all of which are vital to the development of your capital markets. As your economy continues to expand, you are far better positioned to improve the quality of life of your citizens.”

He concluded that: “I am proud that IFAC and the CICPA are working together. Through adherence to high professional standards we can, together, bring about social stability and good governance in business. Through convergence to international standards we can, together, deliver our promise of quality. And through acting in the public interest, we can, together, build public trust and sound economies that support a better quality of life for all. I firmly believe that China’s move toward convergence will go a long way towards improving the life and livelihoods of the people of the People’s Republic of China.”

In line with the convergence towards international auditing standards,  Guidance on Professional Judgment for CPAs (released by the Chinese Institute of Certified Public Accountants on March 26, 2015) states that: “the term professional judgment refers to the application of relevant training, knowledge and experience, within the context provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.” Accordingly, the guidance makes recommendations related to improvement of the quality of CPA’s professional judgment, recommendations for accounting firms, recommendations for CPAs, recommendations for regulators and recommendations for standard setters.

Learn more about the Chinese Institute of Certified Public Accountants – CICPA and the current situation in China by reading the Overview of the Accountancy Profession in China (released by the CICPA on January 21, 2016). The Overview explains that: “The accountancy profession was introduced to China in the early 20th century, mainly serving the booming national industry and commerce. After the founding of the PRC, the profession had played a vital role in the national economic recovery. It was suspended in the Mid-20th century when China adopted a planned economic system; along with China’s historical economic reform and opening up policies, the accountancy profession was revitalized and reconstructed and grew steadily. With over 30 years of development and growth, the accountancy profession in China is now a widely recognized and respectable profession. Accountants are an important link of integrity chain of the market economy and they are entrusted to safeguard the public interest.”