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).

Ethical Lapses Force More CEOs Out of Office

The share of CEOs forced out of office for ethical lapses has been on the rise, according to the 2016 CEO Success study by Strategy&, PwC’s strategy consulting business. The study, which analysed CEO successions at the world’s largest 2,500 public companies over the past 10 years, reports that forced turnovers due to ethical lapses rose from 3.9% of all successions in 2007–2011, to 5.3% in 2012–2016. The 36% increase was due in large part to increased public scrutiny and accountability of executives.

The increase was more dramatic at companies in the US and Canada, where forced turnovers for ethical lapses increased from 1.6% of all successions in 2007–2011 to 3.3% in 2012–2016, or a 102% jump. In Western Europe, the share of CEOs forced out for ethical lapses increased to 5.9% from 4.2%, and in the BRIC countries, to 8.8% from 3.6%.

It is noteworthy that there were 12 women globally appointed to the role of CEO in 2016 – 3.6% of the incoming class. This marks a return of the slow trend toward greater diversity that had been in place over the last several years, and a recovery from the previous year’s low point of 2.8%. The share of incoming female CEOs was highest in the US and Canada, rebounding to 5.7% after falling for the previous three years. Five industries – healthcare, industrials, information technology, consumer staples, and telecom services – did not have a single incoming female CEO in 2016.

Read the full story “More CEOs forced out of office for ethical lapses” at Chartered Accountants Worldwide online. This article was originally published by the Institute of Singapore Chartered Accountants (ISCA) in the June 2017 edition of ISCA Journal. 

Professional Attitude

A thought-provoking discussion of professional attitudes was posted online at Clancy’s Quotes dated March 26, 2009. The discussion suggests that Professionalism is one of those words that’s rather hard to define. Consequently, people have different viewpoints on what characteristics constitute professionalism.

According to Clancy, “Professionalism consists of certain attitudes, beliefs, and behaviors sometimes known collectively as “virtue” or “good character.” Attitudes and behaviors have two things in common. First, both are produced by our beliefs. Second, we have the power to choose our attitudes and behaviors.”

Furthermore, “Becoming a professional is an attitude adjustment process that begins by understanding what it means to be a professional, creating a personal vision of professionalism, and aligning one’s values in accordance with that image. Another way to say this is “change on the outside begins on the inside.” If you were to understand professionalism, then claim it as your set of personal values, where would you start to begin your professional tune-up? A good place is with the attitude called “respect” and a person must start by respecting oneself. Professionalism also insists on respect toward others, explained best by “The Golden Rule.”

Professional Scepticism in an Audit of a Financial Report

In August 2012, the Australian Auditing and Assurances Standards Board (AUASB) issued a Bulletin called Professional Scepticism in an Audit of a Financial Report. The AUASB took this opportunity to emphasize to both auditors and others, the important and fundamental role that professional skepticism has to play in the audits of financial reports. It also reminded audit firms of their role in education, mentoring and inspiring partners and staff to cultivate a skeptical mindset, recognizing that it is a vital ingredient in performing high quality audit engagements.

According to the Bulletin, the inspection programs of the Australian Securities and Investments Commission (ASIC) have raised concerns about whether professional skepticism is being applied properly in practice. The findings question whether auditors: respond appropriately to unreliable audit evidence; seek to corroborate evidence rather than challenge it; and adequately demonstrate in the audit working papers how professional skepticism has been applied.

The ASIC refers to key areas of audit judgment where the level of professional skepticism exercized or evidenced in the audit files needs to be improved, particularly: fair value measurement of assets; impairment calculations; and going concern assessments. Importantly, audit committees play a significant influencing role and commonly seek to foster appropriate professional skepticism in the external audit. Auditors, in turn, should demonstrate the value of their audit by seeking to convince audit committees that they have properly exercized professional skepticism in the conduct of the audit.

In light of these concerns, this 8-page Bulletin, which is presented in Question and Answer format, encourages auditors to bring “professional skepticism” to front-of-mind in the conduct of their audit engagements. The test for auditors, especially in an uncertain economic environment, is to remain alert, to improve audit documentation and to continually and critically re-assess the application of professional judgment.

Mandatory audit rotation seen as a threat to skepticism

An Accountancy Age magazine article published July 2015 notes that forcing companies to change their auditors may put professional skepticism in jeopardy. That’s the conclusion of a number of US academics, who published their thoughts in the American Accounting Association’s journal The Accounting Review.

According to the study, Effects of Auditor Rotation, Professional Skepticism, and Interactions with Managers on Audit Quality, instead of elevating auditor skepticism of clients and raising audit quality, the intended “benefit disappears and even reverses when auditors rotate. Rotation and a skeptical mindset interact to the detriment of audit effort and financial reporting quality.”

Report authors, Kendall Bowlin of the University of Mississippi, Jessen Hobson of the University of Illinois at Urbana-Champaign, and David Piercey of the University of Massachusetts Amherst, said: “Rotating auditors, aware that they will not be in a long-term relationship, will... likely perceive themselves to be less competent in evaluating the honesty or dishonesty of the [corporate] manager relative to auditors who do not rotate.”

As a result, “rotating auditors would find it difficult to garner psychological support for the probability of manager dishonesty, leading them to be less likely to choose high levels of audit effort than non-rotating auditors.”

Auditor Mindsets and Audits of Complex Estimates

A recently published research paper notes that “Auditors experience significant problems auditing complex accounting estimates and this increasingly puts financial reporting quality at risk. Based on analyses of the specific errors that auditors commit, we propose that auditors need to be able to think more broadly and incorporate information from a variety of sources in order to improve audit quality for these important accounts.”

The research tries to experimentally demonstrate that a deliberative mindset intervention improves auditors’ ability to identify unreasonable estimates by improving their ability to identify and incorporate into their analyses contradictory information from diverse parts of the audit and improving their ability to think critically about the evidence. Additional analyses are performed to demonstrate that such intervention improves auditor performance by causing them to think differently, rather than simply to work harder.

The paper demonstrates that critical thinking can improve the identification of unreasonable estimates and, in doing so, provide new directions for addressing audit quality issues. For more information, refer to the article “Auditor Mindsets and Audits of Complex Estimates” by Emily E. Griffith, Jacqueline S. Hammersley, Kathryn Kadous and Donald Young in the Journal of Accounting Research (Vol. 53, No. 1, March 2015).

REAL INTEGRITY: Practical Solutions for Organizations Seeking to Promote and Encourage Integrity

Research carried out by the Institute of Chartered Accountants of England and Wales (ICAEW) notes that: “Integrity is a much-desired but little-understood feature of organizations and of the individuals they employ. It features widely in codes of conduct and lists of ethical principles. A lack of integrity is frequently cited as a cause of crises and scandals in business and public life. On the other hand few people have a clear idea of what integrity means or how it should be understood separately from ethical behaviour more generally.”

According to this research, the responsibility for promoting integrity in organizations ultimately falls to their leaders. Therefore, the aim of the research was to provide practical solutions for organizational leaders to help them achieve this. In addition, there is a clear need to involve human resources in activities, since they have access to many of the organizational levers that can make a difference. The research was conducted in three stages: a desk-based review of academic literature, a large-scale online survey of Chartered Accountants and a series of 94 semi-structured one-on-one interviews with people working in a variety of organizations.

Four major themes arise in the philosophical literature on integrity which can be synthesized into an account of integrity. People of integrity partly define themselves by, and act consistently on the basis of, principles and commitments, at least some of which are ethical in nature and which include honesty, openness and fairness. They will also stand up for their principles and thereby attempt to influence the culture of their organization or society.

Professional integrity involves commitment to the founding values of a profession and may involve attempting to influence the culture of that profession. As well as having employees with greater or lesser degrees of integrity, organizations can exhibit integrity by achieving consistency between their expressed values and what is genuinely valued within the organization by valuing ethical behaviour and by taking a wider view of the social context in which they operate.

To learn more, read the 2012 ICAEW Briefing and related publication REAL INTEGRITY: Practical Solutions for Organisations Seeking to Promote and Encourage Integrity by Jim Baxter, James Dempsey, Chris Megone and Jongseok Lee at the University of Leeds. Also, refer to other guidance on “integrity” matters.