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.

Applying IFRS - Online guidance and resource materials

The Chartered Professional Accountants of Canada (CPA Canada) maintain an IFRS web section to provide guidance and support for understanding and applying International Financial Reporting Standards (IFRS). Whether applying an existing standard, searching for information on new standards, preparing financial statements or communicating with clients or lenders about IFRS, check out these free online resources. The Reporting Alerts series summarizes new and revised standards.

In addition, the Viewpoint series discusses circumstances unique to the mining and the oil and gas sectors. CPA Canada and the Prospectors and Developers Association of Canada (PDAC) created the Mining Industry Task Force to share views on IFRS application issues of relevance to junior mining companies. CPA Canada, the Canadian Association of Petroleum Producers (CAPP) and the Explorers and Producers Association of Canada (EPAC) created the Oil and Gas Industry Task Force to share views on IFRS application issues of relevance to junior oil and gas companies. In addition, learn more about the importance of applying professional judgment when preparing or auditing IFRS-based financial reporting.

Promoting Judgment through Objectives-Oriented Accounting Standards

A recently-published study analyzes how the International Accounting Standards Board (IASB) promotes professional judgment by issuing objectives-oriented accounting standards and exposure drafts. The authors focus on the role of judgment as outlined in Phase I of the IASB Conceptual Framework, Chapter 1, “Objective of General Purpose Financial Statements” and Chapter 3, “Qualitative Characteristics of Useful Financial Information” (IASB 2010).

This study discusses how the Conceptual Framework encourages professional judgment, when viewed through the prism of objectives-oriented accounting standards. Such an approach was recommended by the United States Securities and Exchange Commission (SEC) Report in its “Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System” (July 2003).

The study also analyzes International Financial Reporting Standards (IFRS) and Exposure Drafts issued by the IASB since its inception in 2002 to determine if those documents are consistent with objectives-oriented accounting standards. This analysis is useful for gaining insights into how the IASB integrates the Conceptual Framework with the SEC’s recommended objectives-oriented accounting approach to promote judgment in the interest of IASB/FASB convergence of accounting standards.

According to the study, “An increasingly complex financial environment demands accounting standards that narrow the range of professional judgments in accounting decisions. Although new accounting principles and approaches do not eliminate the necessity of judgments entirely, the IASB’s process of improving transparency and comparability of financial reporting hinges on its ability to promote professional judgment. Its ability depends on the standard setter and the practitioners. The IASB is issuing more objectives-based standards that provide a framework for judgment. Professional accountants, auditors and managers need to be cognizant of the IASB's efforts so they can cooperate in the pursuit to judgment.”

For more information, refer to the 15-page research article “The International Accounting Standards Board’s Progress in Promoting Judgement through Objectives-Oriented Accounting Standards” by Tanja Lakovic and Jayne Fuglister at the University of Montenegro. The article was published in the International Journal of Business and Social Research, Volume 3, No. 7, July, 2013.

Auditor Judgment Under Uncertainty: Doctoral Dissertation 2013

A recent research paper investigates how experienced auditors recognize and respond to the degree of management’s evidentiary support and the level of estimate uncertainty when assessing management estimates. Drawing on information processing research, the paper predicts that auditors can be more comfortable with management estimates, and expect a lower adjustment, when there is alignment between the degree of estimate uncertainty and management’s evidentiary support (that is, high uncertainty and more support or low uncertainty and less support). The following diagram provides a graphical representation of the theoretical predictions.

This prediction is tested using an experiment where experienced auditors evaluate an uncertain warranty estimate. The level of uncertainty is manipulated by varying the range of potential costs as either two-times or eight-times materiality. The degree of management’s evidentiary support is manipulated by management either obtaining industry information, inquiring of technicians, or doing these two plus reviewing records, and performing field inspections.

The results support the prediction. In the higher uncertainty condition, auditors were more comfortable and expected a lower adjustment when management obtained more evidential support, but in the lower uncertainty condition auditors were more comfortable and expected a lower adjustment when management obtained less evidential support. In fact, the alignment between estimate uncertainty and management’s evidentiary support can make auditors more comfortable with management estimates supported by relatively less evidence.

These findings demonstrate how audit risk factors, such as the level of uncertainty and degree of management’s support can interact and cause auditors to more readily accept less supported financial statement estimates. More broadly, these findings reveal how providing more information can actually make recipients more uncomfortable with a proposition.

For more information, refer to the 93-page Dissertation, “Auditor Judgment Under Uncertainty” by Stephen P. Rowe, submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Accountancy in the Graduate College of the University of Illinois at Urbana-Champaign, 2013. The Doctoral Committee included: Professor Mark Peecher, Chair; Assistant Professor Bradley Pomeroy; Professor Ken Trotman, University of New South Wales; and Professor Michel Regenwetter.

Information Integrity – January 2013: An AICPA-CICA White Paper

Various types of information are increasingly being made available by business entities to stakeholders, including management, investors, regulators, shareholders and other interested parties. This information may include: excerpts from financial statements, such as inventories or accounts receivable; data from the company records, such as production volumes; and key performance indicators. Stakeholders use this information in making decisions, interpreting or using other information and generally increasing their knowledge about the subject matter.

To make the best decisions, users need to have confidence in the integrity of the information. With this in mind, the AICPA Trust Information Integrity Task Force, in conjunction with the Canadian Institute of Chartered Accountants (CICA), prepared a white paper called Information Integrity in January 2013. The purpose of this white paper is to define what information integrity means and to provide context for it to users, preparers and practitioners.

The 28-page white paper offers insight on how information can have integrity and discusses how information integrity can be achieved and maintained. It should be of interest to professional accountants in the accounting profession as a whole, including those in public practice, in business and industry, and other participants in the business reporting process, such as producers and consumers of business information.

CIMA, IFAC and PwC combine forces to look at business model reporting

Accountancy Age recently reported that: “The Profession has joined forces in investigating financial reports reflection of the business model and how that can be included into future integrated reporting.” It notes that a background paper Business Model, which reviews business models and how they are represented in financial reports, was prepared for the International Integrated Reporting Council (IIRC) by the Chartered Institute of Management Accountants (CIMA), the International Federation of Accountants (IFAC) and PricewaterhouseCoopers (PwC).

The Executive Summary to the 23-page background paper explores and reconciles divergent approaches in business model reporting with the aim of reaching a common, widely-accepted definition of the business model for use in Integrated Reporting (<IR>). Specific implications for the development of the International <IR> Framework are summarized. A distinction is made between business model disclosures and other information, such as: external factors or context; capitals; governance; strategy and resource allocation; opportunities and risks; performance; and future outlook. These elements are highly interconnected as shown below.

To learn more, read the report Understanding Transformation: Building the Business Case for Integrated Reporting. It tracks the behavioural changes of businesses on their journey towards Integrated Reporting during the first year of the IIRC Pilot Programme. Also, refer to other developments on integrated reporting.

Integrated Reporting: the challenge of assurance

A recent news article on the website of the Institute of Chartered Accountants of Scotland (ICAS) observes that: “Integrated reporting (IR) continues to move forward.  There are now 83 pilot companies across the world which are testing out the integrated thinking processes necessary to deliver integrated reports and experimenting with how best to communicate the resulting information.” It also states that: “A prototype IR Framework was released at the end of November, which shows the direction of travel, and a 3 month consultation on a proposed framework will be published in April 2013.  It is hoped that a final version of the Framework will be published in early 2014.”

 

According to this article, the integrated report is likely to replace today's annual report as the main communication to the company’s stakeholders.  It is likely to contain a varied mix of different types of information - past, present and forward looking, financial and non financial. Some of the information may be extracted from the financial statements, CSR report, Governance report, etc. But, how will users know whether the report contains all the most important information or whether it is so slanted towards the positive that it is not really giving a realistic view?

 

In this regard, auditors could express a “balanced and reasonable” opinion on an integrated report. This would provide slightly less assurance than the opinion on the financial statements, reflecting the more judgmental basis of the information in the integrated report, the mix of different types of information, and the fact that less of the information will be objectively verifiable, thereby relying much more on the auditor’s judgment.  Also, with a greater degree of forward looking information, the inherent inability of anyone to predict the future means that a lower level of assurance is inherent.

“... it is important, though, that a positive opinion is clearly expressed, so that users can understand the nature of assurance being given, and that this will underlie the credibility of integrated reports...negative assurance and reporting by exception are too confusing to users. The auditing profession is perfectly capable of making the necessary judgments to express a positive opinion in this way, although greater judgment will be involved, and the auditor liability regime in some countries may make the auditors slightly reluctant.”

Learn more by reading the online article “Integrated Reporting: the challenge of assurance” by David Wood, ICAS Executive Director of Technical Policy and Services. In addition, see the related articles “A Template for Integrated Reporting” and “A professional judgment framework for financial reporting.”

Professional Judgment Guidance

The American Institute of Certified Public Accountants (AICPA) has created a section of its website that addresses Professional Judgment. It states that: “With the increasingly complex nature of global business, the need for reliable, transparent financial information is more pronounced today than ever before. The accounting profession has been and will continue to be on the front lines of the challenge to provide investors, managers, directors, regulators, and others with up-to-date, reliable, and comparable financial reporting information... We expect financial statement preparers to apply judgment in the preparation and auditors to apply judgment in the audit of financial statements in a professional manner. This involves applying relevant training, knowledge, and experience within the context provided by relevant professional and technical standards, as applicable, in making informed decisions about courses of action that are appropriate in the circumstances.”

A number of organizations have developed guidance discussing the need for professional judgment and professional judgment frameworks. For example, the Institute of Chartered Accountants of Scotland (ICAS) has prepared a report entitled A Professional Judgement Framework for Financial Reporting: An international guide for preparers, auditors, regulators and standard setters which discusses the importance of professional judgment in a principles-based accounting standards model, provides guidance for preparers, auditors and regulators, and provides recommendations for standard setters. In addition, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) has prepared a document entitled Enhancing Board Oversight: Avoiding Judgment Traps and Biases, which details a five-step judgment process that board members and others can use to overcome common pitfalls and mitigate the effects of judgment bias.

A professional judgment framework for financial reporting

The Institute of Chartered Accountants of Scotland (ICAS) has been pursuing a campaign in support of principles-based financial reporting standards since the publication of Principles not Rules: A Question of Judgement in 2006. According to the ICAS, principles-based standards provide a framework within which the economic substance of transactions can be faithfully presented and better serve the needs of business and markets, and the public interest.

 

 

The key to the effective functioning of a principles-based framework is the ability of preparers and auditors to exercise professional judgment in the application of principles to the circumstances of a particular transaction or accounting issue. The basis of such judgments needs to be properly documented, so that regulators (who also need to have the experience and expertise to consider and challenge such judgments) can assess the reasonableness of the judgments based on the facts and knowledge available at the time of the judgments.

 

In an effective principles-based environment, each party plays a key role in making their own judgments and challenging others’ judgments, building up trust that all the parties have sufficient experience and expertise and that they approach their different roles in a proportionate and sensible manner. In the light of comments received on earlier work and involvement in similar work undertaken by the Global Accounting Alliance (GAA), there is a need for guidance on how to make judgments, especially in jurisdictions which are first time adopters of International Financial Reporting Standards (IFRS) or which are used to operating in a prescriptive or rules-based environment.

 

The ICAS has therefore developed A Professional Judgement Framework for Financial Reporting: An international guide for preparers, auditors, regulators and standard setters which offers guidance that may be useful around the globe. Other postings regarding a “professional judgment framework” may also be useful.

Creating a sustainable ethical operating environment

With the importance of ethics and non-financial reporting rising on the global agenda, accounting professionals are in a unique position to make an important contribution to creating a sustainable ethical operating environment. In this regard, the AICPA and CIMA have developed a number of resources to assist professional accountants in guiding their organizations to long-term sustainability and success. These resources shed light on the challenges many business clients face, and so apply to professional accountants in a firm setting as well.

The ethical resources include the following:

(1) The report Managing responsible business – a global survey on business ethics explores the importance placed on business ethics, ethical performance and ethical management within organizations, and the specific role played and challenges faced by accounting professionals. The survey findings show that there are pressure points and ethical gaps within organizations and highlights the role accountants can take in reducing those gaps.

(2) Accountants add value by supporting and driving the right decisions in all areas of a business. They help colleagues understand income, costs, risks and opportunities. Focusing on an organization’s future prospects, in addition to understanding and learning from past performance, accountants know how the different parts of a business come together. Responding to ethical dilemmas: CGMA ethics resources provides links to resources to help accounting professionals navigate ethical dilemmas and respond in a manner that upholds their career success.

(3) The CGMA case study: Navigating ethical issues highlights issues related to non-disclosure at the corporate level that come to the attention of non-executive financial managers and controllers. This case study features the role of corporate controller for a large public company, making decisions that will affect the future of the controller and many others. The facts of this hypothetical case cover integrity and objectivity, confidentiality, internal accounting controls, and procedures for investigating and reporting irregularities.

(4) The Ethical reflection checklist was designed to provide organizations and individuals with an overview of how well ethical practices are embedded in the business. Firms can leverage this checklist with their clients to open the discussion on business ethics in the workplace. Questions cover areas such as ethical statements and codes of conduct, training, collection of ethical data and reporting of ethical issues, and support when faced with ethical dilemmas.

With the backing of a strong ethical culture, all accountants can be highly effective in playing a key role—drawing on both their training and understanding of professional ethics, as well as their skills in obtaining, analyzing and acting upon management information—to guide their organizations, or those of their clients, to long-term sustainability. Explore these and the many other resources available on cgma.org. Also, read the article “Fostering a More Ethical Business Culture” at AICPA Insights online.

Exploring Principles vs. Rules-Based Accounting and Auditing Standards - Deloitte Fireside Chats

The Deloitte Fireside Chats are made possible through a partnership between Deloitte LLP and the SEC Historical Society. As noted in the previous posting (June 24, 2012), an interactive conversation on October 22, 2009 explored the role of professional judgment in accounting and auditing. On October 28, 2009, a further interactive conversation explored the issues surrounding principles versus rules-based accounting and auditing standards.

Patricia Fairfield, Associate Professor, McDonough School of Business, Georgetown University served as moderator. The two panellists were: Scott A. Taub, Managing Director, Financial Reporting Advisors, LLC and former Acting and Deputy Chief Accountant, SEC Office of the Chief Accountant; and Robert Kueppers, Deputy CEO of Deloitte and a trustee of the SEC Historical Society.

The discussion addressed a number of issues. ...What is meant by principles-based and rules-based accounting standards? What are the characteristics of ideal accounting standards? How can ideal standards be achieved? When we talk about principles versus rules, do we have any idea what we are talking about? The reality is that preparers, auditors, investors and regulators all have different needs but they would like to see the same economic substance portrayed in a way that is most useful and most transparent. There’s a lot at stake in this debate.

One of the seminal events in the debate was the Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System. According to that Study, imperfections exist when standards are established on either a rules-based or a principles-only basis. "Principles-only standards may present enforcement difficulties because they provide little guidance or structure for exercising professional judgment by preparers and auditors. Rules-based standards often provide a vehicle for circumventing the intention of the standard. As a result of our study, the staff recommends that those involved in the standard-setting process more consistently develop standards on a principles-based or objectives-oriented basis."

In order to have a true principles-based accounting system, it isn’t just accounting standards that need to be written differently, but those applying the standards need to be thinking differently. There are implications for all parts of the financial reporting system, not just the writer of accounting standards. The term “objectives-based” or “objectives-oriented” recognizes that everybody has different views of what “principles-based” means. For example, a standard would set out the principles or objectives that the accounting for the particular item in the scope of that transaction is supposed to be looking towards. Then, those applying the standard would be charged with finding a method of accounting that is consistent with those objectives and principles.

...Yes, there might be implementation guidance but the purpose of the implementation guidance is to illustrate the principles and objectives, not to address specific fact patterns. An optimum amount of implementation guidance is going to require more judgment, more civil interchange with clients about what’s the best accounting and what’s the right answer. In this regard, those who look at the potential of a professional judgment framework as a panacea and those that look at it as a trap are misunderstanding the purpose of the judgment framework. The purpose is to get to better accounting answers, not to mandate a way to do things. It’s to help people who are applying accounting standards to make those judgments in an intelligent way.

To learn more about this debate, refer to the “Deloitte Fireside Chat – Part II: Exploring Principles vs. Rules-Based Accounting and Auditing Standards (October 28, 2009)” available as an Edited Transcript and as an Audio Recording on the SEC Historical Society website. Also, refer to the August 2011 postings on SEC Views on a Framework for Professional Judgment – Part 1, Part 2 and Part 3.

The Role of Professional Judgment in Accounting and Auditing - Deloitte Fireside Chats

The Deloitte Fireside Chats are made possible through a partnership between Deloitte LLP and the SEC Historical Society. On October 22, 2009, an interactive conversation explored the role of professional judgment in accounting and auditing. The session recognizes that the meaning of professional judgment and its application in accounting and auditing have become subjects of interest and discussion for standard setters, preparers, auditing professionals, investors, regulators, faculty and students.

Zoe-Vonna Palmrose, PricewaterhouseCoopers Auditing Professor and Professor of Accounting in the Marshall School of Business at the University of Southern California served as moderator. The two panellists were: Gregory Jonas, serving on the PCAOB Standing Advisory Group and a member of the SEC Advisory Committee on Improvements to Financial Reporting (CiFR); and RobertKueppers, Deputy CEO of Deloitte and a trustee of the SEC Historical Society.

The CiFR identified five concerns that a judgment framework could help. First, many re-statements have resulted from deemed errors in judgment. Second, regulators believed that there are many cases of unpersuasive or under-supported judgments being made by practitioners. Third, companies and auditors believed that, from time to time, regulators did not respect their reasonable judgments and they substituted the regulators’ personal preferences for reasonable judgments in requiring revisions to financial statements when citing audit deficiencies. In other words, there was some mistrust between preparers and auditors and, on the other hand, the regulatory community on the subject of judgment.

The fourth concern was confusion in practice as to what constitutes a persuasive judgment. In the auditing literature and the accounting literature, the profession has never addressed what are the qualities of a persuasive judgment. Fifth, there seems to be a demand for detailed rules as a substitute for professional judgment, which undermines the goal of principles-based standards. There is a defeatist, self re-enforcing bad loop of practice demanding ever more detailed rules, so that they won’t be second guessed by overseers about the quality of their judgments.

The CiFR suggested that a judgment framework could serve four goals. The first was to improve the quality and reliability of the judgments made in practice. The second was to improve an auditor’s confidence that regulators will indeed respect reasonable judgments. The third was to establish criteria for judgments and thereby reduce uncertainty about the characteristics of sound judgment. In other words, clarify what people are looking for from judgment. The fourth goal was to enable principles-based standards.

To learn more, refer to the “Deloitte Fireside Chat – Part I: The Role of Professional Judgment in Accounting and Auditing (October 22, 2009)” available as an Edited Transcript and as an Audio Recording (one hour) on the SEC Historical Society website. Also, refer to the August 2011 postings on SEC Views on a Framework for Professional Judgment – Part 1, Part 2 and Part 3.

One View on Using Professional Judgment

The meaning of professional judgment and its application in an audit environment continue to be subjects of interest and discussion by auditing and accounting faculty, students, standard setters, regulators and auditing professionals alike. As accounting frameworks continue to call for increased judgment by preparers of financial statements, the auditor assessing those judgments will, in turn, need to apply professional judgment.  An article published in 2009 offers one “view from the profession” about the meaning and importance of professional judgment, as well as one approach that may be employed when applying professional judgment.

The phrase “professional judgment” is not new to the accounting and auditing profession. Recently, there has been an increased emphasis on the importance of professional judgment as a result of regulation, standard setting, inspections and a move toward more principles-based accounting and auditing standards. In its August 1, 2008 report, the Advisory Committee on Improvements to Financial Reporting recognized the “need for a cultural shift towards the acceptance of more judgment” and recommended that both the SEC and PCAOB issue statements of policy articulating how the reasonableness of accounting and auditing judgments is evaluated. So, while professional judgment may not be a new concept, its use is becoming increasingly more vital to the appropriate application of accounting and auditing standards.

For details, read the American Accounting Association (AAA) article “Using Professional Judgment” by Guy Moore, Senior Advisory Partner for Professional Practice, Deloitte & Touche LLP in The Auditor’s Report publication online (Volume 33, No. 1, Fall 2009). Also, refer to the August 2011 postings on SEC Views on a Framework for Professional Judgment – Part 1, Part 2 and Part 3.

Chinese accounting reform: Towards a principles-based global regime

The Institute of Chartered Accountants of Scotland (ICAS) has long advocated the benefits of principles-based accounting standards. The success of such standards relies on the ability of accountants to make "good quality" judgments, but to those new to the profession or new to principles-based standards, making judgments can be difficult.

The need for appropriate guidance to help those making judgments and the need to develop a professional judgment framework became evident from earlier ICAS projects on principles-based accounting standards, particularly while undertaking interviews for the report Chineseaccounting reform: Towards a principles-based global regime (also available in Chinese). The report provides insight into China’s adoption of IFRS-based standards and broadens the principles versus rules debate beyond Canada, Europe and the United States.

The main objectives of the research project were: (1) to identify and highlight the achievements in the implementation of IFRS principles-based standards in China; (2) to identify and consider the issues to be addressed in the implementation of principles-based standards, with a focus on the experience in China; and (3) to assess the degree of support for principles-based standards in China, in order to influence the future development of IFRS. This 32-page report, published in June 2010, is available on the ICAS website, along with other pertinent financial reporting guidance publications.

Current Views on Principles versus Rules

The Institute of Chartered Accountants of Scotland (ICAS) published the research report Principles not Rules: A Question of Judgement in April 2006. Five years on, the ICAS hosted a conference in London on December 8, 2011 to debate the issues. In preparation for this event, a survey was issued to 4,965 ICAS members who had expressed an interest in corporate accounting and reporting. Replies were received from 335 members, a 7% response rate.

Survey findings show that there is strong support for a principles-based framework for financial reporting, with nearly 92% expressing a preference for principles with additional guidance. When asked where IFRS is currently positioned on the continuum of principles versus rules, 16% said it is very rules dominated and 56% said it is mainly rules. Compared to the situation five years ago, 67% said IFRS is now more weighted towards rules, 15% think there is no change and 18% think it is more weighted towards principles.

Survey respondents overwhelmingly believe that the impact of the financial crisis and the outstanding decision on US convergence will lead to more rules-based accounting standards in the future. On the positive side, most respondents believe that both preparers (89%) and auditors (84%) are capable of operating within a principles-based framework. The survey asked participants to rate 17 suggested barriers to principles-based accounting standards. The accompanying two exhibits show the five items that were rated the most significant barriers and the five items that were rated the least significant barriers.

 

Education and professional development of accountants are seen as crucial, as are strong ethical guidelines. In addition, the need for a change in mindset by regulators is seen as essential given that there may be a range of acceptable outcomes when professional judgment is exercised. Furthermore, there is a need for guidance to help put principles-based standards into operation, including the use of case studies to demonstrate the application of principles.

Overall, the survey results suggest that there is a need to ensure judgment remains the cornerstone of the accounting profession and financial reporting. For more information, read the research article “Principles or Rules?” in The CA Magazine, December 2011 (Volume 115, Number 1265), pages 90-91. For details, contact Michelle Crickett, ICAS Director of Research.

Principles not Rules: A Question of Judgement

The Institute of Chartered Accountants of Scotland (ICAS) published (in April 2006, updated July 2008) a research report called Principles not Rules: A Question of Judgement. The Introduction to this 27-page report was written by Hugh Shields, Chairman of the Working Group (Director and Head of Financial Reporting at Barclays Capital, a division of Barclays Bank). He states that: “The key to true and fair financial reporting is the balanced exercise of judgement. If standard setters, preparers, auditors and regulators could all exercise judgement on broadly equal terms, then this would provide the healthy tension which is needed for true and fair financial reporting and for communication with stakeholders.”

According to Shields, “Principles-based accounting standards are based on a conceptual framework, consist of a clear hierarchy of overriding principles and contain no ‘bright-line’ or anti-abuse provisions. Such an approach requires the use of judgement by preparers, auditors and regulators. ...With the safeguards afforded by such an approach, all parties should be more able to accept the consequences of exercising judgement in a principles-based accounting world.

“Against the above background, much greater simplicity in standard setting becomes possible. An interviewee in this project noted that: “Any accounting standard should be capable of being explained in one minute.” Yet some standards currently seem to defy any simple explanation at all. In the interests of all parties involved in financial reporting and, in particular, the broad range of users, such a situation should not be allowed to persist.”

Shields further notes that, “Einstein once said that ‘Everything should be made as simple as possible, but not simpler.’ This perfectly captures the Working Group's view that accounting standards should be firmly governed by high-level principles with only the absolute minimum additional guidance required to make the standard operational. Preparers and auditors would, therefore, need the courage to exercise and defend their judgements in this simplified accounting world. Users and regulators would need the wisdom to accept that there may be more than one answer and, over time, all parties would have to build the trust that this state of the world implies.”

A summary of 10 recommendations is presented in the report (page 3). A review of the professional, academic and regulatory literature on the principles versus rules debate in international accounting standard setting entitled Principles-Based or Rules-Based Accounting Standards? A Question of Judgement is available on the lCAS website. Also available is the output from the financial instrument workshop sessions Principles not Rules: Report on Proceedings of Financial Instrument Workshops.

Should Professional Judgment be a Pillar of Accounting Education?

Chartered Accountants (CAs) practice in a wide variety of fields. For example, they may be auditors of publicly-traded corporations, advisers to privately-held organisations, CFOs (overseeing treasury, financing and strategic investment decisions), IT consultants, corporate finance advisers, tax specialists, forensic accountants, accounting professors, controllers (managing performance measurement and control systems), internal audit directors, government financial officers and insolvency practitioners. Each of these careers requires different competencies and implies the application of professional judgment in a multitude of different contexts.

The diversity that one encounters within the accounting profession raises several questions for which answers are not necessarily forthcoming. For example, do these different career streams require different sets or portfolios of cognitive skills? Do these career streams demand similar or distinct levels of cognitive skills? Moreover, does the optimal configuration between specific expertise and cognitive skills differ across these career streams? In that regard, the advent of articling within business organizations as an alternative to accounting firms is likely to bring further broadening in the range of careers and experiences of professional accountants.

Judgment and expertise in professional accounting have been topics of interest for many decades. Both concepts share many commonalities as judgment is the most evident outcome from expertise, while expertise is required to exercise judgment. However, both concepts can also be considered to be multi-dimensional. Two key aspects that underlie professional judgment in accounting are 1) relevant knowledge and experience so that 2) a choice must be made between alternatives.

In summary, we have learned a lot over the past two decades about professional judgment and expertise, but there remains some uncertainty as to what they are, as well as how and when to develop them. It appears that the development of professional expertise and judgment through generic learning processes may not be optimal. The literature also raises questions as to whether university education is necessarily the best time to provide such professional judgment and expertise abilities.

The preceding views are adapted from the discussant’s comments “Further Developing Professional Attributes in CAs: An Impossible Challenge?” by Michel Magnan, PhD, FCA, Concordia University, in response to the presentation “Teaching the Fine Arts of Being a Professional Accountant” by Susan Wolcott, PhD, CPA. Both the presentation and the discussant’s comments were part of the November 22, 2010 symposium Leveraging Change - The New Pillars of Accounting Education which was held in Toronto, Canada. The pillars of accounting education include: professional judgment; professional and personal attributes; accounting principles and concepts; ethical decision making; and integration.

(For more information on this symposium, contact Irene Wiecek, FCA, at the University of Toronto and/or Tim Forristal, CA, or Gord Beal, CA, at the Canadian Institute of Chartered Accountants (CICA). Refer to the CICA website for more information on What Do CAs Do?)

SEC Views on a Framework for Professional Judgment – Part 3 of 3

According to the US Securities and Exchange Commission (SEC) Committee on Improvements to Financial Reporting (“CiFR”) accounting judgments should be based on a critical and reasoned evaluation made in good faith and in a rigorous, thoughtful and deliberate manner. Preparers should have appropriate controls in place to ensure adequate consideration of all relevant factors (see Final Report, pages 88-96).

Factors applicable to the making of an accounting judgment include the following:

·       the preparer’s analysis of the transaction, including the substance and business purpose of the transaction;

·       the material facts reasonably available at the time that the financial statements are issued;

·       the preparer’s review and analysis of relevant literature, including the relevant underlying principles;

·       the preparer’s analysis of alternative views or estimates, including pros and cons for reasonable alternatives;

·       the preparer’s rationale for the choice selected, including reasons for the alternative or estimate selected and linkage of the rationale to investors’ information needs and the judgments of competent external parties;

·       linkage of the alternative or estimate selected to the substance and business purpose of the transaction or issue being evaluated;

·       the level of input from people with an appropriate level of professional expertise;

·       the preparer’s consideration of known diversity in practice regarding the alternatives or estimate;

·       the preparer’s consistency of application of alternatives or estimates to similar transactions;

·       the appropriateness and reliability of the assumptions and data used;

·       the adequacy of the amount of time and effort spent to consider the judgment.

When considering these factors, it would be expected that the amount of documentation, disclosure, input from professional experts, and level of effort in making a judgment would vary based on the complexity, nature (routine versus non-routine), and materiality of a transaction or issue requiring judgment. Material issues or transactions should be disclosed appropriately. Existing disclosure requirements should be sufficient to generate transparent disclosure that enables an investor to understand the transaction and assumptions that were critical to the judgment. In addition, when evaluating the reasonableness of a judgment, regulators should take into account the disclosure relevant to the judgment. 

It is imperative that the alternatives considered and the conclusions reached should be documented contemporaneously. This will ensure that the evaluation of the judgment is based on the same facts that were reasonably available at the time the judgment was made. The lack of contemporaneous documentation may not mean that a judgment was incorrect, but would complicate an explanation of the nature and propriety of a judgment made at the time of the release of the financial statements.

SEC Views on a Framework for Professional Judgment – Part 2 of 3

According to the US Securities and Exchange Commission (SEC) Committee on Improvements to Financial Reporting (“CiFR”), there are many categories of accounting and auditing judgments that are made in preparing financial statements. Any guidance should encompass all of these categories, if practicable (see Final Report, pages 88-96).

Some of the categories of accounting judgment are as follows:

·       selection of accounting standard;

·       implementation of an accounting standard;

·       lack of applicable accounting standards;

·       financial statement presentation;

·       estimating the actual amount to record; and

·       evaluating the sufficiency of evidence.

In addition, there are many levels of professional judgment that occur related to accounting matters. Preparers must make initial judgments about uncertain accounting issues; the preparer’s judgment may then be evaluated or challenged by auditors, investors, regulators, legal claimants and even others, such as the media. Guidance should not suggest that those who evaluate a judgment must re-perform the judgment according to the guidance. Instead, guidance should provide clarity to those who would make a judgment on factors that those who would evaluate the judgment would consider while making that evaluation.

Judgment, with respect to accounting matters, should be exercised by a person or persons who have the appropriate level of knowledge, experience, and objectivity to form an opinion based on the relevant facts and circumstances within the context provided by applicable accounting standards. Judgments could differ between knowledgeable, experienced, and objective persons. Such differences between reasonable judgments do not, in themselves, suggest that one judgment is wrong and the other is correct.