Professional Judgment in Auditing:

Professional Judgment Frameworks as Teaching Tools

John D. KeyserNational Director of Assurance ServicesMcGladrey LLP

Douglas F. PrawittGlen Ardis Professor of AccountancyBrigham Young University

Jason L. Smith (Moderator)Associate Professor of AccountingUniversity of Nevada, Las Vegas

AgendaTopic Time

Introduction to two Frameworks: KPMG, McGladrey

20 minutes

What is happening in the Profession 15 minutes

Integrating Professional Judgment into the Classroom

15 minutes

Q&A 10 minutes

Why focus on Professional Judgment?

Increased emphasis on judgment in accounting & auditing Principles-based accounting and auditing

standards Movement toward fair value accounting Etc.

Increased importance of ability to exercise effective professional judgment, professional skepticism

Professional Judgment:What it looks like, and common threats

The KPMG Professional Judgment Framework

The KPMG Professional Judgment Framework

7

Steps in the judgment process

8

Polling Question 1 (CPE Credit)

Within an auditing context, what is professional judgment?

a) Professional judgment is the process of using relevant training, knowledge, and experience to reach a decision or draw a conclusion in evaluating evidence, estimating probabilities, or selecting between options.

b) Professional judgment is professional skepticism, which is an attitude that includes a questioning mind and a critical assessment of audit evidence.

c) Professional judgment is the application of one’s experience to make a judgment in the absence of supporting evidence, based on the facts and circumstances of the audit engagement.

d) Professional judgment is the construction of a logical justification to support an outcome or conclusion that is otherwise not supported by the available evidence.

The McGladrey Professional Judgment Framework

McGladrey Professional Judgment Framework

Steps in McGladrey Judgment Process

13

Step 1 - Frame the Issue

Consider other perspectives and the implications of those views:

Regulator, manager, user Error vs. fraud Owner, lender, investor, legal, insurer,

customer, audit committee How might a judgment look in the future

with the benefit of hindsight, assuming various outcomes?

Steps in McGladrey Judgment Process

15

Step 2 - Determine Objectives

Determine Objectives: What is wanted or needed?

Ask how you would justify a judgment or decision

Are you comfortable at a gut level moving ahead with a judgment process?

Step 2 - Identify Alternatives A decision or judgment can only be as

good as the best alternative considered Common Pitfalls:

Consider only typical or first alternative that comes to mind

Do the same thing as prior year Decision “triggers”—an alternative

masquerading as a problem or “issue” to be solved

Steps in McGladrey Judgment Process

Steps in McGladrey Judgment Process

Steps in McGladrey Judgment Process

Fundamental Elements of Professional Judgment Framework

Apply Relevant Knowledge and Learn from Experience Professional knowledge is brought to bear

and reflection on experiences allows for enhanced professional judgment going forward

Professional Skepticism As depicted the judgment process is performed with a

mindset characterized by professional skepticism

Potential Frames Judgments are informed through explicit consideration

of different perspectives or “frames”

Polling Question 2 (CPE Credit)

Which of the following statements about judgment frames is correct?

a) A situation cannot have more than one appropriate frame.

b) There is often no single best frame for a given situation.

c) Frames are not used by risk averse individuals.

d) Professionals should eliminate the use of frames from their judgment processes.

Judgment Biases

Factors Affecting Judgment

External factors

• Time pressure• Limited

resources• Client,

regulatory, industry

Internal factors

• Limitations due to judgment “frames”

• Judgment short-cuts

• Bias caused by self interest

• Judgment traps• Rush to “solve”

Reality - Descriptive

Bounded Rationality Lack important information Time and cost constraints Limited memory capacity Limitations on intelligence and

perceptions

What we do: Systematic shortcuts System 1 (quick) and Satisfice Heuristics

We use simplifying judgment strategies. Rules of thumb developed over time because of our bounded rationality.

Examplecrossing the street in New York…

Paradox

Our minds routinely solve problems too difficult for the mightiest computers, but we also make errors in the simplest of judgments about everyday events

Judgment Tendencies

Overconfidence: Tendency to be overconfident in our judgment abilities

Availability: Tendency to judge likelihood of events by how readily available specific examples are in our memory

Anchoring: Tendency to insufficiently adjust away from an initial anchor

Confirmation: Tendency to seek and overweight confirming evidence

27

A Pervasive Judgment Tendency…

Overconfidence Bias

Most of us are overconfident in our judgment abilities and do not acknowledge the actual level of uncertainty that exists.

Overconfident Experts

“Heavier-than-air flying machines are impossible”

“They couldn’t hit an elephant at this dist…”

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What’s So Bad About Overconfidence?

Overconfidence Can Lead To: Taking on too many projects Over promising on deadlines Considering only one alternative Truncating information search or even

skipping evidence gathering Snap judgments Avoidance or poor execution of judgment

model

Confirmation Tendency

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We tend to have preferences We tend to seek confirming evidence We give confirming evidence greater weight than

disconfirming evidence We often cannot know something to be true

without checking to see how it might be false

What is Happening in the Profession with Respect to Enhancement of Professional Judgment?

Goals of McGladrey Professional Judgment Initiative

Shared frame of reference, common vocabulary

Enhance the ability of audit professionals to consistently exercise quality judgment

Enhance on-the-job training/coaching during engagements

Build confidence to exercise professional judgment effectively and efficiently

McGladrey Training

Timing Course Name Audience

Summer 2012 Introduction to the Framework

Partners, Managers, In-charges

Fall 2012 Professional Judgment in the Trenches

All

Spring 2013 Professional Judgment Self-study

New hires and those needing refresher

Summer 2013 Fraud and the McGladrey PJF

Partners, Managers, In-charges

Analytical Procedures In-charges

Summer 2014 Auditing Accounting Estimates under the McGladrey PJF

Partners, managers, in-charges

Ongoing Infuse into all courses Various

McGladrey – Other Efforts

Consultation forms Practice aids Interoffice inspection

CAQ

Working Group Member firms participate

Professional Judgment Thought Leadership

Description of a judgment process Discussion of common traps and biases

Polling Question 3 (CPE Credit)

The confirmation bias is a subconscious tendency to do which of the following?

a) Seek evidence that confirms a biased judgment

b) Seek evidence that confirms a previously held view

c) Underutilize confirmations in the testing of accounts receivable

d) Seek evidence that disconfirms a previously held view

Integrating Professional Judgment into the Classroom:

Can Accounting Students Learn Professional Judgment in the Classroom?

Can You Really Teach Good Judgment?

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Is it a natural ability or a skill that can be developed?

True or False: Either you have it or you do not…

Good News! It is a skill that can be learned and developed It helps to know what “good judgment” looks like and

the common threats to good judgment The sooner you start learning how to make good

professional judgments, the better!

Factors in Developing the Ability to Exercise Good Professional Judgment

40

Do you agree the following factors contribute to the development of good judgment? Natural ability Personal experience Observing others including mentors Self-studies/books

AND… Formal training

How does a visual illusion relate to judgment?

41

Source: http://www.michaelbach.de/ot/sze_shepardTables/index.html

GRAPHIC OF GOLF SWINGGRAPHIC OF GOLF SWING

The KPMG Professional Judgment Framework

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Practice makes permanent

44

Phil Mickelson Golf Swing

Threats to good judgment

45

Not following a good process Judgment “traps” and “biases” Mental shortcuts

Help simplify a complex situation Can facilitate more efficient judgments USUALLY effective

The purpose and benefits of the topic

46

Mindset, skills, and techniques behind good judgment begin to form at a young age

Training, deliberate practice, and experience can improve judgment

It is important for students to have a solid foundation in good judgment

How does awareness help with this illusion?

47

Source: http://www.michaelbach.de/ot/mot_mib/index.html

KPMG Professional Judgment Framework Monograph

aud it

Elevating Professional Judgment in Auditing

and Accounting:

The KPMG Professional Judgment Framework

kpm g.com

McGladrey Monograph

Polling Question 4 (CPE Credit)

You just cannot teach professional judgment; either you have it or you do not.

a)True

b)False

Q&A