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See\tdiscussions,\tstats,\tand\tauthor\tprofiles\tfor\tthis\tpublication\tat:\thttps://www.researchgate.net/publication/258340692 Elevating\tProfessional\tJudgment\tin\tAuditing\tand Accounting:\tThe\tKPMG\tProfessional\tJudgment Framework ARTICLE\t\tJANUARY\t2011 CITATIONS READS 3 1,448 5\tAUTHORS,\tINCLUDING: Douglas\tF.\tPrawitt Brigham\tYoung\tUniversity\t-\tProvo\tMain\tCam... 39\tPUBLICATIONS 452\tCITATIONS SEE\tPROFILE Available\tfrom:\tSteven\tM.\tGlover Retrieved\ton:\t30\tJanuary\t2016 a | Elevating professional judgment in auditing audit Elevating Professional Judgment in Auditing and Accounting: The KPMG Professional Judgment Framework kpmg.com i | Elevating Professional Judgment in Auditing and Accounting Contents Preface: ii One: Can you really teach professional judgment? 1 Two: Judgment: What it looks like and common threats 4 Three: Judgment framing: The stuff of professional skepticism 16 Four: It's a fact: Your typical judgment processes can lead to bias 22 Five: Give me hope: How to recognize and reduce judgment bias 31 Six: What about judgment in groups? 38 Seven: Coaching, reflection, and conclusion 43 Appendix 1 46 Appendix 2 48 Suggested solutions to end of chapter questions 50 Author biographies 55 Elevating Professional Judgment in Auditing and Accounting | ii Preface Unlike the professional judgments that made the difference between tragedy and success-the tragedy of the Challenger space shuttle and the heroics of Apollo 13, judgments that auditors make do not affect life and death outcomes. They, nevertheless, can be consequential to the continued viability of organizations, the livelihoods of the people employed by them, and the investors who rely on themnot to mention the effectiveness and efficiency of our capital markets. Audit judgmentsboth big and small matter. It matters, then, how well or poorly such judgments are made. Those individuals, teams and organizations known for making good judgments will distinguish themselves in the professional services marketplace. At the same time, the effects of challenging economic times, increased use of fair value measurements, and everexpanding regulations, among other things, have raised the threshold for what is considered effective judgment and decision-making skills. Because the demand for these skills is increasing, auditors must adapt to the changing environment. To help keep pace with this change, KPMG launched an initiative two years ago to enhance the professional judgment and professional skepticism of its people and teams. KPMG collaborated with two professors at Brigham Young University to emphasize these skills in its training. The result of this effort is refreshed professional judgment content throughout KPMG's audit training curriculum for all levels of audit professionals. KPMG has committed itself to keep this training content currenta necessary step to keeping its professionals engaged and aware of the need to continuously improve their own skills and those of their audit engagement teams. KPMG will continue to monitor this ongoing program to understand the impact this training is having on its professionals and how their professional judgment skills are impacting their audit activities. iii | Elevating Professional Judgment in Auditing and Accounting KPMG is now taking the important step of sharing and leveraging the content we have created with the key stakeholder groups that are essential to KPMG's success as a public accounting firm, including the academic community. We believe that the mindset, skills, and techniques behind good judgment begin to form at a young age-and can be taught and improved with experience and practice. We think it is critical that accounting and auditing students receive a strong foundation in the fundamentals of professional judgment. This is why KPMG has made this investment to develop and share this monograph with business and accounting schools, the primary suppliers of audit talent to the public accounting profession. We start the monograph by introducing the KPMG Professional Judgment Framework, which includes a process for what auditors should do when making important professional judgments. The monograph also: Presents simple, but powerful, principles that help overcome common threats to good judgment and that enhance your professional skepticism. Covers several common judgment tendencies and how they can lead to biased judgments, and offers techniques to overcome or reduce the potential impact of these biases. After laying a foundation for individual judgments, we consider common threats to good judgment in groups, and the techniques that can improve the quality of group judgments. We close with a brief conclusion and a review of important \"takeaways\" from the monograph. KPMG is committed to sustaining an ongoing dialogue about professional judgmentwith its own people and with major stakeholders. KPMG believes that engaging with the academic community is a key way to do this-and hopes the monograph proves an effective vehicle to accomplish that goal. We gratefully acknowledge the valuable input and feedback we received in the course of completing this monograph from numerous individuals, including Lisanne Biolos, Matt DeWald, Marty Finegan, Mike Reavis, Heather Ziegler and many others in Audit Learning and Development. We also want to recognize the many KPMG professionals who shared their insights and stories with us over the past few years as we developed our professional judgment initiative at KPMG. It is their enthusiastic response that convinced us that the KPMG Professional Judgment Framework and the commitment to continuous improvement makes a difference in the quality of the services we provide. Sam Ranzilla National Managing Partner of Audit Quality and Professional Practice, KPMG LLP Rob Chevalier Partner, KPMG LLP George Herrmann Partner, KPMG LLP Steve Glover Professor, Brigham Young University Doug Prawitt Professor, Brigham Young University Elevating Professional Judgment in Auditing and Accounting | 1 Chapter One Can you really teach professional judgment? Introduction As you prepare for a professional career, have you ever wondered what characteristics distinguish an exceptional professional from one who is just average? One key distinguishing feature is the ability to consistently make high-quality professional judgments. Professional judgment, which is the bedrock of the accounting and auditing professions, is referenced throughout the professional literature. For example, auditing standards require \"the auditor to exercise professional judgment in applying them\" (AU 150.04). In some of your accounting or auditing classes, you may have had an instructor respond to a question with the classic answer, \"That depends; it is a matter of professional judgment. This is often true in auditing, but it is \" not overly satisfying to a student who wonders exactly what good professional judgment looks like, or how he or she can develop the ability to make good professional judgments. The purpose of this monograph is to help you understand what a good professional judgment process looks like, make you aware of common threats to exercising good judgment, and give you a head start in developing and improving your own professional judgment abilities. Ironically, even though we all constantly make judgments and decisions, most of us receive very little formal training in how to make good judgments. While many of the judgments we make on a daily basis are relatively easy and not terribly important, we also make difficult and important judgments. Many people have a hard time making judgments at allsome prefer to put off judgments until they are absolutely necessary. But such an approach can reduce the alternatives that are available and limit the quality of the ultimate judgment. 1 \u0007The KPMG Professional Judgment Framework, related training materials, and this monograph were developed with the help of two professors from Brigham Young University, Steven Glover and Douglas Prawitt. Professors Glover's and Prawitt's research focuses on the judgment and decision making of accounting and auditing professionals, and they have taught graduate (MBA) courses on effective judgment and decision making for many years. A common question people have is, \"Can you really teach good judgment?\" Many believe that it is a gift; either you have it or you do not. Others would say you cannot teach good judgment; rather, it must be developed through the \"school of hard knocks\" after many years of experience. There is no question that talent and experience are important components of effective professional judgment, but we at KPMG LLP (KPMG) are convinced it is possible to enhance your professional judgment skills through learning and applying some key concepts. As with other important skills, the sooner you start learning how to make good professional judgments, the betterwhich is why KPMG is pleased to produce this monograph for the next generation of professionals. Research in the areas of judgment and decision making over the last few decades indicates that additional knowledge about common threats to good judgment together with tools and processes for making good judgments can improve the professional judgment abilities of both new and seasoned professionals. With the movement in financial reporting toward more principlesbased standards and more fair value measurements, exercising good professional judgment is increasingly important for auditors. To elevate the professional judgment and professional skepticism of its auditors, KPMG developed a Professional Judgment Framework, which is discussed in Chapter 2. The KPMG Professional Judgment Framework provides auditors with a judgment process and a common vocabulary for understanding the components of good judgment and recognizing the threats to good judgment. KPMG recognizes that people who consistently and confidently make highquality judgments will distinguish themselves as audit professionals.1 2 | Elevating Professional Judgment in Auditing and Accounting Mental shortcuts In Chapter 2, we will discuss what good judgment looks like, or what it should look like. In reality, people often do not follow a good process due to common judgment traps and tendencies that can lead to bias. These traps and tendencies are systematicin other words, they are common to most people, and they are predictable. Some of these tendencies are judgment \"shortcuts\" that help simplify a complex world and facilitate more efficient judgments. These shortcuts are usually quite effective, but because they are shortcuts, they can lead to systematically biased judgments. As a simple illustration of how our mental processes that normally serve us very well can sometimes lead to bias, consider the two tabletops pictured below.2 At first glance, do the tops of the tables appear to be the same shape? If you are like most people, your intuitive judgment tells you the shapes are quite different. The table on the left appears elongated, less square than the table on the right. Our eyes and related perceptual skills ordinarily are quite good at perceiving and helping us to accurately judge shape similarity. However, despite appearances, the tabletops above are, in fact, identical in shape. In order to supplement your perceptual intuition, you can introduce rational or analytical tools (such as measuring or tracing), thereby convincing your rational mind that the tabletop shapes are identical. Just as with this illustration of a perceptual bias, there are times when our intuitive judgment falls prey to systematic traps and biases. While the tabletop example illustrates a perceptual bias, research provides convincing evidence that even the smartest and most experienced people similarly fall into predictable judgment traps and biases. 2 S \u0007 ee Shepard 1990. Picture adapted from \"Turning the tables\" www.michaelbach.de/ot/sze_shepardTables/index.html. To find similar examples, search the Internet for \"Shepard tables. \" Unfortunately, when it comes to these traps and biases, experience is not always the best teacher. However, the good news is that once we are aware of traps and biases, we can deploy logical steps to reduce their impact and improve judgment. Does practice make perfect or permanent? As with other skills, such as painting, snowboarding, golfing, or delivering effective speeches, our judgment can be improved by learning new knowledge and skills. Often, when learning a difficult activity, our natural tendencies can lead to bad form and bad habits. For example, if you have never golfed before, simply buying a set of clubs and then playing golf using your natural swing and intuition is unlikely to deliver the desired results, no matter how much repetition and experience. Practice makes permanentnot necessarily perfect! However, a person interested in improving his or her golf swing can get training, which might involve lessons on swing fundamentals and an analysis of the person's current swing compared to that of a professional golfer. With an understanding of common swing flaws and proper swing fundamentals and \"swing thoughts, together with some \" practice, it is possible to retrain the body and mind to achieve an improved golf swing. Similar to any ability that we want to improve, enhancing our ability to consistently make high-quality judgments takes effort. At first, a revised golf swing, or a revised judgment process, may seem awkward and cumbersome. Elevating Professional Judgment in Auditing and Accounting | 3 But with practice, the newly learned fundamentals become a natural part of what we do. It is important to note that in golf, a new, improved swing does not take any more time than the old swing. In fact, the new swing should ultimately save the golfer time during a round of golf, as he or she does not spend as much time tracking down errant shots. Similarly, an improved judgment process will not take much more time than your old process, and it can actually be much more efficient because you will be less likely to invest effort in trying to solve the wrong problem, gathering unnecessary information, or cleaning up a judgment mess that might result from falling prey to the common traps and biases you will be learning about in later chapters. we provide a summary of the steps to a judgment process and important considerations and threats common to each step. In Appendix 2, we provide a list of additional resources if you are interested in learning more in the area of judgment and decision making. The materials in this monograph including the end of chapter questions, illustrative vignettes, and the Professional Judgment Framework are based on materials KPMG uses in its professional training. Snapshot of what is in this monograph In Chapter 2, you will learn about the KPMG Professional Judgment Framework, which includes a process for what we should do when making important professional judgments. The bulk of the monograph, however, will help you understand what we typically do when making judgments. This contrast will help you understand how our typical approaches and processes are often different from what they should be. We will also discuss some simple, but powerful, principles regarding how to overcome common threats to good judgment. Chapter 2 will introduce you to some common traps that can lead to suboptimal judgments. In Chapter 3, you will learn about how to boost your professional skepticism by overcoming a common tendency to only consider one perspective or \"judgment frame. Chapter 4 will cover several common judgment \" tendencies and how they can lead to biased judgments. Chapter 5 will address techniques to overcome or reduce the potential impact of these biases. The first five chapters largely focus on individual judgments. In Chapter 6, we consider common threats to judgment in groups and techniques that can improve the quality of group judgments. Chapter 7 provides a brief conclusion and a review of important \"take-aways\" from the monograph. We believe that you will find this journey through the essential elements of sound professional judgment, including common traps and biases, interesting and insightful. In Appendix 1 at the end of the monograph, End of chapter questions 1. What is the primary purpose of this monograph? 2. How do perceptual biases relate to judgment biases? 3.\t\u0007 True or False: You just cannot teach judgment; either you have it or you do not. 4 | Elevating Professional Judgment in Auditing and Accounting Chapter Two Judgment: What it looks like and common threats Judgment defined Unbiased Consistent and reliable Before we get to what makes a judgment process good or bad, let's start with a common definition of judgment: Appropriately balances experience with knowledge, intuition, and emotion Judgment is the process of reaching a decision or drawing a conclusion where there are a number of possible alternative solutions.3 Uses the right amount of relevant information, including professional literature and evidence A judgment process that includes the components noted above could be used for small, less important judgments, as well as difficult, very important judgments. Of course, we do not need to invest significant time or effort when making easy or trivial judgments. However, as the judgments become more important and more difficult, it is helpful to have a framework to help guide our judgment process. The elements of good judgment noted above are built into KPMG's Professional Judgment Framework. Unfortunately, following a good process will not make hard judgments easy or always guarantee a good outcome, but a well-grounded process can improve the quality of judgments and help auditing professionals more effectively navigate through complexity and uncertainty. Judgment occurs in a setting of uncertainty and risk. In the areas of auditing and accounting, judgment is typically exercised in three broad areas: Evaluation of evidence (e.g., does the evidence obtained from confirmations, combined with other audit evidence, provide sufficient appropriate audit evidence to determine whether accounts receivable is fairly stated) Estimating probabilities (e.g., determining whether the probability-weighted cash flows used by a company to determine the recoverability of long-lived assets are reasonable) Deciding between options (e.g., audit procedure choices, such as inquiry of management, inspection, or confirmation) Components of judgment When you think of someone who seems to consistently exercise good judgment, what characteristics or components of judgment does this person demonstrate? In considering this, you may come up with a list something like the following: Logical Flexible 3 M \u0007 aking judgments can be distinguished from making decisions. Decision making involves the act of choosing among options or alternatives, while judgment, according to Webster's 11th, involves \"the process of forming an opinion or evaluation by discerning and comparing. Thus, judgment is a subset of the \" process of decision makingmany judgments are typically made in coming to a decision. However, for simplicity in this monograph, we often refer to the combined processes of judgment and decision making as \"judgment, \"professional \" judgment, or \"making judgments. \" \" Elevating Professional Judgment in Auditing and Accounting | 5 KPMG Professional Judgment Framework In the figure below, you will see the KPMG Professional Judgment Framework. The Framework includes a number of components, such as mindset, consultation, knowledge and professional standards, influences and biases, reflection, and coaching. At the core of the Framework, you will see a five-step judgment process. The KPMG Professional Judgment Framework ENVIRONMENT Influences/Biases Reflect on Previous Experience Reflect on Lessons Learned 1 5 4 Reach Conclusion Mindset Co nsultatio n Articulate & Document Rationale Coaching 3 Clarify Issues & Objectives 2 Consider Alternatives Gather & Evaluate Information Strategies for Avoiding Traps and Mitigating Bias Knowledge/Professional Standards The steps in the process may not appear overly surprising to you; they may even seem rather simple and intuitive. However, while the KPMG Professional Judgment Framework provides a good representation of the process we should follow when applying professional judgment, it is not necessarily an accurate representation of the processes people follow consistently. The reason that formal steps in the judgment process do not capture how we always make judgments is that the model assumes that we always properly define the important issues and objectives, consider all appropriate alternatives, gather the right amount (quantity) and type (quality) of information, and then properly weight the consequences of each alternative so that we can arrive at the optimal judgment. The reality is that in a world of pressure, time constraints, and limited capacity, there are a number of judgment traps we can fall into. In addition, \" The Framework includes a number of components, such as mindset, consultation, knowledge and professional standards, influences and biases, reflection, and coaching. \" Coaching 6 | Elevating Professional Judgment in Auditing and Accounting Chapter Two we can be subject to biases caused by self-interest or by unknowingly applying mental shortcuts. KPMG recognizes that with the move toward a more principles-based financial reporting framework and increased emphasis on fair value measurement, consistently making quality professional judgments is increasingly important. Auditors face a number of challenges in making those professional judgments. For these reasons, KPMG developed the Professional Judgment Framework. The Framework and related training are designed to provide three primary benefits: 1.\tTo enhance the professional judgment and professional skepticism abilities of our auditors. 2.\tTo provide our auditors a tool to follow to facilitate good judgments in a more consistent manner. A shared understanding of the steps in a judgment process, as well as an awareness of traps and biases that threaten judgment, provide a common vocabulary for auditors and facilitates coaching around good judgment skills. 3.\tTo enhance audit documentation associated with exercising professional judgments. The Professional Judgment Framework assists in the development of audit documentation that provides evidence of professional skepticism in our judgments. The Professional Judgment Framework depicts constraints, influences, and biases that threaten good judgment with the box on the outer rim of the Framework labeled \"Environment\" and the triangle at the top labeled \"Influences/Biases. At the bottom of the Professional \" Judgment Framework, you will see Knowledge and Professional Standards, as these factors are foundational to quality judgments. In this chapter, we will discuss the Environment and some of the influences that can affect professional judgment. In subsequent chapters, we will highlight common judgment tendencies and the associated biases that can influence auditor judgment. In Chapter 7 we , will discuss the \"ribbon\" of coaching and reflection running through the Framework. Where is professional skepticism in the Professional Judgment Framework? The terms professional judgment and professional skepticism often go together in discussions about obtaining audit evidence or evaluating support for management's accounting estimates. Professional skepticism is not separately noted 4 AU 230.07 Due Professional Care in the Performance of Work. , in KPMG's Professional Judgment Framework, so you might wonder where this essential concept comes into play. Consider the following question: Which of the following best describes the relationship between professional skepticism and professional judgment? a.\tProfessional skepticism is an objective attitude that includes a questioning mind and a critical assessment of audit evidence. It is synonymous with professional judgment. b.\tProfessional skepticism is an objective attitude that includes a questioning mind and a critical assessment of audit evidence that is an important part of the professional judgment process. Professional skepticism is an objective attitude that includes a questioning mind and a critical assessment of audit evidence. Professional skepticism is not synonymous with professional judgment, but rather, it is an important component or subset of professional judgment.4 Thus, the correct answer to the question above is \"b. Professional skepticism helps to \" frame our \"mindset, which is at the center of the KPMG \" Professional Judgment Framework. It is essential, for example, that the auditor applies professional skepticism in evaluating management projections to be used in a goodwill impairment analysis. However, the overall determination of whether or not, in the auditor's view, goodwill has been impaired is a matter of professional judgment. Wrapping around \"mindset\" in the Framework is \"consultation. At KPMG, we make sure our professionals \" understand that one way to boost their professional skepticism is to consult with others, including engagement team members, specialists, or other professionals. In Chapter 3, we revisit professional skepticism and talk about other ways you can enhance your ability to effectively apply professional skepticism in your judgments. Environment and judgment traps The outer rim of the KPMG Professional Judgment Framework is \"Environment. Partners, managers, and others on the audit \" engagement team influence the environment in which audit judgments are made. It is important to create an atmosphere that facilitates good judgment. For example, at KPMG, we work hard to foster an environment characterized by open communication so that team members at all levels are comfortable speaking up when they have information that is Elevating Professional Judgment in Auditing and Accounting | 7 relevant to a particular judgment. Our environment fosters input and involvement from all team members, even the newest staff, to encourage openly sharing information and perspectives crucial to exercising good professional judgment. For example, KPMG utilizes a Risk and Audit Quality Assessment (RAQA) process in conjunction with the execution of its audit engagements. RAQA is an overall risk and quality assessment process whereby the audit engagement team discusses and reassesses, based on audit procedures performed and evidence obtained, whether all risks of material misstatement have been identified and assessed, and whether the audit engagement team has designed and performed audit procedures whose nature, timing, and extent are responsive to the assessed risks. RAQA meetings are held at various times throughout the audit process and are predicated on the insights, observations, and assessments of the members of the audit engagement team. The chart below lists other internal and external factors that influence the judgment context. Some elements of the judgment environment are within our control and some are not. For example, significant time pressure poses the risk of lowering the quality of judgments. We may not always be able to completely control the degree of time pressure we face, but often we can reduce the impact of time pressure on a work project, including audit engagements, through effective planning. Environmental Factors Affecting Judgment External Factors: Time pressure Limited resources Client, regulatory, industry 5 The video is a Statoil advertisement. Internal Factors: Judgment traps - Rush to solve - Judgment triggers Judgment shortcuts Self-interest In terms of internal factors, we want to highlight the first of the judgment traps, which is the \"rush to solve.\" One of the most common judgment traps is the tendency to want to immediately solve a problem by making a quick judgment. As a result, we under-invest in the important early steps in the judgment process and often go with the first workable alternative that comes to mind or that is presented. As a result of the rush-to-solve trap, we sometimes end up solving the wrong problem, or we settle for a suboptimal outcome because we did not consider a full set of alternatives. Beware of the Judgment Trap: Rush to Solve For an illustration of solving the wrong problem, follow this link or go to YouTube and search for the \"Car Ice Scraping Gone Wrong. 5 This video provides a humorous illustration \" of solving the wrong problem and highlights the need to properly clarify the issue or problem addressed. We've all likely experienced situations where we've invested time working on the \"wrong\" problem, and we know it can be a real time waster. Most of the time, we do not even realize when we fall into the trap of \"rushing to solve\" because the trap involves not \"seeing\" the issues clearly. As a result, we have a limited view of the issues that are involved and the alternatives that are available to us. The fact that we frequently but unknowingly fall into this trap explains, in part, why experience in making judgments is not always the best teacher. Research in cognitive psychology has demonstrated that our judgments tend to be influenced subconsciously by biases related to self-interest and by the use of mental shortcuts. In this chapter, we walk through the KPMG Professional Judgment Framework and highlight the most common judgment traps. In later chapters, we focus our attention on some of the most basic, common biases that can affect professional judgment. We will also offer some techniques that can help you to avoid the traps and eliminate or reduce these predictable, systematic biases. 8 | Elevating Professional Judgment in Auditing and Accounting Steps in the judgment process At the center of the KPMG Professional Judgment Framework are the steps to follow in making effective professional judgments. We will discuss each of the steps together with some of the common threats to good judgment. One of the most significant benefits of the KPMG Professional Judgment Framework is that it provides our audit teams with a common vocabulary that they can use to discuss how to improve judgment and how to avoid common judgment traps and biases. Active and repeated application of a judgment process like the one below also will help you to make higher-quality judgments and will help you integrate the components of good judgment into your everyday judgment approach.6 5 Articulate & Document Rationale 1 Clarify Issues & Objectives 4 Reach Conclusion 2 Consider Alternatives 3 Gather & Evaluate Information Step 1 Clarify Issues: At the beginning of a judgment process, we clarify the issue, or in other words, we clearly define \"what\" is being solved. If we fail to appropriately consider or define the issue or problem, we might solve the wrong problem, as was illustrated in the video of the poor guy who scraped snow and ice off the wrong car (linked above). The reason that clarifying the issue is so critical is that a good solution to the right problem is almost always better than a great solution to the wrong problem. 7 Beware of the Judgment Trap: Rush to Solve An example of initially solving the wrong problem, as illustrated here, involves two snack food companies competing for market sharelet's call them Ax Snack Company and Bobb Goodies Inc. 6 F \u0007 or other more general models of judgment and decision making, see Hammond, Keeney, and Raiffa, 1999; Bazerman and Moore, 2009. 7 See Hammond, Keeney, and Raiffa, 1999. Bobb's executives were convinced that Ax's competitive advantage was attributable to the company's distinctive, highly recognizable individual snack packaging design. The individual snack packages seemed to draw customers to the products. So, Bobb's executives determined that to gain market share, they would need to develop individual package designs that were equally distinctive. They spent millions on improved packaging appearance for their snack foods to compete against Ax's distinctive packaging. When increased market share did not follow, Bobb's executive team realized that they knew relatively little about what customers really wanted and what drove the consumption of their snack foods. Bobb's executives decided to conduct market research, and along the way, they discovered an important and somewhat unexpected aspect of consumer behavior: regardless of the quantity of product they placed in a home, it would be consumed in relatively short order. Thus, Bobb's executives clarified the decision problem as \"how to get larger quantities of snack products into consumers' homes. Accordingly, they \" focused less on the appearance of individual snack packages and instead introduced bulk packaging that made it easier and more convenient to get more snacks into consumers' homes. The resulting gain in market share was dramatic. This example illustrates one of the biggest traps we run into at the front end of the judgment process, which is under-investing in defining the fundamental issue. In the example above, Ax Snack Company's distinctive packaging functioned as what could be called a \"judgment trigger, or \" an assumed or inherited issue that can lead the decision maker to skip the crucial early steps in the judgment process. It caused Bobb Goodies' executives to focus on the wrong issue or problem.8 Judgment triggers can often be recognized when a particular alternative is used to define the problem. This is a crucial point to understand. Click on the link below to hear a conversation between a partner and a staff auditor discussing a job offer the staff auditor has received. See if you can identify what the fundamental issue is as well as what might be serving as a judgment trigger. Beware of the Judgment Trap: Rush to Solve Hammond, Keeney, and Raiffa, 1999, suggest that every judgment problem has a \"trigger\" or \"initiating force. \" 8 Elevating Professional Judgment in Auditing and Accounting | 9 In the dialogue, you should have noted that the problem is actually defined in terms of the alternative being considered. Often, the trigger comes from the way others have defined the issue. Alternatively, we may create triggers ourselves because we are in such a hurry to \"solve\" or to be decisive. Judgment triggers often lead to judgments made on incomplete facts or understandings. In the vignette between the staff auditor and the partner, the staff auditor seems to have defined the problem as \"should I stay or should I accept the SG job offer?\" But stop and think about this for a second: if he is considering changing jobs, why should he limit the alternative to just the firm that contacted him? A change in jobs clearly should involve careful consideration of a broader set of alternatives, which would result from thinking more carefully about the first couple of elements in a judgment process. How might you overcome this very common trap of skipping the first couple of elements in the judgment process? The answer is to ask \"what\" and \"why\" questions. You can hear the remainder of the conversation between the staff auditor and partner a little later. But first, the exhibit below provides another example of a judgment trigger that auditors frequently encounter in practice. Practice insight For each of the five previous years of a public company's audit, the targeted deadline for the client to publicly release its year-end earnings has been moved closer to year-end. In the current year, the CFO is intent on meeting an even more accelerated reporting deadline and has consistently pushed the engagement team to reach its conclusions more quickly upon being provided with the company's analysis and conclusion. A question arises relatively late in the engagement regarding the company's accounting treatment for certain hedge transactions. The CFO feels very strongly and emphasizes to the engagement team that the company's documented accounting position considers all applicable professional literature and is the correct accounting treatment. She indicates that all of the \"legwork\" has been completed and asks for the engagement team's concurrence with the position as soon as possible. Pressure placed on engagement teams in the form of aggressive timetables can be excessive especially during the height of the financial reporting season. It is therefore important for an engagement team to recognize the potential pitfalls of failing to afford significant judgments the proper consideration, for example, by skipping the first couple of steps in the judgment process and proceeding directly to documenting reasons for why the client's treatment is justified. In developing the KPMG Professional Judgment Framework and teaching the judgment process to our Audit professionals, we emphasize the importance of giving adequate attention to each of the components of the five-step judgment process and allowing the execution of the process to dictate our capabilities with respect to accommodating unrealistic client expectations. Taking the time to clarify the issues and objectives and independently consider other available alternatives is invaluable. Furthermore, sometimes another alternative is the correct answer. When the engagement team fails to consider all of the steps, it is more likely to accept a client position without thinking through the issues and alternatives. Another way of saying this is that the team may fail to apply a sufficient degree of professional skepticism. It is pretty clear that we are more prone to weak and incomplete reasoning or rationalization if we do not invest sufficient time in the initial steps of the judgment process. 10 | Elevating Professional Judgment in Auditing and Accounting 1 5 Clarify Issues & Objectives 4 2 3 Step 1 Continued, Clarify Objectives: Also included in Step 1 of the judgment process is \"clarify objectives. Objectives are what you really want or need. \" In other words, these are the judgment criteria. Objectives help determine needed information and the importance of the judgment or decision, and thus the effort that is necessary. Just like with defining the problem, we tend to spend too little time and effort explicitly identifying our true objectives because we are in a hurry to \"solve. As an \" example, if you are searching for a new apartment or house and you do not carefully identify all relevant objectives such as affordability, safety, distance from the office, etc., you will not be able to identify the criteria necessary to make the best selection. Identifying and clarifying fundamental objectives is not as easy as it soundsthe truth is that we often do not know what we really want. To identify judgment objectives, you might ask questions such as: What would make an outcome or alternative particularly great or terrible? Are you comfortable at a \"gut level\" moving ahead with the judgment process? If not, you may not have properly defined the problem or the objectives. What assumptions (if changed) would have the greatest impact on the judgment? Why is this judgment critical to the financial statements? Test your objectives by asking what is important and why is it important, to get down to the root objectives.9 9 Hammond, Keeney, and Raiffa, 1999. For example, you might initially answer a \"what\" question regarding retirement goals with, \"I want to have a certain amount of money in a retirement fund. That certainly is a \" worthy objective, but as with many initial objectives, it is only a means to an end. Following up by asking why you want a certain amount of money can help you uncover the more fundamental objective, which might be something like, \"to maintain a high quality of life in retirement. Note \" that by clarifying the objective in this way, a number of additional approaches to achieving a high quality of life come to mind (such as good health, no debt, cost of living, location, availability of outdoor recreation, etc.). Carefully clarifying underlying objectives by asking \"why\" is a key step in making important judgments. Let's revisit the audio of the meeting between the staff auditor and partner discussing the job offer. Notice how the partner helps clarify the issue and objectives by asking \"what\" and \"why\" questions. If we are going to consider an important decision like changing jobs, how wise is it to limit our choices to only two alternatives? One very important way we can improve our judgment is by being constantly on the lookout for judgment triggers, which as we said before can severely limit the set of alternatives we consider. It often does not take a lot of time to consider the first step in the judgment process, but the more important the judgment, the more important it is to invest in clarifying the fundamental issues and objectives. A little extra investment in clarifying the issue and objectives will almost always pay off, sometimes in a big way. One very powerful way to improve your professional judgment is to make sure you are not accepting a judgment trigger in place of a solid problem definition, but rather that you are taking time to ensure your problem definition is complete and correct. The practice insight below discusses how understanding objectives of planned audit procedures is important for staff auditors. Elevating Professional Judgment in Auditing and Accounting | 11 will learn in Chapter 4, we all have certain tendencies that can bias our information search. 5 1 4 Consider Alternatives 2 3 Gather & Evaluate Information Step 2 Consider Alternatives: If we have properly clarified the issue and objectives, we often can identify alternatives by asking \"how\" we can achieve our objectives. The most important point to remember when completing Step 2 is that your judgment can only be as good as the best alternative you consider. Our ability to consider alternatives (Step 2) is directly related to how well we clarify the issues and objectives (Step 1). The set of alternatives we consider is usually constrained both by how we define the problem and by the set of objectives we explicitly identify. This is a crucial point that bears reiterating: if we fall prey to the trap of accepting a judgment trigger, the pool of alternatives we consider will likely be seriously constrained. For example, we might consider one of the following: Only the alternative we typically use to solve problems. Only the first alternative that comes to mind. To identify alternatives that will help us achieve our objectives, we often need to be creative in seeking input from others. As illustrated in an upcoming practice insight, the trap of considering only the first alternative that comes to mind can arise in an audit setting if an auditor only considers the alternatives represented by the prior year's audit procedures. Step 3 Gather and Evaluate Information: Gathering and evaluating information is a central part of the audit process. In fact, auditing standards require the auditor to gather \"sufficient appropriate audit evidence\" to support an audit opinion.10 The relevance and reliability of the audit evidence is fundamental to an effective audit, but as you 10 AICPA AU 326, Audit Evidence. It is important for new auditors to realize that they cannot simply gather all necessary information and audit evidence by interacting solely with people within the client's accounting function, such as an accounting manager or the controller. An important step in gathering information is finding the \"right\" person. That person may be outside the accounting function in operations, shipping, or human resources, or he or she could be a vendor or customer of the client. Practice insight If you decide to enter the auditing profession, as a new auditor you will find that most of your tasks will be laid out for you in \"audit steps\" describing procedures to be completed in gathering audit evidence. For many of these standard audit procedures, you may not need to spend much time to determine the problem and objectives that are being addressed or the possible alternatives that were considered in selecting the particular procedure(s) you have been asked to perform. Those factors have already been considered by more experienced auditors in determining the audit plan. However, while these important considerations may have already been completed during the development of the audit steps, you will develop a deeper understanding and you will be a more effective auditor if you take a little time before you begin the procedure to clarify in your own mind what are the issues and objectives that the audit procedure is addressing. For example, suppose you are observing the physical inventory count at a client that retails \"smartphones. \" You are asked to make sure that the inventory count does not include phones that do not belong to the client. You will be more effective in carrying out the procedure if you take time to understand the issue and the objectives of the audit procedure before you startin other words, what are the specific risks the step is intended to address? If you understand the risk before you start, you will understand that the client's warehouse or retail outlets might contain phones on consignment from other vendors, or phones that have been sold, but that the purchaser has asked your client to temporarily hold. With this understanding, you are much more likely to carry out the procedure in an efficient and effective way. 12 | Elevating Professional Judgment in Auditing and Accounting \" The client's fixed assets (net of accumulated depreciation) and related depreciation expense balances are material to the financial statements. \" Practice insight An audit manager and a senior are determining the audit approach for auditing fixed assets and the related depreciation expense. The audit manager (with eight years of audit experience) has not previously worked on this client. The audit senior (with four years of audit experience) has worked on this audit client for the past three years. Because of the audit senior's prior experience with the client, the manager defers to the senior for purposes of determining the best audit approach for auditing fixed assets. The client operates in the retail industry, selling maternity clothing and accessories throughout the country from more than 1,000 distinct store locations. The client's fixed assets (net of accumulated depreciation) and related depreciation expense balances are material to the financial statements. The client uses an off-the-shelf software product to calculate depreciation expense and to maintain its fixed asset subsidiary ledger, which consists of in excess of 30,000 individual fixed asset balances. Consistent with prior year audits, the audit senior, with the concurrence of the audit manager, plans to audit management's calculation of current period depreciation expense by manually recalculating depreciation expense for a sample of 50 individual fixed assets. Since there were no errors identified in the prior year recalculations and because the client's internal controls over the calculation and recording of depreciation expense are operating effectively, the audit manager and the senior do not believe that this is a high-risk audit area that calls for more extensive sampling or additional audit procedures. While the audit senior's planned audit approach for testing depreciation expense may be acceptable, it may not be the most effective or efficient approach. For example, the audit senior and manager could have considered alternatives, including the use of substantive analytical procedures. Substantive analytical procedures, which would entail grouping fixed assets by similar depreciable category (e.g., machinery, buildings, equipment, etc.) and applying various depreciation rates, can be an effective approach to estimate depreciation expense over an entire population of individual fixed assets. Utilizing substantive analytical procedures is not only efficient because it minimizes the number of recalculations performed by the auditor, but it also is effective because it provides an overview of the reasonableness of the entire depreciation expense balance. In addition, the senior and manager could have considered using computer-assisted audit techniques to recalculate depreciation expense. Computer-assisted audit techniques might enable the automated recalculation of the entire 30,000 individual fixed asset balances with a little programming and the push of a button, providing a highly effective audit procedure with optimal efficiencies. In the end, although the audit senior and manager properly identified the issue and objective (i.e., to plan the audit procedures to test depreciation expense), their failure to consider alternatives prevented them from identifying more effective and efficient audit techniques to address their objective. Elevating Professional Judgment in Auditing and Accounting | 13 Gathering information from different sources with different perspectives is an important step in being professionally skeptical. 5 Articulate & Document Rationale 1 4 Reach Conclusion 2 3 Step 4 Reach a Conclusion: After evaluating the information gathered and considering our objectives, we reach a conclusion. Important considerations in this step include: Step back and consider whether the judgment makes sense from a big-picture perspective Weigh the different points of view Evaluate whether sufficient appropriate audit evidence has been gathered Appropriately consider evidence and alternatives in light of relevant professional standards The more important the judgment, the more important it is for all team members to speak up and share what they know. In later chapters when we discuss how to reduce or eliminate effects of common judgment biases, you will see that considering opposing points of view is a powerful technique in reaching a conclusion. Step 5 Articulate and Document Rationale: In developing the KPMG Professional Judgment Framework, we at KPMG debated whether Step 5 should be a separate step or whether it should be combined with Step 4. In a more general judgment context, it might be logical to combine these two steps. However, in the delivery of professional auditing services, we determined that appropriately articulating and documenting the rationale is so crucial to an effective and high-quality audit that it merits designation as a separate step. Having a separate step highlights to engagement teams that while reaching a conclusion is certainly important, of equal importance is articulating and documenting the rationale supporting the conclusion. Recall at the top of this chapter that we indicated that one of the primary benefits associated with KPMG's professional judgment initiative is improved documentation. The KPMG Professional Judgment Framework helps to ensure engagement teams follow a judgment process. As the team documents the rationale for their conclusions, they can consider whether they avoided traps and biases and appropriately demonstrated professional skepticism. One way to demonstrate professional skepticism is to document the full set of information and alternatives the auditors considered in forming a conclusion, which might include information that is not supportive of the final conclusion. KPMG encourages our auditors to consider the steps in the judgment process with the end in mind. In other words, if the goal is to clearly articulate and document the rationale for a conclusion, the other steps in the process can be seen as important steps toward achieving that goal. When engagement teams follow the process, judgments will be more defensible, even though in a world of uncertainty, outcomes will not always be what we expect. Properly documenting and articulating the rationale is particularly important because it is not uncommon for an engagement team to reach a tentative conclusion only to find that the logic falls apart once they attempt to document the rationale. If the logic falls apart, the engagement team knows it needs to go back and identify where in the judgment process they need to invest more time. At KPMG, we work hard to help our people understand how to document and articulate all the relevant evidence obtained, including evidence that may contradict the ultimate conclusion. While gathering evidence, auditors will often find both confirming and disconfirming evidence (i.e., evidence that is consistent and evidence that is inconsistent with the final conclusion). The description of how the confirming evidence overcomes disconfirming evidence is very important in the rationale and documentation, and helps to show that appropriate professional skepticism was exercised. Client management, audit committee members, peer reviewers, and regulators should be able to understand the rationale that was used to reach the conclusion by referring to the audit documentation. Carefully carrying out the five steps in the judgment process in KPMG's Professional Judgment Framework assists our auditors to properly and thoroughly document the evidence gathered and conclusions reached. 14 | Elevating Professional Judgment in Auditing and Accounting Summary The role of judgment in the accounting and auditing professions is finding increasing emphasis. For example, the Final Report of the Advisory Committee on the Improvements to the Financial Reporting to the United States Securities and Exchange Commission (SEC 2008) suggested 11 factors to consider in evaluating the reasonableness of a financial statement preparer's accounting judgments. Those 11 factors can be used within a judgment process. The 11 factors are: 1.\tThe preparer's analysis of the transaction, including the substance and business purpose of the transaction 2.\tThe material facts reasonably available at the time that the financial statements are issued 3.\tThe preparer's review and analysis of relevant literature, including the relevant underlying principles 4.\tThe preparer's analysis of alternative views or estimates, including pros and cons for reasonable alternatives 5.\tThe 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 6. Linkage of the alternative or estimate selected to the substance and business purpose of the transaction or issue being evaluated In this chapter, we covered many of the components of the KPMG Professional Judgment Framework, including the judgment environment and the steps in a judgment process. While the steps in the judgment process may seem quite simple and intuitive, you learned that people have a tendency not to follow such a process. One cause of ineffective judgments is that we fall into predictable judgment traps like judgment triggers and the rush to solve. Remember that you don't need to formally use the Professional Judgment Framework for simple or easy decisionssuch as what sort of jelly to put on your sandwich. Furthermore, for many \"easy\" judgments, the consideration of the judgment process can be applied quickly and some of the steps may not be important. Fortunately, for the vast majority of judgments, it does not take a lot of time to consider the Framework. The more important and difficult the judgment, the more likely it will be worth the investment in time and effort to more carefully apply the Framework, including the judgment process. We will continue to discuss the KPMG Professional Judgment Framework in future chapters. In Chapters 3 and 4, we will discuss additional influences and biases depicted in the triangle at the top of the Framework as well as how to boost professional skepticism. In Chapter 5, we address the pentagon shape surrounding the judgment process, which encompasses strategies for avoiding judgment traps and mitigating bias. In Chapter 7 we discuss the coaching and , reflection \"ribbon\" running through the judgment process. 7 .\tThe level of input from people with an appropriate level of professional expertise 8.\tThe preparer's consideration of known diversity in practice regarding the alternatives or estimates 9.\tThe preparer's consistency of application of alternatives or estimates to similar transactions 10.\tThe appropriateness and reliability of the assumptions and data used 11.\tThe adequacy of the amount of time and effort spent to consider the judgment. ENVIRONMENT Influences/Biases Coaching Reflect on Previous Experience Reflect on Lessons Learned 1 5 Articulate & Document Rationale 4 Reach Conclusion Mindset Co nsultatio n Factors to consider in accounting judgments 3 Clarify Issues & Objectives 2 Consider Alternatives Gather & Evaluate Information Strategies for Avoiding Traps and Mitigating Bias Knowledge/Professional Standards Coaching Elevating Professional Judgment in Auditing and Accounting | 15 End of chapter questions (Select the best answer for the multiple choice questions) 1.\tWhat are the five steps in the judgment process? 5.\tWhich of the following best describes a judgment trigger? 2.\tWhat are two common judgment traps? a.\tAn alternative stated in terms of a judgment objective 3.\tWithin an auditing context, what is professional judgment? b.\tA technique for making effective judgments quickly a.\tProfessional 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.\tProfessional judgment is professional skepticism, which is an attitude that includes a questioning mind and a critical assessment of audit evidence. c.\tProfessional 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.\tProfessional judgment is the construction of a logical justification to support an outcome or conclusion that is otherwise not supported by the available evidence. 4.\tWhich of the following best describes the relationship between professional skepticism and professional judgment? a.\tProfessional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence that is separate and apart from the process of exercising professional judgment. b.\tProfessional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence that is part of the process in forming professional judgments. c.\tProfessional skepticism is synonymous with professional judgment. d.\tThere is no relationship between professional skepticism and professional judgment. c.\tAn issue/problem stated in terms of a particular alternative d.\tA technique for more effectively evaluating another's judgment 16 | Elevating Professional Judgment in Auditing and Accounting Chapter Three Judgment framing: The stuff of professional skepticism Professional skepticism refers to the ability of the auditor to approach issues in an objective, balanced way, with a questioning mind and an appropriate level of critical evaluation. Accordingly, it is important that you learn what professional skepticism is and how to develop and improve your own sense of professional skepticism. It is important to understand that professional skepticism does not mean that auditors should adopt a cynical attitude toward client management. To the contrary, professional standards indicate that auditors should neither assume that management is dishonest nor assume unquestioned honesty. Auditing standards define professional skepticism as ''an attitude that includes a questioning mind and a critical assessment of audit evidence. 11 \" Earlier in this monograph, we talked about how professional skepticism helps to frame the auditor's mindset, which is at the center of the KPMG Professional Judgment Framework. If our mindset is aligned with the objectives of our profession and our duty to the public trust, our judgments are also likely to be appropriately aligned with those objectives. Framing defined At the core of an auditor's ability to effectively question a client's accounting choices is a fundamental but powerful concept called \"judgment framing. This concept relates to \" the early steps in the judgment process. The definition of framing follows: Frames are mental structures that we use, usually subconsciously, to simplify, organize, and guide our understanding of a situation. They shape our perspectives and determine the information that we will see as relevant or irrelevant, important or unimportant. Frames are a necessary aspect of judgment, but it is important to realize that our judgment frames provide only one particular perspective. This is similar to looking out one window of your homeit provides one view that might be quite different from the view through another window. 11 AU 230.07-09, Due Professional Care in the Performance of Work. Frames are necessary and helpful, but the problem is that we often are not aware of the perspective or frame we are using. Also, our frame can blind us to the fact that there are other valid perspectives. In other words, frames help us make sense of things but they also make it difficult for us to see other views. By being proactive in our use of judgment frames, we can improve how well we do with the initial steps in the judgment process: clarifying issues and objectives and considering alternatives. This is important because a distinguishing characteristic of professionals who consistently exercise sound judgment is that they recognize the judgment frame they are using, and they are able to consider the situation through different frames, or what we at KPMG refer to as a \"fresh lens. Sounds simple enough, \" but it is not always easy to do! Mindset Framing influences our mindset, which is at the center of the judgment process in the KPMG Professional Judgment Framework. The mindset of a professional auditor is one of objectivity and professional skepticism. But in terms of training or coaching staff auditors, simply telling them to \"be professionally skeptical\" is not as helpful as demonstrating what professional skepticism looks and sounds like. The concept of judgment framing is important because appropriately questioning management's perspective by viewing the situation through other frames is fundamental to professional skepticism. Elevating Professional Judgment in Auditing and Accounting | 17 The Center for Audit Quality (CAQ) indicates that \"skepticisma questioning mindset and an attitude that withholds judgment until evidence is adequate promotes risk awareness and is inherently an enemy of fraud\" in its 2010 report on Deterring and Detecting Financial Reporting Fraud. The report lists the following characteristics of skepticism. Six characteristics of skepticism Questioning MindA disposition to inquiry, with some sense of doubt Suspension of JudgmentWithholding judgment until appropriate evidence is obtained Search for KnowledgeA desire to investigate beyond the obvious, with a desire to corroborate Interpersonal UnderstandingRecognition that people's motivations and perceptions can lead them to provide biased or misleading information AutonomyThe self-direction, moral independence, and conviction to decide for oneself, rather than accepting the claims of others Self-EsteemThe self-confidence to resist persuasion and to challenge assumptions or conclusions Summarized from Hurtt 2010. Framing illustrated in nonaudit settings Let's provide a few quick illustrations of what we mean by judgment frames. The first is a video of a man in a store talking to a friend on his Bluetooth ear bud about the cost of a construction bid. Click on the link to see the video. If the link doesn't work, search on YouTube for \"you are getting robbed. 12 Come back to this point after you have watched \" the video. What led to this outcome for the poor guy in the video? Different frames! The guy on the phone is reacting to a seemingly outrageous bid for a new deck. But the store owners' frame is \"there's a man in our store who wants our money!\" As this video illustrates, different frames can lead 12 13 The video is an Ameriquest advertisement. See Spilker, Worsham, and Prawitt, 1999. to different understandings or interpretations of a situation, and these different understandings and interpretations will affect choices and behavior. Research shows that people's willingness to take on risk depends on how a condition is framed. For example, doctors and patients tend to select riskier treatment options when a condition is framed in terms of the odds of dying than when the identical situation is framed in terms of the likelihood of survivingsame situation, but different frames. Here's another exampleone study found that tax professionals tend to be more accepting of a client's highrisk tax position when the underlying transaction is a \"done deal\" as compared