Fraud Case Studies
Case 1 – Hamilton Corporation
Overview
Hamilton Corporation (the Company) is a multinational auto parts supplier headquartered in the Midwest. Hamilton began its
operations as a wholly owned subsidiary of Motor Company (MC), and was ultimately spun off and incorporated in 1999. Shortly
after the separation, MC informed Hamilton that the Company owed an estimated $350 to $800 million in warranty claims related
to automotive sales that had occurred prior to the separation in 1999. Hamilton’s management team believed that any warranty
claims related to sales prior to the separation should be limited to the reserve amount that was agreed to at the time of separation.
However, because MC remained Hamilton’s largest client, the management team was motivated to find a solution that would
appease MC.
As a direct result, the management team at Hamilton worked hard to convince MC to cap warranty claims related to prior
automotive sales at $100 million. Unfortunately, MC rejected the idea and instead continued to assert the full warranty claim
against Hamilton. Recognizing that the Company could not afford to make warranty payments in excess of $100 million without
a significant reduction in operating income, management had significant incentives to mask the true level of warranty expense in
order to meet analysts’ forecasts.
Damaged Goods
The management team at Hamilton fully understood that the Company’s performance in its first several quarters was vital to the
long-term success of the Company. Because the marketplace often views spin-offs as “damaged goods” in the early stages,
the demonstration of impressive financial results, right away, was believed to be imperative to the Company’s ability to raise
future capital.
Management quickly realized that a series of challenges existed that were likely to prevent the Company from reporting favorable
results in its first several quarters of operation as a stand-alone entity. To start, management believed that the warranty claims
asserted by MC had the potential to cripple the Company. In addition, management had to address a sharp and unexpected drop
in automotive demand that affected its sales volume during the same time period. Unwilling to report adverse results and risk the
Company’s ability to continue as a going concern, management made the decision to report favorable results, no matter what.
Warranty Claims
Faced with mounting pressure from the warranty claims asserted by MC, management increased Hamilton’s warranty reserve by
$112 million during the second quarter of 2000. The increase in warranty reserve should have been charged as an expense under
GAAP since the company Hamilton did not have a written agreement stating that the claims reflected a correction to its 1999
spin- off agreement with MC. However, in an effort to limit the effect on reported net income, management booked the entry
directly to retained earnings as a net adjustment to the spin-off transaction. In so doing, management failed to reveal the true
nature of the charge to investors.
As deliberations with MC continued throughout 2000, Hamilton eventually agreed to settle 27 warranty claims for a total of
$237 million in the third quarter. Recognizing that another spin-off related adjustment to retained earnings might raise a red
flag, management developed a more elaborate accounting scheme to mitigate the effects of the additional warranty claims on
net income. To do so, management decided to focus on the subjectivity that existed in the determination of pension expense.
More specifically, management determined that if it revised assumptions used in determining pension expenses prior to the
spin-off, the payment to MC could be disguised primarily as a “true-up” of the pension liability.
To support this scheme, management obtained a letter from the Company’s actuary that provided the “reasonable range” for
pension assumptions that had been made in the past. Management then deliberately selected a new point estimate within
each range to make it appear that the Company actually owed MC $202 million for its past pension liabilities. Additionally,
management convinced MC to allow the meeting minutes between the two companies to reflect an erroneous discussion
© 2014KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and “cutting through complexity” are registered trademarks
or trademarks of KPMG International. NDPPS 309511
Case 1
Hamilton Corporation
of past pension estimates to further support the unfounded pension loss claim. As a result, management was able to book
$202 of the $237 million warranty settlement as an actuarial loss in its pension plan. Only the remaining $35 million was
recognized as additional warranty expense in the financial statements.
Off-Balance Sheet Financing
As the end of 2000 was drawing near, management decided to take additional actions to boost reported earnings. Specifically,
Hamilton devised a scheme to remove $200 million of high-value precious metals inventory (used in the production of auto parts)
from the balance sheet through a collateralized loan agreement with Culpepper Bank late in 2000. According to the agreement,
which was deliberately designed to mislead balance sheet readers, Hamilton would receive the cash proceeds of the sale, but
was then required to buy the inventory back from the bank 30 days later for the original purchase price plus $3.5 million in interest.
Prior to executing the agreement, Hamilton’s auditor advised the Company that the transaction could only be accounted for as a
sale and repurchase under GAAP if both prices were based on market, and the transaction costs did not include Culpepper Bank’s
interest costs. Hamilton agreed to the conditions set forth by the auditor and then made sure that the form of the transaction
would meet the auditor’s conditions.
To convince the auditor that the financing transaction qualified as a sales and repurchase agreement under GAAP, management
created false documents including a memo that provided Hamilton’s rationale for the below market prices for the sale of inventory
under the agreement. The memo stated that the below market prices were supported by large volume discounts and one-month
future prices of metals – neither of which were justified by the actual market data. However, the analysis was elaborate and
management convinced the auditors that the transaction qualified as a sale and repurchase agreement under GAAP. Almost
concurrently, Hamilton’s management used a very similar strategy to remove an additional $70 million of batteries and generators
from its reported inventory balance. Since Hamilton used LIFO, each of these liquidating transactions allowed Hamilton to
artificially boost net income with LIFO liquidation gains that were improperly realized under GAAP with the sale and repurchase
transactions.
Fraud Discovery
Initially, management overstated net income by $69 million in booking the warranty claims adjustment to retained earnings
and then improperly increased net income by an additional $130 million through its treatment of the subsequent warranty
claims settlements with MC. In addition, due to the LIFO gains realized with the fourth quarter inventory transactions, Hamilton
recognized an additional $81 million dollars to its bottom line. Taken together, the misstatement totaled approximately
$280 million dollars in 2000.
As noted, management’s financial statement fraud was not limited to a single transaction. Rather each time that pressure existed
to meet market expectations, management appeared to devise a scheme to boost net income. The schemes were supported
by skillfully crafted evidence provided to the auditor by the management team. In the end, it was a whistleblower, believed to be
from a vendor involved in a fraudulent transaction, which objected to the Company’s inaccurate reporting of a specific transaction
that turned management into the SEC. The ensuing SEC investigation uncovered the full extent of management’s wrongdoings
over a four-year period of time.
Case Questions
1. Based on your understanding of fraud risk assessment and the case information, identify at least three specific fraud
risk factors related to Hamilton Company.
2. If you were responsible for planning the audit of Hamilton Company, how would the fraud risk factors identified in
question #1 have influenced the nature, timing, and extent of your audit work?
© 2014KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and “cutting through complexity” are registered trademarks
or trademarks of KPMG International. NDPPS 309511
Case 1
Hamilton Corporation
3. Please consider the five steps of the KPMG Judgment Framework. For each step, think carefully about what the
auditors could have done to help detect the fraudulent activity related to the warranty reserve account at Hamilton
Company. Please use the following questions to guide your critical thinking about this case:
a) Clarify the issues and the objectives related to auditing the warranty reserve account at Hamilton. To do so, please
ask yourself what specific problem needs to be solved by the auditor? What assumptions would have the biggest
impact on the overall judgment to be made? How does this judgment relate to the overall audit process?
b) Consider the various alternatives that should be thought about when auditing the warranty reserve account at
Hamilton. To do so, please ask yourself about each of the alternatives that are reasonably possible, even when
they might contradict the client’s point of view. Are there any external factors that should be considered?
c) Consider the type of information and evidence that should be gathered when completing the audit of the internal
control activities related to the warranty reserve account at Hamilton. To do so, please ask yourself about the
type of information that would be helpful to determine whether the internal control activities were operating
effectively. How can you be sure that the information gathered is reliable? In addition, how can you be sure that
the evidence is appropriate in this situation? Finally, what evidence could be gathered that might reveal that the
internal controls were NOT operating effectively?
d) Consider the type of information and evidence that should be gathered when completing the substantive testing
procedures related to the warranty reserve account at Hamilton. To do so, please ask yourself about the type of
information that would be helpful to determine whether the warranty reserve account was fairly stated in the
financial statements. How can you be sure that the information is reliable? In addition, how can you be sure that
the evidence is appropriate in this situation? Finally, what evidence could be gathered that might disconfirm your
belief that the warranty reserve account was fairly stated?
e) Consider the factors that would have to be thought about when reaching a final conclusion about the warranty
account at Hamilton. Although you do not have access to the actual evidence, what “big picture” issues would have
to be thought about before reaching a final conclusion? Finally, what could possibly go wrong in this situation?
f) Consider the importance of documenting the rationale for your final conclusion. Why do you think it is important
to document your rationale when finalizing your judgment? In addition, describe what is expected to be
documented to support an auditor’s professional judgment.
4. Describe the availability tendency in your own words, and give an example of how the tendency could result in a lack
of audit effectiveness. How can the tendency be mitigated?
5. Describe the confirmation tendency in your own words, and give an example of how the tendency could result in a
lack of audit effectiveness. How can the tendency be mitigated?
6. Describe the overconfidence bias in your own words, and give an example of how the bias could result in a lack of
audit effectiveness. How can the bias be mitigated?
7. Describe the anchoring bias in your own words, and give an example of how the bias could result in a lack of audit
effectiveness. How can the bias be mitigated?
8. What tendency or bias is most likely to have manifested in the Hamilton case example? Please provide support for
your answer.
About the Author
This case study was written by Jay C. Thibodeau (Bentley University) in collaboration and with support from colleagues at KPMG
LLP to help audit instructors integrate the KPMG Professional Judgment Framework into the classroom. This case was based
upon an Accounting and Auditing Enforcement Release (AAER) that was issued by the SEC in the recent past. The material is
intended to be used for academic purposes only. The work of Denise R. Hanes (Villanova University) was instrumental in the
completion of this case study and is gratefully acknowledged.
www.kpmg.com
© 2014KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and “cutting through complexity” are registered trademarks
or trademarks of KPMG International. NDPPS 309511
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 them—not to mention
the effectiveness and efficiency of our capital
markets. audit judgments—both 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 current—a 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 judgment—with
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 all—some 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
the 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 better—which 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 systematic—in 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
See 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 permanent—not 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. 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
Making 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 making—many 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. to enhance the professional judgment and professional
skepticism abilities of our auditors.
2. to 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. to 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. Professional skepticism is an objective attitude that
includes a questioning mind and a critical assessment
of audit evidence. It is synonymous with professional
judgment.
b. Professional 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 share—let’s call them Ax Snack
Company and Bobb Goodies Inc.
6
For 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 sounds—the 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
start—in 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. the preparer’s analysis of the transaction, including
the substance and business purpose of the
transaction
2. the material facts reasonably available at the time
that the financial statements are issued
3. the preparer’s review and analysis of relevant
literature, including the relevant underlying
principles
4. the preparer’s analysis of alternative views or
estimates, including pros and cons for reasonable
alternatives
5. 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
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
decisions—such 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. the level of input from people with an appropriate
level of professional expertise
8. the preparer’s consideration of known diversity in
practice regarding the alternatives or estimates
9. the preparer’s consistency of application of
alternatives or estimates to similar transactions
10.the appropriateness and reliability of the
assumptions and data used
11. the 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. What are the five steps in the judgment process?
5. Which of the following best describes a judgment
trigger?
2. What are two common judgment traps?
a. an alternative stated in terms of a judgment
objective
3. Within an auditing context, what is professional
judgment?
b. a technique for making effective judgments quickly
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.
4. Which of the following best describes the
relationship between professional skepticism and
professional judgment?
a. Professional 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. Professional 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. Professional skepticism is synonymous with
professional judgment.
d. there is no relationship between professional
skepticism and professional judgment.
c. an issue/problem stated in terms of a particular
alternative
d. a 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 home—it 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
“skepticism—a 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 Mind—a disposition to inquiry, with
some sense of doubt
• Suspension of Judgment—Withholding judgment
until appropriate evidence is obtained
• Search for Knowledge—a desire to investigate
beyond the obvious, with a desire to corroborate
• interpersonal understanding—Recognition that
people’s motivations and perceptions can lead them
to provide biased or misleading information
• autonomy—the self-direction, moral independence,
and conviction to decide for oneself, rather than
accepting the claims of others
• Self-Esteem—the 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 surviving—same
situation, but different frames.
Here’s another example—one 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 to when the client has not yet completed
the transaction. there was no difference in the transaction;
however, the professionals either agreed or didn’t agree
with the client’s position depending on the frame with which
they viewed the transaction.13 this example can also apply
to auditors—sometimes clients execute transactions and
then inform the auditors of the accounting treatment rather
than involving the audit team early in the process.
the point here is not to suggest that one frame is better than
another, but rather that evaluating a situation from different
perspectives usually results in better judgment. there often
is no single “best frame.” But we can improve our judgment
through the effective use of multiple frames. We need to be
aware that we adopt a frame any time we make a judgment.
to make effective use of multiple frames, we should work to
identify and understand the frame that is being used either
by us or by others. Our judgment improves as we consider
alternative frames. Referring back to the medical treatment
example, the best way to approach such a decision would
be to think about the odds from both the survival and the
mortality perspectives, and explicitly consider how our
judgment is affected by the different frames.
Framing illustrated in audit settings
Framing and the evaluation of risk:
One area where auditors and their clients may have
different perspectives is in the area of risk assessment.
Client management will have perspectives on risk and risk
management. it is important for auditors to understand
management’s perspective, but auditors also need to be
careful to consider alternative perspectives. in other words,
if a particular client company is soundly outperforming the
competition, or is trending up when others in the industry are
18 | Elevating Professional Judgment in auditing and accounting
flat or trending down, it could be because the client really is
stronger, faster, and smarter than the competition. However,
there are alternative frames that should be considered. One
is that it might just be “too good to be true.” For example,
there was a time when the exceptional results of WorldCom
and Enron, two companies that were engaged in massive
accounting frauds, were explained in terms of the companies
being better, smarter, faster, or part of a “new economy”
trend. With hindsight, evidence to support an alternative
perspective was available. the point is that when an auditor is
evaluating management’s accounting treatment or estimates,
he or she should understand management’s frame, but he or
she should be careful not to adopt it too readily.
The role of framing in gathering and evaluating evidence:
Framing is also important in gathering and evaluating audit
evidence. Research shows auditors’ information search and
evaluation of evidence is significantly affected by the frame
they adopt. if auditors initially frame an observed pattern
as a potential error, their risk assessments and evidence
accumulation approaches are substantially different from the
approaches used by those who framed the pattern as simply
reflecting a change in business conditions.14 For example,
suppose the results of a substantive analytical procedure
suggest that a client’s allowance for doubtful accounts is
understated. the auditor’s approach to gathering further
audit evidence will be different if the results are framed in
the context of a change in business condition or a change
in the client’s credit policy as compared to an indicator of a
likely error. again, this is not to say one frame is necessarily
better than the other, but the auditor can boost his or her
professional skepticism by considering both frames.
Becoming and helping others become “frame-aware”:
a key characteristic of those who make high-quality
judgments is that they are frame-aware. they know how
to seek and consider different frames to get a fuller picture
of the situation. Seasoned, experienced auditors develop
this ability and apply it in situations where they need to
help client management see an alternative viewpoint on
an important accounting issue. For example, an alternative
frame that auditors might use could be an investor or
analyst perspective, or a regulator perspective. Or it might
be a “hindsight” perspective—in other words, how will
management’s judgment look if a regulator later questions
it, or if it is reported in the press in six months? While
experienced auditors are typically quite skilled at challenging
frames and considering issues from different perspectives,
For example, see Libby 1985, Kinney and Haynes 1990,
ayers and Kaplan 1993, asare and Wright 2003.
14
Practice insight
as an example of how frame blindness can affect
judgments, suppose an audit firm was engaged to
perform certain procedures as part of due diligence
for an acquisition. the engagement team was
asked to look at significant contracts and revenue
recognition at the company being acquired. Revenues
at the company being acquired, aBC Company,
were recognized on a percentage of completion
basis. aBC was being sold from a large multinational
conglomerate. Client management had negotiated
what they saw as a favorable purchase price and was
excited about the revenue and diversification aBC
Company would bring to the combined business.
the engagement team found no significant issues
with controls over the contracting and percentage of
completion processes, but the partner had the team
analyze the history of contract performance for the
prior three years. the analysis revealed that actual
margins were, on average, over 25 percent lower
than planned margins. this difference was significant
enough that if the problem was pervasive, it could
materially affect aBC Company’s revenue recognition
and overall profitability, post-acquisition.
the engagement partner raised concerns regarding
revenue recognition and margins on in-process
projects with client management and recommended
additional testing. However, management’s frame
was that the acquisition was too important to pass
by, and rather than approving additional testing, they
closed the deal. unfortunately, not long after the
acquisition was final, management discovered that
the acquired company had materially misstated
revenue and margins. in fact, many of the projects
actually experienced negative margins. the resulting
liquidity problems at aBC Company ultimately
contributed to the company that purchased aBC
Company having to file for bankruptcy.
this is an area where auditors entering the profession
typically need improvement.
Elevating Professional Judgment in auditing and accounting | 19
understanding the big picture
Framing can also help us understand the “big picture” of
what we’re working on as auditors. understanding and
effectively managing frames can improve job satisfaction
and result in better effort and better judgments. there’s an
old story that illustrates this point. a traveler to a European
city comes across a man carrying a load of bricks and asks
him what he’s doing. the man replies, “i’m carrying bricks.”
a little further, the traveler comes across another person
carrying bricks. in response to the same question, this
worker smiles and says, “i’m helping to build a cathedral.”
Both people were doing the same task, but the perspective
they took clearly made a big difference in how they viewed
the task and the satisfaction they felt in doing their work.
in performing audit tasks, we may not be building a cathedral,
but when we understand how important our role is to the
engagement, to the firm, and to the public, the tasks we are
asked to perform are more meaningful and we are likely to do
a better job.
Fresh lens
Finally, let’s think about framing and reframing as it relates
to the selection of audit procedures and the nature of audit
evidence. it is important to periodically evaluate the nature,
timing, and extent of audit procedures so as to adequately
address variations in the client’s business or industry and
in the overall economy. taking the time to look at how
we approach our audits through a “fresh lens” provides
opportunities to improve upon the effectiveness and
efficiency of our work. this means considering issues for the
next audit immediately after signing off on the current audit.
it means getting on top of key issues early and eliminating
unnecessary or redundant testing. it means gaining a
deeper understanding of our clients’ businesses so that we
can obtain better audit evidence more efficiently.
For important issues, it’s worth the effort to become aware
of the frame we’re using, and then to consider alternative
frames. Our natural tendency is to become increasingly
“stuck” in an adopted frame. it takes effort and focus
to become aware of the frame we are using and then to
consider the issue from different perspectives.
Practice insight
an engagement manager challenged the audit
team’s previous frame that testing revenue had to
be done largely through detailed testing of a sample
of individual sales. the manager determined that the
team could replace much of the detail testing with a
highly effective and efficient substantive analytical
procedure. the substantive analytical procedure
developed by the manager gave the audit team a “big
picture” view of what was happening with the client’s
revenues. in other words, the procedure allowed the
team to view the “whole forest” as opposed to trying
to see the forest based on a detailed examination of a
sample of the individual trees in the forest. in the end,
by shifting frames and using a substantive analytical
approach to replace some of the detailed testing, the
engagement team was able to obtain arguably more
effective audit evidence in fewer hours, to the benefit
of the overall engagement.
How do i learn to “reframe”?
this is an involved topic and there’s much that can be
learned, but let’s discuss briefly some ways in which we
can go about reframing a situation in order to enhance our
professional skepticism and improve our judgment.
Understand your current frame and its sources:
First, we have to recognize and understand the frame we
are currently using, and where it is coming from. this is
not easy! One way to do this is to identify the analogies or
metaphors you might be applying. You may have heard of
the phrase “the war on drugs.” in an effort to change the
nation’s approach to the drug problem, when General Barry
McCaffrey became the nation’s “drug Czar” a number of
years ago, one of the first things he did was to change the
metaphor from “the war on drugs” to “drugs are a cancer
on our nation.” think of the implications—if the drug problem
is a “war,” we will send soldiers to the border; we will use
force to attack and arrest. if it is a sickness, we will tend
to treat addicts and look for preventative measures at the
individual level. again, the point is not that one frame is
necessarily better than the other, but rather that the two
metaphors point to very different perspectives and actions.
20 | Elevating Professional Judgment in auditing and accounting
Consider alternative metaphors:
We can also challenge our current frame by considering
alternative analogies or metaphors. People often use sports
metaphors like “this investment is a slam dunk.” You’ll notice
that implicit in that statement is an analogy to basketball,
and even a particular type of basketball shot. We can often
challenge our frame by looking at the situation using a totally
different metaphor, like we illustrated with the two drug
analogies—where the drug problem can be seen as either a
war on drugs or a cancer on the nation. in this situation, you
might consider whether your perspective on the investment
you’re considering would change if you were to think of it as
a three-point shot or as “swinging for the fences.” analogies
are often useful, but it’s important to recognize that they also
often act as powerful judgment frames.
Generate alternative frames and consider how
the judgment differs when viewed from different
perspectives:
Finally, we need to identify and evaluate what issues might
look like using alternative frames. as part of this, we should
consider the implications of different frames. as we noted
earlier, there is often no single “best” frame to use, but we
almost always get a deeper, more complete understanding
when we evaluate an issue through multiple frames. this
can have very important practical implications. in the united
States, for example, one has to “opt in” to become an organ
donor, while in other countries, one has to “opt out.” Same
decision, but framing donation as the default action results
in much higher donor rates.
Challenging and proactively considering issues using
different judgment frames is something that takes effort
and practice, but it’s well worth it. the better you are at
reframing judgments, the better you will be at identifying
and understanding issues, objectives, and potential
alternatives. in addition, you’ll be more effective at
appropriately challenging management’s existing frames,
which is the essence of professional skepticism. Learning to
recognize, challenge, and use different judgment frames is
a fundamental life skill and a key characteristic that can set
you apart as a true professional.
“
another approach is to enlist
the help of someone who
tends to see things differently
than you do.
“
Challenge the current frame—Seek others’ opinions,
welcome diversity:
this is one of the more difficult aspects of reframing. it
refers to the need to challenge our current frame. to do this,
you might ask yourself how you would normally approach
a situation, ask why, and then see if you can look at the
problem a different way. another approach is to enlist the
help of someone who tends to see things differently than
you do. this is not our natural tendency—we all tend to
seek confirming opinions. For example, consider a business
manager who decided to obtain additional training by
enrolling in a night MBa program that would allow him to
continue to work in his current full-time job while going to
school. as he approached the end of his MBa program,
the business manager wanted to find a situation where he
could more fully apply his newly acquired knowledge and
skills, but at the same time, he appreciated his position at
his current employer. in an effort to get an entirely different,
fresh perspective on his decision to leave his employer
and what kind of job to look for, he approached his 13-yearold daughter. after listening to what her father wanted to
accomplish and his reasons for leaving his current employer,
his daughter asked, “Why don’t you just figure out how to
do what you want to do where you work now?” at first his
daughter’s question seemed silly to him, but that simple
question got him thinking about his situation differently; it
gave him a new frame with which to consider the issue. in
the end, he approached his boss with a proposal to create
a new position that allowed him to apply his new skills in
creative ways, resulting in a real win-win situation for both
him and his employer.
Elevating Professional Judgment in auditing and accounting | 21
End of chapter questions
(Select the best answer for the multiple choice questions)
c. Frames are not used by risk averse individuals.
1. What is fundamental to exercising professional
skepticism?
d. Professionals should eliminate the use of frames
from their judgment processes.
2. How can considering multiple judgment frames
enhance an auditor’s professional skepticism?
Explain and give an example.
5. Which of the following is not a step in reframing
a situation?
3. What role do metaphors and analogies play in
judgment framing, and how can they be used to
improve your ability to examine issues through
multiple frames?
4. 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.
a. Challenge the current frame
b. Generate alternative frames
c. Justify the current frame
d. understand the current frame
22 | Elevating Professional Judgment in auditing and accounting
Chapter Four
It’s a fact:Your typical
judgment processes
can lead to bias
as we indicated in earlier chapters, we developed the
KPMG Professional Judgment Framework and related
training to enhance the professional judgment skills of our
auditors. Earlier chapters addressed the steps involved in
exercising judgment and how proactively managing judgment
frames can boost professional skepticism. auditors are
regularly charged with making challenging judgments in an
environment characterized by complexities and pressures. in
such an environment, where both efficiency and effectiveness
are at a premium, it is important that professionals understand
not only what is involved in a judgment process but also where
they are vulnerable to judgment pitfalls and biases. in previous
chapters, we have discussed some of the common pitfalls
that can derail a judgment process. in this chapter, we discuss
judgment tendencies that can predictably and systematically
affect the judgment of audit professionals. Research has
identified a number of common tendencies that can lead
to biased judgment. in this chapter, we focus on four such
tendencies and the related biases that we have determined
are of primary relevance to auditor judgment.
Judgment Continuum
Unaware,
Intuitive
Keenly
Aware,
Formal,
Analytical
a judgment continuum: intuitive to formal
a formal process like that depicted in KPMG’s Professional
Judgment Framework is an approach that provides a model
of important steps we believe one should consider in
making judgments. However, the tendencies or shortcuts
we’ll talk about are descriptions of tendencies we
frequently, but unconsciously, use to simplify judgments.
the exhibit above illustrates a judgment awareness
continuum. When we are operating on the right side of
the continuum, we are keenly aware of the judgment we
are making and we are consciously applying the steps of a
judgment process. On the left side, we are less consciously
aware of the detailed aspects of the judgment; we are using
our subconscious or intuitive judgment processes. For most
day-to-day judgments, people tend to operate between the
extremes, but often toward the left side. understanding
where we tend to take judgment shortcuts and where our
motives can subconsciously affect us can help us identify
when the quality of our judgments can be affected by
systematic bias, and when it is most important to engage in
formal, conscious thought about the judgment process.
Judgment shortcuts that can lead to bias
Your judgment can be unintentionally biased due to
underlying self-interest or because you unknowingly use
mental shortcuts. For the most part, the shortcuts we
use are efficient and often effective, but in certain situations,
they can result in systematic, predictable bias. Keep in
mind that the tendencies or shortcuts we will discuss are
simplifying judgment strategies or rules of thumb that we
have unknowingly developed over time to help us cope with
the complex environments in which we operate. they are
efficient and often effective, but because they are shortcuts,
they can lead to lower quality judgment in some situations.
Here’s a quick example of a simplifying shortcut. When
crossing a city street, say in New York City, some people don’t
wait until they get a “walk” sign; rather, they move through
intersections by quickly looking to the left for oncoming traffic.
if the coast is clear, they will take a step out into the street
and then look to the right for traffic coming the other way. this
is a very efficient and often effective shortcut strategy. Over
time, it can become an unconscious, automatic part of how
people cross the street in a busy city. However, if we were to
use this shortcut strategy in London, where they drive on the
other side of the street, it could result in a very bad outcome.
Even in New York City, the shortcut can lead to a bad outcome
if applied to all streets, since there are one-way streets that
come from the other direction.
Elevating Professional Judgment in auditing and accounting | 23
Similarly, the judgment shortcuts we commonly use are
efficient and generally effective. However, there are situations
where the use of a shortcut can predictably result in a lower
quality or biased judgment. the good news is that once we
understand the implications of a shortcut, we can devise ways
to mitigate potential bias result...
Purchase answer to see full
attachment