The Financial Reporting Council (FRC) has reported for each of the last three years that judgements and estimates are “the area in relation to which the most questions were raised with companies”. Writing last year in the Financial Times, Hans Hoogervorst, Chair of the International Accounting Standards Board commented “Accounting is highly dependent on the exercise of judgement, and is therefore more an art than a science”.
Yet in considering action to meet public concerns about auditing, most current suggestions are about boosting the number and severity of rules, despite the evidence that the enormous (and still growing) number of them have not done the business. I believe that one reason has been insufficient focus on the role of professional judgement as part of a credible framework of audit. This will be more and more of an issue as many of routine tasks in audit are taken over by artificial intelligence (AI) and the focus for the work that is left will increasingly be based on the quality of judgement.
What is professional judgement?
The International Auditing and Assurance Standards Board (IAASB) uses, in relation to audit, “The application of relevant training, knowledge, and experience, within the context provided by auditing, accounting, and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.” A variation is used for other aspects of accounting/accountancy and is used by some of the professional bodies round the world. But there is no accepted definition. The IAASB definition also lacks a reference to personal qualities - surely a crucial element in any definition of judgement. What’s more, there is an ambiguous relationship to the linked concept of professional scepticism and to broader ethical issues.
The lack of an agreed definition matters. For practitioners, vulnerability is increased by the absence of a measurement framework to establish what good professional judgement looks like. Nor is it easy for practitioners to know what to do. Education in professional judgement up to qualification and in later training is patchy and unsystematic.
A framework for measuring judgement is essential so that it can be taught, improved and monitored. Using a definition of “The combination of personal qualities, relevant knowledge and experience with professional standards to form opinions and make decisions”, I suggest that professional judgement has 6 elements:
1) What I take in
In any professional activity, the quality of what is understood in written material and in meetings is an important first step to form a professional judgement. The ability to identify gaps and discrepancies in audit evidence should come with experience. But understanding does not necessarily improve with seniority if there is increasing rigidity of approach.
2) Who and what I trust
This is essential to the quality of professional judgement. Examples of the importance of trust are in whether a new client should be accepted and the professional competence of a member of the team.
3) What I know about this
For audit clients struggling to make sense of new situations, rich professional knowledge and experience is of great value. But these are not enough. Judgement is needed to put an issue, from debtor quality to goodwill impairment, in context.
4) What I believe and feel
The professional needs to be aware of his or her own biases, including risk tolerance or appetite. The need to guard against such biases as anchoring, availability, confirmation and hindsight in the audit is increasingly recognised
5) How I choose
Experience, knowledge and personal qualities comes together to formulate choices. The professional will need to ensure that the right options have been brought forward for consideration and in an appropriate way, particularly for the most contentious areas of the audit and including risk.
6) How I carry it out
Good professional judgement will be necessary to be aware of issues, say on the timing of closing, in carrying the task through, including the management of risk.
To make the role of professional judgement explicit, operational, guidance and practice notes provided by firms need to provide a framework of how to use it. Education (and where necessary retraining) by firms and the profession should incorporate professional judgement.
Rather than relying on yet more laws, regulations and rules, a focus on professional judgement would address part of the current crisis of confidence and help meet the challenge of the impact of AI. This is not an issue for the UK alone, but it is one in which the UK can and should be influential. The framework above illustrates how it can be taken forward.
Professor Sir Andrew Likierman works for London Business School