Eliminating biases that jeopardize audit quality

August 1, 2019

Published: Journal of Accountancy

By Billy E. Brewster, CPA, Ph.D.; Janet B. Butler, CPA (inactive)/CITP, CGMA, Ph.D.; and Ann L. Watkins, CPA, Ph.D.

Certain cognitive biases pose threats to audit work, but it’s possible to recognize and overcome them.

Auditing standards state that inquiry alone does not provide sufficient evidence regarding the lack of material misstatement (AU-C §500, Audit Evidence, ¶.A2), yet regulatory inspections and laboratory findings indicate that even experienced auditors often simply accept management’s explanations without further corroboration. In its staff inspection brief issued in August 2017, the PCAOB staff stated that reviews of audit inspections have continued to raise concerns about whether some auditors apply professional skepticism, particularly in areas that involve management judgment. The brief stated that inspectors observed that some auditors sought to obtain only evidence that would support judgments or representations made by management. The auditors failed to critically take into account all relevant evidence, regardless of whether it confirmed or contradicted management’s assertions.

Why does this problem persist despite the authoritative guidance and its overall importance to the audit process? The PCAOB (2012) offers some insights when stating that auditor skepticism can be hindered by cognitive biases. By expanding on these insights, this article aims to show auditors of both private and public companies how they can improve their judgment and enhance their professional skepticism. We begin by briefly examining the factors likely to influence an auditor’s decision to investigate management’s representations. We then examine common cognitive biases that can make auditors more vulnerable to flawed decision-making, and describe how auditors can learn to apply mental modeling to combat cognitive biases (without the need for specific firm training), thus improving auditor judgment and professional skepticism.

CORROBORATING MANAGEMENT REPRESENTATIONS

AICPA Professional Standards stress that while client inquiry is an important source of evidence, typically such discussion alone does not provide evidence of the absence of a material misstatement or the effectiveness of internal controls (AU-C§500, ¶.A2). The required corroboration can include comparing the explanation to the auditor’s preexisting understanding “of the entity and its environment, and other audit evidence obtained during the course of the audit” (AU-C §520, Analytical Procedures, ¶.A28).

COGNITIVE BIASES IMPACTING AUDITORS

Research in psychology suggests that factors in the audit setting create cognitive biases that can reduce the auditor’s likelihood of following up on client explanations with additional evidence. Cognitive biases represent often unconscious, systemic influences affecting how individuals gather and interpret information when forming judgments and decisions. Identifying these unconscious biases can aid professionals in counteracting the potential “pitfalls” arising during the explanation-corroboration process of the audit. While auditors are susceptible to many types of unconscious bias, we specifically focus on three that regulators and researchers suggest are common influences, increasing the likelihood that the auditor accepts an explanation without additional corroborating evidence.

·         Motivated reasoning

·         Source credibility and complex business environments

·         The nature of the auditors’ listening activity

COMBATING BIASES AND IMPROVING JUDGMENT

Fortunately, mental modeling and simulation activities can help auditors reduce the impact of cognitive biases and improve audit judgments. In another article, Brewster suggests that the auditor must develop a “mental model” of the client operating environment and how it interacts with the outside economy (see “How a Systems Perspective Improves Knowledge Acquisition and Performance in Analytical Procedures,” The Accounting Review, Vol. 86, Issue 3, page 915 (May 2011)). A mental model is a cognitive representation of a particular phenomenon. The quality and detail of an individual’s mental model depends on both the individual’s understanding and his or her information processing ability. Think of the mental model as a “mental picture” that an individual has in his or her head regarding how something works. In an auditing scenario, mental models help auditors develop the expectations that serve as the benchmark against which they can evaluate management explanations. Brewster finds that when auditors do not develop accurate mental models, they are less likely to identify the client’s erroneous explanations.

BENEFITS OF KEEPING COGNITIVE BIASES IN CHECK

Cognitive biases can negatively influence auditor judgments about the need to substantiate management’s assertions and can potentially lead to costly audit failures that damage an audit firm’s reputation. An awareness of the biases described in this article is an important first step in reducing their impact on auditor judgment. Development of robust mental models and simulating business conditions using the models can also be effective tools in combating cognitive biases. It takes commitment and a diligent effort for auditors to properly evaluate their mental models and use them for simulation, but it is reasonable to expect that such efforts can result in professionals’ experiencing improved judgment and decision-makingwith enhanced professional skepticism over time.

Read all document in: 

https://www.journalofaccountancy.com/issues/2019/aug/biases-jeopardize-audit-quality.html

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