Professional Judgement – Guidance from the Financial Reporting Council (Part 1)
Making professional judgements is one of the most crucial and frequent tasks of an auditor. Failure to consistently practice good professional judgement can lead to a significant decrease in audit quality; therefore, it is essential to have an effective methodology for making professional judgements. In 2022 the Financial Reporting Council published guidance entitled Professional Judgement Guidance to address the key aspects which ought to be considered in every professional judgement.
One key aspect discussed in the document is “Mindset,” particularly understanding biases and other relevant psychological factors which can subconsciously hinder logical reasoning.
The Financial Reporting Council publication looks at six biases (taken from International Standard on Auditing (Ireland) 220 (Revised December 2021), ‘Quality Management for an Audit of Financial Statements’, paragraph A35 which states that the six biases set out here are not intended to be a complete list of all biases that could affect audit judgements, just an illustrative list of some that might be especially relevant.
The first three biases alert auditors to be aware of:
- Availability bias: a tendency to place more weight on events or experiences that immediately come to mind or are readily available than on those that are not.
- Confirmation bias: a tendency to place more weight on information that corroborates an existing belief than information that contradicts or casts doubt on that belief.
- Anchoring bias: a tendency to use an initial piece of information as an anchor against which subsequent information is inadequately assessed.
To illustrate anchoring bias, the FRC uses the example of an audit senior manager tasked with determining performance materiality for a company’s current year’s engagement. He starts by looking at the audit file from the prior year and sees that the engagement team set performance materiality at 75% of materiality; however, he is aware that a higher than expected number of misstatements were identified in the prior year, and that the control environment remains relatively weak. To compensate for this he resolves to choose a lower percentage of materiality for performance materiality, setting it at 70% of materiality.
His judgement here may have been affected by anchoring bias, if he put undue weight on the initial piece of information gathered, namely the prior year figure. If he had started from a broader consideration of the entity and its environment and a range of factors that affect the expected level of misstatements in the current year, he may have arrived at a different figure.
Awareness of biases such as these can help auditors avoid falling into these traps, and thus enables the auditor to make more objective professional judgements.
We will cover the last three biases in next week’s blog.
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