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Building a culture that cultivates professional judgement

Author: ICAEW Insights

Published: 27 Jan 2023

Professional judgement is a difficult part of the audit process to define and to apply in practice, including clarifying the differences between it and professional scepticism.

A few years ago, Sir Andrew Likierman, former Dean and now Professor of Management Practice in Accounting at the London Business School, started looking at judgement from a more general management perspective. He believed that the work might also apply to professional judgement in the audit profession and submitted a memorandum about the need for a closer definition and more precise application of professional judgement to Sir Donald Brydon’s enquiry into the quality and effectiveness of audit. The ideas were taken up by the Financial Reporting Council (FRC), which last year published its Professional Judgement Guidance together with illustrative examples.

Sir Andrew emphasises that judgement remains an important part of the agenda, even though the focus on particular areas may shift. “Take going concern, which has always been an area of difficulty in exercising judgement. The issue during the pandemic was mainly in terms of COVID-19-related reduction in demand. The focus is now on the impact of inflationary pressures combined with recession. The stage at which and way in which the firm has to challenge management is an example of the dilemma in exercising professional judgement.” 

He has talked to a number of firms, larger and smaller, about the FRC’s guidance. Sir Andrew says the flexibility offered in the application of the judgement framework was welcomed, but there was some concern about how the FRC would apply the guidance as part of the regular review process. “There was also concern about the ability and willingness of firms being audited, in particular their audit committees, to play their part in keeping standards high. An anxiety not related specifically to this aspect of auditing is about keeping professional standards high in the face of staff shortages and high staff turnover.”

Sir Andrew divides professional judgement into six elements: taking in; trust; relevant knowledge and experience; detachment; choice; and delivery – this last applies to aspects of judgement involving executing the choice.

Taking in is about the ability to understand what is happening within an audit – what auditors see, hear and read, “We know that many people may take something in, but not understand its importance or impact. Was that answer too glib? Is that error a one-off or the tip of a problem iceberg? Is the difficulty in getting that document a sign of incompetence, inefficiency or fraud?”

Trust applies to all aspects of an audit including the information management provides, trust in colleagues and in the support given by the firm to individual auditors. “Trust is critical. You need to understand how much and what you're trusting, especially in relation to the information you get from management.”

Relevant knowledge and experience relates to both the audit process and the firm to which it is being applied. “Audit knowledge and experience will grow over a career and the second year of audit will be better informed than the first. But over-familiarity and complacency can bring their own risks.”

Detachment refers to the ability to understand one’s feelings and beliefs, including biases, in considering the information received. “It’s inevitable that we filter information, and self-awareness of how that filtering is taking place is the key to this element of judgement. I'm not suggesting that people should stop having feelings and beliefs, but they do need to be aware of what they are.” 

Choice is when we bring everything together through a systematic process to form opinions and make decisions. “Whether it’s on going concern, or impairment, or provisions, the four previous elements of judgement will feed into the auditor’s choice. This will also be informed by specific guidance and the culture of the firm.”

Sir Andrew recommends that firms look not only at the more tangible aspects of their training and feedback, but also at the messages about their culture through evaluation and promotion criteria and the example of the most senior staff. Learning should also be continuous. “Did we have the right mix of skills for the team? Should we have called in someone else sooner? Should we have asked which other team had a similar problem? Every audit, successful or less successful, is a learning experience, an opportunity to explore what went well, what could be improved, and how that could be applied to the next audit.” 

When it comes to training, Sir Andrew acknowledges that more has been achieved in recent years, citing the important work done on identifying biases. “We know about the perennial optimist or the perennial pessimist in our own organisations. It’s important to identify them within client organisations. If the CFO has come up with something which is too optimistic in years one and two, it’s quite likely to come up again in year three.” But he also cites lesser-known biases, such as the sunflower bias – the tendency for everyone else in the room to agree with the most important person there: “This is relevant for both the audit firm and the client.”

But Sir Andrew also believes that existing training modules on technique and process could be supplemented by others on elements of judgement such as observation skills or making choices under stress: “On observation, I'm not suggesting that auditors should be psychotherapists, but there is room to help anticipate audit problems by identifying potential problems through observation skills”.

He also underlines the importance of diversity of thinking in judgement: “Some people feel threatened by diversity of thinking, but it can greatly help in forming opinions and making decisions.” He does acknowledge that there needs to be a balance: “When everyone is on the same page, it’s efficient, but may leave certain elements of the process unchallenged. Getting the balance right is a real skill. There needs to be enough difference of view to mean that the discussion is rich, but not so much that it is disrupted.”

Improving judgement is not only about training and diversity of thinking. It is also about creating the kind of culture that encourages good judgement. Sir Andrew explains that this can be done in many ways. For example: 

  • the expectations of a potential client when the audit firm is seeking new business;
  • the messages from the firm’s leadership on trade-offs between retaining and deciding not to retain a client; 
  • the way audit teams are formed and the messages they get; the process and understanding about when consultation is appropriate and when additional resources are essential; 
  • the process of recording professional judgements; 
  • the way the appraisal process is used to assess professional judgement; and
  • the use of stories inside the organisation about good and bad practice and about conditions of stress, such as time pressure and conflict with management.

“In looking at culture, the idea of psychological safety is a very appropriate consideration,” he says. “Psychological safety means that people feel comfortable voicing their doubts and raising issues within the team. You are much more likely to end up with a well-judged opinion than when people hold back because they are scared of challenging a senior person or challenging the management. Those relationships are very much a question of culture.”

He explains that there are still some knotty problems to work out around the definition of professional judgement, including how it differs from professional scepticism, how it should be applied in areas of debate and contention in audit, how it should be measured and monitored, and the role of technology in making choices in the future.

“Professional judgement is very much about the way a firm operates,” says Sir Andrew. “It’s not just about process, but it will be useful to the individual auditor to have helpful guidance. Professional judgement is at the heart of professionalism in audit.”

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