At which situations will professional judgment be a necessary consideration?

Professional judgment in accounting is used while predicting conditions and events and evaluating current situations in conditions of uncertainty (Dawes & Hastie, 2001). Professional judgment is the core of the audit. there is much evidence that auditors do not necessarily make high-quality judgments, Judgments that do not have sufficient quality can have serious consequences for those who make judgements and the users of the judgement results (Bonner, 2008). The emphasis on auditors “professional judgment in many audit standards (ISA 200, 310, 315, 320, 500) indicates the essential role of auditors” professional judgment in the audit process.

Since a large part of the auditor’s judgments is regarding about the matching of information preparers practices with accounting standards, accounting standards and the standard-setting has a significant impact on professional judgment of auditors. Due to the change in the approach of accounting standard setting from a rule-based approach to a principle-based approach and the use of the general principles in the later approach, the choice of appropriate accounting methods requires a consideration of effective conditions. The scope of procedures and accounting methods that result from principled-based approach, lead to a proper presentation of corporates financial position which is a fruit of the professional judgment.

Although the increased professional judgment in the principle-based approach will increase the risk of auditing, applying more judgments by auditors will prevent the opportunistic behaviors of financial statements preparers through using thresholds (Grenier et al., 2015). Increasing audit risk is due to the fact that professional judgments will not lead to the same results in choosing accounting methods and procedures. The advisory committee on improvements to financial reporting required the Public Company Accounting Oversight Board (PCAOB) to provide guidance for appraising the rationality of professional judgment of auditors. Although PCAOB has not yet responded to the request of the advisory committee on improvements to financial reporting, the world's largest audit companies like the KPMG, Deloitte and Institute of Chartered Accountants of Scotland (ICAS) have set up a framework for their judgments.

Due to the global acceptance of international standards and the use of the principled approach in accounting standard setting, auditors should make more professional judgments in evaluating financial reports (Backof et al., 2013). This requires training and experience in accounting and auditing, considering the environmental, legal, economic and professional conditions.

For the auditor’s judgments to be carried out properly, the ability to make judgments should not be taken as full or unlimited authority in the process of auditing. Instead, it is essential to imbibe this concept and identify the factors affecting a professional judgement and the process of making a rational, thoughtful and precise judgment.

In this paper for the first time, after reviewing the relevant literature about judgment and decision making in the field of psychological, the process of making professional judgment was identified through interviews with auditing experts and using the exploratory analysis method. The practical application of this process is also measured by collecting questionnaires.

The remainder of the paper is structured as follows: The next section presents theoretical foundations and literature review. The third section outlines the research methodology and research sample. The last section analyzes interviews and discusses study’s conclusions.

Theoretical Foundations and Literature Review

As explained in the introduction section, the International Accounting Standards Board found that the use of principles-based standards compared to rule-based standards are more attentive to the economic content of transactions and economic events. Based on Securities and Exchange Commission (SEC, 2008) application of principled-based standards is along with some executional difficulties due to inadequate guidelines and lack of appropriate structure for the judgment of auditors and financial statement provider's professional judgment In other hand, the use of a rule-based approach to standard setting provides a tool for (SEC, 2003).

Eventually, SEC concluded that principles-based standards provide the best opportunity for accountants to take into account economic realities (SEC, 2010). However, the critics had warned that the "lack of rule" is a double-edged sword. on one hand, managers can choose accounting methods that reflect the economic reality of transactions and on the other hand, this freedom of action allows managers to report aggressively (Hail et al., 2010; Maines et al., 2003)

Many studies have been conducted regarding the principled and rule-based standards, their impact on aggressive reporting and the role of auditors in each of these standards. Previous studies investigating rule-based standards indicate that when the standards are highly accurate and prescribe many mandatory rules, they provide for the managers the opportunity to use their intended accounting method through re-structuring the financial transactions. (Maines et al., 2003; Schipper, 2003; SEC, 2008). Other studies show that highly rule-based standards motivate managers to manage earnings through re-structuring the transactions without violating those rules, while auditors are reluctant to prevent what managers are doing.

Concerning the principled-based standards Ng and Tan concluded that when there is an ambiguity in a standard, auditors use this ambiguity as a license to aggressive reporting. Rule- based standards reduce the power of auditors in negotiations with the client and on the other hand, they give them a lot of freedom to accept aggressive reporting of their clients. Also, Kadous et al. (2003) find that when accounting standards are ambiguous, auditors tend to allow managers to use methods that lead to aggressive reporting. On the other hand, Agoglia et al. (2011) found that when the imprecise standards were implemented, managers were less likely to report aggressively due to concerns about legal claims. The operational freedom resulting from the use of principle-based accounting standards in the selection of accounting practices and procedures will lead to a fair representation of the performance of the financial situation of the companies, which results from the use of professional judgment (Ionela, 2016).also any elevated litigation exposure associated with imprecise standards is manageable if audit firms can provide credible evidence of the quality of their judgments (Casey & Grenier, 2014).

In summary, past research shows that highly accurate or precise standards encourage managers to report aggressively with the help of precise rules present in the standard. (Cohen et al., 2013), Also, Previous studies show that auditor allow more aggressive reporting when implementing an standard with low precision (principled-based) compared to an standard with high precision (ruled-based) (Hackenbrack & Nelson, 1996; Salterio & Koonce, 1997; Nelson et al., 2002, Kadous et al., 2003; Blay, 2005). Therefore, it seems that the presentation of the professional judgment framework is more requisite when principles-based standards are applied compared to when the rule-based standards are applied.

Method

Sample and Data Collection

The research population is all the partners and managers of the highest rank listed on Iranian Association of Certified Public Accountants (IACPA). For the purpose of conducting interviews the statistical sample is selected based on snowball method. Because of the special knowledge of the auditors and not enough information about the knowledge of research sample, the snow ball method was used. In this method, the researcher continues interviewing until a theoretical consensus is achieved; the interviewees are selected based on the suggestions of other interviewees (Strauss & Corbin, 1990). In this research the theoretical consensus was achieved by interviewing 13 audit experts. Also, factors impacting the process of auditor's professional judgment was identified through analyzing the questionnaires collected from professional auditors with supervisor rank or higher. 147 questionnaires had been distributed and eventually 82 of them collected.

Instrument and Measure

In order to conduct this research, the following steps have been taken: 1) First, previous studies related to the subject of this study were analyzed and explored, 2) An exploratory interview was conducted from a limited number of audit professionals, 3) By combining the information gained from the analyzing the previous studies and the information from exploratory interviews, the main interview’s questions were designed and then the interviews were conducted. Interviews continued until the interviewees didn’t mentioned new subjects or points. After completing interviews the interview transcripts were analyzed and the data interpretations were done. Finally, using the interpretive analysis methodology, the auditor's professional judgment process was developed. After the steps mentioned above, the data obtained from the questionnaires was analyzed by using independent t-test method and then the factors influencing the auditor's professional judgment was identified.

Descriptive Statistics

In Table 1 demographic information about the respondents is summarized. Based on results, sample includes as follows: most respondents (90 percent) were men, and members of in scientific and professional Associations Membership in scientific and professional Associations indicate that the respondents had enough professional knowledge certificate to answer the questions. as well as 86% respondents were less than 40 years old and 82% of respondents had a degree upper than Bachelor’s these indicate that sample members had enough theoretical knowledge also the respondents had more than 5 years’ experience in auditing therefore, it is obvious that the respondents had enough knowledge and experience to answer the questions.

Results

In Table 2 Based on interviews from the audit professionals we found that auditors go through 9-step process for professional judgment. Also, the results of questionnaires analysis indicated the factors affecting each of the steps for a professional judgment. In the following, we refer to the process of auditor's professional judgment and the factors affecting each stage.

Discussion and Conclusion

We expanded previous research in the field of psychology and auditing, we tested the process of auditor's professional judgment based on psychological concepts and its practical application. Based on interviews from the audit professionals, in this research auditors’ professional judgment process and the factors affecting it were identified. Also, factors affecting the auditor's professional judgment process were identified by collecting questionnaires from professional auditors with a supervisor or higher. The results show that in this process, first, the problem should be defined, then the best solution to the problem of effective judgment is identified; in order to judge effectively the information must be collected through "memory retrieval" or "Collection and evaluation of information". In the next stage, the subject of judgment is reviewed again, then judgment's hypothesis are identified and evaluated, and the judgment of the client is challenged. Finally, according to the above steps, the discussion and conclusion are made; Professional judgment should also be documented appropriately. Recognition of mentioned process causes auditors to consider all the important and relevant dimensions when making a professional judgment. Also, this framework can be a basis for the documentation of professional judgment process, performance evaluation of audit personnel and audit firms evaluation by authoritative and legal bodies.

This research implications are important for auditors, accountants, legal and professional authorities. It is useful for auditors because this research identifies the stages of an effective and efficient judgment and also, it provides a basis for the documentation, assessing the performance of audit staff and defending professional performance against competent legal and professional bodies. Also the mentioned process provides guidance to accountants in conducting professional judgments that are used to prepare financial statements based on accounting standards. Eventually, identification of the process of the auditor's professional judgment helps legal authorities and professional bodies to better assess the performance of accountants and auditors.

Under what circumstances may an auditor rely on their professional judgment?

Can you think of examples where professional judgement is used?

Why is it important to use professional judgement?

Where auditors should apply professional judgement?