Professional Judgment: A Model for Accounting and Auditing Decisions
Schmutte, James, Duncan, James R., The CPA Journal
The transition of U.S. companies from U.S. GAAP to IFRS, along with the related discussion of rules-based versus principles-based standards, is a hot topic in accounting circles. Both sets of standards derive from conceptual frameworks of accounting principles. The differences exist in the extent to which authoritative standards provide guidance in implementing those principles. The common element - regardless of the standards used - is the need to exercise professional judgment in deterrnining and applying an appropriate approach to account for and report a transaction or event.
Similarly, professional judgment is an increasingly important aspect of the independent audit function. Recently issued audit risk standards reflect this emphasis; they describe a broad process and the general types of information the auditor should acquire. The auditor must employ judgment in using that information to identify the risks of material misstatements and develop an appropriate audit response. Professional judgment synthesizes the collection of information and the resulting conclusions.
This article presents a framework for making accounting and auditing judgments as recommended in the recently issued report by the SEC's Advisory Committee on Improvements to Financial Reporting (CIFiR). The report's recommendations focus on accountants and auditors of public companies; however, the suggested judgment process, factors to consider, and trail of documentation equally apply to all practitioners for both nonpublic and publicly traded companies. Public Company Accounting Oversight Board (PCAOB) inspections and the AICPA's peer reviews reveal that documentation deficiencies are common audit findings. This article also provides an example for preparers and auditors of the professional judgment model to illustrate how it can be applied to accounting and auditing issues.
In July 2007, the SEC chartered the 17-member CIFiR, whose mandate was to examine the U.S. financial reporting system; make recommendations to improve the usefulness of financial information; and reduce the complexity of the financial reporting system for investors, preparers, and auditors. The final report, issued in August 2008, included recommendations in five areas:
* Increasing the usefulness of information in SEC reports,
* Enhancing the accounting standards-setting process,
* Improving the substantive design of new accounting standards,
* Delineating authoritative interpretive guidance, and
* Clarifying guidance on financial restatements and accounting judgments.
Regarding accounting judgments, the report specifically recommended that the SEC and PCAOB issue statements of policy articulating how they would evaluate the reasonableness of accounting judgments, including factors they would consider in making their evaluations. The AICPA subsequently encouraged the SEC to implement the professional judgment recommendations as an initial step in the move to IFRS. In addition, the SEC's study on mark-to-market accounting issued in late 2008 echoed the CIFiR's recommendations.
Areas of Professional Judgment
The CIFiR report cites several categories of accounting and auditing judgments. Judgment is often necessitated not only in the selection of an accounting standard but also in its implementation. For example, determining whether SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, is the applicable standard to address a potential asset impairment is only the first step. Complying with the standard requires a series of judgments as to the amount, timing, and uncertainty of the projected cash flows that are critical to its application.
All transactions and events, however, do not neatly fall within the scope of existing standards. In such situations, practitioners need to apply judgment to identify the applicable underlying accounting principle or, by analogy, extrapolate an existing standard to address the reporting situation. …