Are audit errors the result of fraud or biases? Improving International Auditing Standards (IAS) to

In 2002, a notable article was published in the Harvard Business Review. Professor Bazerman from Harvard Business School and Professor Loewenstein from Carnegie Mellon University showed that numerous financial scandals of the early 2000ies and errors made by accounting firms could have resulted from auditors’ vulnerability to unconscious bias rather than from the deliberate corruption. Perhaps, even more important, though, is the immanent character of biases, so that no one can be sure to have taken an unbiased decision.

Who is to blame? Cognitive science research has proved that biases are likely to appear when we deal with incomplete, insufficient information, uncertainty or when a decision is taken under time pressure. Uncertainty is the most commonly spread and dangerous situation. It allows for different interpretations of facts and figures – which is distressing and uncomfortable for most of us. In an attempt to bridge the gap we use mental shortcuts and explain our actions by existing routines (“we have always done like this”), experience (“this scheme worked in the past, so it will work this time”) or intuition (“I simply trust my gut”) – and get trapped by our biases.

In the quest for objectivity the auditor shall plan and perform an audit with professional skepticism and exercise professional judgment (IAS 200). However, neither of these requirements guarantees that the judgment will be impartial. If an auditor is motivated to come to a particular conclusion, it is quite probable that he or she will distort the numbers in a way that supports his or her view without even knowing that the conclusion is biased. In the best case ill decisions are recognized ex post leaving the managers no other choice but remedy their consequences. But most often biases remain uncovered and lead to a chain of slanted decisions and compromised conclusions thereafter.

To mitigate the negative effects of biases in controlling and audit the two professors suggested that audit standards and regulations should recognize the existence of biases and take into account their impact on accounting practices.

15 years later, in 2017, the Association of Certified Chartered Accountants (ACCA) released their recommendations to improve the quality of audit. Here are some of them:

  • Review the use of “bias” in auditing standards to conform its use with how it is used in the psychology literature.

  • Establish within International Standard on Quality Control (ISQC) 1 “Quality Control for Firms that Perform Audits and Reviews of Financial Statements“ and International Standard on Auditing (ISA) 220 “Quality Control for an Audit of Financial Statements” how firms implement firm-level and engagement-level quality control processes that reduce the impact of cognitive biases on professional skepticism.

  • Examine the impact of availability and anchoring bias on the auditor’s collection of sufficient appropriate evidence in ISA 500 “Audit Evidence.

  • Support auditors in understanding bias and how biases can be mitigated through continuing professional development and targeted training.

Establishing a system of checks & control policies into the company’s internal routines can moderate the ill effects of biases. However, control procedures alone are not enough to guarantee fair-minded decisions. To be able to handle with slanted decisions you must learn to recognize biases and use techniques to mitigate their effects.

By the way, hier you can test the quality of your decision.

What information and policies do you think are crucial while checking management reports for cognitive biases? Please share your thoughts in the comments section below.

If you have some ideas about quality control processes that reduce the effects of cognitive biases or want to know more about them, lets have a talk!

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