Professional Judgment A CPAB Perspective

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Professional Judgment A CPAB Perspective

• Paul LohnesAugust 7, 2008

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Agenda

• CPAB overview
• Why is professional judgment important to CPAB?
• What is professional judgment?
• How is professional judgment applied?
• Importance of consultation
• CPABs expectations for professional judgments

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CPAB

• MANDATE
• Contribute to improvement in the quality of
  auditing of reporting issuers.

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CPAB (contd)

• Operations
• Inspect registered Firms that audit Reporting
  Issuers (RI)
• Inspection focus
• CICA GSF-QC quality elements
• Review of RI audit files
• Smaller firms greater focus on file reviews
• Issue report with recommendations
• Disciplinary actions (if necessary)

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CPAB (contd)

• Frequency of Inspections
• Annual if 100 or more RI clients
• Annual or biennial if between 50 and 99 RI
  clients
• Triennial if less than 50 RI clients if audit
  fees from RIs in excess of 1 million or Firm
  registered with PCAOB
• Others based on risk or special circumstances

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CPAB Registrant Firms/RIs - June 30, 2008
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Importance of Professional Judgment to CPAB

• Good professional judgments result in good
  financial reporting and good auditing
• We want more than the response professional
  judgment when we ask how a key audit decision
  was made.

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Defining Professional Judgment

• Until recently no authoritative definition in
  Canada or elsewhere, but important current
  developments
• IAASB (International Auditing and Assurance
  Standards Board) auditing judgments
• SEC accounting judgments

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Proposed IAASB Definition

• Proposed definition of PJ in revised and
  redrafted ISA 200
• Professional judgment - The application of
  relevant training, knowledge and experience,
  within the context provided by auditing,
  accounting and ethical standards, in making
  informed decisions about the courses of action
  that are appropriate in the circumstances of the
  audit engagement.

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Proposed IAASB Requirement

• The auditor shall exercise professional judgment
  in planning and performing an audit of financial
  statements
• Plus 5 paragraphs of Application and Other
  Explanatory Material summarized in the next 2
  slides

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Audit Decisions Where PJ is Particularly
Necessary (IAASB)

• Materiality and audit risk
• The nature, timing, and extent of audit
  procedures
• Evaluating whether sufficient appropriate audit
  evidence has been obtained
• The evaluation of managements judgments in
  applying GAAP
• The drawing of conclusions based on the audit
  evidence obtained, for example, assessing the
  reasonableness of the estimates made by management

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Other Aspects of PJ (IAASB)

• Auditor has the necessary competencies to achieve
  reasonable judgments
• Based on facts and circumstances known by the
  auditor up to the date of the report
  consultation assists in making informed and
  reasonable judgments
• Exercised throughout the audit
• Needs to be appropriately documented to enable an
  experienced auditor to understand the significant
  PJs made in reaching conclusions
• PJ NOT used as justification for decisions not
  otherwise supported by facts and circumstances or
  sufficient, appropriate audit evidence

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Consultation ISA 220

• The engagement partner shall
• Take responsibility for the engagement team
  undertaking appropriate consultation on difficult
  or contentious matters
• Be satisfied that members of the engagement team
  have undertaken appropriate consultation during
  the course of the engagement, both within the
  engagement team and between the engagement team
  and others at the appropriate level within or
  outside the firm

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Consultation ISA 220 (contd)

• The engagement partner shall
• Be satisfied that the nature and scope of, and
  conclusions resulting from, such consultations
  are agreed with the party consulted and
• Determine that conclusions resulting from such
  consultations have been implemented.

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Consultation ISA 220 (contd)

• Effective consultation on significant technical,
  ethical, and other matters within the firm or,
  where applicable, outside the firm can be
  achieved when those consulted
• Are given all the relevant facts that will enable
  them to provide informed advice and
• Have appropriate knowledge, seniority and
  experience.

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Consultation ISA 220 (contd)

• It may be appropriate for the engagement team to
  consult outside the firm, for example, where the
  firm lacks appropriate internal resources. They
  may take advantage of advisory services provided
  by other firms, professional and regulatory
  bodies, or commercial organizations that provide
  relevant quality control services.

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When to Consult?

• The less experienced the practitioner /
  engagement team , the greater the need for
  consultation
• The less knowledge of the practitioner /
  engagement team of the specific industry or
  accounting topic, the greater the need for
  consultation
• The greater the complexity, materiality and risk,
  the greater the need for consultation

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Example of Professional Judgment

• Background
• Company in the entertainment business.
• Company has an operating agreement in place with
  a government
• Issue- Recognition of amounts to be reimbursed to
  the company by the government on eligible capital
  expenditures
• Reimbursement for eligible capital expenditures
  was based on a percentage of revenues over time
• Company recorded a very material receivable on
  its balance sheet with an offset to fixed assets
  (thereby reducing amortization expense)
• The receivable was recognized based on revenue
  projections that went out for many years

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Example (contd)

• Application of CICA Handbook to the accounting
  for the agreement
• All Conditions had NOT been met to accrue the
  reimbursement
• Partner had limited public company experience
• Relevant CICA Handbook Sections were not given
  appropriate consideration in the engagement
  teams accounting analysis
• Lack of due care and professional skepticism
  (complex agreement)
• No formal consultation outside the team at time
  professional judgment was exercised
• Subsequent consultation - covered the
  accounting but not the auditing
• Documentation and related consultation subsequent
  to the audit report release date
• Financial statements were restated and a stronger
  partner brought in as the EQCR

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Preparers (clients) Make Judgments

• Selection of appropriate accounting standards
• Implementation of accounting standards
• Lack of applicable standards
• Financial statement presentation and disclosure
• Estimating amounts to record
• Evaluating sufficiency of evidence

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Auditors Make Judgments

• These include evaluating the clients judgments
  in making accounting estimates, applying
  accounting policies and preparing the financial
  statements and notes
• Are assumptions made justified and documented by
  the client and did the auditor challenge them and
  subject them to audit procedures ?
• Were ranges of probable outcomes considered and
  documented - by the client? by the auditor?
• Is there documentation evidencing the relevant
  accounting standards and other applicable sources
  that were considered by the client and the
  auditor?
• Did the auditor consult and is this documented?
  (fly alone die alone)
• Are the facts and circumstances on which
  judgments are based clearly documented?

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CPABs Expectations

• It is clear from the file where professional
  judgment has been exercised by the engagement
  team
• The facts and circumstances pertinent to the
  judgments are clear and are documented
• There is evidence that the auditor has challenged
  the clients assumptions and judgments
  professional scepticism
• Consultations occur on complex, risky, and
  contentious matters, and are documented
• Documentation allows CPAB to understand the
  significant professional judgments made in
  reaching conclusions on all significant matters

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CPABs Expectations (contd)

• CPAB does not want to have to second guess the
  auditors judgments BUT
• Hiding behind statements like Based on
  professional judgment the amount of the provision
  is reasonable without supporting facts and
  circumstances and audit evidence - will NOT fly
• If there is no documentation of the basis for
  judgments made then the procedures in question
  were not done