Auditor Bias

Auditor Bias - 21/09/2009 Auditor Bias The gray area of...

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The gray area of bias By James L. Gunn Illustration: Gary Clement Revised international standards on auditing tackle possible bias in accounting estimates Auditing financial statements has never been a matter of following a strict, rules-based approach. This is true not only because of the fundamental nature of an audit itself, but also because of the need for the auditor to evaluate the various judgments management has made in applying accounting rules to an entity’s facts and circumstances when preparing the financial statements. Dealing with the gray area of management judgment, however, has always been a challenge for auditors. For example, even when audit evidence supports the reasonableness of individual accounting estimates, the overall picture presented by the financial statements may in fact be distorted. Such an outcome may arise through bias in management’s judgment, the cumulative effect of which is the failure of the financial statements to fairly present the entity’s financial results and position. In such circumstances, the auditor’s exercise of professional skepticism in evaluating management’s judgment, including how it may have been subject to bias, becomes critical. Given the increasing complexity of today’s financial reporting regimes and the public interest for sound and credible financial statements, it is understandable why the application of judgment has attracted so much attention in recent years, particularly in relation to financial statement items that are more susceptible to bias. Taking into account the increased prevalence of accounting estimates measured at fair value — estimates that may be especially prone to management bias — it is essential that auditors appreciate the challenges that management bias can pose and recognize where they need to focus audit effort. What is bias? Generally, bias may be described as a preference for a specific outcome or perspective. It follows, therefore, that one is biased if one’s judgment is not neutral or objective but subjective. This implies that one has not given appropriate weight to all relevant facts and circumstances based on their merits, resulting in an uneven dispensation of judgment. In relation to financial reporting, management bias may be viewed as a lack of neutrality in the preparation and presentation of financial information. Management bias has different facets: for example, it may reflect an inherent conservatism in management’s philosophy of financial reporting; it may arise from management’s desire to achieve certain financial performance targets on which remuneration incentives are based; or it may represent a legitimate desire to minimize the reporting entity’s tax liability. Management bias is a complex subject, however. It may manifest itself in different and often subtle forms. At one end of the
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Auditor Bias - 21/09/2009 Auditor Bias The gray area of...

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