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AICPA Code of Professional Conduct Section 0.300 and Section 1.100,

"Integrity and Objectivity."

a distinguishing characteristic of professionals who consistently exercise sound judgment is that they recognize the judgment frame they are using, and they are able to consider the situation through different frames, or what KPMG professionals refer to as a

"fresh lens."

Professional skepticism helps to frame our

"mindset."

At the very center of the KPMG framework is

"mindset." · It is important that auditors approach matters o objectively and independently o with inquiring and incisive minds.

Section 301.4 of The Sarbanes-Oxley Act of 2002 set up requirements of internal control procedures. They are

- Audit committees of a public company are required to establish procedures for the receipt, retention, and treatment of complaints received by the company regarding accounting, internal controls, or auditing matters. - The audit committee is required to establish procedures for those complaints to be treated confidentially, and for the submission process to be anonymous for employees submitting the complaints about accounting or auditing matters. These procedures are often referred to as "whistleblowing" procedures.

In the areas of auditing and accounting, judgment is typically exercised in three broad areas:

1) Evaluation of evidence (e.g., does the evidence obtained from confirmations, combined with other audit evidence, provide sufficient appropriate audit evidence to determine whether accounts receivable is fairly stated) 2) Estimating probabilities (e.g, determining whether the probability-weighted cash flows used by a company to determine the recoverability of long-lived assets are reasonable) 3) Deciding between options (e.g., audit procedure choices, such as inquiry of management, inspection, or confirmation)

KPMG Professional Judgement Framework

1) Identify the problem 2) Consider all of the alternatives 3) Gather & evaluate information 4) Reach conclusion 5) Articulate & document rationale

What are the five steps in the judgment process?

1. Clarify Issues and Objectives, 2. Consider Alternatives 3. Gather and Evaluate Information 4. Reach Conclusion 5. Articulate and Document Rationale.

What are the five interrelated components of an entity's internal controls

1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information and Communication 5. Monitoring

The three potential ways to mitigate the effects of biases are

1. First way to mitigate is to make actively questioning of assumption which can include seeking more complete information. 2. Consulting with others can also help in mitigating the biases as it provides the different viewpoints that one can have. 3. One can also mitigate the effects of bias by objectively evaluate the pros and cons for each alternative as this will help an individual to consider all the possible arenas of an alternative.

Two common judgment traps that can affect our judgement are

1. Rush to Solve & 2. Judgment triggers

What are two common judgment traps?

1. Rush to Solve and 2. Judgment Triggers

1. What is fundamental to exercising professional skepticism?

1. The fundamental to professional skepticism is the attitude of the auditor to approach issues in an objective, and critical nature. Therefore assessing evidence as such, before making judgments. "The [skeptic] promotes risk awareness and is inherently an enemy of fraud." (KPMG Ch. 3 PG16) The concept of judgment framing is important because appropriately questioning management's perspective by viewing the situation through other frames is fundamental to professional skepticism. challenging management's existing frames, which is the essence of professional skepticism.

what impedes professional judgement?

1. in a world of pressure, time constraints, and limited capacity, there are a number of judgment traps we can fall into. 2. In addition, we can be subject to biases caused by self-interest or by unknowingly applying mental shortcuts.

AICPA Code of Professional Conduct Section 0.300 and Section 1.100, "Integrity and Objectivity."

1.100 a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment .300 overall principle of due care: A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability.

Which of the following best describes a judgment trigger?

An issue/problem stated in terms of a particular alternative

Who served as WorldCom's external auditor and who replaced them

Arthur Andersen, LLP, served as WorldCom's external auditor until June 2002 replaced by KPMG after the Enron Scandal Author Anderson was part of

What responsibility does an auditor have to detect material misstatements due to errors and fraud?

Auditors are required to plan and perform audit engagements to provide reasonable assurance that the financial statements are free of material misstatement, whether the result of error or fraud.

an example of the confirmation bias

Auditors may be prone to over rely on management's explanation for a significant difference between the auditors expectation and managements recorded value, even when the clients explanation is inadequate

What is the most important factor in avoiding traps or reducing bias?

Awareness of potential traps and conditions that lead to bias is the most important factor.

True or False

Awareness, coupled with the terminology to identify and label the potential traps and biases, is key to improving judgment.

Finally wrapping around "mindset" in the Framework is

CONSULTATION which includes with o engagement team members, o specialists, or other professionals

Who reported WordComs fraud and what was their position?

Cynthia Cooper from their internal audit staff

In December 2002, Time magazine named WorldCom's ___________ as one of its "Persons of the Year" along with two other whistleblowers: _____________of Enron and _________ of the FBI.

Cynthia Coopers, Sherron Watkins & Colen Rowley

How can considering multiple judgment frames enhance an auditor's professional skepticism? Explain and give an example.

Evaluating issues and objectives from different frames, or what we at KPMG would call looking at an issue through a "fresh lens," can help auditors to understand a variety of different perspectives. Considering multiple frames can bring additional insights or ways to understand a situation.

True or False: You just cannot teach judgment; either you have it or you do not.

False. While experience is important, gaining knowledge and skill relating to exercising good judgment can help elevate and improve students' and professionals' judgment maturity.

true or false ; People are simply hardwired to use judgment shortcuts, and as such, there is no way to avoid the related biases.

False. While reliance on judgment shortcuts does come naturally, awareness of conditions that can lead to bias provides decision makers the ability to identify logical methods to reduce the bias.

True or False: At the time Cynthia Cooper discovered the accounting fraud, WorldCom had whistleblower hotline process in place

False: At the time Cynthia Cooper discovered the accounting fraud, WorldCom did not have whistleblower hotline process in place

True or False: Mangagement should be involved in the Whistleblower program

False; Management should never be involved

AICPA Code of Professional Conduct Section 0.300 and Section 1.100 deals with

Integrity and Objectivity

CATCH US IN THE EARLY STEPS OF THE JUDGMENT

Judgement Traps

It is a situation when a particular alternative is used to define a problem in place of a well thought out problem.

Judgement Trigger

Which of the following is not a step in reframing a situation?

Justify the current frame

What role do metaphors and analogies play in judgment framing, and how can they be used to improve your ability to examine issues through multiple frames?

Metaphors and analogies both play a powerful role in judgment framing. General Barry McCaffrey; general in the united states army, successfully changed the tone toward drug trafficking from changing the metaphor "The War on Drugs" to "Drugs are the Cancer to the Nation." The first metaphor creates a different frame which denotes the combat against drugs; while "drugs are the cancer to the nation" suggest that the drug problem in america is a sickness. This creates a different attitude and hence, different frame.

How can considering multiple judgment frames enhance an auditor's professional skepticism? Explain and give an example.

Multiple judgment frames enhance an auditor's professional skepticism because better judgments can be made from considering the fact that other frames exist; different points of view. "For example, doctors and patients tend to select riskier treatment options when a condition is framed in terms of the odds of dying than when the identical situation is framed in terms of the likelihood of surviving—same situation, but different frames." (KPMG Ch. 3 PG17) If we consider both frames, the odds of dying vs the odds of surviving we can make a better judgment. Hence, the importance of multiple frames.

What could be the consequences of whistleblowing?

REPERCUSSION FROM SUPERIORS COMPANY WENT BANKRUPT EMPLOYEES LOST THEIR JOBS EVERYBODY MAD LEGAL ISSUES, MEDIA COULD BE HARDER TO GET FUTURE WORK, DON'T WANT THE ATTENTION TEACH SAYS; IN REALITY MOST WHISTLE BLOWERS WILL LOSE THEIR JOB AND WON'T GET HIRED WITHIN THE SAME INDUSTRY PRESSURE FACED BY WHISTLE BLOWER

What Act's procedures were referred to as whistle blowing procedures?

Section 301.4 of The Sarbanes-Oxley Act of 2002

How do perceptual biases relate to judgment biases?

Similar to how our minds can be deceived by optical illusions or perceptual biases, there are times when our intuitive judgment falls prey to systematic traps and biases.

Judgment is the process of reaching a decision or drawing a conclusion where there are a number of possible alternative solutions TRUE OR FALSE

TRUE

The tendency of decision makers to make assessments by starting from an initial numerical value and then to adjust insufficiently away from that initial value in forming a final judgment.

The anchoring tendency

The tendency for decision makers to consider information that is easily retrievable from memory as being more likely, more relevant, and more important for a judgment.

The availability tendency

What is fundamental to exercising professional skepticism?

The concept of judgment framing or appropriately questioning a client's perspective by viewing the situation through other frames is fundamental to exercising professional skepticism.

The tendency for decision makers to seek for and put more weight on information that is consistent with their initial beliefs or preferences.

The confirmation tendency · once people have adopted a preference or an opinion, they tend to consider and gather information that supports and agrees with their preference. · people tend to seek confirmatory evidence, rather than looking for something inconsistent with their opinions or preferences.

How did WorldCom perpetrate their fraud?

The fraud at WorldCom involved the erroneous capitalization of billions of dollars of network expenses as assets. · Normal lease operating expenses related to fees paid by WorldCom to local telephone companies for use of their telephone networks were capitalized on the balance sheet.

The tendency for decision makers to overestimate their own abilities to perform tasks or to make accurate diagnoses or other judgments and decisions.

The overconfidence tendency

What is the purpose of MANAGEMENT OVERRIDE OF INTERNAL CONTROLS: The Achilles' Heel of Fraud Prevention document

The purpose of this document is to offer guidance to audit committees in addressing the risk of fraud through management override of internal control over financial reporting.

Describe the availability tendency in your own words, and give an example of how the tendency could result in auditor bias.

The tendency for decision makers to consider information that is easily retrievable from memory as being more likely, more relevant, and more important for a judgment.

Describe the confirmation tendency in your own words, and give an example of how the tendency could result in auditor bias.

The tendency for people making judgments to seek for, and put more weight on, information that is consistent with their initial beliefs or preferences.

Which of the following statements about judgment frames is correct?

There is often no single best frame for a given situation.

What is the primary purpose of the KPMG monograph?

To help readers understand the nature of professional judgment and to give them a head start in developing and improving their own professional judgment abilities.

True or False Professional skepticism helps to appropriately frame an auditor's mindset.

True

True or False KPMG Professional Judgment Framework provides a good representation of the process we should follow when applying professional judgment, but o it is not necessarily an accurate representation of the processes people follow consistently.

True

Which company was Bernie Ebbers from who was convinced for his role in the fraud and sentenced to over 20 years in prison. Currently, he is appealing his verdict.

WorldCom

which company had the largest bankruptcy in U.S. history.

WorldCom

What company was a Mississippi- based telecommunications company that grew through aggressive mergers and acquisitions

WorldCom Inc.

which companies used the fraud tactic of capitalizing expenses

WorldCom,

What tendency is most likely manifest in the following situation? An engagement team performed a substantive analytical procedure over an expense account. When investigating a significant difference, the team was satisfied with limited evidence to support the client's plausible explanation (which was in fact incomplete) for the difference. a. Confirmation tendency b. Limited resources c. Overconfidence tendency d. Time pressure

a. Confirmation tendency

Which of the following is NOT recommended when trying to mitigate the risk of bias attributable to the availability tendency? a. Consider the most unusual case b. Make the opposing case c. Consult with others d. Get objective data

a. Consider the most unusual case

Which of the 5 internal controls includes methods and records established to record, process, summarize, and report transactions and events and maintain accountability for assets, liabilities, and equity a. Information and Communication b. Control Environment c. Risk Assessment d. Monitoring e. Control Activities

a. Information and Communication

Within an auditing context, what is professional judgment? a. Professional judgment is the process of using relevant training, knowledge, and experience to reach a decision or draw a conclusion in evaluating evidence, estimating probabilities, or selecting between options. b. Professional judgment is professional skepticism, which is an attitude that includes a questioning mind and a critical assessment of audit evidence. c. Professional judgment is the application of one's experience to make a judgment in the absence of supporting evidence, based on the facts and circumstances of the audit engagement. d. Professional judgment is the construction of a logical justification to support an outcome or conclusion that is otherwise not supported by the available evidence.

a. Professional judgment is the process of using relevant training, knowledge, and experience to reach a decision or draw a conclusion in evaluating evidence, estimating probabilities, or selecting between options.

KPMG Professional Judgment Framework includes a. mindset, b. consultation, c. knowledge and professional standards, d. influences and biases, e. refection & coaching f. all above

a. mindset, b. consultation, c. knowledge and professional standards, d. influences and biases, e. reflection & coaching f. all above

The most important step in avoiding judgment traps and reducing bias caused by subconscious mental shortcuts or self-interest is

awareness

Which sets the tone of the organization towards controls? a. Information and Communication b. Control Environment c. Risk Assessment d. Monitoring e. Control Activities

b. Control Environment

Which of the following best describes a technique to mitigate the confirmation bias? a. Consider the most unusual case b. Make the opposing case c. Consult with others d. Get objective data

b. Make the opposing case

Which of the following best describes the relationship between professional skepticism and professional judgment? a. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence that is separate and apart from the process of exercising professional judgment. b. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence that is part of the process in forming professional judgments. c. Professional skepticism is synonymous with professional judgment.

b. Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence that is part of the process in forming professional judgments.

The confirmation bias is a subconscious tendency to do which of the following? a. Seek evidence that confirms a biased judgment b. Seek evidence that confirms a previously held view c. Underutilize confirmations in the testing of accounts receivable d. Seek evidence that disconfirms a previously held view

b. Seek evidence that confirms a previously held view

Which of the following best describes a judgment trigger? a. An alternative stated in terms of a judgment objective b.A technique for making effective judgments quickly c. An issue/problem stated in terms of a particular alternative d.A technique for more effectively evaluating another's judgment

c. An issue/problem stated in terms of a particular alternative

Which of the following is NOT a step in reframing a situation? a. Challenge the current frame b. Generate alternative frames c. Justify the current frame d. Understand the current frame

c. Justify the current frame

What is the process used by management to identify, analyze, and manage risks relevant to the preparation of the financial statements a. Information and Communication b. Control Environment c. Risk Assessment d. Monitoring e. Control Activities

c. Risk Assessment

Which of the following is not a technique to help an auditor mitigate possible bias stemming from use of a judgment shortcut? a. Be aware of the bias and when you might be vulnerable to it b. Seek disconfirming evidence c. Seek the advice of someone who agrees with your position d. Identify and acknowledge personal preferences

c. Seek the advice of someone who agrees with your position

a Judgement Trigger can cause people to

create triggers because they are in such a hurry to solve the problem and their judgments are often based on the incomplete facts or understanding. ex. executives clarified the decision problem as "how to get larger quantities of snack products into consumers' homes."

Which of the following is an example of the confirmation bias? a. An auditor improperly concludes on a complex revenue recognition matter without having the appropriate technical accounting background. b.An auditor improperly concludes on the valuation of an investment security by looking at only the most recent sale of the security. c. An auditor improperly concludes on the accounts receivable balance because negative confirmations were sent instead of positive confirmations. d.An auditor improperly concludes a contingent liability is properly stated after examining only the evidence that supported the amount accrued in the financial statements.

d. An auditor improperly concludes a contingent liability is properly stated after examining only the evidence that supported the amount accrued in the financial statements.

What internal control includes management's process to assess the quality of controls a. Information and Communication b. Control Environment c. Risk Assessment d. Monitoring e. Control Activities

d. Monitoring

Which of the following is true with respect to the overconfidence bias? a. Overconfidence is always a conscious bias. b. Overconfidence could result in the consideration of too many alternatives. c. Overconfidence usually decreases with experience. d. Overconfidence could result in engagement team members performing audit procedures that are beyond their skill sets.

d. Overconfidence could result in engagement team members performing audit procedures that are beyond their skill sets.

Which of the following describes how the availability tendency is most likely to affect auditors? a. Auditors may first consider different potential causes for an observed fluctuation before seeking the client's explanation with regards to analytical procedures. b.Auditors may rely on information provided by client staff who is most knowledgeable about an audit area rather than the staff most easily accessible. c. Auditors may seek evidence that supports their belief of how a transaction should be accounted for. d.Auditors may weigh more heavily the information that was received most recently from a client relative to information received earlier during the audit.

d.Auditors may weigh more heavily the information that was received most recently from a client relative to information received earlier during the audit.

True or False Professional skepticism is synonymous with professional judgment

false; it is an important component or subset of professional judgment.

To overcome rush to solve or judgment triggers ask

o "what" and "why" questions. o invest in clarifying the fundamental issues and objectives.

In the Rush to Solve Trap

o having a tendency to immediately solve the problem by making a quick judgment. o an individual can sometimes end up in solving the wrong problem. o in rush to solve their problem as soon as possible and often choose the easily available alternative. o settle for a suboptimal outcome because we did not consider a full set of alternatives.

Mindset requires that auditors approach things

o objectively and independently o with inquiring and incisive minds.

Judgement Triggers are

one of the biggest traps we run into during the first couple of steps of the judgment process, which is under-investing in defining the fundamental issue

Judgement Frames

provide one view that might be quite different from the view through another window facing a different direction.

Section 302 of the Sarbanes-Oxley Act of 2002 requires

requires a CEO and CFO to certify in each annual and quarterly financial statement report filed with the SEC

What are control activities?

specific policies and procedures established by management

What is management override of internal controls

the intervention by managers in the approval and/or processing of transactions that is contrary to an entity's internal control system.

The Professional Judgment Framework depicts constraints, influences, and biases that threaten good judgment with

with the box on the outer rim of the Framework labeled "Environment" and the triangle at the top labeled "Influences/Biases."

Who should oversee Whistleblower programs and how it is handled?

· Whistleblowers programs should be overseen by the board's audit committee. Confidentiality and trust. e.g., culture: valuable contribution · Submission of complaints are automatically and directly submitted to the audit committee. Role of third-party vendors to administer the whistleblowing program. o Can provide telephone or internet-based hotline for reporting complaints • Internal audit is an effective monitor of the whistleblower program

Professional skepticism is

· an objective attitude that includes a questioning mind and · a critical assessment of audit evidence.

At the bottom of the Professional Judgment Framework, you will see Knowledge and Professional Standards,

· as these factors are foundational to quality judgments.

Which of the following statements about judgment frames is correct? · a. A situation cannot have more than one appropriate frame. · b. There is often no single best frame for a given situation. · c. Frames are not used by risk averse individuals. · d. Professionals should eliminate the use of frames from their judgment processes.

· b. There is often no single best frame for a given situation.

Judgment Frames are

· mental structures that we use, · usually subconsciously, · to simplify, organize, and · guide our understanding of a situation. They shape our perspectives and determine the information that we will see as relevant or irrelevant, important or unimportant.

What are the four common judgment tendencies that are most applicable and important for audit professionals:

· the availability tendency, · the confirmation tendency, · the overconfidence tendency, and · the anchoring tendency.

Under Section 302 of the Sarbanes-Oxley Act of 2002, The signing officers are required to disclose to its auditors and the audit committee:

• All significant deficiencies in the design or operation of internal controls and all material weaknesses identified • Any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal controls. The signing officers have indicated in the report whether there were any significant changes in internal controls that could significantly affect internal controls subsequent to the date of their evaluation.

What obstacles do Whistleblowers face as a result of bringing the inappropriate actions of others to light

• Doubt as to whether their claims are accurate. • Disgruntled individuals responding to an emotional reaction • Consequences of whistleblowing • Personal losses • Legal issues

What are the things to consider when thinking of bringing forward a potential fraud?

• Ensure a clear understanding of the facts give rise to the concern. Avoid premature "claims". • Gather evidence. • Consider approaching his or her superiors for a chance of additional information. • Follow established company procedure. • If necessary, outside legal counsel

What two main categories of fraud affect financial reporting?

• Fraudulent financial reporting • Misappropriation of assets.

What factors should an auditor consider when evaluating the control environment?

• Integrity and ethical values • Commitment to competence • Board of directors and audit committee participation • Management's philosophy and operating style • Organizational structure • Assignment of authority and responsibility • Human resource policies and practices

According to professional standards, what are the organizational reporting lines of authority appropriate for an effective internal audit function within an organization?

• International Standards for the Professional Practice of Internal Auditing issued by The Institute of Internal Auditors (www.theiaa.org, section 1110): "The chief audit executive should report to a level within the organization that allows the internal audit activity to fulfill its responsibilities. The chief audit executive must confirm to the board, at least annually, the organizational independence of the internal audit activity" (see Section 1110 of those standards). Those standards note in the Interpretation of Section 1110 that "Organizational independence is effectively achieved when the chief audit executive reports functionally to the board." • Most recommend that internal audit report directly to the audit committee of the board of directors. Because of its independence from top management, the audit committee can effectively ensure that internal audit's scope is not restricted by top management and that the findings are addressed appropriately by top management. While internal audit reports functionally to the audit committee on matters related to audit scope and findings, often internal audit reports administratively to the CEO.

What are Pitfalls of a whistleblower hotline?

• Occur whenever the perception of confidentiality or anonymity is breached. • Employees don't believe that appropriate follow-up actions will be taken. • Management's over-involvement in the process.

What are the (AU)240 Section procedures required by auditors to further address the risk of management override of internal controls?

• The three mandated procedures required by (AU) Section 240. 1. Examine journal entries and other adjustments for evidence of possible material misstatement due to fraud. 2. Review accounting estimates for biases that could result in material misstatement due to fraud. 3. Evaluate the business rationale for significant unusual transactions to determine whether the transactions may have been entered into to engage in fraudulent financial reporting.

Under Section 302 of the Sarbanes-Oxley Act of 2002, the CEO & CFO must

• They have reviewed the report • That, based on the signing officer's knowledge, the report does not contain any untrue statements of material fact or omit any material fact necessary to make the report misleading. • The financial statements, based on the officer's knowledge, are fairly presented. • The signing officers: • Are responsible for establishing and maintaining internal controls • Have designed such internal controls to ensure that material information related to the company and its subsidiaries is made known to those officers by others in the entity. • Have evaluated the effectiveness of internal controls as of a date within 90 days prior to the report • Have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date.