R
E S P O N S I B I L I T I E S
ethics
&
L
E A D E R S H I P
Making Independence Decisions under the
Code of Professional Conduct
Understanding and Controlling Common Cognitive Biases
By James Schmutte and
James R. Duncan
C
onsider the hypothetical case of
Robert Jones, CPA. Jones, an audit
partner in the firm Jones & Smith
(J&S), feels quite pleased with himself
because he just spoke with the controller
of Ace Manufacturing, a nonpublic entity
and long-term audit client, about an
engagement for J&S to assist in revising
the company’s financial reporting system.
J&S has performed several nonattest
engagements for the company; in addition,
J&S has performed three special internal
audit projects this year and is scheduled
to prepare the corporate tax returns. Jones
is already contemplating next year’s audit
and how to address the AICPA’s new
ethics guidance defining the preparation of
financial statements as a nonattest service.
Like many CPAs, Jones is faced with
the challenge of serving audit clients with an
expanding array of nonattest services, while
maintaining the independence required for
core attestation services. Before accepting a
nonattest engagement, Jones consults the
AICPA’s Code of Professional Conduct to
determine whether the service is permitted
under the independence standards. If the specific service is not prohibited, Jones understands that he is required to exercise professional judgment in the consideration of
additional factors before accepting the
engagement. But CPAs should be aware of
some common cognitive biases that can
impact one’s decision making with respect
to independence.
Independence Requirements
The AICPA’s Code of Professional
Conduct requires CPAs to remain independent in fact (and in mind) and in appearance
for all attest engagements. Independence of
mind means that the CPA can perform the
attest service without being affected by influ-
68
ences that compromise professional judgment; this enables a professional to act with
integrity and exercise objectivity and professional skepticism. In essence, the CPA
holds no preconceived notions about the outcome of the attest function as a result of
personal biases or other circumstances.
Independence in appearance is the avoidance
of circumstances that would cause a reasonable and informed third party that has knowl-
Decisions made using
a structured framework
are more likely
to be successful.
edge of all relevant information (including
safeguards applied) to reasonably conclude
that the integrity, objectivity, or professional
skepticism of a firm or a member of the attest
engagement team had been compromised. In
other words, neither the firm nor the attest
team members are viewed as engaged in any
conflict of interest regarding the client.
Independence in fact and appearance do
not mean a practitioner must be free of any
and all influences (i.e., a state of absolute
independence); rather, independence means
that the practitioner is not engaged in a situation or relationship presenting an unacceptable risk that integrity, objectivity, and
professional skepticism will not be exercised (or perceived as being unable to be
exercised) by a reasonable and informed
third party. The AICPA’s Code of
Professional Conduct defines certain client
relationships as presenting unacceptable
risks to independence that cannot be mitigated—and therefore are prohibited
(Interpretation 101-3, “Performance of
Nonattest Service”).
The AICPA’s Code of Professional
Conduct does not (and cannot) address all
possible nonattest services and other client
relationships. In 2006, the Code of
Professional Conduct incorporated a conceptual framework for independence that CPAs
are required to consider when making decisions on independence matters not explicitly
addressed by the code. The conceptual framework is based on a “threats and safeguards”
model and requires a “risk-based” application
(Exhibit 1). The Government Accountability
Office’s (GAO) 2013 “Revision of
Government Audit Standards” incorporates
a comparable independence conceptual framework. (For a discussion of a conceptual framework model, see Mark Myring and Robert
Bloom, “ISB’s Conceptual Framework for
Auditor Independence,” The CPA Journal,
January 2003.)
Common to both the AICPA’s and
GAO’s independence standards is the
added requirement to evaluate independence threats not only individually, but also
collectively. (The AICPA’s requirement
applies to periods beginning on or after
December 15, 2014.) Accordingly, CPAs
need to consider both the appropriateness of
the added service and its incremental impact
on independence in light of existing services or relationships. This can be viewed
as analogous to the auditing standards requirement to evaluate the materiality of misstatements, both individually and in aggregate,
as well as prior uncorrected misstatements.
Decision-Making Biases
When a nonattest service and client relationship is not specifically prohibited in the
Code of Professional Conduct, a CPA must
exercise professional judgment in applying
the “threats and safeguards” model to
decide whether to accept a nonattest
engagement. Research shows that decisions
OCTOBER 2014 / THE CPA JOURNAL
made using a structured framework are
more likely to be successful. Guidance
from the Committee of Sponsoring
Organizations (COSO), Enhancing Board
Oversight: Avoiding Judgment Traps and
Biases (2012), illustrates a structured
approach: 1) define the problem and identify the fundamental objectives, 2) consider the alternatives, 3) gather and evaluate information, 4) reach a conclusion, and
5) articulate and document the rationale.
Using a structured framework, however, does not guarantee that professional
judgment will not be compromised. To
deal with the number and complexity of
daily decisions, humans subconsciously
develop mental routines or shortcuts. The
social sciences use the term “heuristics”
to describe the cognitive strategies that people employ when solving problems or making decisions. Research demonstrates that
heuristics can introduce cognitive blinders
and biases that corrupt and hamper decision making.
For example, “bounded awareness” is a
form of cognitive tunnel vision that individuals experience when absorbed in a task.
Being overly focused inhibits the ability to
seek, see, and process easily information
that is relevant to decision making.
Exploiting this vulnerability is the secret
of every successful theatrical magician.
In the hypothetical example above, if
Jones is so focused on providing client services and generating firm revenue, he
might fail to recognize a potential threat to
his independence from providing added
nonattest services for Ace Manufacturing.
With his attention bounded by client service and business development, he is not
alert to the incremental independence
threats that an additional nonattest service
can present. Professional standards
require independence in mind and in
appearance; thus, if Jones only focuses on
independence in mind, he might be blind
to threats to independence in appearance.
Bias in a decision-making context does
not mean being prejudicial and unwilling to
have an open mind; rather, it refers to an
unconscious inclination toward a particular
outcome or belief that can affect how
humans search for and process information.
The social sciences identify more than 90
such cognitive biases. Biases can be neatly
defined in the literature, but in reality they
often overlap and are interrelated, similar to
OCTOBER 2014 / THE CPA JOURNAL
many other social and psychological phenomena. (For a discussion of cognitive biases in an audit context, see Michael C. Knapp
and Carol A. Knapp, “Cognitive Biases in
Audit Engagements: Errors in Judgment and
Strategies for Prevention,” The CPA Journal,
June 2012.)
The biases that can impact decision making are unconscious; thus, it is hard to
recognize when and how they are impacting decisions. For example, Jones must initially acknowledge certain fundamental
biases before they negatively affect his
decision making. First, practitioners tend
to act or make decisions quickly. Although
a quick response time is critical to providing client services, some decisions
require more thoughtful processing.
Second, people have a natural tendency
to be self-serving and to seek outcomes
that benefit them or their organization.
Adding another line of service can improve
Jones’s performance appraisal and compensation. Third, individuals must
acknowledge their vulnerability to biases
when making decisions. Researchers refer
to this blind spot as “illusory superiority”—
that is, a tendency to overstate abilities or
to think of ourselves as less biased than
others. Accordingly, Jones must accept the
reality that, as he applies professional judgment in assessing his independence, unconscious forces might influence his decisions.
For example, “anchoring bias” is the tendency for one’s first impressions or reactions to become the reference point (or
anchor) for subsequent thoughts and
actions. When the client proposed the need
for an added service, Jones could very easily become subconsciously anchored on the
decision to accept the engagement. His subsequent actions might incorporate acceptance of the engagement as the focus point.
In a similar vein, people can introduce
bias by how they initially “frame” the independence issue. Social science research
shows that how individuals phrase or frame
a decision question not only anchors an initial position, but also directs subsequent
inquiries. For example, if Jones poses the
question in terms of whether the engagement will impair his independence, his
decision making will likely focus on the
independence-in-fact dimension. This will
anchor him on a characteristic in which
he places great pride and confidence. On
the other hand, if he poses the question in
terms of whether the engagement will
cause others to question his independence, Jones is forced to consider independence from a different perspective.
Independence in appearance is a dimension that he might not be as comfortable
and confident in assuming.
If individuals anchor on a position, confirmatory bias can influence their search for
information. People tend to seek evidence
that supports their point of view and downplay that which contradicts it. As Jones
reviews the professional standards and guidance, he might assign greater weight and
importance to information that sustains his
decision to take on the new engagement. On
the other hand, he might discount any contradictory information he discovers.
“Availability bias” refers to the tendency
to believe that the information one can easily recall from memory is more relevant or
important to the decision at hand. People are
especially vulnerable if the information relates
to significant or important outcomes of earlier decisions or events. The decision regarding Ace Manufacturing’s current request can
be overly influenced by the fact that Jones
easily recalls the positive effects to his client,
himself, and his firm from the earlier decisions to accept nonattest engagements.
The unconscious desire to maintain or
support earlier decisions can also introduce
biases into decision making. The “status
quo bias,” for example, is a motivation
for the current decision to result in an
action that supports earlier decisions. If
Jones decides that the new nonattest
engagement does not pose an independence
threat, the validity of the independence
decisions regarding the earlier engagements
would be maintained; on the other hand,
deciding otherwise could bring into question his decisions regarding independence
on other nonattest engagements.
In a similar manner, the “sunk-cost bias”
influences current decisions, as individuals
unconsciously seek to support the choices
they have made in the past. The sunk cost
is not a financial cost in an accounting sense;
rather, it is the psychological investment one
has made in earlier decisions. People are
especially prone to the sunk-cost bias when
there are negative or unfavorable consequences if earlier decisions are proven
wrong. If Jones determines that acceptance
of the proposed nonattest engagement creates an independence threat, his indepen-
69
dence on other nonattest engagements might
also be called into question.
If a practitioner decides to consult with
others, biases may still be introduced. The
“halo effect bias” refers to incorrectly transferring impressions of a person’s abilities or
traits in one area to another unrelated trait or
ability. Practitioners naturally seek counsel
from those they consider experts.
Unfortunately, Jones’s colleagues, who are
qualified in accounting and auditing matters, are not necessarily equally competent to
make independence determinations. As an
additional risk, those with whom Jones seeks
counsel might interject their own unconscious
biases into the decision-making process.
Controlling Biases
CPAs can utilize several measures to
mitigate the basic cognitive biases that can
affect professional judgment when considering the independence implications of performing nonattest services for attest clients
(Exhibit 2). In this example, Jones must first
EXHIBIT 1
AICPA Code of Professional Conduct
Independence Threats
n
n
n
n
n
n
n
Self-review threat
Advocacy threat
Adverse interest threat
Familiarity threat
Undue influence threat
Financial interest threat
Management participation threat
EXHIBIT 2
How to Mitigate the Effects of Bias
n Frame questions from both
internal and external perspectives
n Seek opposing and disconfirming
evidence
n Question expert opinions
n Encourage opposing points of view
n Slow down the decision process
70
acknowledge that everyone harbors these
biases. Heuristic strategies typically result in
efficient and effective decision making, but
in some settings they impair professional
judgment. Second, Jones must be prepared
to turn down the engagement in order to
maintain his audit independence. Lastly, Jones
needs time to thoughtfully apply a structured decision-making approach, control his
biases, and exercise professional judgment.
Time allows individuals to broaden their
focus, and it is an important strategy to counteract bias threats.
How Jones defines or frames the independence issue is critical to decision making. Professional standards require independence in both mind and appearance.
Jones should frame the independence question from both internal and external perspectives. He should ask whether performing the nonattest engagement will present
an unacceptable risk to his ability to
make objective judgments during performance of the audit (an internal perspective). Then, he should ask whether others
would perceive performing this nonattest
engagement as an unacceptable risk to his
independence during the audit (an external
perspective). If a risk to independence is
unacceptable, Jones should critically consider the effectiveness of the various
independence safeguards in mitigating the
framed threat. Framing the issue from multiple perspectives helps alleviate the risk
that Jones may subconsciously anchor on
one dimension or solution.
When researching independence issues,
Jones should make a conscious effort to
search for and consider information that may
support or negate audit independence if the
nonattest engagement is accepted. One
approach would be to separately assign the
research tasks: one party to gather information in support of an acceptance decision and
another to research why the engagement
should be declined. This approach would
help reduce availability bias as well as provide a broader search to minimize the risk
of bounded awareness.
Another effective risk reduction strategy is to reach out and include others in
the decision-making process. Caution, however, should be exercised in identifying
from whom to seek counsel. Jones might
want to look beyond his accounting and
auditing colleagues (to avoid any self-serving and halo biases). The ideal candidate
would be knowledgeable about the Code
of Professional Conduct’s conceptual
framework and wouldn’t have a stake in
the issue. Such a party would be free of
not only self-interest biases, but also residual biases due to earlier decisions. Jones
should also look for someone who has
license to tell him what he needs to hear
instead of what he might want to hear.
During the discussions, the consultant
should be asked to play the role of devil’s
advocate in order to test the strengths of
the decision alternatives. In addition, the
AICPA Ethics Hotline (888-777-7077)
might be a useful resource for some.
Once Jones has determined that a nonattest service is not specifically prohibited by
the applicable professional standards and
does not represent an unacceptable threat
to independence (after taking into account
appropriate safeguards, if necessary), he
would be wise to document his decisionmaking process and supporting rationale.
In addition, Jones must satisfy other Code
of Professional Conduct requirements.
Specifically, he should 1) not assume management responsibilities for the attest client;
2) determine that the client has agreed to
assume all management responsibilities,
designate an appropriately qualified individual to oversee the services, evaluate the
adequacy and results of the services performed, and accept responsibility for the
results of the services; and 3) establish and
document in writing his understanding with
the client.
Looking to the Future
As the variety of nonattest services continues to expand, the standards in AICPA’s
Code of Professional Conduct might not keep
pace. Accordingly, CPAs can expect to face
more independence-threatening situations that
will require their professional judgment.
Knowledge, experience, and skepticism are
commonly viewed as critical factors of professional judgment. Another component,
equally important, is acknowledgment and
control of the many cognitive biases that
can affect one’s decisions.
q
James Schmutte, DBA, CPA, is a professor, and James R. Duncan, PhD, CPA, is
an associate professor, both in the
department of accounting, Ball State
University, Muncie, Ind.
OCTOBER 2014 / THE CPA JOURNAL
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