Role of Judgment in Accounting and Auditing

Accountants and auditors exercise professional judgment in considering whether the substance of business transactions differs from its form, in evaluating the adequacy of disclosure, in assessing the probable impact of future events, and in determining materiality limits. This informed judgment on the part of the practitioner is the foundation of the accounting profession. In providing an attest engagement, the result is often the rendering of a considered opinion or principled judgment. In effect, the auditor gathers relevant and reliable information, evaluates and judges its contents, and then formalizes an opinion on the financial information or statements.

A review of current authoritative literature reveals that certain pronouncements require disclosure on the applicable accounting principle for a given business transaction. Other pronouncements provide only general guidelines and in some cases suggest acceptable alternative principles. The process of applying professional judgment in choosing among alternatives is not carried out in isolation but through consultation with other professionals who are knowledgeable in the area. In rendering professional judgment, the accountant/auditor must exercise critical-thinking skills in the development of a solution or an opinion.

The codified Statements on Auditing Standards make the following points on the use of professional judgment in conducting an audit: professional judgment is essential to the proper conduct of an audit. This is because interpretation of relevant ethical requirements and GAAS and the informal decisions required throughout the audit cannot be made without the application of relevant knowledge and experience to the facts and circumstances.

In particular, professional judgment is necessary regarding decisions about the following:

• Materiality and audit risk.
• The nature, timing, and extent of audit procedures.
• Evaluating whether sufficient appropriate audit evidence has been obtained.
• The evaluation of management's judgments.
• The drawing of conclusions.⁷

To render an opinion based on professional judgment, the auditor often considers the opinions of other professionals. In such cases, the practitioner can use several published sources to determine how others have dealt with specific accounting and reporting applications of GAAP. The AICPA publishes Technical Practice Aids, which contains the Technical Information Service. This service consists of inquiries and replies that describe an actual problem that was encountered in practice and the interpretation and the recommendations that were provided, along with relevant standards and other authoritative sources.