Framework for Critical Thinkingcanmedia.mcgrawhill.ca/college/olcsupport/... · A less formal framework is the one used by the judge in the . Continental Vending. case of the chapter

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A P P E N D I X 3 A

Framework for Critical ThinkingI. Critical Thinking and Principles-Based Reasoning: Key Ideas and Relevant Research.

As indicated in Chapter 3, professional rules of conduct follow a principles-based reasoning process in which a few key principles drive the logic of all the rules and their implementation. This approach has been so successful that accounting standard setters such the International Accounting Standards Board (IASB) are planning to follow a similar approach in establishing future International Financial Reporting Standards (IFRS). This is referred to as “principles-based” accounting as opposed to “rules-based” account-ing, which does not have an over-arching set of principles guiding the detailed accounting rules, such as accounting for leases. This distinction between a “fair presentation framework” and a “compliance frame-work” is important in CAS 200.13. A fair presentation framework is principles based, whereas a compliance framework is based on separate rules with no over-arching conceptual framework to guide standard set-ters in setting consistent rules.

The conceptual framework is what justifies auditors in departing from or making disclosures beyond the detailed rules in a fair presentation framework, as specified in CAS 200.13. IFRS has a conceptual framework, which can serve as a basis for principles-based accounting that can result in “fair presenta-tion.” A less formal framework is the one used by the judge in the Continental Vending case of the chapter. Informal frameworks like social norms or society’s expectations of auditors help explain why auditors need to think more broadly about their role and ethical financial reporting, This broader thinking process is the essence of critical thinking.

The purpose of a formal conceptual framework as in IFRS and in CAS 200 is to guide the development of standards consistent with the framework and to guide practising auditors in appropriate, consistent thinking about auditing and financial reporting. We refer to such guides as “warrants” in the thinking pro-cess. Using the same warrants is what helps achieve consistency in audit and accounting reasoning. Con-sistency is important in logic because lack of consistency can create contradictions, and contradictions violate the most basic principles of logic (e.g., for those who have taken a logic course, the principles of identity, excluded middle, and contradiction are violated). Use of principles to guide standard setting means more detailed rules can be overridden by the principles. If such principles are placed at the begin-ning of a reasoning process, then we get top-down reasoning. In top-down reasoning, the most important reasons are listed first, followed by the less important ones. Any conflict among reasons is resolved by giving priority to higher-level reasons. Implicit in CAS 200 is a top-down reasoning process.

To better understand why auditors need a more structured way to approach reasoning with professional judgment, we first review some research on professional judgments, indicating how it may be flawed.

LO8 Explain how professional judgment, critical thinking, and principles-based reasoning are related.

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APPENDIX 3A Framework for Critical Thinking 3A-2

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Professional Judgment as per CAS 200.13 (k) A23–A27Professional judgment is the application of relevant knowledge and experience to the facts and circumstances that are required to make informed decisions in an audit consistent with ethical requirements and Canadian Auditing Standards.

Auditor characteristics include knowledge, experience, objectivity, integrity, judgmental biases, and pro-fessional skepticism. Auditors, like all people, are susceptible to judgmental biases because of the use of short-cuts or heuristics in the reasoning process. Examples of such biases are the anchoring and adjustment heuristic in which the first instance that comes to mind has a disproportionate influence on judgment. A good example of this bias is an experiment in which people were asked to estimate the percentage of African countries in the United Nations by first spinning a wheel of fortune to get a number between 0 and 100 and then adjusting upward or downward from this number to make their estimates. The median estimate for people getting a 10 on the wheel was 25, while the median estimate for people getting a 65 was 45. Note that this bias occurs because of ignorance. If someone were truly knowledgeable about the number of African countries in the United Nations, they would not be influenced by such an irrelevant factor as a wheel of fortune result. For example, how many of you would be influenced to adjust your age based on a wheel of fortune result? This result suggests that if an auditor were truly knowledgeable about a client’s business, industry, and economic factors, then the auditor would be much less likely to be influenced by irrelevant factors. Also, first impressions of any new situation tend to have a disproportionate influence on judgments. Behavioural studies have shown that the impression someone makes in the first few minutes of an interview or initial meeting has a lasting impact on the subsequent relationship. As you can imagine, this can be an especially important feature in a job interview. Over-reliance on last year’s audit plan is probably the most common anchoring bias in public accounting practice.

The representativeness heuristic is one that leads to use of stereotypes in making judgments, e.g., “all accountants are boring.” If you think stereotyping applies only to other people, consider the following sce-nario. Imagine that “a person named Steve is described as shy, withdrawn, and helpful, but as having little interest in people or the world of reality, and then being asked to assess the probability that Steve is a farmer or librarian.” Chances are you would guess that Steve is a librarian. But the fact that there are many more farmers than librarians in the population should be considered in estimating the probability that Steve is a farmer. For this reason it is more likely that Steve is a farmer. This phenomenon also explains why many diagnostic medical procedures result in so many false-positive results. Even when a diagnosis is, say, 90% accurate it does not mean a positive result indicates you have a 90% chance of having the disease. The 90% statistic applies to people actually having the disease. With a relatively rare disease, a positive result still means that you have a low (but higher than without the result) risk of actually having the disease.1 Note that the representativeness heuristic illustrates that use of stereotypes can affect your probability judgments, such as inherent risk assessment based on assessing people’s capabilities by using erroneous stereotypes.

Yet another judgmental bias is that of the availability heuristic. The availability of the heuristic pre-dicts that people estimate frequency or probability by the ease with which instances or occurrences can be brought to mind. Ability may depend not only on historical frequency but also on such factors as familiar-ity, saliency, recency of occurrence, imaginability, and the effectiveness of a search test. Events that are familiar, salient, easy to imagine, and so on are likely to be judged as more frequently occurring than are events that do not possess these characteristics.2 As a result, auditors may base their conclusions on data that are easy to access rather than the most appropriate data for the decision at hand.

For example, people tend to put more weight on vivid information, such as attractiveness of a person, than on pallid information that may be more relevant, such as a letter of reference from somebody who can better evaluate the person’s performance on the job. Note that the key issue here is which is the more relevant information as opposed to the more vivid information. Vividness can overwhelm relevance, as

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3A-3 PART 1 Introduction to Auditing, Public Practice, and Professional Responsibilities

many studies reviewing court decisions illustrate. For example, there is much data to show that the attrac-tiveness of a person influences not only the chances they will be found guilty but also the severity of the punishments when they are found guilty—the more attractive the person, the less severe the punishment and the less likely they are to be found guilty.

Keep these heuristics in mind as we go through the rest of this book, and try to understand where audit reasoning can fail. For example, a common “anchor” in auditing is last year’s audit file. Too many auditors use last year’s file in a mechanical unthinking way to get them through the current year. The professional judgment problem this may cause is that auditors may not adjust their audit plan sufficiently for their cli-ent’s changed circumstances. Auditors may tend to ignore negative evidence that does not conform to their (last year’s) expectations. This is why constantly checking one’s assumptions (a form of skepticism and critical thinking) is a good way of maintaining one’s professional skepticism. Also, making the assump-tions more explicit by documenting them will remind auditors to reconsider their assumptions in light of changed circumstances.

Other biases include the hindsight bias, which is the tendency to exaggerate the inevitability of causal sequences, and the endowment effect, which is the tendency to value what we have because it is ours regardless of its intrinsic value.

The judgmental biases are important because they affect all professional judgment as well as everyday practical reasoning. In fact, the study of logic probably got started in the first place when ancient philoso-phers became aware of these judgmental biases over 24 centuries ago. Also, con artists and fraudsters are intuitively aware of these biases and exploit them to deceive people, including auditors. There are four main ways to counteract these biases: (1) being aware of them, (2) consulting with others (for example, several people being involved in an interview help achieve a more objective interview process) (3) docu-menting one’s reasoning so that the hidden assumptions become more apparent, and (4) being knowledge-able about the subject matter (e.g., industry specialization and good knowledge of the client’s business).

Other Research on Professional JudgmentBelow are brief summaries of other research on a range of biases and other factors that can affect profes-sional judgment.

1. P. Cowperthwaite, “Tougher than you think,” CA Magazine, March 2013, pp. 43–45. This recent article reviews judgmental biases discussed earlier in this appendix. Cowperthwaite starts by noting that professional skepticism is a key to audit quality because it helps define professional judgment: “Hav-ing a skeptical attitude is essential for auditors when analyzing evidence, looking for inconsistencies, and considering explanations from management.” He then goes on to review some recent summaries of research in the psychology of judgment literature. Everyone is susceptible to overconfidence bias, which means people have a tendency to feel they know more about something than they really do, leading to hasty (premature) conclusions. An audit example is evaluating sample results judgmentally. Anchoring bias (discussed earlier in the appendix) occurs when the starting point biases the rest of the judgment. An audit example is auditors being excessively influenced by management’s initial account-ing estimate. This means that if you want to negotiate something, for example, the purchase price of a car, you can bias the results by creating an anchor. Unfortunately, car dealers and other salespeople already know this, which is why they list a price even when they ask you to make an offer: they know that you will subconsciously already be influenced by the sticker price! Availability heuristic is another judgmental bias arising from saliency of information, such as recent events or items reported in the news. All these biases influence professional judgment, and they are best addressed through height-ened professional skepticism. This is discussed in more detail in the next article.

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2. P. Cowperthwaite, “Good Judgments,” CA Magazine, April 2013, pp. 45–47. This recent article gives more details on judgmental biases and suggests solutions. People believe what they are told when their impressions are positive, they tend to ignore evidence that contradicts their beliefs, and auditors’ ranges of outcomes are greatly influenced by management’s initial estimate (an example of anchor-ing). To offset these biases, audits should use formal decision-making frameworks, be aware of the biases, and consciously strive to uncover biases within the audit team. This is especially important for accounting estimates. Documentation of the audit judgment process is key to counteracting the effects of these biases because it makes the auditor more accountable. In your documentation: (a) Clearly state the issue: for example, what is the estimation uncertainty for the estimate? (b) Document who is affected and how. (c) Evaluate management’s estimation process. (d) Obtain evidence from other sources. (e) State and document your conclusion and why you think it is true (note this is what we call critical thinking). (f) Review previous judgments for this client and its track record of accuracy. This approach should be followed on even the smallest audit engagements.

3. S. Salterio, “Shedding light on negotiations,” CA Magazine, April 2013, pp. 54–57. Auditing involves lots of negotiations on accounting matters with the CFO, and these CFOs have better negotiating skills than auditors! What does that tell you about the quality of financial reporting with estimates? A pro-posed solution is to rely on the audit committee to mediate the negotiations, but CFOs prefer to deal directly with the auditor. Audit partners are reluctant to negotiate issues and thus appear to be bullied by the CFO. Part of the problem appears to be that auditors need to have more training in negotiating strategy, and the other problem seems to be the judgmental biases outlined above. In this book we work from the assumption that auditors are poor negotiators in part because accounting and audit concepts may be a problem in establishing a strong negotiating position.

4. G. T. Tsakumis, D. R. Campbell Sr., and T. S. Doupnik, “IFRS: Beyond the standards,” Journal of Accoun-tancy, February 2009, pp. 34–39. This article deals with an important aspect of the professional judg-ment environment—that of the context of the audit reasoning. Here is an example of what is meant by the effects of context: culture and language have an important impact on meaning in audit argu-mentation. Note that another framework is introduced here to deal with cultural differences, that of a cultural framework. This consists of language and the following cultural dimensions (page 35):

• Uncertainty avoidance—how comfortable individuals in a society feel with uncertainty and ambiguity

• Individualism—a society’s preference for a loosely knit social fabric or a more interdependent, tightly knit social fabric

• Achievement orientation—how much values such as performance and visible achievement are emphasized

• Power distance—how much hierarchy and unequal power distribution are accepted in a culture.

Power distance is covered extensively in the bestselling book by Malcolm Gladwell, Outliers. It refers to how hierarchical a society is in treating individuals. The greater the power distance, the more author-ity is respected (e.g., the auditor is less likely to question the authority of management). It turns out that power distance is high in most of the world, according to Gladwell. The United States is an intermediate case, while Northern Europe has the smallest power distance. Conservative accounting is associated with higher uncertainty avoidance and lower individualism and achievement orientation. More-restricted dis-closure (higher secrecy) is associated with higher uncertainty avoidance and power distance and with lower individualism and achievement orientation. Thus, culture influences accounting values, which in turn influence the application of accounting standards and implementation of principles. There are good examples of how the meaning of the uncertainty expressions widely used in accounting, such as remote,

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probable, and even assurance, varies around the world. Tsakumis et al. conclude that auditors should be exposed to these differences early in their careers.

In general, research has shown that there are limitations in the ability of public acccountants (PAs) to be perfectly rational decision makers. This human limitation is frequently referred to as “bounded ratio-nality,” which you may have learned about in your economics courses. Virtually all the research on pro-fessional judgment in public accounting has been done within the context of auditor decision making (as opposed to the preparer). In the previous section, we already noted some of the common judgmental biases that are part of auditor characteristics to consider in the professional judgment framework. To minimize such errors, many firms have developed structured audit approaches with standardized audit programs, decision aids, and computerized expert systems. However, recent research has shown that audit problems can be caused by a complex interaction of the individual auditor’s ability to withstand client pressure, the task involved, and the environment (e.g., severe time pressures for completing the audit).

Related audit research has shown that there are ways to investigate the effects of judgment errors and biases. One way is to require auditors to defend their conclusions orally or in writing. Another solution is group decision making, where group dynamics can help eliminate individual errors in judgment.

Many firms have moved to business or strategic systems approaches to auditing, which are covered in Chapter 6. These approaches emphasize much more knowledge about the client’s business and indus-try. The emphasis is on understanding a client’s competitive position in the industry, its plans and goals, and threats or risks to achieving those goals. This requires “softer evidence” of people, their motivations, and competitive pressures. But the advantage is that such approaches result not only in more-effective audits, especially audits of management estimates, but also in useful business advisory services. Is the client’s business plan viable and reasonable? Can the auditor identify risks to the client’s strategic goals? Is management effectively managing these risks? To address these questions, the auditor needs a high-level understanding of the business, its risks, and its strategy. The auditor also needs to be able to link this understanding to specific product planning issues.

These newer approaches tend to increase the role of judgment in the audit process because of the greater emphasis on subjective evidence related to the valuation of business risk, controls, and perfor-mance measures. The use of such evidence increases the need for auditors to learn to deal with qualitative and ambiguous evidence and makes understanding auditor professional judgment and decision making all the more important. Auditors need to consider client management’s intentions and capabilities more, which requires greater judgment than just passive evaluation of routine documentary evidence.

Research has demonstrated that even in simple situations auditors have difficulty dealing with unusual financial results, generating explanations for unexpected patterns of financial results, critically evaluating management’s explanations, and relying appropriately on analytical evidence. Many of these problems can be characterized in terms of improper justification of the auditor’s conclusion. So we next focus specifi-cally on what audit research suggests about justification problems in auditing.

The auditing research on justification in audit practice suggests that the perceived need for justification among PAs varies with the context. Specifically, the familiarity of the situation, the types of consequences and their likelihoods, and the position and role within the public accounting firm affect the PA’s need for justi-fication. In general, justification processes appear to take up a considerable portion of professional judgment time.3 An important practical tactic in justification where authoritative guidance does not exist is the use of available precedents. If the precedents are consistent, they can be highly influential; otherwise, an auditor may be unduly influenced by management preferences when there’s no authoritative guidance.4

An early definition of accountability in the behaviour literature is the social pressure to justify one’s judgments to significant others. Accountable people tend to be more conscientious and thorough in per-forming their tasks and processing information. Under this view, justification amounts to explaining a

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judgment, and accountability is the expectation that such explanations will be provided. Generally, researchers appear to feel that such accountability tends to improve professional judgment.5

In the mid-1990s, research slightly modified the definition of justification to be a defence or support for a decision, and the required documented output of this process. There was also increasing recognition of multiple accountabilities in the public accounting environment, from junior to senior in the audit team on to multiple external parties for the overall audit opinion. Generally more justifications were required with increased account-ability, including increased likelihood of subsequent review of the auditor’s work.6 More justification was also required when evidence was lacking, or the evidence was inconsistent, or the task was generally unstructured. Justification was operationalized in these experiments as a number of reasons provided in the explanations.7

The recognition that increased accountability may provide increased incentives to auditors to justify their decisions has led to deeper concerns about the nature of the justifications and their validity. In partic-ular, the more recent research has tended to focus on broader, persuasive aspects of justification, including illicit manoeuvres such as selectively seeking evidence to stylize the auditor’s documentation to persuade a target audience, such as a reviewer of the audit working papers, in a particular direction. In other words, under the persuasive perspective of justification, auditors can engage in opportunistic game playing, such as influencing the type of evidence gathered, interpreting the evidence, and selecting what and what not to document. This of course introduces a whole new aspect to the justification process and the nature of the accountability achieved. In particular, we may need to consider cheating on the part of the auditor herself or himself. We can view this as the ethical component of the auditor’s reasoning process.

As a result, the latest research has tended to focus on factors that affect faulty justifications. These fac-tors include the weight that the client’s integrity has on the explanations, the levels of review that working papers go through, and the expertise of the reviewers. The knowledge level of clients and industries varies across members of the audit team (junior staff, senior, manager, partner). Partners typically have the high-est levels of knowledge of the client’s business and the client’s industry. Partners don’t normally get bogged down in technical double-entry accounting and auditing procedures unless problems or conflicts arise.

Key features of acceptable justifiability as far as current audit practice goes include consultation with others, even if the advice is not followed; reliability of sources of corroborating information; auditor knowledgeability relative to the task; and even whether the justification has been documented in writ-ing. In general, if the audit review process is to be effective, reviewers need to be knowledgeable about the subject matter, have more-detailed preparer justification, and be aware of persuasive methods that can be employed by the preparers and working papers. Of course, auditing is a complex process, and the research in audit justification has managed to cover only some aspects of it. For example, the primary focus of behavioural research of professional judgment in accountability and justification has been on tasks related to analytical review procedures. Whether these justifications also apply to the substance of detail procedures, control testing and evaluation, inherent risk justification, independence risk justifica-tions, or accounting estimate justifications is largely an issue of future behavioural research. However, what we can do is compare what little we know about justifications in audit practice with justifications as viewed by philosophy, the ancient discipline of the study of wisdom in its many forms. After all, justifica-tion is a form of reasoning, so the next section introduces justifications from the philosophical viewpoint.

II. Critical Thinking in Financial ReportingThe top-hatted broker on the right side of the frieze appears to have his hand in the worker’s pocket. (Description of the 22-metre frieze on the façade of the Old Toronto Stock Exchange built in 1937 and

designed by Charles Comfort in the art moderne style.)

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Positive and Negative AssertionsThere exist certain propositions for which financial statement auditors must find supporting evidence in every audit to comply with professional standards. These propositions are referred to as assertions. The assertions currently used in financial auditing standards relate to existence, ownership, complete-ness, valuation, and presentation. Every introductory audit textbook provides a discussion of these assertions because they are the basis for determining which kind of evidence is required in every finan-cial audit engagement (e.g., every asset recorded in the financial statements exists, is owned by the entity, and is properly valued and presented in conformity with generally accepted accounting prin-ciples (GAAP), and that all such assets are included).

Positive AssertionsThe above assertions are important concepts in financial statement auditing. These propositions can be labelled as positive assertions because the presumption is that social norms have evolved about positive assertions requiring supporting evidence on every audit. (For example, the requirement to observe inven-tory was prompted by the McKesson & Robbins audit failure in 1939 and the resulting court case. Before this case there was no audit requirement to observe and count the inventory.) If the auditor manages to provide sufficient supporting evidence, then the user will find acceptable the post-audit uncertainty (or residual audit risk as it is sometimes called) associated with the positive assertions.

Special types of fraud-related assertions for which there is “presumptive doubt,” which assumes there is a risk of fraud related to an assertion, require that the auditor explicitly (i.e., documented in work-ing papers) assess the risk of fraud. Such presumptive doubt assertions require even more evidence than positive assertions. This issue will be discussed in more detail when we review auditor responsibilities for detecting fraud. In other words, they can be viewed as the propositions with the highest-priority risk of being untruthful or risky, and therefore the auditor needs to provide the most supporting evidence for presumptive doubt assertions.

It is noteworthy that the presumptive doubt concept has also been introduced to Rules of Professional Conduct in CPA Ontario disciplinary hearings. For example, if you as a CPA/CA have been convicted of the illegal activities set out in Rule 102, then there is a rebuttable presumption that you have failed to maintain the good reputation of the profession and serve the public interest. In defending yourself your job is to override this presumption with evidence as to why you should not be expelled or disciplined by your provincial accounting body because of mitigating factors. At this point you might find it educational to read the disciplinary decisions on the CPA Ontario website, such as an illustration of ethical dilemmas in an audit context. See CPA Ontario discipline committee reports on Marina Messina and Tonino Fiorino relating to Livent at https://ebusiness.cpaontario.ca/discipline/.

Negative Propositions (Don’t Mix These Up with Negative Assurance!)For other propositions, however, no supporting evidence is required because they are assumed true unless negative evidence concerning them is uncovered in the audit. These we call negative propositions. Perhaps the best known of such propositions is the criminal law’s presumption of the innocence of an individual unless he or she is proved guilty in a court of law. A good example in financial reporting is the going-concern assumption. Auditors have traditionally assumed that this assertion is true unless there is evidence to the contrary. This assumption is now being called into question by standard-setting bodies as a result of the many unexpected bank failures in the 2008/2009 financial crisis. What is likely to happen is that auditors in future will need to get corroborating evidence that this proposition is true, effectively turning it into a positive one.

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A Hierarchy of Warrants in AccountingLogical links and inferences take place in the human mind. This reasoning process is manifest through lan-guage. The analysis of argumentation involves assessing how the rational mind works through the medium of language—a medium that has all the properties we associate with rhetoric: logos, ethos, and pathos. Argumentation is essentially a study of how language can be used to persuade others. So, the usefulness of accounting is, in large part, determined by how it can be used in argumentation. An important aspect of that usefulness is how convincing accounting logic can be in a court of law.

It is instructive to clarify that the role of a conceptual framework in terms of argumentation is to act as a warrant for more-detailed rules. Optimally, detailed rules should follow from the conceptual framework. Any inconsistency in rules should be reconciled with the conceptual framework. This is the only way to get a defensibly coherent system of reasoning in financial reporting. Such an approach is followed by profes-sional ethics in public accounting: a handful of guiding principles (e.g., maintain the public interest/reputa-tion of the profession) serve to guide and justify more-detailed rules of appropriate professional behaviour. As noted above, such an approach is also consistent with legal reasoning—an important pragmatic consid-eration in financial reporting.

The warrants in accounting have a hierarchy (or qualifications) that limit the use of a rule (e.g., use GAAP unless it is misleading under the circumstances). The purpose of a hierarchy of warrants is to determine which warrants take precedence whenever there is a conflict among warrants (e.g., maintain-ing confidentiality of sensitive entity information versus not issuing misleading information about the entity). The hierarchy should be consistent with the objectives of financial reporting. The current hier-archy of accounting warrants is in a state of flux internationally, especially if the concept of “fairness of presentation” is also included as a warrant. (See Alexander and Jermakowicz8 [p. 146] for their table of hierarchies used by different standard setters.) None of the current and proposed conceptual frame-works put what are alleged to be the fundamental concepts at the top of the hierarchy, despite wide-spread agreement that the purpose of the concepts is to provide “an adequate foundation for consistent standards.” 9 The most fundamental concept is the objectives of financial reporting (p. 12).

This conceptual framework also suggests a hierarchy with objectives ranked first, followed by other concepts (e.g., as illustrated in Bullen and Crook10 [p. 4]). In view of the IASB’s (2006, p. 16) statement that “The boards have concluded that they need a framework to provide direction and structure to their work in developing requirements for financial reporting,” it appears that this logic requires that financial reporting standards and more-detailed rules should follow from the conceptual framework. Thus, the most general warrant should be the conceptual framework (with its internal hierarchy), followed by the more specific standards that help determine how the facts of a particular situation are best reported. Because much of accounting involves forecasting,11 it is rather surprising that the current conceptual framework says so little about forecast uncertainties12,13 and the accounting risks they represent. Accrual accounting can be viewed as a type of forecast modelling—although this is not the traditional view of accounting standard setters. Some progress on rectifying this deficiency has been made in International Standards on Auditing (ISAs) via the concept of estimation uncertainties. (See ISA 540 (Revised and Redrafted), Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, 2008).

Alexander and Jermakowicz (2006) identify one remaining exceptional warrant—fairness of presenta-tion. However, noting that the IASB’s 2006 Discussion Paper on the conceptual framework identifies the key objective as “to assess the amounts, timing, and uncertainty of the entity’s future cash flows,” and that this corresponds closely to the risk-based fairness of presentation concept of Smieliauskas, Craig, and Amernic,14 then fairness of presentation corresponds to meeting the objectives of users. Thus, we see how

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argumentation can be used to assess accounting issues. The problem is that the conceptual frameworks do not yet acknowledge this hierarchy. This helped to prevent logos from dominating expert witness account-ing arguments in the trial of Skilling and Lay (Enron; see below).

Argumentation presented in court possesses important rhetorical aspects. An expert witness’s evi-dence contains a strong appeal to the authority (ethos) of the professional reputation of that expert wit-ness. But, ideally, an expert witness’s evidence should appeal extensively to logos, and much less to ethos or pathos; otherwise, it risks becoming “emotional, imprecise and open to interpretation” (Norreklit,15 p. 595). Nonetheless, arguments usually draw strength from the credibility (or ethos) of the provider. This is why maintaining the reputation of an expert witness is important and why much trial questioning is focused on enhancing (or destroying) the ethos of the expert witness. An arguer, such as an expert witness, risks (or ought to risk) losing credibility by invoking bad arguments involving poor logos.

Warrants are especially important in understanding why particular conclusions follow from testi-mony. Because of this, we highlight the important warrants supporting the experts’ opinions. They are not left implicit, as in court-based argumentation. In evaluating trial argumentation, a problem is posed by enthymemes. These are premises, statements, or conclusions not made explicitly because, for example, of the widespread use of social norms reflecting shared knowledge, conventions, and assumptions.16 This kind of omission is expected because it is impossible to specify every aspect of the universe one is assum-ing in making an argument.17 In formal and everyday informal interchanges, we all use shared conventions and values to a considerable degree, without making them explicit, or even being overtly aware of the conventions we use and expect. Some have argued that the conceptual framework should acknowledge the reliance on conventions (e.g., Macve, 2008). There are many enthymemes associated with financial reporting that we need to be alert to—including concepts of materiality, GAAP, and fair presentation.

Detailed accounting standards and rules should be consistent with the conceptual framework. In spe-cific circumstances when they are not, the rules should be overridden by the overall objectives of the framework. Failure of standard setters to develop such a system (such as in FASB 162: “The Hierarchy of Generally Accepted Accounting Principles,” issued in May 2008) will prevent GAAP from becoming more logical. Less logic means less defensibility—in argumentation in court, and to users of financial state-ments. If GAAP rely too much on ethos and pathos then they can be undermined more easily in court using the legal tactics described in Hueston.18 If GAAP are not a reliable defence in court, then they lose their relevance. GAAP need to have more logos via a more appropriate set of warrants that justify the measure-ments and disclosures made in financial reporting.

A more appropriate set of warrants would include explicit guidance on controlling the accounting risks of financial reporting to acceptable levels (as suggested here). This would address the problem noted in Benston’s (p. 483)19 characterization of Enron’s accounting as high risk. Such guidance would be based on two important requirements: first, that accounting risk become a key concept of the conceptual frame-work of financial reporting, and second, that the conceptual framework be elevated to the top of the GAAP hierarchy. In this text we propose that accounting theory and accounting standards be more risk based with respect to accounting estimates, similar to the way audit theory and standards are risk based with respect to audit evidence (e.g., the recent, ISA 540, para. A93–94, A118, focuses on estimation uncertainties and judgmental misstatements in verifying fair value accounting estimates).

Accounting Argumentation at the 2006 Enron TrialThe accounting expert witnesses argued logically, within the restricted limits of GAAP reasoning, that Enron’s accounting conformed to GAAP. Nevertheless, their argument was either not persuasive enough to sway the jury or else considered not to be relevant. The lack of persuasiveness was probably

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due to the technical nature of the accounting rules that were raised in court, and to the capacity of these rules to confound lay jurors. The defendants did not ask their accounting expert witnesses to testify on specific special purpose entity (SPE) transactions that had been the focus of much critical commentary in the accounting literature, nor were they pressed on such matters by the prosecution. Some SPE transactions were clear violations of GAAP rules (e.g., see Benston and Hartgraves,20 p. 109, p. 113; Knapp,21 p. 15). We can perhaps understand why Jeffrey Skilling and Kenneth Lay of Enron would not have wanted to focus on these issues, and this may explain why their expert witnesses did not do so. But it is puzzling that the prosecution did not focus on the detailed accounting rules. Perhaps the prosecution felt it would have been too confusing for the jury, and that it would be preferable for the jury to consider what was misleading or unfair or unreasonable rather than get bogged down in detailed accounting rules. In other words, the prosecution may have focused implicitly on the objec-tives of financial reporting.

The prosecution strategy would have been facilitated by a more appropriate GAAP hierarchy in which failure to adhere to the principles would have helped uncover the ethos of the defendants (noted earlier). The basic reasoning process of the expert witnesses insofar as it contributed to the overall defendant strat-egy seems to be as follows:

• Warrant: GAAP do not condone lying. • Data: Enron management’s financial reporting is in conformity with GAAP. • Conclusion: Enron management was not lying.

The warrant was left as an enthymeme at the trial. And, since the prosecution did not want to get involved in “disputes over the defendants’ respective understandings of the application of often arcane accounting rules” (Hueston 2007, pp. 197–198), the data premise in the above argument was de-emphasized and the prosecution took a different route to disprove the conclusion.

A likely contributor to the prosecution’s strategy was the judge’s admonition to not confuse account-ing materiality with legal materiality. Given that materiality was a major point of discussion, it is unsurprising that the jurors relied more on the pathos (e.g., “misleading” reporting that can result from GAAP) and the perceived ethos of the accounting expert witnesses. For this reason it is unsurprising that the prosecution relied on undermining the credibility (ethos) of the expert witnesses by questioning their motives (e.g., how much they were paid for their testimony) and the reliability of their evidence (e.g., whether they attempted to corroborate the defence claims with their own independent analysis and inquiry).

III: Additional Notes on Critical Thinking and LogicThis subsection extends the discussion of Section II by further reviewing key concepts from natural lan-guage argumentation, logic, and the professional judgment literature. Here we try to integrate these ideas to better reflect critical thinking.

In philosophy, a statement (also called a proposition) is a complete declarative sentence for which it is appropriate to respond either “true” or “false.”

Statements ultimately relate to facts about the world.There are two basic categories of facts: (1) facts about things or objects (these include relationships)

and (2) facts about events.When you can’t directly observe (direct evidence) a fact, you need to rely on indirect evidence (e.g.,

historical record of past events or reliance on others for information on facts). Indirect evidence is a major

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source of reliability problems in logic. Unfortunately, auditors and accountants need to rely quite a bit on indirect evidence.

Facts can also be categorized on whether they are objective or subjective.Objective facts are in principle directly observable by everyone (e.g., the height of the CN Tower).Subjective facts, on the other hand, are not directly observable by everyone (e.g., your headache is

directly observable only by you, whereas everyone else must rely on indirect evidence of your headache, such as your statement about the severity of your headache). Subjective facts depend for their reliability on indirect evidence.

A very important class of subjective facts comprises value statements (e.g., financial statements “present fairly”) and the social norms associated with these statements. Social norms are essentially a variety of behaviours, and accompanying expectations, shared by a group of individuals. They can very much depend on the context of a situation, for example, the conditions that constitute a valid wedding ceremony.

The role of norms is to help regulate and coordinate behaviour within a group, whether the group is a professional body such as CPA Ontario, a student club, or an entire country. An important type of norm is symbols and their meanings. Symbolic thinking, such as language, writing, and math, seems to be at the heart of human intelligence. For example, the value of paper currency is entirely symbolic and has a meaning independent of its physical characteristics. This symbolic meaning and its related social norms are referred to as “social reality,” and the entities and relationships so created as “socially constructed.”

For our purposes the relevance of social reality is that it is the basis of the social sciences, including economics and financial reporting (e.g., see Shapiro 1998,22 p. 653). The problem for auditors is that they need to verify social reality and social constructs such as income, and this can be difficult because much of social reality is subjective. Auditors use norms in the form of suitable criteria such as GAAP to help deal with subjectivity. In this text we will spend considerable time on what kind of social reality should be included in financial reporting. In particular, we focus on the risks associated with the estimation uncertainties con-cept of CAS 540—mainly because it is a pervasive problem of financial reporting and greatly influences the nature of the social reality that is reflected in financial reporting. It is not sufficient to just look at the CPA Canada Handbook for guidance because there is a gap between the standards and the implementation of the standards. This has been noted by accounting academics, such as in the following reference:

• R. Ball, “What Is the Actual Economic Role of Financial Reporting,” Accounting Horizons, Decem-ber 2008, pp. 427–432. On page 428, Ball notes that a major reason that accounting rules do not fully determine financial reporting practice is that “practice is more detailed than standards; standards lag innovations in practice; and companies do not invariably implement standards.” For this reason the independent accountant as “mere rule-checker” is problematic.

The significance of Ray Ball’s observation should become evident to you in this appendix. What fur-ther complicates things is that the standards themselves are inconsistent. We will cover these issues in more detail later in the text.

Words should match facts, whether social or otherwise. In this way statements ultimately relate to facts about the world. If a person is delusional or untrustworthy, all statements that they claim to be true may be unreliable.

Statements that rely on indirect evidence or subjective facts do not lend themselves to a simple true or false response. Such statements are referred to as evaluative and are open to argument. If you want an evaluative statement (e.g., Halifax is a great city) to be accepted, you must be ready to argue for it.

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Logic is the study of relationships of statements to one another.Since statements ultimately relate to facts about the world, logic can be characterized as the search for

the truth.Logic and language are closely linked in the sense that the validity of inferences is closely tied to lan-

guage and the relationships of statements to one another. We are all born with linguistic rules (Chomsky’s universal grammar) that influence the meaning assigned to words and statements. Hence language affects the reasoning process. Some researchers even claim we can’t even think without a language, but this is a minority view. However, there is no doubt that language is very important to our social lives and in work-ing with others. In particular, for our purposes the order of statements has a huge impact on the effective-ness of reasoning. This is illustrated by the examples below.

Arguments can get complicated, chiefly because of the number of statements they contain, but every argument, no matter how complicated, is fairly simple in its essential character. This is what Barnes’s23 framework tries to highlight with its concept of warrants, data, and conclusion. You can think of this frame-work as “the standard form” of an argument, which makes it easier to follow and evaluate the argument. People deviate from standard form because of the importance of language and rhetoric in persuasion. (For example, “all persons are mortal” can be represented as the conditional “if X is a person, then X is mortal.” This obviously sounds too formal in everyday speech and writing. Why it may be considered too formal is a topic from the field of rhetoric.) Many times individuals don’t want to admit or make obvious the weakness of their reasoning and so they hide this weakness through the pejorative use of rhetoric to deceive others. They might also exploit judgmental biases discussed below as part of the persuasion process.

In order for an argument not to be deceptive it should be “sound.” It should be sound with respect to its subject matter (its contents) and to its form (its structure). An argument is sound with respect to its subject matter if all the statements it is composed of are true (i.e., the epistemic probability [EP] of the premises is one). This depends on the arguer’s knowledge of the field that the subject matter deals with.

An argument is sound with respect to its form (validity) if its logical structure is appropriate for the burden of proof for the situation (i.e., has appropriately high inductive probability [IP]). This aspect of soundness is the focus of logic. In some cases deductive logic is required (e.g., math or logical theorems), but in most practical situations, including auditing, inductive proof is sufficient. Inductive proof means an acceptable level of IP. Since accounting and auditing deal with a world of uncertainties, inductive argumen-tation is the dominant one in this text. This appendix indicates the major issues in inductive argumentation.

Truth is the search for ultimate causes. There is an eventual explanation for everything, but because of limits to our knowledge, the truth cannot be established clearly in many cases. We thus need to accept uncertainty with respect to truth.

Reasoning means being able to show or demonstrate that a statement is true. This is achieved by argu-ment. An argument is a series of statements that purport to support the truth of another statement, the claim (conclusion). This is the reasoning process. This is how one justifies a claim.

The statements in an argument should relate to some facts or more-general knowledge. There are two types of general statements—universal statements and particular statements. Universal statements apply to all things in a reference class (e.g., “all persons are mortal” applies to all things in the class of people). A particular statement applies to some subset of things in the reference class (e.g., “most adults drive cars” means there are some who do not).

Universal statements are more precise—no exceptions noted—whereas particular statements can be very imprecise (e.g., “most,” “some,” “hardly”). Always be as precise in your reasoning as your knowledge allows (e.g., you are 95% sure that candidate X is ahead in the polls this week).

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Generalizations can be either universal or particular statements. What frequently complicates argu-mentation is that the exact nature of the generalizations used is not made explicit and must be interpreted. Nevertheless, generalizations are a key to argument analysis. It is usually the exceptions to a generaliza-tion premise that prevent an argument from being deductive. Anderson and Twining24 (p. 68) note that in the legal system:

Generalizations may range over a broad spectrum. At one end are scientific laws (such as the law of gravity); well founded scientific opinions (such as the conclusions of a qualified forensic expert based upon comparison of specimens of handwriting alleged to have been written by the same individual); and widely shared conclusions based upon common experience (for instance, everyone knows that a driver must stop for a red light). In the middle are commonly held, but unproven or unprovable beliefs (for instance, fleeing the scene of a crime is evidence of a guilty conscience). At the other end are biases or prejudices that may be strongly held irrespective of available data. Some or all of these types of background generalizations are involved in all factual adjudications.

Anderson and Twinning (1998, p. 67) also note that it is important “to force into prominence (i.e., make explicit) the generalization on which an inference rests.” This is all part of the process of clarifying the reasoning. Jurors need to take these into account in their deliberations. And by extension so should auditors in trying to convince a courtroom or accountability board. Thus the generalizations that can be used in an argument can vary quite a bit as to how likely they are to be true. This results in “risky” argumentation, which is a type of argumentation in which probability or uncertainties are assigned to the truth values of the various statements of an argument. In the real world these are the most common types of arguments.

In essence an argument invites us to accept one idea as true on the basis of other ideas. In risky argu-mentation the degree of the probable truth of a conclusion or claim depends on the degree to which the premises give strong and convincing support for the conclusion. In constructing an argument your focus should be on the premises because presumably you are clear on the point you want to make (the conclu-sion). A premise may be substantially true but not precisely true, as noted with the various generalizations that can be used as premises. Many premises are possible, but you should focus on the stronger ones or the ones your audience is most likely to accept. In this sense argument depends on context, specifically the audience you are trying to persuade.

The standard form of an argument as outlined by Barnes (1991) makes most prominent the Major Premise or Warrant by listing it first. But what if we have more than one warrant that supports a con-clusion? Thus, if there are a number of reasons supporting a conclusion, we need to put a structure on the reasons by setting up a hierarchy of them that most effectively supports the conclusion. This is a very important issue in the CAS 700 fairness of presentation framework because as you know from your financial accounting courses, there is a GAAP hierarchy. The big question is whether any GAAP hierarchy will do for fair presentation. Or are some hierarchies more logical in supporting a fair presentation opinion than others? Be prepared to discuss this issue in the context of the discussion question in EP 3A-2 below.

We end this discussion by noting that despite all efforts, not all ethical issues can be resolved by identi-fying good reasons. Reliance on one moral theory, such as utilitarianism, by economists, business people, and some accounting firms can lead to problems in practice (e.g., see the discussion of ethics in the first half of Chapter 3). Ethics deals with the social world and relationships. Even with critical thinking it is not always possible to come up with good reasons for all actions. That’s why audit documentation sometimes settles for simply describing the situation. A good illustration of difficulties in trying to find good reasons

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for ethical actions (and why strictly utilitarian approaches fail) is the famous moral dilemma in philosophy of the Runaway Train outlined below.

An Ethical Thought Experiment: The Runaway Train DilemmaCan you provide good reasons for the moral differences in the following scenarios? Note that in both cases you save five lives at the cost of one, so by strict utility theory they should be equivalent.

Case 1. You see a runaway train hurtling out of control toward five people walking on the tracks who don’t see or hear the train coming up behind them. If you pull the switch next to you, you can direct the train to a different track that has only one person walking on it. Should you pull the switch?

Case 2. Same as case 1 except now the only way to divert the train off the track is to throw a heavy object in the train’s path. You are standing on a bridge over the track and the only suitably heavy object is the large man standing next to you. Should you push the man over the bridge?

Based on an Internet survey of over 100,000 people around the world, 90% of people are willing to pull the switch in case 1 but hardly anyone is willing to push the large man in case 2. When pressed for a reason most people can’t explain it, including philosophers. There is no classical moral theory that explains this result. However, this dilemma may illustrate that some aspects of moral reasoning are hard-wired in our brains and reflected in our emotions. It also illustrates the importance of context in moral reasoning—under some conditions moral people would not sacrifice one person’s life to save five others. There seems to be a fundamental principle about not using people as a means to an end, and not physically coercing or killing them to achieve those ends.

This and other more fundamental principles we will leave as enthymemes (hidden warrants, principles, or assumptions) in this book. In many cases the enthymemes are not a major issue, but when they are it is important to bring them into prominence. This is a major reason professional judgment cannot be reduced to mechanistic rules. For example, in the runaway train dilemma above, a medical ethics principle that might be used to support not taking action in case 2 is the principle of non-maleficence, which states that we should not harm people. Then the issue becomes one of how indirectly you can harm people and not be considered in violation of the principle. For example, how much pollution should be allowed by a fac-tory in order to not be considered in violation of the principle of non-maleficence? Hopefully, this clarifies why moral imagination is needed in applying general principles to specific circumstances, and ethics is not always a matter of applying some mechanical rule. Ethics is more of an intent to behave the right way and thus ultimately reflects the character of an individual.

What the runaway train and related thought experiments also illustrate is that it can be difficult to find universal principles about people and their relationships. We live in complex societies in which the inter-ests of many may conflict. In financial reporting there is an inherent conflict of interest between buyers and sellers of securities and thus difficulties in identifying universal principles. If there are no universal principles of financial reporting, then the arguments of auditing will tend to be inductive and the conclu-sions risky (both in terms of the non-zero IP and the non-zero EP of the conclusion). Good argumentation in auditing requires not just reasoning tools but also imagination. In a rapidly changing business world there is always the possibility of a leap of the imagination, or of a different perspective, or an interesting comparison that can put an issue in a whole different light and take our thinking forward. Critical thinking is one approach to identifying these various perspectives of professional judgment.

Good professional judgment in auditing involves several generic tools:

1. Logic 2. Concepts (and related conceptual analysis using logic)

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3. Consistency in the application of judgment in similar cases (this is where rules, and moral imagination if there are no specific rules, are most important)

4. Reasoning from principles (top-down reasoning) or principles-based reasoning (this is how logic is usually implemented in public accounting)

Logic and reasoning are the focus of this appendix. Concepts such as materiality, audit risk, asser-tions, and knowledge of the client’s business are the basis of much of this. You can think of concepts as a type of warrant, but sometimes you may need to do a whole separate conceptual analysis just to identify warrants that apply to a particular case.

The focus on consistency of judgment (and standards) is crucial for treating similar cases simi-larly. To get this result the focus is on the specifics of a particular situation because that is how an auditor decides whether and when two situations are similar enough to be treated consistently. If two similar situations are not treated consistently, then the reasoning in professional judgment or the stan-dards is wrong!

The underlying principle of consistency is that if you conclude you should make different decisions, or do different things, in two similar situations, then you must be able to point to a morally relevant difference between the two different situations that accounts for the different decisions. Otherwise you are inconsis-tent. Note that the basic reasoning approach for consistency is reasoning by analogy.

An interesting paradox called the sorites paradox arises from reasoning for consistency, and this para-dox leads to the slippery-slope fallacy of logic.

The sorites paradox arises from the ancient Greek word for heap: “soros.” The paradox arises from the fact that one grain of sand is not considered a heap of sand. If you add another grain you do not get a heap of sand with two grains of sand. Using this logic and arguing that one grain of sand does not make a heap, and adding another grain to something that is not a heap will not make a heap, you can never have a heap.

Related to this is the slippery-slope fallacy, which says that once you accept one particular position, then it will be extremely difficult, or indeed impossible, not to accept more and more extreme positions. If you do not want to accept the more-extreme positions, you must not accept the original less-extreme position.

These types of paradoxes arise because most concepts have a certain vagueness: if a concept applies to one object, then it will still apply if there is a very small change in that object.

The way to get around a slippery-slope fallacy is to create a barrier or draw a line at some point in the slope. Preferably the barrier should be justified for some principled reason. But even arbitrary barri-ers may be necessary to ensure clear policy. The line may be arbitrary but it is not arbitrary that a line is drawn. For example, stopping a car on a red light may be an arbitrary rule, but if everyone follows it you get order out of traffic chaos. Another example of a rather arbitrary barrier is the 0.1% rule used in CPA Ontario’s Rules of Professional Conduct Interpretation 204.4 (7) and (6) of percentage ownership of an auditee that is considered to impair independence. Could you have come up with this rule using the objectivity principle? CPA Ontario probably creates such rules so that different practitioners do not use dif-ferent cutoffs. Using such rules is why the overall materiality and acceptable risk levels that are the basis of risk-based auditing are set. It is also the logic that is used to develop statistical decision rules. Although somewhat arbitrary, such rules can help assure consistency in reasoning so that a principle (which can be vaguely worded of necessity) is consistently being adhered to.

A lot of factors come into play in analyzing professional reasoning. Perhaps the most complex factor is the use of natural language in the reasoning process. Natural languages, such as English and Mandarin, are

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quite versatile and have allowed people to develop societies of amazing complexity. Many fields of study relate to some aspect of language, including the studies of literature, linguistics, philosophy, and computer science, to name a few. Auditors reason using natural language in their work. Rather than attempting to summarize what the humanities and social sciences contribute to natural language reasoning, we will use some simple examples to get at the key ideas.

Reasoning in natural language means being able to show or demonstrate that a statement is true. This is achieved by argument. An argument is a series of statements that purport to support the truth of another statement, the conclusion (claim). Statements that purport to establish the conclusion are referred to as the premises of the argument. This is how one rationally justifies a conclusion or claim in natural language. Within the auditor’s report, the written conclusion, the audit opinion, should be justified in statements or “argumentation,” in which reasoning actively organizes thoughts to support the conclusion. Such justifica-tion should be provided in the audit file. The auditor, in fact, claims that this is the case when he or she states in the report, “We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for the audit opinion.”

There is a logic to natural language reasoning—it boils down to the meaning of words and how they are used in everyday reasoning. In essence, reasoning relates to how a series of statements (the premise state-ments) work together to support another statement called the conclusion. For example, if you tell someone that you are living in Canada, chances are good that they will assume that you like ice hockey. What is their reasoning? They might conclude you like hockey based on the fact that you live in Canada. Maybe their view has been shaped by the popularity of “Hockey Night in Canada” broadcasts, their recollections of the passion Canadians show when their team plays in the Olympics or the World Hockey Championships, or Canadians’ reactions to a Canadian NHL team winning the Stanley Cup. All of these give the general impression that many, if not most, Canadians are devoted hockey fans. So, someone could be forgiven for thinking that all Canadians like hockey. This reasoning can be summarized in a two-statement argument, as follows:

Premise: You live in Canada.Conclusion: You like hockey.

Is this good reasoning? Philosophers say that it could be, but it depends on the conventions, social norms, and shared knowledge you have with the person with whom you interact. Right away, you can see the complexity developing. You have to start making some assumptions about the person you are dealing with and the context of the situation. For example, to confirm their reasoning on this, you would have to assume the other party knows the English language. In Chapter 19, Part I (available on Connect), the concept of the representativeness heuristic, from psychology, is introduced. This heuristic or rule of thumb of judgment is commonly used in estimating a probability that event A originates from process B. Such probabilities are typically evaluated by the degree to which A is representative of B, that is, by the degree to which A resembles B. It is the basis for stereotype judgments about groups of people. In this case, someone who sees Canada mainly in the context of hockey games may very well have a stereotype that all Canadians are passionate about hockey. They could find the above argument very convincing!

Moving beyond heuristics, however, philosophers have come up with some useful tools to analyze reasoning. One of the most powerful is the syllogism, or the concept of the “three-statement argu-ment” for analyzing at least key parts of any reasoning. The above argument is not a syllogism because it lacks a key statement. What could that key statement be? We have a conclusion and one premise statement, which we can classify as an observation or data or evidence about you (yes, this is like audit evidence), but we do not have a guiding principle or rule that we could say justifies the conclusion.

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A premise or statement playing such a role has a special name in logic: “warrant” premise. If, through shared knowledge and convention, both parties think the warrant premise is obvious, then there is no need to specify it. You can leave the statement implicit. On the other hand, if you want your stated rea-sons to really justify the claim made in your conclusion, philosophers say that your documented reason-ing should include the warrant. This is especially true if your unstated warrant (or data or conclusion, for that matter) is not obvious to everyone else. Documentation, such as the working papers in audit files, is one way to be accountable for the reasoning supporting your claim or conclusion. The war-rant is so important that philosophers call it the “major” premise in a syllogism. It is considered more important than the data premise. Can you guess what the other person was using as a major premise in the previous syllogistic reasoning? Here is a second argument with all three statements of the syllogism now made explicit:

Warrant (premise 1): All who live in Canada like hockey.Data (premise 2): You live in Canada.Conclusion (claim): You like hockey.

Are you satisfied by the above reasoning (the premises)? If you are not satisfied, two significant features within natural language reasoning might help you evaluate whether the reasons are “good enough.” One such feature is the IP. The truthfulness of an audit opinion depends on the truthfulness of other state-ments (premises). If the premises are rationally acceptable, and the argument has logical strength, then there is a sound argument. The logical strength of the link between the premises and the conclusion is the IP of the argument.25 The IP applies to the argument as a whole (not unlike the overall evaluation given in an audit opinion).

The IP can be assessed through serious consideration of the meaning of the statements and their rela-tionships to the conclusion. A common test is as follows: Assuming that the premises of the argument are true, what is the probability that the conclusion is true? Note that you are not asking if the premises are true, but instead you are assuming that they are true. If you cannot imagine any way that the conclusion could be false while the premises are true (you should think of this as a type of thought experiment), then you should conclude that the IP is 1.00.

What is the IP of the above three-statement argument (i.e., the second argument shown)? It is 1.00. If you assume that the first two premises are true, then the conclusion must be true with a probability of 1.00, using the above test. You are forced to reach this conclusion because of the quantifier “all” used in the first premise. “All” means without exceptions, and that includes “you” if you live in Canada. What, then, is the IP of the first argument, which has only two statements? Its IP is less than 1.00 if we can imagine at least one Canadian who does not like hockey.

IP of 1.00 means that you have ideal logic in your natural language reasoning. Philosophers call this type of logic deduction. Note that in the world of deductive reasoning there is no uncertainty. It is the same logic used in mathematics and the inner workings of logic circuits in computers. It is ideal knowledge; the ancient philosophers referred to deductively obtained knowledge as wisdom. If, on the other hand, you can imagine that the conclusion might be false while the premises are true, then the IP becomes less than 1.00, and the resulting logic is called induction. Thus, the first argument shown uses induction, and the argu-ment itself is referred to as an inductive argument. However, the second argument uses deduction, and the argument itself is referred to as a deductive argument. Note that a deductive argument requires a more complete specification of the premises relative to the counterpart inductive argument. Perhaps this is one of the reasons the ancients referred to deduction as “wisdom.” But that is not all there is to the analysis; the specific words used in a statement and their meanings also affect the logic.

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Most natural language reasoning is inductive in spite of the fact that it cannot be called “wisdom.” The world seems to function on induction; however, distinguishing between high IP reasons and low IP reasons is useful. Good reasoning should have fairly high IP.

We can make our earlier sample argument inductive by simply changing one word in the warrant, so that it reads as follows:

(revised) Warrant: Most people in Canada like hockey.

With this warrant, you should now be able to convince yourself that the IP is less than 1.00. And if you changed the warrant further to read, “Few in Canada like hockey,” your IP plummets. This change illus-trates how crucial the specific words used in your reasoning are, and how significant they are to influenc-ing its strength. Be careful in the wordings you select when providing your reasons! IP relates to the logic of the reasoning. The higher the IP of your reasons, the better the reasons are, all else being equal.

But that is only part of the analysis of the reasons, or premises. In the real world, all else is not neces-sarily equal. To complete our analysis of reasoning, we also need to incorporate the EP of the reasons, the second of the two tools for analyzing reasoning.

You might be troubled by the analysis up to this point because we have ignored whether the reasons are true or not. To assess IP, you assume that the premises are true, but how do we know that they are true? You do not have to know for certain; you just need to have some idea of whether the premise is true. This is where your background knowledge of the world comes into play in analyzing an argument. EP captures the concept of the certainty of the truth of the premise in relation to the real world; in other words, how well does the premise reflect reality? This is what is meant by the empirical question, “What is the chance that the premise is true?” The EP concept captures the degree of empirical truth.

For those of you who were dissatisfied by the original argument given, chances are that this was due to your disagreement with its major premise that all who live in Canada like hockey. And the reason you disagreed with it is likely because you know someone in Canada who does not like hockey, making it dif-ficult to accept this premise. You would like to see it watered down to something like, “Most people in Can-ada like hockey,” or even, “Some people in Canada like hockey.” Note that here we are dealing with only one word in our statement. In logic, these are called quantifiers, and they help establish the reach of the warrant. This illustrates that the choice of even a single word in a statement can greatly affect the strength of the reasoning. Language can be slippery! This means we have to take care in specifying our reasoning.

Let us say, for the sake of argument, that it is true that 80% of people living in Canada like hockey. Knowing this, what is the EP of the statement that all people in Canada like hockey? We would have to say that the words do not match the empirics, and so the EP of this original warrant is below 100%. The same would be true of the EP of the premises “No one in Canada likes hockey” or “Few in Canada like hockey” because these statements, used as warrants, do not suitably match the empirical knowledge that 80% in Canada do like hockey. This illustrates that, ideally, our warrants should be statements that conform as closely as possible to our state of knowledge about the world.

The principle that the language of our warrants should match the true nature of the subject of the warrant as closely as possible applies to all premises in our reasoning. However, this is less of a problem for data premises because data premises usually refer to facts, which are verifiable and, thus, less con-troversial. For example, data premise EPs can frequently be controlled by the amount of audit evidence gathered. In fact, the audit assurance concept provides a measure of the EP associated with the data we call audit evidence. Hence, in audit engagements, data premises usually have high EPs, as is required by the Canadian Auditing Standards (CASs). There is a lot of authoritative guidance concerning this. In auditing, it is rather the major premises (warrants) that are problematic. You can view the warrant prem-ise as the major principle in reasoning, since it helps explain why the data premise is relevant. However,

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you also want the warrant premise to be as true (high EP) as possible. Ideally, all premises are true with probability 1.00, and with an IP that is also 1.00. It is in conjunction with true premises that deduction reflects wisdom concerning a conclusion, such as an audit opinion. Hopefully, now you can better appre-ciate why, when we put reasoning in standard form—first the warrant, then the data premise, and then the conclusion—we get top-down reasoning. We get principles-based reasoning also, if the warrant is also based on a principle.

Now that we know the elements of good reasoning, how do we put them together to evaluate the rea-sons? An auditor is mostly interested in the truthfulness of the conclusion, in the form of the audit opinion— the EP of the audit opinion. The EP of any conclusion is a function of the truthfulness of the premises used in the reasoning and the IP of the specific reasoning as stated by the auditor. If the premises are 100% true, then the EP equals the IP.26 Note, however, that only the auditor and those who review the audit file (such as in a court of law or an accounting oversight board) can directly assess the EP of the auditor’s conclu-sion, the audit report. Most users need to rely on the wording of the report and an implicit appeal to expert opinion (or other authority) argumentation.27

For reasoning to be good, it should be “sound” with respect to its subject matter (its contents) and to its form (structure). Reasoning is sound with respect to its subject matter if all its component statements are true (i.e., the EP of the premises is 1.00), which depends on the arguer’s knowledge of the field the argument deals with.

Reasoning is sound with respect to its form (validity) if its logical structure is appropriate for the burden of proof in the situation (i.e., has appropriately high IP). This aspect of soundness is the focus of logic. In some cases, deductive logic is required (e.g., mathematical or logical theorems). However, in most practical situa-tions, including auditing, inductive proof (i.e., an acceptable level of IP below 1.00) is sufficient. Accounting and auditing deal with a world of uncertainties, and inductive argumentation is the dominant one. But how high or low can the EP of the audit conclusion (opinion) be and still appropriately meet the auditor’s social role? Audit standards claim that the auditor provides “reasonable” assurance that the financial statements are free of material misstatement and present fairly. From a reasoning perspective, fair presentation means, in part, being as precise in the reasoning and statements as the arguer’s knowledge allows.

There is frequently a trade-off between the IP of the reasoning and the EP of the reasons. Remember that IP applies to the entire reasoning process (“If the premises are true, what is the chance the conclusion is true?”). EP applies to the statement, and, therefore, the warrant has an EP and the data statement has an EP. What we and the auditor are interested in is the EP of the audit opinion. How do you get that? If you know the rest of the EPs and you know the IP, then you can think of the EP of the conclusion as being a function of the IP and EP of the premises. This is the way to assess the strength of the reasoning, or to determine how well the conclusion is supported by the reasons. To illustrate simply, we will represent the EP of the reasoned conclusion as a product of the IP and EPs as follows:

EP (conclusion) = IP × EP of premise 1 × EP of premise 2

This roughly corresponds to the analysis required, and it focuses on the important thing, which is the interaction of the IP and EPs of the premises. This is a straightforward way to capture the meaning of language in the statements used. For example, we noted that when “all” was used in the wording of the warrant, then IP was equal to 1.00 for that set of statements. EP analysis, on the other hand, involves the need to take into account the correspondence of each premise to the real world. If 80% is the real prob-ability, but we only have a vague idea as to its value, we use language to communicate this uncertainty as clearly as possible; critical thinking and logic are very concerned with the clarity of the communication. Thus, saying that “all” like hockey when 80% is more realistic is misleading, so the EP is below 1.00. “Most” corresponds more closely to the facts and, thus, has EP close to 1.00. Note that “most” cannot have higher EP than “80%” because 80% is known for certain. The 80% warrant is the only one that can have EP of 1.00

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because this wording exactly reflects the reality. So, the warrant with “most” has EP somewhat less than 1.00, and the warrant with “some” has even lower EP because it is not as accurate a reflection of reality.

Now, let us get back to the original argument and combine the EPs with the IP. The IP when using “all” in the premise is 1.00. But the EP of “all” is not true, although one might interpret it as, say, 80% correct. So, an estimate of the EP of the conclusion of the original argument is IP × EPs = 1.00 × 0.8 × 1.00 = 0.8, where IP = 1.00, EP of warrant (with “all”) = 0.8, and EP of data premise = 1.00.

Normally, the real action in analyzing reasoning is the trade-off between the IP of the argument and the EP of the warrant. For example, if the warrant is stated as “most people in Canada like hockey,” then the IP goes down to about 0.8, because the conclusion that “you like hockey” based on this argument cor-responds to what we mean by “most.”

It is very important to consider what would happen if we changed the wording of the conclusion to correspond to what we really know. What if we had the following argument:

Warrant: 80% of people in Canada like hockey. Data Premise: You live in Canada. Conclusion: The chance that you like hockey is 80%.

The IP of this argument is back to 1.00. (Note that if the conclusion of this argument were stated as “you like hockey” then the IP would be only 80%. In other words, the uncertainty is either made explicit in the argument or, if it is not, the strength of the argument is weakened. This is another illustration of the impor-tance of relevant words in affecting the strength of the reasoning.) The EP of the warrant is 1.00, the EP that you live in Canada is 1.00 (we have assumed throughout this appendix that you are not lying or hallu-cinating, and, therefore, when you say you live in Canada you actually do so—truly skeptical philosophers consider such issues). Thus, the above EP of conclusion, based on the argument, is now 1 × 1 × 1 = 1.00. Note how this was achieved: be as precise in your wording of the reasons as is justified by your knowledge, and aim to maximize both the IP of the argument and the EP of the premises.

High IP means giving a conclusion that does not go beyond the premises; it means what it says. For example, if we used the warrant “Few people in Thailand like hockey,” you would ask, with justification, “What does that have to do with your liking hockey?” This is an example of an irrelevant premise in an argument. Similarly, if you used the warrant “No people in Canada like hockey,” not only is the warrant false but your conclusion contradicts this warrant. These are examples of bad reasoning. To avoid bad rea-soning, think ahead to the claim or conclusion you want to make, and identify the more general principles and concepts you can relate to this conclusion.

We have introduced the ethical and legal concepts to help identify these principles. Your financial account-ing courses provide additional principles. Finally, this textbook gives more audit-specific reasoning. But remember that in practice arguments are more complex than syllogisms. Audit arguments need to consider sev-eral warrants and to rank them in a hierarchy. However, most audit issues seem to be reducible to a few general principles that are at issue in a particular situation or reporting context. Critical thinking is the broader thinking that requires thinking about the context and the appropriate application of accounting in that context. At the end of this section, a hierarchy of principles in financial statement auditing is outlined. Standards alone have not yet identified sufficiently clarified principles. Standards, like the profession itself, are a work in progress.

Another thing to note about the last argument is that its conclusion contains a great deal of uncertainty about your attitude to hockey. That is because that conclusion is based on the reasoning given. You, person-ally, know what your attitude is toward hockey, but other people need to be convinced, and that is why the argument is given. An auditor is in a similar situation, trying to convince others (financial statement users) that the financial reporting presents fairly or is “true and fair.” That is why an auditor needs to develop an argu-ment based on the audit work (data premise). The issues associated with this fundamental audit argument are

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developed further in this appendix and throughout the text. For example, you may still be skeptical about the relevance of the issues associated with the hockey argument given above. So let’s change the context.

Let’s say you are an auditor who has obtained sufficient appropriate evidence to conclude that the probability that the auditee will fail within the next year is exactly 20%. How should this knowledge be reported so that the financial statements present fairly or are a true and fair representation? Specifically, is it okay to still record financial statement line items assuming the going-concern assumption is true? Should this probability be disclosed in the notes to the financial statements, and how should it be disclosed?

To get even more realistic, what if the auditor is not sure exactly what the probability of failure is based on the evidence gathered. In reality, both auditors and business people live in a world of uncertainty. To represent this uncertainty, assume that there is a range of probabilities (you will see that audit standards like to work with ranges) of not meeting the going-concern assumptions of 20% plus or minus 20%—that is, the range of probability of client failure is 0–40%. Put another way, the chance of satisfying the going-concern assumption falls in the range 60–100%. Should any assets be written down now? Is it sufficient to disclose this possibility in the notes to the financial statements? What is the acceptable disclosure?

Note from our discussion above that if the auditor discloses exactly what the auditor knows, then that is the way to get an EP of 1.00, as discussed above. But is this more informative than saying that violation of the going-concern assumption is “unlikely” or that violation is “somewhat possible”? Problems with using qualitative expressions of this type (in words) have been identified in research such as Piercey,28 which we discuss later in this appendix. For now, we want to identify a second decision the auditor needs to make. Is note disclosure sufficient? Should there also be an adjustment to values recorded in the financial statements? Fortunately there is some guidance in accounting conventions and different measurement bases, such as historical cost, market value, and discounted cash flow measurement bases.The above issues should make clear that there is not just one argument associated with the audit but many. There will need to be at least as many arguments as there are line items and related note disclosures in the financial statements. Nevertheless, the basic idea is that each argument should conclude that an acceptable level of EP still holds. What these questions illustrate is that implementing the concepts of IP, EP, and argumentation will create major practical challenges for audit judgment.

Suggested Hierarchy of Principles in Audit of Financial StatementsThe goal is to serve the public interest. One way of doing so is to reduce the risk of misleading capital pro-viders via financial reporting. (Ethical financial reporting is defined in Appendix 1B.) But a true critical thinker should also consider other ways the public interest might be affected in a specific audit engage-ment. In brief, we can summarize the hierarchy of principles in an audit engagement as follows. They are arranged in top-down order, indicating that if there is a conflict of principles, the higher-up principle takes precedence. You can thus think of this as the hierarchy for ethical and fair presentation reporting:

I. Principles of ethics (highest-level principles that can apply in a specific situation) II. Conceptual framework of financial reporting and related accounting standards III. Principles of auditing IV. Audit evidence V. Reaching a conclusion on financial reporting using all of the above (a fairness of presentation

reporting framework requires the most complex argumentation in auditing)

Note that the above outline of the reasoning process requires integration of ethical principles from ethics, accounting, and auditing. At any one time, only one or two principles might be at issue, and this is where the auditor focuses the most attention. Next we discuss more specifically the integration of accounting and auditing.

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IV. Example of Critical Thinking, Integrating Accounting and AuditingThe auditor’s unqualified report claims that the financial statements “present fairly” in conformity with Canadian GAAP. Note that this is a claim the auditor makes and, therefore, he or she is fully responsible for justifying this claim if challenged. Also note that merely citing references to the CPA Canada Handbook may not be sufficient to support such a claim, since the CPA Canada Handbook does not define fairness of presentation but only provides guidance on GAAP and generally accepted auditing standards (GAAS).

How do we know then when this claim is justified? As you will see, the text is devoted to the topic of gathering sufficient appropriate evidence to help support this claim. However, you will also need to make use of the GAAP that you learned in your accounting courses as part of the justification. Furthermore, you need to consider other issues, such as the role of ethics, and you may need to consider whether the hidden assumptions of accounting theory apply under the circumstances to fully support this claim from a critical thinking perspective. Proper accounting depends on the legal, cultural, and regulatory aspects of the envi-ronment that can affect the economics of the auditee. Critical thinking reminds auditors to consider these broader aspects of financial reporting.

You can think of the accounting issues in auditing as consisting of two basic parts: (1) the financial reporting in conformity with GAAP and (2) the financial reporting that is fairly presented. Historically, most auditors assumed that if sufficient appropriate evidence showed that the financial statements were within a material difference of GAAP numbers, then an unqualified opinion was justified. However, as accounting standards become more “principles based” and accounting standard setters put more focus on the meaning of “present fairly,” auditors need to focus on fairness of presentation within GAAP. In other words, there is increasing appreciation that not all GAAP will result in fair presentation in all cir-cumstances. Auditors are expected, instead, to make decisions about the proper application of GAAP under the circumstances. And if GAAP is vague on an issue, the auditor’s critical thinking is further complicated.

Auditing and accounting standards are becoming more integrated, but the process of integration is not yet complete. In the past, the two sets of standards developed independently of one another, thereby creating two sets of largely independent criteria, or two professional “silos” of knowledge. This silo effect has been reflected in your courses—you have probably taken courses in financial accounting and separate ones in auditing. This silo effect explains why there are some inconsistencies between accounting and auditing. For example, some argue that there are differences between accounting and auditing materiali-ties, and some wonder why auditing is risk based while accounting is not, even though each has its own set of uncertainties. There are also some important differences between the two in basic qualitative cri-teria. The four principal qualitative characteristics of financial reporting under CPA Canada Accounting Handbook (Part II), paragraph 1000.18, are understandability, relevance, reliability, and comparability. In contrast, the assurance section, 5025.36, of the CPA Canada Handbook lists five qualitative characteristics: relevance, reliability, neutrality, understandability, and completeness.

Under existing standards, the auditor is assumed to use something like critical thinking (what the profes-sion has historically referred to as professional judgment) to justify fairness of presentation in the circum-stances. For example, the completeness concept of section 5025 does not seem to be quite captured by any of the concepts of paragraph 1000.18. So, does this mean that fair presentation incorporates the complete-ness concept in financial reporting? Current standards and conceptual frameworks give no definite answer.

As auditing and accounting reasoning become increasingly integrated, it is also becoming evident that the fairness of presentation concept needs clarification. For example, fairness might refer to the completeness of

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disclosure, to the appropriateness of the accounting under the circumstances, or to how well the accounting deals with the disclosure of accounting estimation uncertainties of CAS 540 (covered in depth in Chapter 19, Part I). These different concepts illustrate the importance of being aware of different perspectives on an issue.

These issues suggest an important aspect of critical thinking in public accounting—that auditor judg-ments about accounting uncertainties can have a big impact on what is considered fair presentation. Audit judgments need to be integrated with accounting judgments to justify the auditor’s report. Also relevant to critical thinking concepts, the following important warrant needs to be considered in auditor justification:

Warrant on integrated critical thinking for auditors with regard to accounting uncertainties: The degree of uncertainty with respect to going concern, contingencies, and other accounting esti-mates affects not only the audit report but also the proper form of accounting disclosure.

Note that this warrant does not exist in the CPA Canada Handbook. It is one that a critically thinking auditor needs to consider in deciding if proposed disclosures by a client present fairly. Critical thinking is the type of thinking needed for the increasing demands in the current audit environment for higher quality in financial reporting.

In deciding on the degree of acceptable uncertainties for specific disclosures, auditors need to con-sider a very important issue in their critical thinking—the self-fulfilling prophecy. This refers to the fact that if the auditor were to insist on disclosure of going-concern risks (or even of contingencies, such as lawsuits), then the mere act of disclosing can cause the bad outcome that is disclosed, for example, by cre-ating financing problems for the company and thereby pushing it over the brink into failure (a self-fulfilling prophecy). The client might even sue the auditor if the disclosure is perceived as causing the failure. For this reason, auditors may be reluctant to disclose these problems.

However, the self-fulfilling prophecy problem looks at the issue of going-concern disclosure from only one perspective—that of management. What about the perspective of prospective investors who are the ones relied on to prevent the company from going under? Do they need to be appropriately informed of the risks of their potential investment? The existence of these two perspectives creates an ethical dilemma for the auditor because both need to be considered in deciding on the amount of disclosure that results in fair presentation for all parties concerned. Thus, focusing only on the self-fulfilling prophecy problem is not true critical thinking. Similar issues arise whenever an accounting standard is argued as having harm-ful effects on particular industries (e.g., the enormous resistance put up by high-tech companies against the expensing of stock option compensation). It is usually better to have such issues sorted out at the standard-setting level within accounting standards. But as in the case of going-concern problems, if the standard setters have not yet resolved the truthfulness of the going-concern assumption, then the burden is left on the practising auditor to sort it out within the context of a specific engagement. This is when critical thinking becomes very important and the basis for documentation in the audit files. Such documentation of critical thinking can be useful in showing due care in case the auditor’s judgment is ever questioned in court or by the Canadian Public Accountability Board (CPAB).

Have auditors been doing a good job of implementing a critical thinking perspective in the case of going-concern problems? You be the judge. Studies have shown that half of audited companies that fail did not have any indication of going-concern problems in the immediately preceding audited financial state-ments. If you invested in a company that failed within a few months of your investment, and there was no indication of problems in its audited financial statements, would you consider those financial statements to have been fairly presented (e.g., think back to the Thai restaurant example from Chapter 1)? Would you consider the financial statements to have “high” assurance that they are not misleading? Keep in mind that when a company fails, the actual realized values for its assets are usually materially different from what was reported in the financial statements. So when auditors fail to detect going-concern problems 50% of

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the time, are they providing high assurance that there are no material misstatements for the failing compa-nies? These are the types of questions a critically thinking auditor needs to ask.

Objectivity versus IndependenceAnother issue we will consider here is the relationship of the more traditional concepts of objectivity and independence to critical thinking. A competent auditor needs to collect and evaluate audit evidence in an impartial way. He or she must be convinced by the facts of the situation. This is what seeking the truth means in critical thinking. The part of critical thinking that considers other perspectives on an issue is also part of being impartial. Being aware of others’ perspectives does not mean you approve of those perspec-tives. For example, later you will learn that sometimes auditors need to think like a crook to detect decep-tions in financial reporting. This does not mean the auditor approves of the way the crook is thinking. What it does mean is that the auditor will anticipate what ways a crook might try to deceive and, therefore, the best procedures to detect these activities.

This attitude of impartiality is what we call being objective. Objectivity is a state of mind. Evidence of it is apparent in the form of the quality of critical thinking that is documented in the audit files. Inde-pendence is a precondition of objectivity. Independence in appearance is an indication to third parties of independence in fact. Impairment of independence threatens the perceived objectivity and, therefore, the perceived quality of critical thinking (e.g., the thinking may be viewed as biased). The quality of the critical thinking affects the quality of the audit and the audited financial statements.

V. More on Argumentation and LogicLogic is the study of reasoning. Reasoning is not the same as thinking, however. Thinking includes things like daydreaming and playing tennis, whereas reasoning is actively organizing thoughts to either support a conclusion or provide an explanation. When reasoning is expressed in statements, it is called an argument. In particular, an argument consists of a set of statements, one or more of which support (or provide rea-sons for) another statement called the conclusion. The truthfulness of a conclusion (e.g., an audit opinion) depends on the truthfulness of the other statements (reasons, or in philosophy frequently referred to as premises). If the premises are rationally acceptable and the argument has logical strength, then we have a sound argument. The strength of the link between the premises and the conclusion is the central issue in the study of logic. This strength can be measured by the IP of an argument, which is the probability the conclusion is true if the premises are true. IPs apply to the entire argument.

Review Checkpoints 3A-1 Are auditors providing high assurance when they fail to disclose going-concern problems for failing companies?

3A-2 What is wrong with the self-fulfilling prophecy argument from the auditor’s perspective?

3A-3 Identify the perspectives possible and the resulting arguments regarding the expensing of stock option

compensation.

3A-4 How does the auditor know if the disclosure of going-concern problems is complete; that is, what criteria

tell the auditor that the client needs to disclose going-concern problems?

3A-5 What do you think fair presentation should mean, in addition to not being materially misstated from a

GAAP number? Can you defend your decision to the rest of the class?

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The auditor, however, is usually interested in the truthfulness of the conclusion itself. This probability is the EP. EP is based on our stock of knowledge, which, in turn, influences the strength of our argument. In particular, the EP is a function of the truthfulness of the premises used in the argument, and the IP of the argument itself. If the premises can be assumed to be 100% true, then EP = IP. In this sense, the stronger the argument, the stronger the conclusion.

Since the central problem in auditing is the strength of the auditor’s conclusion as reflected in his or her opinion, it should immediately be apparent why argumentation is so critical to auditing. The audit opin-ion, if it is to be justified, should be the conclusion of an audit argument incorporating moral reasoning as well as reasoning with the evidence gathered in the audit.

As in biomedical ethics, informal logic in the form of critical thinking appears to be a good general reasoning model for supporting audit conclusions. Critical thinking also dominates in law; in other pro-fessions; and, in fact, in everyday reasoning. Perhaps it is for this reason that philosophers have recently shown increased interest in critical thinking and that it is rapidly evolving as a specialized branch of logic.

Informal logic is the primary means of justifying audit conclusions. This is true regardless of whether the conclusion relates to ethical issues involving value judgments on people or purely factual ones.

Of course, the overall audit conclusion should be consistent with the audit opinion and supported by the auditor’s entire argument. The auditor’s argument should be reflected in the audit working papers. The overall audit argument is a complex argument with some premises supporting an intermediate conclusion (e.g., that inventory is fairly presented) and the intermediate conclusions then becoming premises in the next step of argumentation. Thus, each of the intermediate steps of reasoning that are linked together to form a complex argument can be an argument in its own right. Ethical arguments are thus intermediate arguments that help support the audit opinion. Generally, audit evidence is used to form auditor beliefs about fairness of presentation, and decisions as to auditor actions, such as the wording of the opinion, are ethical decisions. Ethical reasoning is, thus, part of the complex audit argumentation that is needed to jus-tify the audit opinion. The complexity of ethical argumentation in auditing should be evident, for example, from the boxes and discussion in Chapter 3 related to independence and objectivity.

Justification is generally viewed in philosophy as an evaluation of how a conclusion was reached. This is usually done by looking at the reasons offered. There are two basic philosophies to justification: coher-entism and foundationalism. Foundationalism focuses on individual beliefs as the ultimate source of jus-tification, whereas coherentism looks at whole systems of belief for justification. Critical thinking, which uses a pluralistic approach, relies on a coherence theory for justification. As a starting point, critical think-ing uses social norms that are accepted without recourse to other judgments. These initial norms must, however, cohere with one another. This approach is dialectical in the sense that justification is viewed as a discourse among the affected parties. In dialectic, the starting points of justification are the premises conducted by the participants, followed by a search for conclusions that can be derived from the agreed-to premises. Experience, background knowledge, and character, as well as general principles, are brought to bear in deciding how to resolve ethical issues within the dialectical framework.

A coherent approach is a combination of inductive (reasoning from the particular to the general) and deductive (deriving particulars from the most general assertions or principles) approaches. As in argumenta-tion, a deductive approach has traditionally been promoted as the best model for justification. For example, particular judgments may be derivable from rules, which, in turn, are derivable from principles. In practice, however, combining deductive and inductive approaches using different principles, rules, theories, and judg-ments, depending on the circumstances, results in a system more amenable to the dialectical framework, where not all premises may be acceptable to all parties. Thus, the concept of coherentism better captures the justification needed to help resolve the conflicts of interest that can arise in ethical dialectics. As J. Rawls, a

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famous ethics philosopher, has noted, justification is a “matter of mutual support of many considerations, everything fitting together into one coherent whole.” Principles in this context are more general guides that leave considerable room for judgment in specific cases that provide substantive guidance for the development of more-detailed rules and policies. Principles, thus, are major reasons to be used in an audit argument.29

We will summarize this discussion of critical thinking and logic by employing concepts used in an argu-mentation model (Exhibit 3A–1) developed by philosopher Stephen Toulmin. He has constructed a model that can be applied to any form of reasoning, including legal reasoning, argumentation in the sciences, arguing about the arts, and ethical reasoning. The major contribution of the model is to identify the major elements of argument structure.

This model was first proposed for use in auditing in a 1991 CICA research study authored by D. M. Barnes (1991). An illustration of how it would be applied to a financial statement audit is given in Exhibit 3A–2. We will use the model as a cornerstone of our critical thinking framework.

Backing B

Warrant W

Grounds

G

Claim

C

Quali�er

Q

Rebuttal

R

EXHIBIT 3A–1

Toulmin’s Argumentation Model30

In narrative form, the model shows that “given grounds G, one may appeal to warrant W (which rests on backing B) to justify the claim, C—or, at any rate, the presumption (Q) of C in the absence of some specific rebuttal or disqualification, R.

The terms used in the model are described as follows: • Claim—assertions put forward for general acceptance (the opinion or conclusion) • Grounds—generally accepted and relevant “facts” on which the claim is based (the evidence) • Warrants—general laws, rules, or principles making these facts relevant to the claim (the rationale/criteria supporting the claim) • Backing—support making explicit the body of experience relied on to establish the trustworthiness of the warrants presented (the

authorities supporting the rationale/criteria) • Qualifiers—phrases showing what kind of and degree of reliance is to be placed on the conclusions, given the arguments

available to support them. These consist of adverbs and adverbial phrases, for example, necessarily, certainly, presumably, in all probability, very likely, very possibly, apparently, and so on.

• Rebuttals—extraordinary or exceptional circumstances that might undermine the force of the supporting arguments

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To further illustrate the universal features of this model, we simplify it to a standard form involving three statements called a syllogism. Depending on what the statements actually say, we can have an infi-nite number of syllogisms. Syllogisms, while deceptively simple looking, can be quite complex, depending on the meaning of each statement. Hence, syllogisms can capture the essence of many critical thinking features that we briefly review in the next few pages.

Major Features of Natural Language Reasoning in Assurance Engagements, in Syllogistic Form

ARGUMENT 1 ARGUMENT 2 ARGUMENT 3 ARGUMENT 4 ARGUMENT 5

Statement Premise 1 Warrant = Major Premise All persons are mortal.

Statement Premise 2 Data = Minor Premise Socrates is a person.

Statement Conclusion Conclusion = Conclusion Socrates is mortal.

• Argument 1 is the most abstract generalization of an argument. It does not distinguish between an argument and an explanation or any other set of communications or utterances.

• Argument 2 suggests the essential feature of argument structure: some statements (premises 1 and 2) purport to justify another statement (the conclusion) following rationally from the premises.

• Argument 3 reflects three essential features of argumentation.

A FINANCIAL STATEMENT AUDIT LOGIC MODEL

The accumulated experience of accounting andauditing practitioners (as codified in the CPACanada Handbook and other authoritativesources) has demonstrated the following:

B

Annual financial statements that reflect theassets, liabilities, equity, and transactions of thecompany, presented in accordance with GAAP,can be said to present fairly the company’sfinancial position, operating results, andchanges in financial position.

W

Audit evidence and auditor accounting knowledge provide high assurance that user needs inthe circumstances are met throughthe company's financial statementsin accordance with GAAP.

the financialstatements arefairly presented inaccordance withGAAP.

most likely,

G C

Q

So,

EXHIBIT 3A–2

Barnes Example Three (as modified)

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• Argument 4 (Aristotle’s system) specifies a generalization premise, the major premise, which deter-mines why the data are relevant to the conclusion. It corresponds to the concept of a “warrant” (in Argument 3), which links the data premise to the conclusion. Aristotle’s syllogisms teach us that the more important premise is the warrant because it determines which data are relevant for the con-clusion. Warrants are also referred to as connecting premises because they connect the data to the conclusion, thereby making the data relevant to the conclusion. Warrants are usually rules or gener-alizations of some type involving at least one quantifier (e.g., all persons are mortal). Theories and models are forms of generalizations. A very common generalization used in everyday reasoning is the conditional form. We frequently argue that if so and so is true then something else must be, that is, the “If statement A is true, then statement B is true” type of generalizations that are represented symboli-cally as A → B.31 One of the most important developments in psychology and artificial intelligence of problem solving is that heuristics used by experts in a variety of fields can be represented in a uniform way as sets of “if . . . then” rules (if certain conditions hold, then perform a certain action; for example, in accounting, for leases, there are special rules for deciding if leases are to be recorded as capital or operating leases). Such rules are known as productions, and a problem solver or production system can, therefore, be built from a set of productions.32

• Argument 5 sets out a well-known syllogism to illustrate how syllogistic reasoning works. This argu-ment is expressed in natural language, the type used in all audit engagements, rather than in an arti-ficial, symbolic language, such as C++. The statements of Argument 5 align with the major premise, minor premise, and conclusion of Aristotle’s syllogistic framework. The first premise (or warrant) is a generalization that “explains” why the second premise supports the particular conclusion. Without this first premise (or warrant), the second premise (data) alone would not “prove” the conclusion. Given the first warrant, the conclusion follows 100% from the data premise. Thus, the relevance of the data in Argument 5 is determined by the warrant. This reinforces the importance of the warrant in making the data relevant to the conclusion. Therefore, we should treat warrants and similar generalizations, such as “laws” or models, as the more important premises in determining the relevance of the data used.

The differences in deductive and inductive argumentation are noteworthy. A deductive argument is one in which the conclusion is always true if the premises are true. Traditionally, deduction has been viewed in philosophy as the ideal way of gaining knowledge (the conclusion) from argumentation. The IP (probability of the conclusion being true when the premises are true) of a deductive argument is always 100%. If the IP is less than 100%, then we have a non-deductive argument, which is labelled induc-tive. Thus, with deductive argumentation, the IP is always 100%, whereas in inductive argumentation, it is less than 100%.

Another complication with inductive arguments is that a true conclusion does not necessarily follow from true premises. Deduction gets 100% IP by never going beyond the knowledge that is already inher-ent in the premises. But induction, in searching for new truths, goes beyond the premises of an argument to take the risk of reaching a false conclusion from true premises. In this sense, while deduction is truth preserving, induction is truth creating. For example, the most common argument form used in the sciences is as follows:

ARGUMENT 6 ARGUMENT 7 ARGUMENT 8

Major premise (warrant) A ⇒ B Theory All persons are mortal.

Minor premise (data) B Data consistent with (verifying) theory

Socrates is mortal.

Conclusion A Conclude theory is true. Socrates is a person.

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• Arguments 6, 7, and 8 illustrate the formal fallacy of affirming the consequent and are invalid. They demonstrate that a true conclusion does not necessarily follow from true premises. The IP is less than 100%, and the argument is, therefore, inductive. Argument 7 should be regarded with caution. There may be other reasons for observing data (B) predicted by theory (A) of the major premise. Hence, we are not 100% sure that theory A is true. The reasoning in Argument 7 is quite familiar in the sciences. Argument 8 illustrates that observing that an object is mortal does not guarantee it is human. Socrates may be the name of a horse.Consider the following two arguments that are typical of everyday reasoning:

ARGUMENT 9 ARGUMENT 10

Warrant: Visitors to Mexico almost never contract malaria.

More than half the visitors to Mexico contract Montezuma’s revenge.

Data: Jack is visiting Mexico. Jack is visiting Mexico.

Conclusion: Jack will not contract malaria there. Jack will not contract Montezuma’s revenge there.

• Arguments 9 and 10 are inductive arguments. There is a higher IP for Argument 9 than Argument 10, which is evident from the wording and meaning of the two arguments. But which conclusion has the higher EP is not clear because we do not know the probabilities assigned to the warrants. Thus, EPs are a function of additional information that may be available. They would be represented as addi-tional warrants and data to the argument. For example, if we added to Argument 10 the evidence that Jack has visited Mexico many times without experiencing Montezuma’s revenge, most would find the conclusion much more likely to be true. The effect of specific wording on the argument is important. Imagine replacing Mexico with Canada in Arguments 9 and 10. The EPs would be affected consider-ably, thereby illustrating the potentially important role of natural language and common-sense back-ground information in everyday reasoning, including audit reasoning. These effects open the way for rhetorical moves that can shift the persuasiveness of the argumentation one way or the other.33 As examples of how persuasive misleading arguments can be, consider the following arguments, which most university students get wrong.

Argument 11:Warrant: All roses are flowers.Data: Some flowers fade quickly.Conclusion: Therefore, some roses fade quickly.

Is the above a good argument? Most university students say yes, mainly because it seems they look at the believably of the conclusion. They agree that it is true, so they assume the argument is true. Do not make this mistake as an auditor! The argument must support or justify a conclusion. Does it? If both premise and data are true it does not follow that the conclusion is true: roses might not be the flowers that fade quickly.

Argument 12:Warrant: The bat costs $100 more than the ball.Data: A bat and ball cost $110.Conclusion: The ball costs $10.

This argument is wrong! $10 may seem like the intuitive answer. If you think that, then you are wrong, because the total cost is $120 if the cost of the ball is $10. Thinking this through should reveal that the

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correct cost of the ball is $5, and the bat costs $105. These exercises with syllogisms should illustrate that the simplicity of syllogisms can be misleading. Below is another syllogism that illustrates additional prop-erties. Arguments 11 and 12 should illustrate to you the amazing complexity of even three-statement syl-logisms. That is because of the complexity of language, the way meanings of individual words can change within the context of statements, and the background knowledge about the world needed to get at those meanings. Note that despite sharing of considerable background knowledge (common knowledge), some people will have more or different background knowledge than others. For this reason, the analysis of the same syllogism (and other reasoning such as that of management’s) can vary. This helps explain why effective communication among audit team members is needed to identify the best audit argument (i.e., with the best reasons) in the circumstances.

Argument 13:Warrant: If the sky is green, then the grass is pink.Data: The sky is green.Conclusion: The grass is pink.

The argument above is a syllogism that has IP of 1.0 but EP of 0; that is, it is logical in a hypothetical world that has no empirical content. This is also a deduction that is internally but not externally valid (i.e., not sound because the premises are not true).

Argument 14: Warrant: If there is sufficient audit work and detected errors are immaterial, then give an unmodified audit opinion.Data: Detected errors are immaterial.Conclusion: Give an unmodified audit opinion.

Argument 14 is an inductive one that depends crucially on what is considered sufficient audit work. The data must be sufficient as well as indicating immaterial errors in order to support an unqualified opin-ion without corrections. Sampling theory of Chapter 10 helps the auditor decide on the important matter of the sufficiency of audit evidence (the data). This illustrates the role of more formal models in the audit decision process.

Critical thinking means that we have good reasons to believe a claim or make decisions. These reasons include other people’s (such as management) attempts to persuade us to take an action or to believe some-thing. Attempts to persuade may be argumentative or non-argumentative. Most of the latter are referred to as rhetoric, which we will define here as any attempt to persuade solely through the power of words used (e.g., “you are either with us or against us”). Rhetoric can be used to assist in providing good reasons, or it can be abused to provide bad reasons or no reasons to accept a claim (conclusion), decision, or action.

Rhetoric makes use of linguistic phenomena, the power of words, in persuading us to accept a claim, decision, or action. This power is achieved through cognitive meaning (factual) and emotive meaning (negative or positive overtones) associated with words. Linguistic phenomena include ambiguity, vague-ness, metaphor, rhetorical questions, irony, sarcasm, and generalizations. Critical thinking makes use of language and linguistic phenomena to develop the reasoning for a claim, decision, or action. Deciding whether rhetoric is used to provide good reasons is part of critical thinking.

The pejorative use of the word “sophistry” refers to intellectual charlatanisms involving use of lan-guage to deceive people. In ancient Greece, the sophists trained students to persuade their audience on either side of an argument—a very practical skill for the growing litigiousness of Athenian society— leaving the impression that any reasoning could be used as long as it was effective in influencing people. What mattered was who won the argument, not who was right. The study of rhetoric includes positive use

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of language, as by famous authors (e.g., Shakespeare), as well as the effective use of language to deceive. Rhetoric is a major component in the study of literature.

Our focus here will not be so much on the bad reasons that are possible for a decision as it will be on good reasoning, although some common errors in reasoning and attempts at intentional deception will be noted. An entire book can be written on the types of bad reasoning that have been used throughout his-tory (e.g., the Big Lie technique used in many dictatorships to blame scapegoats for a nation’s problems). Our interest, however, will be on the potentially bad reasoning that is used in our profession, including within the standards. We will first focus on what makes for good reasons and then use this good reason-ing framework as a benchmark to more easily identify the bad reasoning. In this appendix, we emphasize those aspects of good reasoning that are generally independent of the field in which the decision is made (field-independent aspects of reasoning). These more universal elements of reasoning are part of the study of philosophy, especially logic. However, despite the emphasis here on the more abstract aspects of good reasoning, we nevertheless use important examples from the public accounting profession to show how these aspects apply to professional practice.

The preceding sections demonstrated that both language and context can have important roles in influencing the strength of all argumentation, including assurance arguments. These two factors explain why rhetoric is also important to audit argument evaluation. In its broadest sense, the word rhetoric cov-ers the logic, the language, and the context of argumentation. But it is up to the PA to use rhetorical prin-ciples in effective argumentation and to expose through skepticism and critical analysis any deception that management and other accountable individuals attempt through their own rhetoric. Some have analyzed rhetoric as an economic transaction, using “selling” an idea as analogous to selling a good. The gist of the analysis is that when information costs are high (the listeners are uneducated or the information is difficult to understand because it is complex), then rhetorical devices, such as appealing to the authority of the speaker or using emotional appeals, become more important.34

Perhaps the most important use of rhetorical devices is to aid in making ethical decisions. If rhetoric can be used in a conflict-of-interest situation to persuade a party to accept a particular position that is not favourable to him or her, it may play a useful role in the reporting of that position. The disclosure should then be consistent with the aims of the agreement. Rhetoric should not, of course, be used to mislead people about the nature of the agreement.

Rhetoric helps to make PAs aware of the power of language in influencing people’s beliefs. For exam-ple, accounting labels, such as “assets,” “expenses,” and “losses,” send signals to users about how well resources have been managed. Thus, accounting terminology itself has an important rhetorical effect. To maintain relevance, PAs need to be aware of rhetorical impact. This relevance of rhetoric can only increase as accountability becomes more important in society (i.e., as the audit society evolves).

A good illustration of an application of rhetorical principles in accounting can be found in accounting firms’ written responses to a company’s invitation for alternative opinions on an accounting matter.35 The raw data came from a regulatory agency’s files, and the correspondence makes it evident that account-ing firms were engaging in the use of rhetoric in these specific situations. The “winning” firm’s arguments would clearly affect the accounting for the case and might even become part of the audit working paper file justifying the accounting.36

Context includes not only the immediate physical circumstances of the engagement but also broader features, such as the reputation of the person making the argument and the social aspects of the account-ability relationship being reported on. For example, tone of voice and body language can convey the strength of convictions. In some situations, context itself may be the message and override anything that is said or written, regardless of the strength of the logic of the expressed argument. Consider, for example, an arguer who loses credibility, such as an auditor who lacks the appearance of independence. Ultimately,

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arguments are intended to persuade—and thus add credibility. If they fail this acid test, the assurance engagement fails as well. This is why the most important ethical principle is to maintain the reputation of the profession.

Emotions are important for reasoning because they help shape the basic goals of reasoning and influ-ence our intuition. This does not mean advanced mathematics or logic is intuitive, however; instead, these types of mental tools are learned and have evolved to solve more-complex problems.37

The primary role of the emotions seems to be to decide on the ranking of objectives that trigger thinking and actions.38 Emotions seem to be indispensable to coordinating the various mental modules and are, therefore, essential for all human reasoning.39 This helps explain why the mind does not always seem to follow logical rules. Formal logic can uncover trivial truths yet miss consequential ones. Other complications include the meaning of words and language understanding in specific contexts; a person’s background knowledge of the reason or implicit assumptions; uncertainties; and special mental modules or inference rules tailored to specific contexts, especially the cheater detection inference rules.40 It is, therefore, not surprising that philosophers long ago concluded that reasoning depends on three basic appeals—its logic, its emotional quality, and the reasoner’s perceived character. The persuasiveness of the reasoning to a particular audience is determined by all three appeals. The latter two appeals are fre-quently based on the rhetorical aspects of the reasoning. An auditor must consider all three aspects of the reasoning. For example, the auditor’s perceived character is influenced by the perceived independence and objectivity of the auditor.

Embedded in the above standardized framework format is the assumption that reaching the goal involves some decision making. In fact, as we will see, the end result of critical thinking is reaching some kind of decision, whether it is on an adjusting entry or the wording to choose in notes or an engagement report disclosure. This has traditionally been referred to as professional judgment. Professional judgment is part of critical thinking.

We explain the principles and concepts for a professional judgment framework in Chapter 19, Part I, after you have learned more about professional issues affecting auditors. This framework is also consis-tent with the broader framework for critical thinking.

There is no true theory of professional judgment because there is no set of universally acceptable hypotheses that are capable of verification through observation in the audit setting. For example, there is no universally acceptable set of social laws or behavioural laws on which to base a theory of professional judgment in auditing.41 Because many effects in auditing are based on intentional, meaningful actions dependent on context rather than physical cause and effect relationships, general laws are difficult to establish. As a consequence, the logic used in audit professional judgment involves less-formal reasoning that includes evaluation of thought processes as well as the intentions behind the thought processes.42 Many options may need to be considered, each with positive and negative consequences for a given inten-tion and context. As a result, most reasoning in auditing is not as mathematical and abstract (i.e., univer-sal) as in the physical sciences. Of course, when it is appropriate, more-rigorous mathematical or logical tools can always be included to help guide professional judgment.

So, the key to professional judgment is the standards of the profession combined with the critical thinking concept. We will be studying GAAS and related guidelines throughout the rest of this book.

In summary, critical thinking involves use of the principles in the following section, which should be actively considered in analyzing a controversy or issue facing the auditor (such as a disagreement with management on a financial reporting issue). The principles with a dominant ethical component are marked with an “E.” As you can see, all of the principles other than the strict logical ones have an important ethics component. In particular, note how important a questioning mind is. It represents a mental attitude that incorporates the rest of the critical thinking principles. It should be clear that skepticism is a key part of

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critical thinking through the questioning mind concept. Thus, critical thinking takes traditional audit vir-tues and extends them to a more holistic approach to judgment.

Principles of Critical Thinking 1. (E) Critical thinking has a purpose that leads somewhere, has implications and consequences, and

settles a question or solves a problem. These issues are identified through having an inquiring mind-set about the true purpose and goals of a particular audit engagement, which means identifying which of the ethical, accounting, and auditing principles are most at risk of being violated on the engagement.

2. (E) Critical thinking requires a skeptical mindset that requires evidence to clarify all important issues or controversies in the engagement, considers what the goals are in light of the many perspectives pos-sible on the issue, and decides on the best goal under the circumstances. Critical thinking identifies the critical claims that need to be justified to achieve ethical reporting.

3. (E) Critical thinking is used to persuade someone (including yourself) to accept a claim. Of course, others may try to persuade you to accept another claim. And you and others are aware you may have these conflicting claims. You try to resolve this in a cooperative way via the critical thinking process, in which you and others are open minded and receptive to being persuaded by good reasoning. You have to be skeptical even of the reasons for your own position and be ready to justify it or change your position if the evidence does not support it.

4. Critical thinking is based on reasoning using argumentation. The argumentation supports or justifies a claim related to resolving a controversy or issue.

5. (E) Critical thinking is expressed through and shaped by language, which can be used to develop concepts and ideas. In particular, critical thinking incorporates the principle of conversational coop-eration, conversational implicatures arising from it, and the Gricean conversational maxims that arise from the implicatures.

6. (E) Critical thinking requires being aware of the power of language, how this power can be manipu-lated, and the importance of specific words chosen to persuade. The words chosen reflect value judg-ments and have emotional content, which is communicated to the listener. This is part of the persuasion process.

7. Critical thinking requires making important assumptions and reasons explicit so that they are open to scrutiny by yourself and others. This is the best path to truth and knowledge, and these are the ultimate goals of a questioning mind.43

These principles can be viewed as ideals in the ways issues and controversies should be analyzed. They will rarely be achieved exactly in professional practice, usually under some very formal conditions using very precise language and concepts, and when sufficient time and resources are available. Part of pro-fessional judgment is to make the proper trade-offs in practice. Nevertheless, the above principles may remind you of how difficult your responsibilities are as an auditor. We saw in Chapter 1 that a special type of accountability, three-party accountability, is central to the assurance concept. Critical thinking in an assurance engagement requires that the audit provide three-party accountability in the audit reason-ing process. For example, the context in an assurance engagement means that the auditor needs to be aware of the three-party accountability and that at least three different perspectives on an accounting issue are possible.

The above principles are very general in that they can be applied to any discipline or field of study. In this respect, the principles are independent of the field. To apply these principles to a specific field such

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as auditing requires the addition of audit- and accounting-specific concepts and principles. But these more specific parts of audit thinking should ideally conform to the framework of critical thinking as much as possible. Simply being aware of these and similar principles is an important step toward becoming a criti-cal thinker.

The first principle states that critical thinking has an objective and tries to be practical. The second principle states that this objective is identified with a questioning mind that takes into account different perspectives. Implicit here is some kind of social context involving communication. This idea came from the ancient concepts of discourse, or open debate, and discussion, making the alternative viewpoints clear to all. The basic idea is to resolve conflicting viewpoints. The contexts of politics, courtroom, and open debate on any social issue are the paradigm cases. But critical thinking takes the conventions that evolved in these settings and applies them to reasoning on any subject matter in any context. The key idea is that it involves an issue with conflicting viewpoints and that a reasonable decision must be made. This is really a problem that arises in ordinary daily reasoning when dealing with people and life’s problems. Except most times it is sufficient to deal with the problem informally, using intuition and common sense. When you think about it, however, common sense is largely a sharing of norms of acceptable behaviour (like no smoking in classrooms). In this sense and the sense of trying to learn the process of critical think-ing, the exercise is one of cooperation for the common good by those affected by the issue, but always in a specific context.

The third and fourth principles focus on how to achieve the objective of resolving the issue. Prin-ciple three acknowledges that what is really at stake is persuasion of people. For example, manage-ment may be trying to persuade investors, and the auditor’s task is to reduce the risk of deception in management’s persuasion attempt to acceptable levels. How is this achieved? We use the time-tested technique from philosophy called argumentation to reduce this risk. So, what critical thinking is say-ing is that argumentation is the way we establish our claims. The principal claims of interest in audit-ing are the ones made by management about the financial statements. These management claims are verified in the auditor’s report. But the audit report is itself a claim, which we call a conclusion or opinion, about the results of the audit. This claim also needs to have a supporting argument. This is why we are interested in arguments that the auditor will make to support his or her opinion (the auditor’s claim). Although the profession has traditionally not thought of it this way, the increased attention to quality control, new types of audit engagements, and increased auditor accountability to the accountability boards is putting increased expectations on auditors to justify their conclusions on stronger philo-sophical grounds. This accountability is achieved by justifying one’s conclusions better, which means paying more attention to the structure of sound argumentation, including on ethical issues as part of the reasoning.

The fourth principle, that we reason by argumentation, is probably the least familiar and least intui-tive, which is why the first section of this appendix focuses on argumentation concepts. As explained earlier, this means providing good reasons for a conclusion, claim, or action. Arguments can be stated in an infinite number of forms, but the reasoning process itself can be put into a standard form. Doing this in real-life situations can be quite difficult, and we have discussed the most basic issues already. A major complication is that many reasons in an argument are themselves claims that, in turn, may need a support-ing argument in order to be justified for use as a valid reason. But the point is that we can reconstruct all arguments in a standard form, such as a syllogism, and then apply the analysis to that form. So, what criti-cal thinking says is that the critical thinker must be prepared to defend his or her reasons and assumptions if they are called into question by an opponent, such as a court or an accountability board. In other words, the auditor must be prepared to justify his or her decisions and judgments.

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Argumentation takes place in all levels of social life, although not as formally as discussed here. There can be arguments among friends, in a court of law, in the political arena, and among experts. Auditors have to be prepared to argue among experts, and it is these situations where more formality and uses of professional standards and concepts come to the fore. Debate is a form of argumentation that brings together various techniques of persuasion, right choice of words, demeanour, tone of voice, and intelli-gence. Whether in a courtroom or regulatory hearing or dealing with a client or the media, debating skills can be as useful for auditors as they are for lawyers and politicians.

In debating teams or clubs or even in business case competitions, the arguer must be prepared to argue an issue. The major point of such debates is not necessarily to find the truth but to improve debating techniques generally. But the debate needs a focus, an issue, which is what the second prin-ciple is about.

The point of debate is to convince or persuade another party of the correctness of a claim. This is an essential element of all critical thinking and why we have the third and fourth principles. Also, you need to be aware that there are different viewpoints, and that good arguments recognize these viewpoints, to jus-tify a claim. And it may turn out that no one viewpoint can dominate. This is summarized in Exhibit 3A–3. For example, in this exhibit, can you identify the three parties in three-party accountability? (Refer back to Exhibit 2–4 in Chapter 2.) Management (circle 2) is the accountable party that makes the assertion to the users (circles 1, 3, 4, 5, and 6), and these assertions are verified by the PA (circle 3). Who wins the debate is decided, in large part, on who has the burden of proof in establishing a claim. This is largely determined by social conventions. For example, under criminal law in the Anglo-American system, an accused is pre-sumed innocent until the state can establish guilt “beyond a reasonable doubt.” When the state has done this, it has met its burden of proof in court, but if not, the accused does not have to prove that he or she is innocent and so wins the case (i.e., wins the debate). Critical thinking is, thus, a disciplined thinking that takes into account various social norms and other contextual factors in the reasoning process. The remain-ing principles clarify other aspects of critical thinking.

6CanadaRevenueAgency

1Investor

4Regulator

3Auditor (PA)

5Creditor

2Management

Notes:

• Only some of the facts are highlighted in any point of view.

• All points of view ignore or play down some facts.

• No single point of view provides total understanding.

• Understanding multiple viewpoints increases insight.

The total set of facts relevant to understanding a given set of events

EXHIBIT 3A–3

Multiple Points of View with Respect to a Given Set of Facts

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The fifth principle recognizes that a major influence on viewpoint or perspective is the words and concepts one uses. It is important to be aware that choice of words affects value judgments and the taking of an ethical position. For example, whether to call use of company resources an “investment” or a “speculation” illustrates that the choice of words can imply different motives and, hence, differ-ent ethical valuations. Accounting terms can be used as euphemisms, which is reframing the harm in the words so that it seems less immoral. Applying an “expense” label to a cost instead of a “loss” label makes the cost seem more acceptable because the incurrence becomes necessary to running the business. It is very important in critical thinking to be aware of the power of language in reflecting such value judgments, and, if you disagree, to address that issue in your argumentation so that the language used reflects the perspective taken. Another example of this is that financial statements “present fairly.”

The concepts used also influence viewpoint. Concepts are important in that they help us assign mean-ing to our senses and the information we use. Immanuel Kant’s views on this have been very influential in computer science and artificial intelligence. These views can be summarized in the statement: “Concepts without data are empty, and data without concepts are blind.” What this means is that both concepts and data are needed to make sense of the world, including in critical thinking. In other words, concepts provide meaning to our observations and evidence, and without concepts we have no way of knowing how useful or relevant our evidence, including audit evidence, is.

This is reflected in arguments by the fact that the most important reasons (major premises) are usually conceptual ones based on some assumed model, theory, or principle. These major premises determine what data are relevant in an argument. For example, in auditing you will learn about man-agement assertions. These are the major points at issue in financial reporting. They, in turn, are embed-ded in the theory and assumptions of accrual accounting, which determine the kind of data needed to verify the assertions. For example, much of financial reporting is based on historical cost. So, to verify assertions related to historical cost, auditors need evidence on what the auditee actually paid for vari-ous items. This means that the relevant evidence the auditor needs to gather is driven by historical cost accounting theory. This illustrates that the evidence is less important than the historical cost account-ing theory because without the theory, we would not know what evidence to gather. For this reason, audit evidence is treated as a minor premise in audit argumentation and in critical thinking, and this is also why principles of auditing are shown lower down in the hierarchy below the accounting standards. The accounting determines the “suitable criteria” for the engagement, and these criteria determine what evidence is relevant for the audit. For example, the historical cost concept is what gives meaning and relevance to the audit procedures that involve gathering evidence about records related to what was actually paid.

Making this relationship between concepts and evidence explicit is a necessary component of critical thinking. But critical thinking is also practical. It does not necessarily question everything, but it must be ready to respond if challenged. Normally, it is sufficient to refer to authoritative sources, such as GAAP, rather than reproducing all the arguments used in accounting theory. However, auditors must be prepared to defend the appropriateness of their accounting choices in case someone questions their actions (such as the CPAB or a court of law). Critical thinking means that auditors should be prepared and anticipate such eventualities, which is a major reason it is important to be aware of other viewpoints. The fact that it is the auditor who uses the words “present fairly” requires nothing less from the perspective of the critical thinker. As more people question the auditor’s role and the quality of financial reporting, a structured criti-cal thinking approach is probably the best way to rationally justify one’s claims and decisions in a particu-lar engagement.

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Being aware of the framework and having an understanding of its components is the first step to being a critical thinker. Applying these concepts and principles to a specific situation is the best way to understand them better. Keep in mind, however, that the framework is very general and applies to all fields of study. To be a critical thinker in a particular field such as auditing requires combining these critical thinking concepts and principles with the more field-specific ones of accounting and auditing. This is most evident in the explicit argumentation that is developed to support an audit conclusion.

You will not need to make all your assumptions, concepts, and principles explicit because your audi-ence may readily accept the vast majority of your reasons. It is only a few contentious reasons that are normally the centre of controversy, and most people will agree with or accept most of your reasons with-out question. This is because in a society, we share much common knowledge (the obvious or common-sense items) and many social conventions (such as a shared language and all its conventions for efficient communication—often taken for granted). A good critically thinking auditor should be able to anticipate which reasons will be controversial (i.e., be able to understand the perspectives of others), sharpen the argument to explain why a reason is appropriate in a particular case, and have this reasoning documented in the audit file to support the auditor’s position.

Implications of the Gricean Maxims of Conversation for AuditorsPhilosophy is based on language usage, which includes one of the oldest uses of language as part of conversation. There are three basic aspects to language use: syntax, semantics, and pragmatics. The analysis of argumentation we have covered so far has incorporated the concepts of syntax and seman-tics. Syntax is concerned with the relationship between expressions of language, such as the relationship of statements in an argument. Semantics deals with the meanings of the statements, such as the way we assessed the EPs of statements. But semantics is only a part of the meaning. The other parts of meaning are called pragmatics.

Pragmatics is primarily concerned with how statements are used in language, particularly in normal conversation. A famous philosopher of pragmatics, H. P. Grice, has identified something called the “Prin-ciple of Conversational Cooperation.” This principle assumes that parties to a conversation are being coop-erative. That is, they are aiming for a common goal of truthful communication. It turns out that in natural language not everything is explicitly stated in statements; some things are only suggested. These sugges-tions are called “conversational implicatures.” For example, when somebody asks you directions to a store, presumably you will give them directions to the nearest one, and not to one on the other side of town. Note how this interpretation helps further explain the meanings of statements like those giving directions to a store—such as that this is the nearest store that is still open.

Underlying conversational implicatures are a series of rules identified by Grice. He refers to them as conversational maxims, and they can be subdivided into sub-maxims as follows (from L. T. F. Gamut,44 pp. 204–205):

• Maxim of Quantity – Make your contribution to the conversation as informative as is required. – Do not make your contribution any more informative than necessary.

• Maxim of Quality – Do not say what you believe is false. – Do not say that for which you lack evidence.

• Maxim of Relation – Be relevant.

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• Maxim of Manner – Avoid obscurity of expression. – Avoid ambiguity. – Be brief. – Be orderly.

Grice does not claim that this list is exhaustive—other maxims may yet be identified. In fact, you have already seen from the earlier discussion of argumentation the importance of the maxims of quality, manner, and rela-tion. Standard setters and others are already aware of these maxims but may call them by some other name. However, the important point is that these maxims are not just relevant for informal communication, such as conversations, but also apply to more formal communications, such as financial statements, note disclosures, and audit reports. The maxims are thus useful in guiding critical thinking and professional judgment in commu-nications. They help to make operational the idea of ethical reporting. The Maxim of Relation reminds us that audits need to be relevant to users of financial statements, which also means auditors should be aware of what is relevant to their needs. This can be interpreted as one of the dimensions of the meaning of fair presentation.

The Maxim of Quantity reminds the critically thinking auditor that fair presentation requires that the auditor be as concerned about providing too much information as about providing too little information. Thus, the critically thinking auditor should be concerned about finding the right balance of disclosures to meet user needs.

Research on the psychology of audit judgment has identified a problem with using words as qualitative expressions to describe a broad range of possibilities. The problem is that the meaning of words can be manipulated by auditors to make auditors less accountable for their work. M. D. Piercey44 finds that audi-tors can use linguistic expressions such as “somewhat possible” to mean either something less serious when applied to a risk of material misstatement, or more serious if additional evidence suggests that the risk is higher than assessed. This is used to create an “illusion of objectivity” on the part of the auditor (Piercey 2011, p. 228). The police use a similar strategy when they use the term person of interest instead of suspect. These word games or strategies are a potential problem when we expect professionals to abide by the pragmatic aspects of logical reasoning as outlined by Grice’s principles of conversational cooperation. One way around this problem is to use more-precise, quantified risk assessments. For example, if a relatively precise 20% probability of client failure can be justified, then this can be more directly compared with guidance in the standards. Quantification through use of probabilities is an important way of being precise in communica-tions and in detecting language games of the type identified in studies such as Piercey’s. Perhaps this is why the present system of accounting evolved as a measurement system for financial reporting in the first place.

The problem is under what conditions is it appropriate to use quantitative measures instead of describing the situation purely in words. This really gets to the heart of whether successful implementation of Grice’s principles in auditing and financial reporting requires quantification or not. There is no clear answer in the standards, and thus the auditor who is essentially evaluating the financial reporting should use the broadest principle: the principle of cooperation with the users of financial statements. Cooperative communication is not a problem unique to auditors, but the Gricean principles are broad enough to serve as a useful guide. Being aware of the problems of cooperative communication could be half the battle by helping put the audi-tor in a mindset and attitude that encourages critical thinking. Keeping in mind that the goals of financial reporting and auditing are the most fundamental principles should help clarify the central ideas behind audi-tor thinking, which is to lead to conclusions that help meet the goals of cooperative communication through financial reporting. This would have been useful for the auditors of Continental Vending to have kept in mind.

Please see further discussion on going-concern issues in light of the latest audit standards in Exercise EP 3A-1.

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E X E R C I S E S A N D P R O B L E M S

EP 3A-1 Critical Thinking about Quantitative versus Qualitative Disclosures. LO8 A basic assumption of accounting theory is that the going-concern assumption is true. If the auditor assesses that there is a 20% chance the auditee will fail, what should the auditor do? If the audi-tor assesses a range of risks of failure 0–40%, what should the auditor do? When are quantitative assessments better than qualitative assessments using words? Discuss.

EP 3A-2 How Logical Is a Generally Accepted Accounting Principles Hierarchy? LO8 Adrogué and Ratliff46 (pp. 483–484) recommended that courts adopt the “hierarchy of GAAP for finan-cial statements of non-governmental entities” published by the AICPA.47 This hierarchy has five strata, listed below in descending order of authority:

1. FASB Statements and Interpretations, APB Opinions, and AICPA Accounting Research Bulletins 2. FASB Technical Bulletins, AICPA Industry Audit and Accounting Guides, and AICPA Statements

and Practices 3. Consensus positions of the FASB Emerging Issues Task Force and AICPA Practice Bulletins 4. AICPA accounting interpretations, “Questions and Answers” published by the FASB staff, and

widely recognized and prevalent industry practices 5. Other accounting literature, including FASB Concept Statements; AICPA Issues Papers;

International Accounting Standards Committee Statements; GASB Statements; Interpretations and Technical Bulletins; pronouncements of other professional associations or regulatory agencies; AICPA Technical Practice Aids; and accounting textbooks, handbooks, and articles

The AICPA’s GAAP hierarchy ranks the FASB Concept Statements (components of the conceptual frame-work) in the bottom stratum. However, on April 28, 2005, pursuant to the FASB’s issuance of an exposure draft titled “The Hierarchy of Generally Accepted Accounting Principles” and associated documentation, the FASB48 (p. i) conceded that the place of the conceptual framework in its hierarchy was too low, out of kilter with the IASB, and that the FASB intended to do something about this. Nonetheless, in May 2008, when it issued a revised version of this exposure draft as FASB 162, it observed in its “Summary” preface that FASB 162 was not expected to result in changes in current practice. It is noteworthy that in FASB 162, FASB Con-cept Statements remain in the bottom stratum of the hierarchy—although it does mention that they should “normally be more influential than other sources” in the (bottom) category in which they appear (para. 5).

RequiredDoes the above hierarchy result in a fair presentation framework per CAS 200? Discuss.

EP 3A-3 Failure to Follow Generally Accepted Accounting Standards. LO8 It is going to be a long night! First thing this morning, the senior partner of your three-partner firm, Peters, Peters, and Paul (PPP), called you into her office to tell you that she had a confidential but exciting assignment for you. The firm has been retained to review the audit working papers of another firm in connection with its audit of TVB Software (TVB), a public company. That firm, Yeller, Louder, and Soft (YLS), had performed the audit of TVB for the last two years, since the date it went public. It appears that the bank did not renew TVB’s loan when it matured some six months ago, and TVB was unable to obtain other financing. As a result, your firm’s client lost a good portion of the $2 million he had invested in the shares of TVB. Your client is suing the auditors of TVB, alleging that they failed to perform the audit in accordance with GAAS and that as a result, your client relied on financial statements that were not correct when he made his decision to hold on to his TVB shares. The last audited statements are included in Exhibit EP 3A-3–1.

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Victoria Smyth, the partner, has reviewed the contents of YLS’s working papers. Her notes are in Exhibit EP 3A-3–2. You have been asked to review these notes and prepare a report identifying any departures from GAAS to support your client’s view that the audit was not conducted in accordance with GAAS. In this regard, you should note whether each instance is a clear departure from GAAS or whether the matter is grey and, therefore, subject to potential challenge in court. Victoria is also concerned that your firm may have some professional responsibilities under the Rules of Profes-sional Conduct in connection with this agreement. She would like you to identify these for her.

RequiredPrepare the report requested by Victoria Smyth.

(© 2000, American Institute of CPAs. All Rights Reserved. Adapted by permission)

EXHIBIT EP 3A-3–1

Extracts from Audited Financial Statements

TVB SOFTWAREBALANCE SHEET

AS AT DECEMBER 31(IN THOUSANDS OF DOLLARS)

ASSETS 20X3 20X2

Current assets

Prepaids $ 237 $ 410

Accounts receivable 6,146 5,410

Inventory 13,904 9,382

20,287 15,202

Other assets

Fixed assets 13,640 14,975

Goodwill 4,084 4,310

Other assets 6,950 7,010

24,674 26,295

$44,961 $41,497

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities

Bank indebtedness $ 4,940 $ 1,749

Accounts payable 10,641 5,940

Deferred revenue 140 3,643

Current portion of long-term debt 1,400 1,400

17,121 12,732

Long-term debt 18,210 19,990

Share capital 8,500 8,500

Retained earnings 1,130 275

Total liabilities and capital $44,961 $41,497

(continued)

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TVB SOFTWAREBALANCE SHEET

AS AT DECEMBER 31(IN THOUSANDS OF DOLLARS)

ASSETS 20X3 20X2

Sales $21,724 $31,490

Cost of sales 15,908 20,130

Gross margin 5,816 11,360

Sales and administrative expenses

Salaries 1,760 3,170

Research costs 304 3,775

Marketing and sales 501 2,607

Interest 1,739 1,889

Other 657 16

4,961 11,457

Net income before taxes 855 (97)

Income taxes — 203

Net income $ 855 ($ 300)

TVB SOFTWAREFOR THE YEAR ENDED DECEMBER 31, 20X3

From Note 1—Accounting Policies

Goodwill

Goodwill is amortized to income over its 40-year life.

From Note 7—Fixed Assets

Fixed assets comprise the following:

DECEMBER 31, 20X3

COST ACCUMULATED DEPRECIATION

BOOK VALUE

Computer equipment $29,790 $26,100 $ 3,690

Furniture and fixtures 10,650 7,700 2,950

Building 11,000 4,000 7,000

Total $51,440 $37,800 $13,640

EXHIBIT EP 3A-3–1

Extracts from Audited Financial Statements (continued)

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EXHIBIT EP 3A-3–2

TVB Software

“PRIVILEGED”

Victoria Smyth’s notes on the review of audit working papers of TVB Software prepared by Yeller, Louder, & Soft 1. I reviewed YLS’s working papers at their office. The audit report for the year ended December 31, 20X3, was signed by YLS on

February 20, 20X4. The working papers were neat and appeared to be well organized. All of the files have been prepared by audit staff and have

been reviewed by a YLS junior audit partner, though not the one who signed the financial statements. This is the only public company audited by YLS.

I asked to review the files of the previous year but was told that YLS only retains one year of files. The 20X2 files had been destroyed. I reminded YLS that the 20X2 files had now been subpoenaed by the Court.

2. The audit was staffed by two YLS PAs. Neither had performed audits of a software company before, but one of them had several years of auditing experience. The other PA had recently qualified and had spent the previous two years working for a government internal auditor’s department. The audit partner told me that he was not concerned about this other PA because he was related to TVB’s CFO and, hence, had a good knowledge of some of the workings of the company.

3. The audit was fully substantive in nature. All three of YLS’s files contain working papers documenting the results of its substantive testing. Each section of the work contains a checklist of substantive tests. The tests appear to have been developed specifically for this assignment. The steps on the checklists appear to be signed off and cross-referenced to the appropriate working papers.

4. The first file is called the “TOP FILE” and contains several memos to file. The most significant of these are as follows: (a) Materiality: A short memo sets materiality at $400,000. The memo notes that the company is not currently profitable

although it is expected to be in the near future. As a result, it is more appropriate to use balance sheet numbers to determine materiality. Once the company becomes profitable, YLS would expect to use normalized income as a basis for materiality. Thus, 1% of total assets is approximately $400,000.

(b) Plan: A short memo sets out that the audit will be fully substantive against a materiality of $400,000 and follow the approach used in the previous year, including the tailored audit programs developed that year.

(c) Engagement letter, signed by the client. (d) Legal letters to each of TVB’s lawyers, each with a standard reply. (e) A standard management representation letter, containing no unusual or tailored paragraphs. 5. Prepaids: As these amounts were not material, YLS only compared this year’s schedule to that of the previous year. There were

no unusual items on either of the schedules. 6. Accounts receivable: The audit work in this section included a confirmation of the 15 largest accounts and 10 other accounts

selected at random, covering 79% of the population. All but two of the confirmations (totalling $326,000) were received back with no problems noted. In view of the satisfactory result on the other confirmations, no additional procedures were carried out in relation to these two items.

A review was done to identify subsequent payments, and as at the date of the audit opinion, 85% of the receivables had been collected. Of the remaining accounts, none were above $100,000, so no further work was carried out.

Procedures were carried out to ensure that balances outstanding at year-end related to shipments before year-end. These procedures included agreeing amounts to invoices and shipping documents.

7. Inventory: The inventory consisted of software packages, most of which were manufactured by TVB, and some purchased for modification and resale.

YLS attended the inventory count at year-end and reviewed the procedures necessary to achieve a proper cutoff. As a result of these procedures, YLS found cutoff errors that resulted in an overstatement of sales of $182,500. They concluded that as this amount was not material, no adjustment was necessary. They also reviewed the inventory valuation by reviewing the process for allocating costs to specific products. This is a very complex process, and the audit work seems to be detailed and thorough, with much recomputation and testing in the files. They concluded that the allocation methodology was appropriate under the circumstances. They did not identify any errors.

8. Fixed assets: YLS’s work was limited to reviewing the schedule of purchases (there were none above $100,000) and recomputing the depreciation for the year.

9. Goodwill: YLS recomputed the amortization for the year. 10. Bank indebtedness: YLS confirmed the amount of the bank indebtedness and the long-term debt, which is also owing to the

bank. The confirmation noted that the debt was up for renewal in June of the following year. There is a note in the file that company management was confident that the debt would be renewed for a five-year term. As well, the file contained copies of some internal TVB memoranda, written over a four-month period in 20X3, summarizing management’s meetings with the bank

(continued)

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and supporting the view that the debt would likely be renewed. On this basis, YLS concurred with management’s view that the debt should continue to be classified as long-term debt.

11. Accounts payable: The files contained a confirmation of 100% of the accounts payable. All of the replies were in the file and all discrepancies had been followed up. As a result of these procedures, YLS concluded that accounts payable were understated by $232,000 but that as this amount was immaterial, no adjustment was required.

12. Income taxes: Very detailed work was carried out in this section by a tax manager from YLS. The review appears very thorough, and amounts are reconciled down to the penny.

13. Profit and loss: YLS carried out analytical procedures, comparing the current year’s results to those of the previous year on an account-by-account basis. Explanations were obtained from management for all variances over $50,000 or 5% of the previous year’s balance.

14. The file includes a detailed review of all invoices paid to outside consultants, including several other accounting firms, and copies of their reports. One of the assignments relates to a “business review” of TVB carried out at the request of the bank. The report for that assignment is not in the file.

E N D N O T E S

1 I. Hacking, An Introduction to Probability and Inductive Logic (Cambridge, U.K.: Cambridge University Press, 2001).

2 R. H. Ashton, “Integrating research and teaching in auditing: Fifteen cases in judgment and decision making,” The Accounting Review, January 1984, pp. 78–97.

3 C. Emby and M. Gibbins, “Good judgment in public accounting: Quality and justification,” Contempo-rary Accounting Research, Spring 1988, pp. 287–313.

4 S. Salterio and L. Koonce, “The persuasiveness of audit judgments: The case of accounting policy judgments,” Accounting, Organizations, and Society, August 1997, pp. 573–588.

5 V. E. Johnson and S. E. Kaplan, “Experimental evidence on the effects of accountability on audit judg-ment,” Auditing, A Journal of Practice & Theory, Supplement, 1991, pp. 96–107.

6 L. Koonce, U. Anderson, and G. Marchant, “Justification of decisions in auditing,” Journal of Account-ing Research, Fall 1995, pp. 369–384.

7 U. Anderson and L. Koonce, “Evaluating the sufficiency of causes in audit analytical procedures,” Auditing: A Journal of Practice & Theory, Spring 1998, pp. 1–12.

8 D. Alexander and E. K. Jermakowicz, “A true and fair view of the principles/rules debate,” ABACUS, June 2006, pp. 132–164.

9 IASB Discussion Paper on a Conceptual Framework for Financial Reporting, July 2006, pp. 8, 16.

10 H. G. Bullen and K. Crook, “Revisiting the concepts: A new conceptual framework project,” FASB/IASB, May 2005, fasb.org/project/communications_paper.pdf.

11 W. H. Beaver, “Problems and paradoxes in the financial reporting of future events,” Accounting Hori-zons, December 1991, pp. 122–134.

12 J. S. Glover, Y. Ijiri, C. B. Levine, and P. J. Liang, “Separating facts from forecasts in financial state-ments,” Accounting Horizons, December 2005, pp. 267–282.

13 R. H. Macve, The Conceptual Framework: Revisiting the Basics: A Comment on Hicks and the Con-cept of “Income” in the Conceptual Framework, paper presented at the 2008 EAA Annual Congress, Rotterdam, Netherlands.

EXHIBIT EP 3A-3–2

TVB Software (continued)

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14 W. Smieliauskas, R. Craig, and J. Amernic, “A proposal to replace ‘true and fair view’ with ‘acceptable risk of material misstatement,’” ABACUS, September 2008, pp. 225–250.

15 H. Norreklit, “The balanced scorecard: What is the score? A rhetorical analysis of the balanced scorecard,” Accounting, Organizations and Society, August 2003, pp. 591–619.

16 M. Hechter, “The rise and fall of normative control,” Accounting, Organizations and Society, August 2008, pp. 663–676.

17 D. Walton, “Enthymemes, common knowledge, and plausible inference,” Philosophy and Rhetoric, April 2001, pp. 93–112.

18 J. C. Hueston, “Behind the scenes of the Enron trial: Creating the decisive moments,” American Criminal Law Review, Spring 2007, pp. 197–239.

19 G. J. Benston, “Fair-value accounting: A cautionary tale from Enron,” Journal of Accounting and Public Policy, July–August 2006, pp. 465–484.

20 G. J. Benston and A. L. Hartgraves, “Enron: What happened and what we can learn from it,” Journal of Accounting and Public Policy, Summer 2002, pp. 105–227.

21 M. C. Knapp, Contemporary Auditing: Issues and Cases (St. Paul, MN: West Publishing, 2006).

22 B. P. Shapiro, “Toward a normative model of rational argumentation for critical accounting discussions,” Accounting, Organizations and Society, October 1998, pp. 641–663.

23 D. M. Barnes, Value-for-Money Audit Evidence (Toronto: CICA, 1991).

24 T. Anderson and W. Twining, Analysis of Evidence: How to Do Things with Facts Based on Wigmore’s Science of Judicial Proof (Evanston, IL: Northwestern University Press, 1998).

25 B. Skyrms, Choice and Chance, 3rd ed. (Irvine, CA: University of California at Irvine, 1986), p. 11.

26 Ibid., pp. 15–18.

27 D. Walton, The New Dialectic: Conversational Context of Arguments (Toronto: University of Toronto Press, 1998), pp. 56–57.

28 M. D. Piercey, “Documentation requirements and quantified versus qualitative audit risk assessments,” Auditing: A Journal of Practice & Theory, November 2011, pp. 223–248.

29 W. C. Booth, G. G. Colomb, and J. M. Williams, The Craft of Research (Chicago: University of Chicago Press, 1995), p. 145.

30 D. M. Barnes, Value-for-Money Audit Evidence, 1991.

31 A. Garnham and J. Oakhill, Thinking and Reasoning (New Jersey: Wiley-Blackwell, 1994), pp. 85 and 166.

32 Ibid., p. 203.

33 J. Sillince, “Rhetorical power, accountability and conflict in committees: An argumentation approach,” Journal of Management Studies, December 2000, p. 1130.

34 R. A. Posner, Overcoming Law (Cambridge, MA: Harvard University Press, 1995), pp. 501–503.

35 J. Amernic, “The rhetoric versus the reality, or is the reality ‘more’ rhetoric? A case study of public accounting firms’ responses to a company invitation for alternative opinions on an accounting matter,” Critical Perspectives in Accounting, February/April 1996, pp. 57–77.

36 Ibid.

37 S. Pinker, How the Mind Works (New York: WW Norton & Co, 1997), pp. 338–341.

38 Ibid., p. 73.

39 Ibid., p. 70.

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40 Ibid., p. 338.

41 R. Audi, The Cambridge Dictionary of Philosophy (Cambridge, U.K.: Cambridge University Press, 1995), p. 612.

42 Ibid., p. 636.

43 See criticalthinking.org; A. Fisher, Critical Thinking, an Introduction (Cambridge, U.K.: Cambridge University Press, 2001); and W. Hughes, Critical Thinking, 2nd ed. (Peterborough, ON: Broadview Press, 1996).

44 L. T. F. Gamut, Logic, Language, and Meaning (Chicago: University of Chicago Press, 1991).

45 M. D. Piercey, “Documentation requirements,” 2011.

46 S. Adrogué and A. Ratliff, “Kicking the tires after Kumho: The bottom line on admitting financial expert testimony, Houston Law Review, Summer 2000, pp. 431–514.

47 American Institute of Certified Public Accountants, “News report,” Journal of Accountancy, February 1999.

48 Financial Accounting Standards Board, “Joint FASB/IASB Conceptual Framework Project,” Exposure Documents FASB, 2005 and 2006, fasb.org/ed_info.shtml.