Steam-Vac Case and Judgment Traps

Steam –Vac Case Steam-Vac Case Requires you to use professional judgment How do you obtain an understanding of the Control Environment? Using Risk Assessment Procedures - What are they? Observation, inspection, inquiry, and analytical procedures Inquiries can be informative, but are less reliable because they are subjective and easily manipulated

Cognitive Biases Our brains can sometimes fool us to see one thing but not what is really there. Cognitive biases can affect decisions made by auditors.

Professional Judgment and Framing Effects Framing effects occur if you are influenced by the way the information is presented e.g., you are influenced by the perceptions, attitudes, and/or communication habits of the person supplying the info drawing different conclusions from the same information, depending on how that information is presented (framed) The listener also uses frames - Judgment frames are mental structures that we use, usually subconsciously, to simplify, organize, and guide our understanding of a situation Frames determine the information that we will see as relevant or irrelevant, important or unimportant Judgment frames influence our mindset e.g., one study found that tax professionals tend to be more accepting of a client’s high-risk tax position when the underlying transaction is a “done deal” as compared to when the client has not yet completed the transaction

Professional Judgment and Framing Effects To help mitigate this problem Generate alternative frames and consider how the judgment differs when viewed from different perspectives Consider the implications of different frames and identify the most appropriate frame

How does a visual illusion relate to judgment? Your judgment is susceptible to predictable traps and biases than can impair your judgment. Some believe it is hard wired into your brain. Once we are made aware of the misperception, we can introduce logical tools to help determine whether the tabletops are different or whether they are in fact identically shaped. A logical mitigation strategy might be to measure the two tabletops or trace one tabletop and lay the traced area over the top of the other table. Source: http://www.michaelbach.de/ot/sze_shepardTables/index.html

Mitigation Strategies Your judgment is susceptible to predictable traps and biases that can impair your judgment. Once you are aware of these misperceptions, you can introduce logical tools to help determine whether the tabletops are different or whether they are in fact identically shaped. A logical mitigation strategy might be to measure the two tabletops or trace one tabletop and lay the traced area over the top of the other table.

Mitigation Strategies Ask yourself: “If this document were a fake, what would it look it?” Adapt the oppositional view point. Always ask one more question. Consider what assumptions, if changed, would have the greatest impact on the judgment? Make the case for your conclusion as well as the opposing case. If in a group, have everyone speak up and share their opinion.

Conclusion Auditors should study judgment biases to learn when and how their judgments may be biased so that they can take steps to mitigate biases and improve judgment.

Cognitive Biases in Auditing

Other Bias Availability bias Confirmation bias Overconfidence bias Anchoring bias Rush to judgment bias Now let’s look at some specific biases. Definition.

Availability Bias Consider the letter R. Is it more likely to appear in the first position or the third position of a word? The ratio is _____ to 1. Most individuals find it easier to list works beginning with the letter R than think of those that contain R as the third letter.

Availability Bias The tendency to consider information that is easily retrievable from memory as being more likely, more relevant, and more important for a judgment. Estimating the likelihood of events based on the ease with which you can call them to mind. Now let’s look at some specific biases. Definition.

Availability Bias What accounting/auditing judgments might be susceptible to this bias? Identifying risk areas. Investigating unexpected variances in analytical procedures. Tax person recalling case evidence regarding a tax question. Relying on last audit’s results Relying on last year’s results – maybe just read over last year’s WPs Identifying risk areas. Investigating unexpected variances in analytical procedures. Tax person recalling case evidence regarding a tax question. Relying on last audit’s results Relying on last year’s results – maybe just read over last year’s WPs

Confirmation Bias I have listed a series of numbers “2, 4, 6” on your handout. Your job is to hypothesize the simple rule that I used to develop this series and tell me how confident you are in your proposed rule from 0% to 100% (with 0% having no confidence and 100% reflecting complete confidence). After you have listed your first hypothesis, you have the opportunity to test your theory by offering another series of numbers. You may propose any series of numbers you like. It does not need to be a continuation of my series. I will tell you whether or not your series fits the rule. With this additional information, you may choose to change your proposed hypothesis for the second round or keep your original hypothesis. You will record your level of confidence and have the opportunity to test your current hypothesis with another series of numbers. We will continue this process until you are fairly confident you have identified the rule. On your sheet of paper, make your first hypothesis about the rule I used to generate the number series “2, 4, 6”, list your level of confidence, and propose a new series of 3 numbers to test your hypothesis. The underlying rule for the number series in this exercise is “increasing numbers.” However, due to the variety of possible solutions, people frequently begin with the wrong hypothesis (e.g., successive even numbers, or numbers increasing by two). Research shows that individuals would reflect confirmation bias by testing their theories only with numbers that met their proposed rule (e.g., 6, 8, 10 or 12, 14, 16). When each additional test yields positive results, an individual’s confidence in their proposal increases and he/she becomes less inclined to change their hypothesis.

Confirmation Bias We tend to have preferences We tend to seek confirming evidence We give confirming evidence greater weight than disconfirming evidence We often cannot know something to be true without checking to see how it might be false

Confirmation Bias When a decision maker comes across both confirming and disconfirming evidence, the tendency is to overweight the confirming and underweight the disconfirming evidence. After obtaining confirmatory evidence, we often are confident that we have sufficient, appropriate evidence to support our belief—and the more confirmatory evidence we pile up, the more confident we become.

Overconfidence Bias Relative to the other students in the Accounting Program, how would you rate your intelligence? Indicate your response by circling one of the numbers on the scale. 1 2 3 4 5 6 7 8 9 Far Below Average Far Above Average Average

Overconfidence Bias Most of us are overconfident in our judgment abilities and do not acknowledge the actual level of uncertainty that exists. Overconfidence among experts: “Heavier than air flying machines are impossible” Lord Kelvin, British mathematician, physicist, and president of the British Royal Society, c. 1895, not long before the first successful flight at Kitty Hawk “They couldn’t hit an elephant at this dist--” General John B. Sedgwick, Union Army Civil War officer’s last words uttered during the Battle of Spotsylvania, 1864 Successful professionals have certain beliefs about their ability that tend toward overconfidence.

Overconfidence tendency results Group Tested Information Type (Percent Misses) Target/Observed Harvard MBAs Trivia facts Computer Co. Managers General business Company-specific Physicians Probability of pneumonia

Anchoring Bias Professionals make assessments by starting from an initial value and adjusting away from that initial value to form a final judgment. However, the adjustment from the anchor is typically insufficient. A client’s estimate or unaudited account balance can serve as an anchor. The initial value, or starting point, may be suggested from historical precedent or from the way in which a problem is presented can even be influenced by irrelevant information. In an audit setting, clients’ estimates or reported values can serve as anchors. The anchor that is provided can be done unintentionally or intentionally.

Anchoring Bias The following three slides provide the results of the last 12 quarters’ unit sales. In the first slide, the projected unit sales for product Y in the 13th quarter are noted by the star (72,000 units). The next slide provides the same results for the last twelve quarters’ unit sales; projected unit sales for product Y in the 13th quarter are noted by the star (50,000 units). The question asked of participants (audit managers) in the two conditions was: What do you estimate the 13th quarter’s unit sales will be for product Y, if you ignore the projected outcome (i.e., where the star is located). The only difference in the two slides presented to the participants is where the star is located, which is the information the participants were told to ignore.

Anchoring Bias

Anchoring Bias

Anchoring Bias Audit Manager Estimates High star: 63,200 Low star: 58,000

Anchoring Bias While participants in the study didn’t blindly follow the star (which served as a form of numeric anchor), their adjustments away from the anchor were, on average, insufficient (otherwise there would have been no difference between conditions). The important take-away is that if the anchor had not affected participants’ judgment, there would be no difference in their final estimates.

Rush to Judgment Bias Jumping to conclusions about someone or something without having all the facts. This bias can result in the interpretation of all other information being influenced by a change in one datum. Thus one character quality (i.e., cold vs. warm) can significantly influence perceptions of many other characteristics.

Rush to Judgment Bias A critical example is when an auditor relies on the perceived “trustworthiness” of a client as a strong indicator against fraud. The COSO monograph warns that managers and board members are also susceptible to this bias if they reach an early consensus on a decision without sufficient deliberation.

Judgment Biases Availability: Tendency to consider information that is easily retrievable as more important for a judgment Confirmation: Tendency to seek and overweight confirming evidence Overconfidence: Tendency to be overconfident in our judgment abilities Anchoring: Tendency to insufficiently adjust away from an initial anchor Rush to Judgment: Jumping to conclusions about someone or something without having all the facts.

Additional Biases Obedience for Authority Bias: desire to please authority figure causes you to give more weight to evidence that confirms authority figure’s conclusion. Information Overload Bias: The difficulty a person can have understanding an issue and making decisions that can be caused by the presence of too much information. Ambiguity Bias: The tendency to avoid options for which missing information makes the probability seem unknown. Choice-Supportive Bias: The tendency to remember one's choices as better than they actually were.