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The Dangers of Heuristics and Biases in Audit

The Dangers of Heuristics and Biases in Audit. James Bone President Global Compliance Associates, LLC. The Dangers of Heuristics and Biases in Audit. What a strange topic for Internal Audit! There can’t be any research or relevance! YOU MAY BE IN FOR A SURPRISE!

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The Dangers of Heuristics and Biases in Audit

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  1. The Dangers of Heuristics and Biases in Audit James Bone President Global Compliance Associates, LLC

  2. The Dangers of Heuristics and Biases in Audit What a strange topic for Internal Audit! There can’t be any research or relevance! YOU MAY BE IN FOR A SURPRISE! WE WILL EXPOSE A FEW MYTHS AS WELL………

  3. What is this philosophical hogwash? • Who is the founding father of “Free Enterprise” in America? • Adam Smith • What was his occupation and title? • Professor of Moral Philosophy at the University of Glasgow • What year was “An inquiry into the nature and causes of The Wealth of Nations” written? • 1776 • What year was “The Theory of Moral Sentiments” written? • 1759 (17 years earlier)

  4. SOX speaks toHuman Behavior but does not address how to audit for it? Sarbanes-Oxley (PCAOB) Title I, Section 103 • Defines auditor independence • Processes & Procedures for compliance audits • Inspecting and Policing Conductand Quality Control • Corporate Responsibility • Enumerates specific limits on certain Behaviors of Corporate Officers

  5. How does it apply to audit? Auditing involves judgment and expertise Judgment is very good most of time We can be lead astray Heuristic; Greek: "Εὑρίσκω", "find" or "discover") refers to experience-based techniques for problem solving, learning, and discovery that give a solution which is not guaranteed to be optimal. (EXPERIENCE, INTUITION, INSTINCTS)

  6. How does it apply to audit? "inherent bias" refers to the effect of underlying factors or assumptions that skew viewpoints of a subject under discussion. In statistics, sampling bias is a bias in which a sample is collected in such a way that some members of the intended population are less likely to be included than others. It results in a biased sample, a non-random sample[1] of a population (or non-human factors) in which all individuals, or instances, were not equally likely to have been selected.[2] If this is not accounted for, results can be erroneously attributed to the phenomenon under study rather than to the method of sampling.

  7. Cars Beautiful woman/man 10,000 hours (expert) – golf, study, auditing Do you know everything there is to know? What You See Is All There Is Beliefs Exposure Novel experience/events – we must make sense of strange new things/events/change Practical examples of Heuristics and Biases Heuristics Biases

  8. How Heuristics and Biases lead us astray Availability, Emotion and Risk Bernoulli’s errors A bias of confidence over doubt Anchors

  9. Detect financial statement fraud

  10. Evidence and evaluating data Evaluating risks and professional skepticism Procedural & Process orientation (time crunch) Law of small numbers (WYSIATI) What You See Is All There Is Substitution/Bernoulli’s error Cognitive Bias 3 common audit weaknesses Cognitive solutions

  11. Why “Tone” at the Top Misleads • Very few business leaders start out intent on committing fraud Enron’s Code of Ethics - • "As officers and employees of the Enron Corp., its subsidiaries, and its affiliated companies, we are responsible for conducting the business affairs of the companies in accordance with all applicable laws and in a moral and honest manner."

  12. Sam Antar & Crazy EddieMaster’s of Heuristics & Biases

  13. Sam Antar, CFO Crazy Eddie Why does Heuristics and Biases matter? http://youtu.be/o0tUZ6lmnls http://youtu.be/o0tUZ6lmnls

  14. What does science suggest? Building organizational awareness Audit expectations gap: • Use technology to facilitate/enhance data gathering and analysis • Audit as learning – Not punishment • Audit as deterrence - Strategically • Audit as motivation • Audit as process improvement • Organizational support for audit • Audit as risk awareness

  15. “Switch”How to change things when change is hardChip Heath & Dan Heath • Direct the Rider • Motivate the Elephant • Shape the path

  16. Workshop/Questions

  17. James Bone • Global Compliance Associates, LLC • TheGRCBlueBook.com • jbone@globalcomplianceassociates.com • info@thegrcbluebook.com • Copies of the presentation or references and publications used

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