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!
WE WILL EXPOSE A FEW MYTHS AS
WELL………
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)
SOX speaks to Human 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 Conduct and Quality Control
 Corporate Responsibility
 Enumerates specific limits on certain Behaviors of Corporate
Officers
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)
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 nonhuman 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.
Practical examples of Heuristics and Biases
Heuristics
 Cars
 Beautiful woman/man
 10,000 hours (expert) –
golf, study, auditing
 Do you know everything
there is to know?
Biases
 What You See Is All There
Is
 Beliefs
 Exposure
 Novel experience/events –
we must make sense of
strange new
things/events/change
How Heuristics and Biases lead us astray
System 1
Bernoulli’s errors
Availability, Emotion and Risk
System 2
The Law
of Small
Numbers
Law of
Least
Effort
Illusions:
Anchors
Substitution
Priming
Causality
(WYSIATI)
A bias of confidence
over doubt
Detect financial statement fraud
Insufficient
audit
evidence
80%
A lack of
sufficient
business
skepticism
?
New tools are
Needed to
overcome
these
errors
Failure to
assess risk
& adjust
audit plan
44%
Failure to
Apply
GAAP
50%
Cognitive Bias
3 common audit weaknesses
 Evidence and evaluating
data
 Evaluating risks and
professional skepticism
 Procedural & Process
orientation (time crunch)
Cognitive solutions
 Law of small numbers
 (WYSIATI) What You See Is All
There Is
 Substitution/Bernoulli’s error
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."
Sam Antar & Crazy Eddie
Master’s of Heuristics & Biases
Judgement Errors
Lack of internal controls
Poor audit training
Inadequate
questions/follow up
Poor testing: AP,
Inventory, etc.
Poor or incomplete
analytics
Over reliance on trust of
management
Sam Antar, CFO Crazy Eddie
Why does Heuristics and Biases matter?
http://youtu.be/o0tUZ6lmnls
http://youtu.be/o0tUZ6lmnls
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
“Switch”
How to change things when change is hard
Chip Heath & Dan Heath
Direct the Rider
Motivate the Elephant
Shape the path
Workshop/Questions
James Bone
 Global Compliance Associates, LLC
 TheGRCBlueBook.com
 jbone@globalcomplianceassociates.com
 info@thegrcbluebook.com
 Copies of the presentation or references and publications
used