Audit judgment and decision-making (JDM) research

Judgment and decision-making (JDM) studies in auditing is part of the psychology research on behavioural decision theory (BDT). Studies in this interdisciplinary line seek to understand how audit judgments are made and how they can be improved (Hogarth 1993;

Trotman 1998) and usually employ experiment to find evidence to bear on issues in audit judgment (Solomon and Trotman, 2003).

Prior literature of audit JDM research basically served four purposes (Trotman, 1998). First, some studies aim to evaluate the quality of audit judgments. Such studies examine indicators of audit quality like the level of consensus between auditors (e.g., Trotman and Yetton, 1985); the accuracy and consistency of audit judgments (e.g., Trotman, 1985); and, the extent of biased audit judgment due to over-reliance on heuristics, such as recency effect (i.e., later information considered as being more important) (e.g., Kennedy, 1993;

Anderson and Maletta, 1999) and anchoring (e.g., Joyce and Biddle, 1976; Kinney and Uecker, 1982).

Second, some JDM researchers were trying to describe the audit judgment and decision-making process and provide insights into the factors influencing auditors‘ performance. For example, research on information choice and information processing tries to offer knowledge on how auditors use information available to form judgment (e.g., Anderson and Kida, 1994 on source credibility; and Trotman and Sng, 1989 on confirmatory strategy, in information search).

Third, some research examines the role of knowledge and memory in audit judgment. For instance, Ramsay (1994) found seniors – reviewers at lower level, are better at detecting mechanical errors while managers – reviewers at higher level, are more accurate at detecting conceptual errors. Studies addressing this issue reported cost and efficiency gain by matching knowledge with specific tasks and helped explain why review mechanism adopted by audit firms uses a hierarchical structure.

Fourth, a number of researchers try to offer recommendations on how to improve the quality of audit judgment, through for example feedback from audit review (Miller, Fedor, and Ramsay, 2006) and the form of review – e.g., electronic or face-to-face (Agoglia, Hatfield, and Brazel, 2009; Payne, Ramsay, and Bamber, 2010). Trotman (1998) condensed the above four aims into the ultimate purpose of audit JDM research to improve

judgments.

A significant number of audit JDM research studies tested heuristics and biases in audit judgment. This type of study is concerned with the use of simplified judgment rules in audit. They are reviewed in next section (Subchapter 2.3). Among experimental works on information processing in audit, studies addressing the issue of persuasiveness of evidence specifically are discussed in Subchapter 2.4. Within the environmental and motivational factor category, studies addressing the issue of accountability are considered in Section 2.5, with a discussion of the psychology of accountability in Section 2.5.2.

Research on multi-person judgment and decision-making in audit usually examines interactions between auditors and auditors (e.g., audit review); auditors and clients (e.g., audit negotiation); and, auditors and other personnel in the financial reporting process (Nelson and Tan, 2005). The part of the literature on audit review is reviewed later in this chapter (Section 2.6). The pre-experimental fieldwork in this thesis was carried out to glean more information of audit review in practice. Findings from pre-experimental fieldwork are reported in next chapter of this thesis (Chapter Three).

There have been several review papers covering different periods. Hogarth (1993) reviewed early-stage studies in audit JDM and traced research in audit JDM back to several publications in 1950s. Hogarth suggested that the first generation of research in this area attempted to study the process of audit judgment systematically; to build descriptive models of audit judgment; and, to establish standards to evaluate audit judgment (Hogarth, 1993). Then in 1970s, theories and methods to guide audit research were imported from psychology literature in judgment and decision-making (Ashton and Ashton, 1995).

Psychologist in the 1970s suggested that people do not always act rationally but refer to a range of heuristics that can lead to errors in judgment. Largely influenced by the remarkable work by Kahneman and Tversky‘ on heuristics and biases, the focus of audit JDM research from the 1980s shifted from ‗how well‘ auditors make judgments to understanding ‗how‘ such judgments are made. Since then, a large number of interesting studies have accumulated dealing with auditors‘ cognitive limitations, their use of heuristics and their susceptibility to biases (Nelson and Tan, 2005). Hogarth concluded his paper by reviewing findings in behaviour decision theory (BDT) and recommended a few possibilities for succeeding audit JDM research. A later review by Trotman (1998) provided a comprehensive examination of studies of audit JDM till late 1990s. More recent review by Nelson and Tan (2005) assessed the cumulative knowledge in the field for a

period of 25 years since late 1970s. Another chronological review of extent research of JDM by Trotman, Tan and Ang (2011) summarised studies in every decades during the past 50 years in the field of auditing, financial accounting and management accounting. These review papers represented different ways to categorize prior research (see Table 2.1 below).

Table 2.1 Various classification schemes of audit JDM research Solomon and Shields

(1995) Solomon and Trotman

(2003) Trotman (1998) Nelson and Tan (2005)

Solomon and Shields (1995) developed a theoretical framework scheme to classify research in audit JDM. They divided the literature into the five frameworks / topics: policy capturing⁸, probabilistic judgment, heuristics and biases, cognitive processes and multi-person information processing. Since the late 1980s, evidence had been collected on the existence and effects of auditor expertise while there had also been an increasing number of research studies exploring the cognitive limitations of auditors and the influence of environmental factors in audit. Solomon and Trotman (2003) refined Solomon and Shields (1995)‘s scheme by separating studies focussing on indicators of auditor‘s ability – knowledge and memory, from those concentrating on the environmental and motivational factors affecting audit as viewed in terms of a cognitive process framework.

8 Policy capturing studies ‗focus on the issues related to between-judgment consensus, the relative importance of cues, the functional form of the decision rule, and the judge‘s self-insight‘. These studies often examine decisions like materiality judgments, internal control evaluation, reasonableness of forecasts, uncertainty disclosures, policy making and loan classification‘ (Riahi-Belkaoui, 2004, pp. 373-374).

Trotman (1998) provides an alternative reading and review of the literature. He focused on the process of audit judgment including the specific categories of audit judgment, including task like hypothesis generation, information search and information selection and the multi-personal aspects of the audit group decision-making process. With the growing number of research studies and expanded scope of research topics in the field, a more recent review paper by Nelson and Tan (2005) classified prior literature by pooling research interests in respect of three main features in the audit context: task, person and interpersonal interactions: The audit task, the auditor and his or her attributes; and, interaction between auditors and other stakeholders in task performance (Nelson and Tan 2005, p 41). The most recent review paper by Trotman, Tan and Ang (2011) provides a more general review of researches in a chronological order, which did not use classification of schemes in the field of audit JDM research.