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AF301 Tutorial 9

If decision makers in accounting display heuristics like representativeness, availability, or anchoring and adjustment, it could lead to less effective decision making. Specifically: - Using representativeness, decision makers may ignore important base rates and use their own judgment. - With the availability heuristic, they may overestimate probabilities of sensational events. - Anchoring and adjustment could result in insufficient adjustments to decisions when circumstances change. Overall, heuristics are meant to simplify complex problems but uncritical use could increase financial losses and legal risks from improper decisions.

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44 views

AF301 Tutorial 9

If decision makers in accounting display heuristics like representativeness, availability, or anchoring and adjustment, it could lead to less effective decision making. Specifically: - Using representativeness, decision makers may ignore important base rates and use their own judgment. - With the availability heuristic, they may overestimate probabilities of sensational events. - Anchoring and adjustment could result in insufficient adjustments to decisions when circumstances change. Overall, heuristics are meant to simplify complex problems but uncritical use could increase financial losses and legal risks from improper decisions.

Uploaded by

Elisa Sharma
Copyright
© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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Question 4

Explain the implications for accounting if decision makers in accounting context display any or all of
the representatives, availability, or anchoring and adjustment rules of thumb.

A Heuristic is a defined as a mental shortcut which allows a person to be able to solve a problem and
make a quick judgement in an efficient manner using rule of thumb strategies that shorten the time
used in making the decision. A person who is a heuristic is therefore able to function without
necessarily having to stop and reconsider their next move.
Explanation:
Heuristics is a method of coping with a complex situation whereby the uncritical use of a principle
can lead to an improper decision making by an auditor or an accountant. This increases the chances
of potential financial losses and legal consequences that are unfavourable.

i) Representativeness
The base rate provided to the person making decision is in most cases misused.
The importance and usefulness of such base information is therefore largely ignored and is rarely
put into use.
The accountants and auditors therefore use their own judgement and reasoning when making the
decisions.

ii) Availability
The probability assessment and decisions that are 'sensational events' related are likely to be
overestimated.
An example is when the financial report of a company indicates that Tge Company is stable, liquid
and is very profitable. But when it is aired by the media that there is a person who is suing the
company, and then the users of the financial report may view the company as that which is at the
brim of collapse yet even no official information has been issued regarding the case.

iii) Anchoring and Adjustments


This is where insufficient adjustments are made in the light of changed scenario or circumstance.
Let us take an example where the auditor did an assessment previously where the control risk
assessment which was very low for the last audit is used as the foundation for the assessments of
the current period. The various structural changes at the client necessitate a higher assessment, but
the auditor simply decides to use the low risk anchor previously used. This will definitely result to the
audit process and reports being ineffective.

2nd Answer

In such situation one needs to understand that, although heuristics is one of the best way to cope
with complex problems, but its uncritical usage can lead to less effective decision making process
which also gives rise to risk associated with financial losses and legal consequences.

Explanation:

Representatives -
It has been noticed that the framework or model provided to respective decision maker is misused in
many instances and sometimes also ignored. This also concludes that effectiveness and usefulness of
such base information and data to respective decision makers is very rarely make use and ignored. It
has been seen that auditors and other finance officers implement their own knowledge and
judgement in decision making process.
Availability -
It has been also noticed that decisions associated with probability assessment and few sensational
events are overestimated. This can be explained with the help of example; let’s consider a financial
statement or report of ABC organization. The report suggests that, the organization is profitable and
liquid. Let’s say JOHN, is a person who is seeking to sue ABC organization. Users such as stakeholders
may weight this information given by the report heavily and also assess whether the organization is
close to shut down or collapse, even though no disclosure of the amount is claimed, etc.

Anchoring and adjustment rules of thumb -


It has been seen that in the changed circumstances, effective and insufficient adjustments are made.
Let’s say that auditor's prior period risk control assessment is used as a base or anchor for current
period assessment. Certain changes in the internal control structure with respect to client hints
towards higher assessment in required. But when the auditor which is making use of low risk base or
anchor, do not adjust upward enough. This low anchoring further leads to ineffective auditing.

Question 10

.     Most people are not good intuitive statisticians. Discuss this statement in an accounting
context, drawing on research using the probabilistic model.

Probabilistic judgement theory and research suggests that most individuals are not good intuitive
statisticians because tasks employing probability assessments and reassessments require
multiplicative rules, such as Bayes’s Theorem, to be used. However, individuals do not readily ‘think’
multiplicatively, but rather use additivity or employ heuristics to simplify the task at hand. Students
might be asked to think of specific examples (not necessarily accounting examples) of the accuracy
of their own likelihood judgements (for example, will it rain today?, ‘how well will I do in the exam or
assignment?’). What factors influence the accuracy of these judgements?

Research in the accounting context of probabilistic judgement, particularly auditing, indicates that
probability revisions are made by employing the heuristics of representativeness, availability, and
anchoring and adjustment. Furthermore, research suggests that auditors tend to revise probabilities
to a lesser extent in the light of changed circumstances than Bayes’s Theorem suggests, due to the
use of heuristics and judgement bias that are adopted to simplify complex judgement tasks.

For example:

·  Representativeness. Joyce and Biddle’s (1981) study of auditors’ judgements regarding the
incidence of management fraud. Auditors did not consider the ‘base rate’ (basis of using Bayes’s
Theorem is to consider explicitly the base rate or prior odds) sufficiently.

·  Availability. Maser (1989) found some environmental event pertaining to a particular company that
led to disproportionate news coverage may systematically affect or influence the predictive
judgements of investors.

· Anchoring and adjustment. Joyce and Biddle (1981) found no evidence of anchoring and
adjustment in auditors’ adjusting the scope of the audit following changes in internal control
systems. Kinney and Uecker (1982) found evidence of anchoring and adjustment in analytical review
and compliance test tasks.

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