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University

Microfiims International

300 N Zeeb Road Ann Arbor, MI 48106

Okopny, D Robert

INTERNAL AUDITOR JUDGMENT

University

Microfilms

International soon zeeb Road, Ann Arbor, Mi 48108

A Dissertation

by

D ROBERT OKOPNY

Submitted to the Graduate College of

Texas A&M University

in partial fulfillment of the requirements for the degree of

DOCTOR OF PHILOSOPHY

August 1985

Major subject: Accounting

August 1985

ABSTRACT

Planning An International Audit:

An Empirical Investigation Of Internal Auditor Judgment (August

1985)

D Robert Okopny, B.S., Southern Illinois University;

M.B.A., Eastern Michigan University;

M.S., Texas A&M University Chairman of Advisory Committee: Dr Robert H Strawser

Previous research on auditor judginent has concentrated on the

judgments made by external (independent) auditors in a variety of

settings In contrast to those studies, the research reported in this dissertation investigates the judgments made by internal auditors

during the preliminary planning process for an international internal audit assignment Specifically, this research examines judgments

regarding estimations of the time budgets necessary to satisfactorily complete various international internal audit assignments (cases)

Initially, the information factors perceived by internal auditors

as most important to the preliminary audit planning process for an

international assignment are identified Next, the usage of these

information factors by professional internal audit managers is

empirically examined This examination is performed by analyzing the auditors' responses to several representative assignments (cases)

Three measures of auditor judgment consistency are examined in

this dissertation First, the degree of judgment consensus among

auditcrs is evaluated Second, each auditor's self-insight into his judgment process is evaluated This concerns the consistency between the auditors’ perceptions of the importance of information factors and their actual utilizetions of the information factors, Third, the

stability of each auditor's judgments is examined

This dissertation shows that there are substantial differences in the ways various internal auditors use information in planning

international internal audit assignments

support, I could not have completed this undertaking The

encouragement received from my wife, Elizabeth, along with the

additional hardships she endured is greatly appreciated I am also greatful to my daughter, Tiffany and son, Matthew for giving up much

of their time with me so that progress could be made on this

dissertation Additionally, the author dedicates this dissertation to his parents, Mr and Mrs Alex Okopny, whc have always stressed the importance of an education and encouraged the author to do his best

The contributions to this dissertation by the author's

dissertation committee are gratefully acknowledged The suggestions and advice provided by Professor Robert H Strawser, chairman of the author's dissertation committee, are greatly appreciated Working

with Professor Strawser has been an enjoyable experience and his

friendship is especially valued

TABLE OF CONTENTS

ABSTRACT 2.1 6 ew we we we we we et we ee ew ht iii DEDICATION 2 6 ee ew ew we et ww we te ee te hh ee V ACKNOWLEDGMENTS 2 2 2 6 6 0 0 ew ee ee ee Hw we ew vi TABLE OF CONTENTS 2 1 2 6 6 © oe ee ew we te we th we we we ew vii LIST OF TABLES 2 1 6 6 2 © © © ee ew ow wt th we ewe x CHAPTER I INTRODUCTION 1 2 2 © © © © © © © ww we we we 1

Planning as a Necessary Audit Activity «es 4 The Nature of the Internal Audit Preliminary

Planning Process + «© « «© © + © ee we ew we © 9 6 The Importance of Judgment in the Auditing Process 7 Comparison of International and Domestic Internal

Audit Assignments 2 «6 +» «© © ee ee we wwe eee es 9 Problem Statement 2 6 2 2 2 2 0 oe tw ew ee te 1 1 9 12 Purpose and Justification of the Research « «+ 13

Scope and Delimitations 2 2 2 2 2 2 we ew we ee wwe 17 Organization of the Dissertation 2.22 eee 18

CHAPTER II REVIGW OF RELATED JUDGMENT LITERATURE oe ew ew we 21

Policy Carturing 6 1 6 6 2 1 et eee we we ee wr ww 35

Design of Experiment 2 «© © © «© © © © © © © w © oe 101

SubjectS 2 6 6 8 ee eee eee tt ee th tt tt 118

Administration of Experiment 2 « «© «© e © © we ww 125 Statistical Analysis 2 2 2 «© 2s ee © ee ee wwe wwe 125

Methodological Limitations 1 2 2 2 «© © ee we we we 132 Summary 6 2 6 © © © © eo eo ee ww ew wt et 135

CHAPTER IV RESULTS 1 2 © © 6 © © © © © © 1 2 ee eh oe 137 Introduction 2 2 2 6 © © © © © © we oe ww ee te wt 137 Auditors! Descriptive Models 2 2 2 ee we we wee woe 139 Interauditor Consistency «eee ee ee ewe 159 Auditor Self-Insight 2 © ee © © ee we we ww 165 Auditor Judgment Stability 2 6 2 2 eee ee ee 169 Overall ANOVA 2 1 6 ee we ew ew we ee et tow 172

CHAPTER V SUMMARY, IMPLICATIONS, AND

SUGGESTIONS FOR FUTURE RESEARCH 2 2 © 2 © ee we we eo oe 179 Summary 6 0 6 ee ee th ee ew we ee et we ew we) «9

Implications 2 « 2» vo vo 1 1

Suggestions for Future Research

SUPPLEMENTARY SOURCES CONSULTED

APPENDIX A - CUE DEVELOPMENT INSTRUMENT

Initial Set of Information Cues Relevant to

Planning an International Internal Audit

Reduced Set of Information Cues .e.4

Expert Panel Task No 1 - Results Grouping of

Specific Cues and Naming of General Cue Categories

Expert Panel Task No 2A — Results Magnitude

Estimation Training - Numerical Estimation of

Line-Lengths 2 1 2 ee we te ww ee ewes

Expert Panel Task No 2B — Results Magnitude

Estimation Evaluation of Specific Information Cues

Relative to Reference Cue Assigned a Value of 20

Calculation of Average Ranks of Forty-Four

Specific Cues 2 6 2 we ww eee we eee eae

Expert Panel Task No 3 = Results Magnitude Estimation

Evaluation of General Cue Categories Relative To

Reference Cue Assigned a Value of 20 e6+8

Cue Selection Summary 5.6 ee ee

Summary of Specific Cue Assignments by General

Cue Category 6 we ww ee we ew ew ee

Summary of Cue Categories with Specific Cues

Listed by Rank Order over All Forty-Four Cues

Treatment Combinations 2 ee ew ee ee ae

Aliases for a 4 x 2” (One-Half Replicate) s-

Three Orders Used to Present Treatment

Combinations to Auditors .e.s ee ee

Countries Most Often Indicated by Auditors’ Experience

Frequency of Man-Days Responses by Subject

Significance of F-ratios and R-squared Values for

Each ANOVA Model by Auditor «2 «ee ee ee

Significant Main Effects by Auditor

Significant Interaction Effects by Auditor

Number of Significant Main Effects and

Interactions by Auditor + © se ee se ee ee

Number of Auditors' Models Showing Significant

Effects by Effect 2 2.6 6 «© 5 © © eo we ew we wee

we Statistics — Proportion of Variance in Estimates

of Man-Days as Accounted for by Main Effects

we Statistics - Preportion of Variance in Estimates

of Man-Days as Accounted for by Interactions ,

Ranking of Main Effects by Auditor .e.e.e-

Auditors by Cluster Provided with we Statistics

Frequency of Occurrence of Auditors’ Self-Insight

forrelation Coefficients 2 2.» «se 0 se © we we ow

Frequency of Occurrence of Auditors! Stability

In recent years, there has been an unprecedented increase in

auditing research An area which has shared substantiaily in this growth is that of auditor judgment A number of studies «uve

concentrated on the judgments made by external (independent) auditors

in a variety of settings In contrast to those studies, the research reported in this dissertation investigates the judgments made by

internal aucitors during the preliminary planning prowess for an

international internal audit assignment Specifically, vhis esearch examines judgments regarding estimations of the time buvsrts necessary

to satisfactorily complete various international internal sudit

professionalization of internal auditing is indicated by tne

development of a Code of Ethics, Standards for the Professional

Practice of Internal Auditing, a professional certification program (Certified Internal Auditor), and professional development training, The Accounting Review was selected as the model for format and style

corporations In their survey of internal auditing, White and Xander [1984] found that almost one-third (32.4 percent) of the 1,618 U.S, companies surveyed had operations in foreign countries This

percentage reached 46.8 percent for companies classified as large (internal audit staff size of ten or more) Of the firms which have foreign operations (473), 87.7 percent stated that these non-U.S operations were audited, The responsibility for conducting the non- U.S audits largely fell upon U.S./home office personnel (58.5

percent), although 8.2 percent was conducted by non-U.S./home office residents and 30.2 percent was conducted by a combination of the two The remaining audits (3.1 percent) were conducted by other sources Clearly, then, the internal audit profession is a dynamic one and one which is worthy of investigation The following sections of this chapter further describe the internal audit environment, the

importance of preliminary planning to that environment, the use of judgment thoughout the audit process, and simularities and differences between international and domestic internal audit assignments Once these descriptive aspects are presented, then the problem statement, the purpose and justification of the research study, the research questions, the scope and delimitations, and the organization of the dissertation are given

activity known as "internal auditing." Some organizations refer to this activity as "internal consulting," while others use terms such as

"operational auditing," "management auditing," "performance auditing," and "program results auditing." Two comprehensive definitions of internal auditing which incorporate many of the ideas expressed by those terms are the following:

An independent appraisal of the diverse operations and

controls within an organization to determine whether

acceptable policies and procedures are followed, established standards are met, resources are used efficiently and

economically, and the organization's objectives are being

Internal auditing is an independent appraisal function

established within an organization to examine and evaluate

its activities as a service to the organization [Institute

The overall objective of internal auditing is "to assist all members of management in the effective discharge of their

responsibilities, by furnishing them with objective analyses,

appraisals, recommendations, and pertinent comments concerning the activities reviewed" [Thornhill, 1981, p 29] The internal auditor, then, functions as an early warning system to inform management of situations which may represent inadequate control conditions or unused opportunities for increased efficiency In this manner, the internal

audit function derives its economic value,

within an organization, the benefits of internal auditing must exceed the associated costs to warrant its continued existence Planning activities help to provide the direction necessary to minimize the costs and simultaneously maximize the benefits of internal auditing

Planning as a Necessary Audit Activity

Clearly, the importance of planning within the internal audit function goes beyo:4 being an intuitively integral part of the

auditing process, since the Standards for the Professional Practice of Internal Auditing include planning as a required internal audit

activity These standards were established to describe the practice

of interual auditing as it should be, as judged and adopted by the Board of Directors of the Institute [Institute of Internal Auditors, 1978] The standards represent a level of quality to be adheared to and maintained throughout the audit process,

Two of the five sections of the Standards for the Professional Practice of Internal Auditing explicitly concern planning The first subsection included under Section 400, Performance of Audit Work, requires that internal auditors plan each sudit "Planning should be documented and should include:

1 Establishing audit objectives and scope of work,

4, Communicating with all who need to know about the audit,

5 Performing, aS appropriate, an on-site survey to become familiar with the activities and controls to be audited,

to identify areas for audit emphasis, and to invite

auditee comments and suggestions

6, Writing the audit program,

7 Determining how, when, and to whom audit results will be communicated,

8 Obtaining approval of the audit workplan" [Institute of Internal Auditors, 1978, p.400-1]

The second subsection under Section 500, Management of the

Internal Auditing Department, is Planning This subsection requires that "the director of internal auditing should establish plans to carry out the responsibilities of the internal auditing department" {Institute of Internal Auditors, 1978, p.500-1] The remaining

sections of the Standards for the Professional Practice of Internal Auditing (Independence, Professional Proficiency, and Scope of Work)

do not explicitly concern planning; nevertheless, planning is an important activity within those sections as well The planning for each situation should be consistent with the internal audit

department's charter and with the goals of the organization The planning process also involves establishing the following: (1) goals; (2) audit work schedules, including the estimated time required; (3) staffing plans and financial budgets; and (4) activity reports In order to attain each of these qualitative goals or standards, a

The Nature of the Internal Audit Preliminary Planning Process

The preliminary audit planning process makes use of internal audit operational management and is usually performed at the firm's administrative headquarters prior to the deployment of audit resources

to the audit location This process is sometimes referred to as pre- audit planning or the preliminary survey

Sawyer [1981] describes the primary purpose of the preliminary survey as auditor familiarization, Although his discussion concerns the on-site survey, a similar emphasis may be applied to the

preliminary planning process prior to the on-site survey,

Inefficiency, ineffectiveness, and a general lack of understanding can result from inadequate preliminary audit planning Auditor

familiarization prior to the allocation of audit resources can

facilitate risk identification, scope definition, time budgeting, and auditor assignment tasks,

A description of the steps involved in the preliminary planning process was not found in the literature In an effort to identify these steps, a two-part process was undertaken First, the

hypothesized steps were listed by the researcher based on an analogy

of the steps in the scientific approach (to problem solving) and

through personal experience gained during the performance of

necessary The six steps which were identified by the two-part

process are these:

1 Data gathering

2 Data analysis

3 Determination of audit objectives and scope as outlined

by corporate policy and auditing standards

4, Selection of audit resource alternatives, including:

a staff specialists

b experience mix of staff

c computer assistance

d time budget allocation

5 Implementation of audit management control procedures,

6 Establishment of reporting requirements including

evaluation of audit performance

Although these activities are listed in step form, it is important to recognize that these steps overlap to a great extent There is also a Significant amount of reedback and readjustment that goes on

throughout the process,

The Importance of Judgment in the Auditing Process

Judgment has always played an integral part in the auditing

process It is as important to internal auditing and governmental auditing as it is to external auditing The auditor makes judgments

attention, has been defined as "the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information" [Committee to Prepare a Statement of Basic Accounting Theory, 1966, pp 6-7] External

auditors make informed judgments when they attest to whether or not their client's financial statements present fairly the financial

position, results of operations, and changes in financial position of the firm Although the internal auditor does not provide a comparable formal attestation, the internal auditor must use his professional judgment to reach conclusions regarding the efficiency and

effectiveness of both the accounting and operational areas audited Since auditing is an investigative process [Committee on Basic Auditing Concepts, 1973], it shares certain attributes with scientific inquiry Initially, data is gathered for the purpose of planning the audit Judgments are made concerning the amount and quality

(sufficiency) of data to be collected Then, using professional judgment acquired through training and experience, auditcrs evaluate the data for competence When performing each audit procedure,

auditors judge the adequacy of the evidence collected, the need to adjust audit programs, the relationship between areas currently being audited to the areas to be audited, end the overall quality cf the audit as compared with the predetermined audit objectives After the evidence has been collected and evaluated, audit management uses its

personnel decisions, among other administrative duties

The importance of judgment to the audit process is demonstrated

by the significant amount of academic research currently being

conducted on judgment topics Academic journals have published a significant number of behavioral/ judgment research articles

Furthermore, during the last decade, several research seminars have been conducted which focused specifically on auditor judgment For example, seminars co-sponsored by the University of Southern

California and Deloitte Haskins and Sells have attracted a large

number of both academic and practitioner participants

Judgment is critical to the preliminary audit planning process Because of the high costs associated with inadequate preliminary

planning, this function is usually performed by those at the highest levels of management within the audit department It is asssumed that they have considerable experience, which results in a highly developed level of professional judgment

Comparison of International and Domestic Internal Audit Assignments

Several aspects which describe international internal audit

assignments are introduced in this section by providing a comparison

to domestic internal audit assignments International internal audit

assignments are discussed more fully in Chapter III, the Method

general international internal audit environment, and more

specifically, the following: data collection and evaluation, audit procedure objectives, and audit management techniques,

The techniques used to collect and evaluate data in both domestic and international audit assignments are basically the same However, slight differences in collection and evaluation techniques may exist between these two types of assignments, just as they de among

different domestic assignments, Auditors utilize the knowledge and experience gained in past audits and adapt them to each successive assignment

The objectives of specific audit procedures also generally do not vary much between domestic and international audit locations, For example, the count of a cash fund at a Dallas, Texas audit location has the same objective as a count of a similar fund at a London,

England audit location, Although the procedural audit objectives do not change, the performance of these procedures may vary Slightly due

to different currencies, monetary regulations, and other factors

Finally, management techniques used to oversee the audit and

supervise audit staffs also do not vary significantly between domestic and international assignments, International assignments, however, often result in less frequent direct contact between higher level

audit management and international audit staffs As a result, the modes of communication used to manage the international audit staff

are affected,

At least three major differences exist between domestic and

international audit locations, One is that of environment

Environmental differences affect the firm as well as the auditor The firm's operations are affected by the following: regulatory policies, political systems, languages, and other factors, Auditors are

affected by some of the same factors, as well as others, such as local customs which influence not only how auditors spend their leisure

time, but also the manner in which they perform their professional tasks

Another major difference between international and domestic

audits is the substantially increased cost of conducting an

international audit In a speech given by the general auditor of a large multinational firm early in the 1970's, the average annual cost

to the company per international auditor was stated as $54,000

Foreign duty bonuses, transportation expenses, extremely expensive living costs, as well as numerous fees for miscellaneous items such as visas, passports, and inoculations all contribute to making the

international audit much more expensive than a comparable domestic audit These cost factors lead to increased importance being placed

on the planning of international audits

Another major difference between international and domestic

audits is the increased exposure to risk generally attributed to

international locations The rapid expansion of firms into the

multinational environment is the result of increased profitability and

growth motives With these opportunities come risks associated with doing business at many international locations To some extent, as the risks of doing business increase, so do, the risks facing the

internal auditor The reasons that risks are higher for international internal audits than for domestic audits are only introduced in this section Further explanation is presented in Chapter III, the Method Chapter (in the section on cue development) The unavailability of highly qualified employees, less sophisticated operating standards and procedures, and the rapidly changing economic environment are some of the reasons for increased risk in the international audit environment Additionally, language and cultural problems, unfamiliarity with many diverse operations, and the complexity of many international audit locations are factors which may contribute to increasing the risks of error detection in this international environment These brief

comments indicate some of the reasons for the selection of an

international rather than a domestic environment as the focus of this research, Increased audit costs and risks place additional emphasis

on judgments regarding preliminary audit planning

audit judgments In accomplishing the above objectives, each manager was presented a set of cases (representative audit situations) Each case provided the managers with five factors, the levels of which were varied systematically from case to case, The managers’ responses to each case were elicited regarding the expected number of man-days to

Method Chapter (in the section on the experimental instrument) for a detailed discussion of the development of the cases

Purpose and Justification of the Research

Purpose

The topic and subjects selected in this research study have

received little attention from prior researchers, This research

study, then, is exploratory Its purpose is threefold The first purpose is to examine one aspect of the internal auditor's judgment process and compare the results to existing research which examines external auditor judgments Although judgment research methods have been adopted from psychological research and utilized by accountants

in substantial volume for some time, the primary focus has been on the judgments of external auditors The second purpose is to identify factors of importance to international internal audit planners This effort is consistent with the purposes of an exploratory study, to investigate new areas of interest in order to generate future

research, Finally, the third purpose is to provide descriptive models which represent internal auditors’ judgment strategies The

strategies, modeled herein, reflect the degree that specific cues were utilized by each auditor in the judgment task The models can then be evaluated for consistency, a substitute measure for judgment quality (see Ashton [1982a] for a review)

Justification

The justification of this research is based upon its potential contributions to accounting practice, development of research

methodology, and judgment research As research is a cumulative,

step-by-step process, this project attempts to add to the collective knowledge of the topics discussed herein

Accounting practice In this research, the segment of the

internal auditing profession that is concerned with international

auditing is provided with the general categories of information which experienced international internal audit planners have determined to

be most critical to the preliminary audit planning process By

identifying relevant data, the internal audit manager may implement systematic data-gathering and analysis procedures, Standardizing

these procedures can, to some extent, insure that major factors are not overlooked in the planning process This list of data should be used as a decision aid, not as a replacement for the decision or

judgment process of the internal auditor

Research methodology Although many of the research methods used

herein replicate those used in prior studies, a few variations have been implemented Magnitude estimation (see Chapter III, the Method Chapter for a detailed explanation) was used as a means of reducing the number of independent variables (international audit planning

information factors) to be presented to the subjects This method, which was developed by Stevens [1966] in the area of psychophysics, has not yet received significant attention among accounting

researchers Additionally, a sorting technique which was performed individually by five expert panelists (the panelists averaged eight years of international internal audit experience), was also used to select and categorize independent variables for later study (see

Chapter III, the Method Chapter for a detailed explanation) These methods were used in an effort to overcome possible experimental bias regarding the independent variable selection process in previous

techniques is justified because the new problems can be solved

efficiently and the problem solving techniques can be generalized to new populations This process can validate the techniques and expand their applicability

Judgment research Previous judgment research in accounting (see

Chapter II, the Review of Related Literature Chapter) has concentrated

on micro-type judgments These micro-type judgments have been

concerned with such issues as the strength of internal controls in a particular department, the materiality of specific audit items, the evaluation of internal audit departments, and similar topics, This research, however, is primarily concerned with macro-type judgments

It analyzes auditor judgment regarding the use of specific data in the overall planning process, The subjects in this research were

requested to respond to a comprehensive audit assignment from an

overall viewpoint, not one of a specific audit procedure or objective This approach is justified because exploratory research is used to define problems such as identifying the factors used by internal

auditors in planning international audits, Once the overall problem

is delineated, future researchers can investigate specific aspects or segments of the problem Of course, the primary justification for studying auditor judgment is to improve judgment quality by making auditors more sensitive to both the judgment process and its

Limitations

Research Questions

The following research questions reflect the problems addressed

oy this research, This list provides an introduction to the goals of Chapter III, the Method Chapter and is again referred to during the reporting of results,

be most important to the international internal audit

preliminary planning process by each of the expert

panelists? (The initial comprehensive set of factors

was taken from the practitioner—oriented literature.)

2 Into which general categories of information factors

(cues) do each of the expert panelists place the above

specific cues?

3 Which information cue categories are most important as

shown by their utilization by the subjects (internal

audit planners) in making international internal audit

preliminary planning judgments?

4, What are the individual judgment models (cue utilization

patterns) of the auditors?

5 Which information cues are perceived to be the most

important in contrast to those utilized by the auditors?

6 How do the above perceptions of importance and the

actual utilizations of information cues differ for

each auditor (self-insight)?

7 Are judgment models consistent between auditors

(interauditor consistency)?

8 How stable are the auditors' judgments (intratemporal

consistency)?

Scope and Delimitations

While this research is intended to provide descriptive data

regarding judgments concerning the international internal audit

preliminary planning process, it focuses only on a portion of that process, This study examines judgments involving only three steps of the preliminary planning process: data analysis, determination of

audit objectives and scope, and selection of audit resources The raw data is presented to judgment-makers (subjects), thus eliminating any

study of the data-gathering activities of international internal audit planners The objectives of the audit were stated from a corporate audit policy perspective in the experimental instrument, so judgments regarding the selection of objectives are not examined Furtrermore, only one of a possible number of resource alloction judgments was

required (estimation of time budgets) The judgments examined herein reflect a concern for the general information used by internal audit practitioners to estimate time budgets for forthcoming international audit assignments

The examination of the above judgments provided information which was then used to make several types of analyses concerning judgment consistency, The study of judgment itself is reduced to the study of representations of judgment This makes the research dependent on the degree to which such representations accurately reflect the

corresponding judgments

Organization of the Dissertation

The remaining four chapters of this dissertation are organized as follows: Review of Related Literature; Method; Results; and Summary, Implications, and Suggestions for Future Research The remainder of this chapter is devoted to a discussion of those chapters

business, and accounting, this chapter provides a theoretical

development of judgment research The chapter begins by providing a brief historical perspective of judgmental research taken from the psychology literature Within this section, conceptual models of judgment and methods used to study judgment are described,

Next, the topic of judgment is brought into closer focus by

examining the relevant accounting literature The area of most

concern involves "policy capturing" research, by which judgments are analyzed as a means of determining the underlying opinions (policies)

or reasons for a particular judgment Furthermore, several different topical categories of judgments are reviewed The Review of Related Judgment Literature Chapter concludes with a summary

Method

The Method Chapter begins with an extensive section on cue

development, This section identifies the information factors (cues) used in this research, factors which were initially developed from the practitioner-oriented literature The method used to reduce the number of cues to manageable categories is also reviewed The cue development process leads to the specification of the research

instrument Next, the experimental task to be performed by the

Next, the methods used to select subjects and a summary of

subject demographics are presented Analytical techniques, including data processing methods and statistical measures used to evaluate

data, are then described Methodological assumptions, followed by a presentation of the weaknesses and limitations of the methods, are last

Results

The Results Cnapter, which consists of an introduction, findings and interpretations, and summary is presented next This chapter is based on the data analysis which provides the findings regarding the research questions stated in the Introduction Chapter

Summary, Implications, and Suggestions for Future Research

This final chapter brings the entire research study together by summarizing the findings, Next, the implications of the findings are discussed, Finally, suggestions for future research are given

paradigm are reviewed The fourth section summarizes the presentation

of the related judgment literature reviewed in this chapter

The Nature of Judgment

Judgment has been described as an “umbrella” term that designates

a class of phenomena {Newell, 1968] Due to its umbrella-like nature, judgment and the study of judgments take on vastly different meanings, depending on which of its aspects is being examined The American Heritage Dictionary defines judgment as the exercise of "the capacity

to make reasonable decisions, especially in regard to the practical affairs of life." Hogarth [1980] states that judgment is an

inevitable aspect of living With the understanding that judgment is

a pervasive activity, the discussion which follows will attempt to describe the nature of judgment, the human information-processing

system, and a few of the fallibilities of judgment

Hogarth [1980] identifies two kinds of judgments which are common

to most situations that involve the making of choices, First,

individuals or groups make value judgments which indicate their

preferences among alternatives, These judgments reflect the rank

ordering of alternatives which is based upon some individually defined value scale, For example, in the undertaken research study, an

auditor may prefer to perform a foreign audit in one country versus another based upon his attitudes regarding the relative ease of

communications in the preferred country Second, individuals or

groups make predictive judgments These judgments reflect an

individual's or a group's expectations concerning a future event or the probability of the occurrence of a specific outcome For example, the determination of the amount of time expected to complete an

international internal audit assignment would represent a predictive judgment This research is concerned with predictive judgments

Preference and predictive judgments are made continually by

individuals in both their working and social environments, The

importance of these judgments has increased substantially over time due to the interdependencies and complexities of modern iife, thus

leading to judgments which are characterized by greater consequences than they were in years past [Hogarth, 1980] As we have evolved into the "information age," everyone is faced with the problem of

assimilating more data and assimilating it more rapidly Today,

conceptual skills are more valued than the physical skills which were required by our forefathers Thus, the increased attention given to judgmental research is justified,

Early studies of judgment and related topics have produced two significant conclusions: (1) individuals have limited information- processing capacities; and (2) individuals are adaptive in their use

of judgment [Hogarth, 1980] (See Slovic and Lichtenstein [1971] and Newell and Simon [1972] for reviews and a summary of this literature.) The examination of individuals' limited information-processing

capacities has been made primarily within the discipline of cognitive psychology

The Human Information-Processing System (HIPS)

Judgment is affected by the manner in which the individual

processes information To completely understand judgment, it is

necessary to comprehend the human information-processing system (The following description has been adapted from the presentations of

Norman [1976]; Kilatzky [1980]; Libby [1981]; and Ashton [1982a].)

Initially, the human inforuation-processing system is presented with some form of stimulus Some information about the stimulus is

registered in the system The device which registers the stimulus is called a "sensory register." There is one sensory register for each

of the five senses While the stimulus is held in sensory form in the sensory register (a memory device the first of three memory stages),

a pattern recognition process is performed This process reflects the interaction of the sensory form with previously acquired knowledge This process is sometimes referred to as "naming." It is important to realize that the sensory form weakens or "decays" over time and

disappears

The pattern recognition process also encodes the stimulus so that

it can be transferred to the second memory stage, which is called

"short-term memory." Short-term memory stores information in its

identified (recognized) form, not in sensory form Stimuli can be held in short-term memory for periods that are considerably longer than are possible in the sensory registers A process called

"rehearsal" allows information to be maintained indefinitely The third memory stage is called "long-term memory." Long-term memory is essentially a permanent memory which enhances the human information-— processing system in two ways, Initially, it functions to match the stimulus pattern to the knowledge in the long-term memory, thus

allowing for stimulus pattern recognition, Finally, recognized

stimuli may be retained on a more permanent basis in long-term memory This discussion of the human information-processing system provides the background necessary to identify some of the limitations of the judgment process, which are discussed in the next section

Hogarth [1980] has identified four major consequences of the

limited information-processing capacity of humans, First, people

perceive information not comprehensively, but selectively Since we come in contact with an unlimited supply of stimuli through our

environment, people must select the stimuli to be received and

processed This selection process is constrained by physical and

motivational factors, including motivational factors that are

anticipatory That is, we select stimuli that are anticipated for

motivational reasons (e.g., "people only see what they want to see"

sequential manner since they are unable to process large quantities of data simultaneously The sequential aspect of information-processing sometimes leads to judgmental biases Third, people do not possess the ability to make calculated judgments The word "calculated"

refers to the manipulation of quantitative/qualitative data in order

to reach some optimal solution People use simple "rules of thumb" or heuristics to overcome their inability to make complex calculated

judgments Fourth, people have limited memory capacities, As

discussed earlier in the description of short-term memory, the

duration of that memory stage is dependent on "rehearsal." Memories must be peconstructed through the forming of associations among

fragmented data Time, the number of associations, and the perceived Strength of associations all contribute to the memory process