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MANAGEMENT ACCOUNTING

COSO explores common judgment traps, lays out five-step decision-making process

 

By Ken Tysiac
March 2, 2012

Many faulty business decisions can be traced to “confirmation bias” that leads people to unwittingly seek information that bolsters what they want to believe, says Brigham Young University accounting professor Doug Prawitt.

“We don’t realize it when we do that, but it’s a very, very powerful human bias,” he said Thursday during a telephone interview.

Prawitt is co-author of Enhancing Board Oversight: Avoiding Judgment Traps and Biases, a white paper on business judgment released Wednesday by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Prawitt identified confirmation bias and a phenomenon the white paper calls judgment “triggers” as two particularly damaging “traps” that lead to poor judgment and decisions. He said considering other points of view is essential to avoiding confirmation bias and making good decisions. The white paper speaks primarily to boards of directors in their strategy-setting role. But Prawitt said the process described in the white paper applies to anybody who makes important decisions.

“As you evaluate information, always sit back and take time to make the opposing case,” Prawitt said. “… If I’m [a lawyer who’s] going to go into the courtroom, I want to know my opposing attorney’s case better than he knows it.”

Judgment triggers often result from a possible solution’s being misidentified as a problem that needs to be overcome, the white paper says. When a problem is improperly defined, decision makers sometimes move forward without considering other, better alternatives.

The white paper uses the example of an executive who was asked to oversee the in-house development of customized software to track important projects at his company. The need for custom-developed software was posed as the problem, when it really was just a potential solution. The problem was the need to find an efficient way to track projects. The executive avoided falling victim to a judgment trigger. He did more investigating and found a third-party software product that was more cost-effective.

Prawitt said that, about 2½ years ago, he and co-author Steven Glover, also an accounting professor at Brigham Young, began working with KPMG to create a professional application for their research on business judgment and decision making. What emerged was a professional judgment framework put into practice by KPMG, which also co-authored the COSO white paper. The framework describes a five-step process for decision making:

  • Define the problem and identify fundamental objectives.
  • Consider alternatives.
  • Gather and evaluate information.
  • Reach a conclusion.
  • Articulate and document rationale.


According to Prawitt, the guidance is spreading rapidly, particularly among accounting firms. He said that, as a result of PCAOB reviews of audits, public accounting firm leaders are eager to review decision-making processes undertaken by employees of their firms.
 
“If you’ve carefully laid out the rationale for your judgment,” he said, “you’re in a lot better position to justify the judgment that you made.”

The white paper mentions additional common traps:

  • Rush to solve: The quickest judgments aren’t always the best ones.
  • Overconfidence.
  • Anchoring: This often occurs in negotiation when a faulty initial value is set and decision makers fail to adjust sufficiently far from it.
  • Availability: This is the tendency to consider information that’s easily retrievable from memory rather than the best information.


Solutions mentioned in the white paper include seeking disconfirming evidence, questioning expert opinions and encouraging opposing points of view.

Prawitt said that, although professional judgment is an important everyday task for accountants, they often haven’t received formal training in how it can be improved. But he said there’s now enough research on the subject that it’s gaining popularity.

Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.

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