Use of decision theory in auditing -- A practitioner's view;

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Use of Decision Theory in Auditing— A Practitioner's View
James K. Loebbecke
Touche Ross & Co.
In 1974, Bill Felix delivered a paper at this symposium entitled "A Decision Theory View of Auditing," for which I was the discussant. At that time Howard Stettler asked if we would consider reversing roles in 1976. This paper is the result of our agreement to do so, with the caveat that I could speak only from the point of view of a practitioner since I am neither an academic nor a mathematician.
In planning this paper, I made a limited review of current academic literature on the use of decision theory in auditing and, in addition to Bill Felix' 1974 paper, found several notable works. These will be referred to below. I also formally surveyed a group of my peers to determine 1) their familiarity with decision theory and 2) their advice on how it might be used in auditing. Their response indicates that a very small proportion of practitioners have considered the subject formally. Without going into great detail, 70% stated they have no truthful idea of what decision theory is, 15% acknowledged having a general idea, and 15% stated they could specifically define decision theory as presented in the literature.
These findings should not be interpreted as evidence that auditors are ignorant or that they are making poor audit decisions, but rather that decision theory is a relatively new concept which has not yet been widely exposed to them. My feeling, as was expressed in 1974, is that if decision theory were presented to practicing auditors on a broader basis (e.g., in The Journal of Accountancy), the introduction would be successful only if the more technical aspects could be presented in the auditor's own terms. Since this introduction, to the best of my knowledge, has not yet been made, I consider the purpose of this paper to be input to that future undertaking. Accordingly, I have tried to identify a decision frame that I believe many auditors are using in a way that relates to formal decision theory, and to examine some of its implications.
Review of Decision Theory in Auditing
A broad definition of decision theory is an essential starting point. Decision theory is a systematized approach to problem solving such that the choices made will produce the optimum outcome. Formal decision theory utilizes statistical techniques extensively. Thus, relative to auditing, the use of statistical sampling,
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