auditing week 1
1.26 Value of auditing
Required:
Would you obtain an audit for this company? Explain the reasons for your decision.
Yes, audits exist because of regulatory mandate (required by government). There are three theories which propose reasons why demand for audits might exist without regulatory mandate:
1. Agency theory
(The focus of the agency demand for auditing is more related to the stewardship role of accounting- which is more an examination of what has happened.)
The separation of ownership and control of organizations has resulted in an information asymmetry problem for the owners of the organization- -agency problem. The owners entrust managers to run the company so they could control the business to make any decision about the business. However, the managers do not necessarily have the same incentives as the owners of the company and will probably be trying to maximize their own resource consumption. It may be that they may enjoy first-class travel, dining and accommodation which may be more than is necessary for the company. Most importantly, they might manipulate earnings in the short term to earn bonuses, which would not be in the long-term interest of the company. The agency problem is why managers produce financial reports for shareholders to try to alleviate their concerns. However, there is still a risk that this information may be biased. For this reason, it is in the best interest of both parties to obtain the services of an independent auditor to check the financial statements prepared by management and provide reasonable assurance that it is true and fair to the users of the financial statements. An audit by someone independent of the manager reduces the incentive problems that arise when the firm manager does not own all of the residual claims on the firm (Jensen and Mackling). So, an audit is a monitoring activity that will increase the value of the firm when there are agency problem. Following these arguments, regulation would not appear to
Required:
Would you obtain an audit for this company? Explain the reasons for your decision.
Yes, audits exist because of regulatory mandate (required by government). There are three theories which propose reasons why demand for audits might exist without regulatory mandate:
1. Agency theory
(The focus of the agency demand for auditing is more related to the stewardship role of accounting- which is more an examination of what has happened.)
The separation of ownership and control of organizations has resulted in an information asymmetry problem for the owners of the organization- -agency problem. The owners entrust managers to run the company so they could control the business to make any decision about the business. However, the managers do not necessarily have the same incentives as the owners of the company and will probably be trying to maximize their own resource consumption. It may be that they may enjoy first-class travel, dining and accommodation which may be more than is necessary for the company. Most importantly, they might manipulate earnings in the short term to earn bonuses, which would not be in the long-term interest of the company. The agency problem is why managers produce financial reports for shareholders to try to alleviate their concerns. However, there is still a risk that this information may be biased. For this reason, it is in the best interest of both parties to obtain the services of an independent auditor to check the financial statements prepared by management and provide reasonable assurance that it is true and fair to the users of the financial statements. An audit by someone independent of the manager reduces the incentive problems that arise when the firm manager does not own all of the residual claims on the firm (Jensen and Mackling). So, an audit is a monitoring activity that will increase the value of the firm when there are agency problem. Following these arguments, regulation would not appear to