Chapter 1 – Introduction toAuditing
The Importance of Auditing
• Auditing is critical to the proper functioning of capital markets.
• Audit Societies – Societies in which there is extensive examination by auditors of economic or
politically important activities.
• Auditing – The verification of information by someone other than the one providing it. (reduces
information risk for a 3 party)
• Gives clients assurance (minimizes risk) to base their decision.
• Three PartyAccountability – Consists of:
1. An asserter
2. An assurer
3. Auser of the asserted information
• Accountability relationship – Where at least one of the parties can justify its actions/claims to
another party in the relationship.
• Acting in the public interest – Auditors are required to act in the interest of the financial statements’
users (the expected social role).
• Audits are part of ‘assurance engagements’class that are licensed.
• Agency problems occur when ALL 3 conditions are present:
1. Agent has different objectives than principal
2. Agent has more information that principal
3. Contract between them is incomplete because not every contingency can be anticipated
• Agency Theory – Study of using contracts to mitigate the agency problem.
• 3 Conditions which affect users’demand for accounting information:
1. Complexity –Accountants must collect/complete information.
2. Remoteness – Users are separated by distance, time, and knowledge.
3. Consequences – Determine investors’and users’wealth
• Accounting tries to record/summarize economic realty for the benefit of economic decision makers
• ExternalAuditor –An outsider/ INDEPENDENT auditor of the entity being audited. (aka objective
Provides assurance – adds credibility
• Assurance engagement – When the auditor a