The Economic Demand for Auditing
During Medieval times when manual
bookkeeping was prevalent, auditors in Britain
used to hear the accounts read out for them and
checked that the organization's personnel were
not negligent or fraudulent. In 1951, Moyer
identified that the most important duty of the
auditor was to detect fraud. Michael Chatfield
documented in 1974 that early united states
auditing was viewed mainly as verification of
bookkeeping details. Today, the need for
accountability and compliance with laws and
regulations drive business organizations to
spend millions each year for the annual audit.
These needs were largely fueled by the
industrial revolution and the growth of capital
market. The industrial revolution gave birth to
modern accounting and auditing as well as the
proliferation of corporations by previous sole
proprietorships and partnerships who merged
their businesses to form a larger entity. Because
businesses were generally run by their owners
prior to the corporations and borrowing was
limited, accountability to outside parties was of
course minimal. When companies become
larger and needed to raise capital to finance
expansion, they are allowed by law to sell small
pieces of ownership that is stocks or to borrow in
the form of thousands of small loans that is
bonds so that vast amounts of capital can be
raised from a wide range of investors and
creditors. Over time, regulations from the
securities and exchange commission and other
regulating bodies were imposed to protect the
interests of the investors and the creditors.
Auditing enforces accountability over the steel
worksheet function, how they manage the
company's assets and operations on the part of
management, who are not owners of the
business. The relationship between the
stockholders or owners and managers often
result in an information asymmetry between the
two groups with the latter generally having more
information about the true financial position and
result of operations of the business. The other
group, the owners, are often prevented by the
remoteness of information to even begin to
understand how the entity operates.
The Nature of Assurance Services
According to the International Framework for
Assurance Engagements issued by the
International Federation of Accountants Council
or IFAC, Assurance Engagement means an
engagement in which a practitioner - a cpa of
course- expresses a conclusion designed to
enhance the degree of confidence of the
intended users other than the responsible party
that is the management about the outcome of
the evaluation or measurement of a subject
matter against criteria. The outcome of the
evaluation or measurement of a subject matter is
the information that results from applying the
criteria to the subject matter. In general,
Assurance services consist of two types:
 one those that increase the reliability of
information (example of the first type is
the audit or review of historical financial
information which requires the auditor to
issue an opinion as to the level of
assurance) and
 two those that involve putting
information in a form or context that
facilitates decision making (example of
the second type are the agreed-upon
procedures and compilation
engagements that does not require the
auditor to issue an opinion as to the
level of assurance)
The nature of assurance services is one of an
information enhancement designed to enhance
the degree of confidence in the subject matter
information.
There are several types of assurance services
but the significant portion of this is known as
attestation services under the first type. To attest
to information means to provide assurance as to
its reliability. In such engagements, a CPA
provides a report on the subject matter or an
assertion about the subject matters. One of the
most sought-after services is the examination or
audit of historical financial statements.
Philosophy of an Audit
A popular definition for audit is proffered by
Gupta and Kamal in November 2004 in their
book contemporary auditing. They defined it as
an independent examination of financial
information of any entity whether a profit-
oriented entity or not irrespective of its size or
legal form when such an examination is
conducted with a view to express an opinion
thereon. Auditing also attempts to ensure that
the books of accounts are properly maintained
and the financial reports properly presented by
the entity as required by standards and or by
law. Auditors consider the management's
assertions obtain evidence and to evaluate the
assertions based on the evidence and express
their opinion in their auditing report. This
definition is focused on financial audit. There are
other types of audit but they are beyond the
scope of this course. As the amount of capital
involved in the number of potential owners
increase, the potential impact of accountability
also increases. The auditor's role is to determine
whether the reports prepared by the
management conforms to the engagement
contracts provision. Thus, the auditor's
verification of the financial information adds
credibility to the report and reduces information
risk or the risk that the information circulated by
a company's management is materially
misstated and thus false or misleading.
Reducing information risk potentially benefits
both the owner and the manager. As
consequently, such reduction in information risk
will result to the reduction of risk in decision
making. In a financial statement audit, the
auditors undertake to gather evidence to obtain
high level of assurance that financial statements
are free of material misstatements due to fraud
or errors and that they are presented in
accordance with appropriate accounting
framework. The external audit is intended to
enhance the confidence that users can place on
management prepared financial statements.
When the auditor has no reservation about
management's financial statements or internal
controls, the report is referred to as an
unqualified audit report.
Importance of Audited Financial Statements
Audited financial statements are the accepted
means by which business corporations report
their operating result and financial position. The
word audited when applied to financial
statements means that the balance sheet in the
statement of income retained earnings and cash
flow are accompanied by an audit report
prepared by independent public accountants
expressing their professional opinion as to the
fairness of the company's financial statements.
Reporting in accordance with accounting
principles does not solve the problem by itself
because the managers are responsible for
reporting on the results of their own actions
which the absentee owners cannot directly
observe. The manager is in a position to
manipulate the reports to their benefit.
For example, when their bonuses are linked to
the results of operations: the higher the net
income for example the bigger will be their
bonuses. It is at this point that the demand for
auditing arises. If the managers are honest it
may very well be in the manager's self-interest
to hire an auditor to monitor and independently
report to the owner on their activities assuming
that the owner will assume that the managers
will manipulate the reports. If the auditor finds
the financial statements reported fairly, the
owners will likely be willing to invest more in the
business and to pay the managers more for
being accountable and honest even if the results
of operations may not be so desirable.
Financial statements prepared by management
and transmitted to outsiders without first being
audited by independent accountants leave a
credibility gap. In reporting on its own
administration of the business, management can
hardly be expected to be entirely impartial and
unbiased. Independent auditors have no
material personal or financial interest in the
business, their reports can be expected to be
impartial and free from bias. Moreover,
unaudited financial statements may have been
honestly prepared but management and staff
may not be knowledgeable about acceptable
accounting principles and methods or they may
have committed material errors in recording or
summarizing the financial transactions.
Especially so, if the company uses information
system which is not programmed accurately
then millions of records of data may be
presenting financial information that are
materially erroneous. The management and staff
may have committed errors in the presentation
of the accounts according to the prescribed
manners.
Lastly, there is always the possibility that the
financial statements may have been deliberately
falsified in order to conceal fraud or as a means
of inducing the users of the financial statements
to invest in the business or to extend credit to
the business. Although not common deliberate
falsification does occur in the real world and can
cause losses to persons who are misled. All
these reasons may cause the financial
statements to depart from financial accounting
and reporting standards and principles.
Audits provide users with assurance that the
financial statements are presented in
accordance with these standards and principles.
Users of Audited Financial Statements
Organizations maintain records of their financial
condition and progress as necessary references
to evaluate and guide business operations, to
determine financial status, to meet legal
requirements and to serve as a basis for credit.
Labor unions (Union) refer to the financial
statements in making collective bargaining
decisions.
Retired employees (Employees) protect
themselves from surprises concerning pensions
and other post-retirement benefits.
SUMMARY: Auditing is in demand because it
plays a valuable role in monitoring the
contractual relationships between the entity and
the various stakeholders. Certified Public
Accountants have been charged with providing
audit services because of their traditional
reputation of competence, independence,
objectivity and concern for the public interest,
thus they are able to add credibility to
information produced and reported by
management.

Rating agencies based their credit ratings of

organizations partially on historical performance
of the company.

Creditors, vendors and investors present and

prospective may wish to study the financial
statements of many enterprises for credit
extension and investment purposes.

Government agencies will need financial

reports to help them carry out their duties
imposed upon them by the law.

Regulatory agencies need inputs from financial

statements to enhance or develop regulations
and monitor compliance, even the court assess
the financial position of a company if it is in
litigation.

Of course, internal management

(management of the company) needs financial
reports for reviewing performance, planning,
directing and controlling business operations as
well as report the results of operations to capital
markets for example to the Philippines stock
exchange.

Investment Analysis: Stockholders and

bondholders make decisions whether to buy and
sell.