The audit function in a market economy ultimately evolves by social consent because:Society either accepts or rejects the role of a professional group assumes for itself, in timethe group either finds a role acceptable to society or the group disappears. As conditionsand apparent needs change, society may reject roles formerly considered accepted so professional groups must continually be alert to the desirability of role modification andrevision.However, it is important to note that the change in society’s expectation and the responseof the auditing profession towards these changes are not always at the same pace. Hencethere is a natural time gap between the changing expectation of the users and the response by the profession and due to this time gap there arises what has been stated as theexpectation gap or audit expectation gap. Even though the existence of such a naturaltime gap is inevitable, auditors should be sensitive to the changing expectation of therelevant groups while at the same time containing these expectations within theconstraints of what is possible. There are inevitably economic and practical limitations onwhat an audit can do, and this is something which those who wish the benefit mustunderstand.
The Agency Theory/Problem
The objectives of management may differ from those of the firm’s Stockholders.Ownership and control are separate, a situation that allows management to act in its own best interests rather than those of the Stockholders.Management is an agent of the Stockholders and decision making is delegated.Due to the differences in objectives, Stockholders then have to motivate management tothink along the lines of the owners (stockholders) by way of incentives, such as stock options, bonuses and perquisites for management to make optimal decisions.Stockholders apart, from giving incentives, can monitor management through bonding,systematically reviewing management perks,
auditing financial statements
andexplicitly limiting management decisions.
Definition of Auditing
An independent examination by a qualified appointed person (auditor) of a company’sfinancial statements and books of accounts so as to express or formulate an opinion as towhether the financial statements show a true and fair view of the financial position of thatcompany and its results, and whether the financial statements have been prepared inaccordance with International accounting standards, International Financial reportingStandards or Generally Accepted Accounting Principles.
True and Fair View explained
There are three possible auditing approaches which might be used and these are:2