Module Overview: \ «How isthe game played? © Implications forauditwy - . LESSON 2.2.2: Te Market Grame: A Step-by-Step \Wlustration Rave 4. (44 mia) + Sellers generally ean moneyloy making one or move 5 Sales at Apiice tratris above the Cos teeh the unit. 1 A sellers camminas are calculated as the sum ofthe camings onthe units actually sold . “LE a Second unit's sold, tr must oe atthe same pice and grade asthe fivse unit. A seller does noe make asale mn apenod will eam 40 L_» Seller eamings = eatles pace - costog goods (eyweae) Produced . + You begin by elnoosing apnee and quality grade (i e- lower, medium nigher) Scanned with CamScannerPACT IL ke + We asking price is Known, Me quality is in question. \E allthe sellers were highly eticaland Awstworthy, ANe asKing Price would have been Feflective of quaity - * Most buyers are willing tovisk that the sellers ave #ustwortny. * Tis would evadicate heneed of an auditoy However, that is not tne Case OF ‘he realWovid. + Example, seiterone Selling low quality @ $n 26 5 Stvategic_misre presentation _ + Selley L will cripple theiv lousiness image and pevnars, Not have veeuwent business. —) Prase 3: Adding tne vevifier. * he vevifiey can maveet to sellers oy buyer. The buyers and sellers can each suemit apvivace bid for the vevigiers audit FEPOVE With the highest bid being the winner op me venfier's services . — sellev 3 bids fov the vevigev & then charges apvemium, Scanned with CamScannerOne Was AWAY OF NE seller's Cost structure , dhe only leaming stemmed fom the buver's rese\\ value stvcture * Sellers Know dhe cost structure indicative of - Buyers know thelv vecell value veal wovid . Ly either one can oniy estimate for other, + Setting price: $140 > Lowey grade 7): + Yesel\ value: $4D Bid -ask Resell vatue - SP = 4-0- \-40 ] = 2-6 -9bId- ask spyead. Y example 4 QV When bom setter 4 buyers + Selling price: $4.4 ( know Quality and price in + Resell Value 44 [ advance, Mavicet > Sociaity + Bicl- = ao i ‘ A-ASKs = Resel)_

What happens Whenbuyers did wot Know quality th advance? 7 Wpically ouyers worry sellers select ewer quatity Scanned with CamScanner| When re puvatio; i _cannor be ete Sellers who ne highev quay : + Strategic misrepresentacion wan in asimpie Jane. However, tunis counts for frauds the real word —9 ~nalicious Inrente fave i> -—Did any Seller(S) ty to establish’ a Yeputation for credibility aoout quality using fair prices ? \€ SO were Sellers rewarded? Laues, selleys wit Multiple YOuNdls o¢ Monesty were Sometimes rewarded. Howeveriney, ss AO nt receiv = — kuditey is g soiution Fulloenert: arecent cstwmave OfME ase vate OF fraud is@7. ) pev year in US companies wich conmputes +o our understanding thate Neca og auditing. cannor be evadicated And Grows Inne market tharis suseptivle to fraud. PaveB — Demand prauaiting and whe should pay ? who should select tne auditov? +The prospect of naving mixed Kind og Neterogenous uses they have bon similay and diggerent measures CE pergomance. — MBttimes the promisey paysthe Auditor Scanned with CamScanner* Client Management SEEMS to nave urderstaced ixcome, AasseB, and Over stclted Uabilities. Overstated Wtome , cKsels and understated UAloi ities. TW Studies: W® xi mney + Martin (aaa) _ Gi) Ninnis (2014) f ei tuciting teauce atin Financial Reporting : Nes ib aves. Puditing on Pre-qualitad neg eaminas Stabemeng. Kinney* Martin, ‘WY las + Asnton Waar) 2) Bei, Knechel + willingan (1442) @) Scanned with CamScanner oe 7 Mis~statements O¢cuv When:Date :. — overstated \44(2) 4 tort) Numbe ror <=? Undeverated 13 (2) 4 C31 (1) Eayninas Envoy. Does UAVEING Feduce-Companie SCS OF Capital?» * Audited firms have Significantly lower cost of debt * Audited firms Aefinively benefic fom thc from non-audited firms» ——~3 . Minnis (2014) Farell — Sample 2001 +e 2007 * Audited firms have_asignificanty lower cose of debt. (i- €. charged alower interest rate when they get alain) camp ared io unaudited te. 64 basis points lower interest race,on average. . Lenders place more veignt on audited Anancial information in setting the _martec rave. In other words, lenders believe audited finanual infpmiacon ts more reliable informanon:- “Only $193a FIG oukop 25,184 opted for an auctit Which is only 237. Scanned with CamScanner