The Function of Auditing

What is the function of auditing, and why is it important? In recent decades there have been a series of financial disasters, affecting thousands, if not millions, of people, many of whom have lost their life savings, and which have destroyed once successful companies, further damaging the economy. Enron, WorldCom, Parmalat and Lehman Brothers are oft-cited examples of what can happen when auditors are alleged to have failed at their job. The function of auditing is not to prevent those disasters, but to help ensure that stakeholders have reliable information on which to base their decisions and possibly foresee how such disasters may arise. Where that information later proves to be unreliable, auditors may be implicated for failing in their duties, allowing bad situations to get worse, and the damage caused by financial reporting misstatements to carry on. In this book we cover some of the most important issues in twenty-first century auditing, with a focus on what is known from research, and what can be done to improve auditing. In this first chapter, we examine the most fundamental auditing issue, namely the function of auditing. Understanding the function of auditing is helpful in understanding all of the other issues raised in this book. We explore economic reasons for auditing, which provide numerous explanations why auditing developed and why it can be of value to companies, their managers, and investors, regardless of whether it is required by regulations. The explanations discussed are the information role of auditing; agency theory; insurance; organizational control; as confirmation (of previously released information); and as part of risk management. We also examine why it is commonly found that auditing is compulsory, including both public interest and pubic choice explanations for mandatory auditing