Chap001 - CHAPTER 1 AN INTRODUCTION TO AUDITING AND...

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CHAPTER 1 AN INTRODUCTION TO AUDITING AND ASSURANCE SERVICES Answers to Review Questions 1-1 There is a demand for auditing in a free-market economy because the agency relationship between an absentee owner and a manager produces a natural conflict of interest due to the information asymmetry that exists between the owner and manager. As a result, the agent agrees to be monitored as part of his/her employment contract. Auditing appears to be the most cost-effective form of monitoring. The empirical evidence suggests auditing was demanded prior to government regulation. In 1926, independent auditors audited 82 percent of the companies on the New York Stock Exchange. Additionally, many private companies and municipalities not subject to government regulations such as the Securities Act of 1933 and Securities Exchange Act of 1934 also demand auditing. 1-2 The agency relationship between an owner and manager produces a natural conflict of interest because of the information asymmetry that exists between the manager and the absentee owner. That is, the manager generally has more information about the "true" financial position and results of operations of the entity than the absentee owner does. If both parties seek to maximize their own self-interest, it is likely that the manager will not act in the best interest of the owner.
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