Assurance services are intended to decrease information risk for the user of the assurance service. In capital markets, information risk leads to higher required rates of return, which can hamper capital investment and impede economic growth. Investors, whether public or private, depend on assurance services—in particular auditing services—to gain comfort that the financial information provided by the issuer or borrower (usually a company), has been prepared in accordance with the relevant criteria such as U.S. GAAP and is trustworthy.
Investors are essentially making a bet on the future business prospects of a given company. They develop a thesis about the future of a company by first establishing a “baseline” using historical information and then making assumptions about the future. To do so with any level of confidence, they must trust that the historical financial information is reliable. Financial statement audits are intended to provide this level of confidence.
In addition to having confidence in the historical financial information, investors must also be comfortable that the management team has the appropriate controls in the place to maintain the level of accuracy and transparency that have come to rely on in the past. An audit of internal controls is an assurance service designed to meet this need. A company with poor internal controls should expect to have a significant information risk premium priced into its stock or bonds, which makes raising capital very expensive.
Audits are generally performed by CPAs, but not all CPAs perform audits. The majority of CPAs perform some sort of accounting service and accounting should be distinguished from auditing. Put one way, accountants make the entries, while auditors make sure the entries are made correctly in accordance with the appropriate criteria. Both functions are important and, when done properly, lead to a highly transparent and investable economy where capital can flow efficiently....