1.4 The Role of Auditors

External auditors assist companies in overcoming the challenges posed by information asymmetry by improving the quality of the information they provide. Companies engage auditors to provide information users with assurance that the information is reliable. Auditors provide this assurance by performing rigorous tests and other procedures to identify any misinformation. When auditing financial statements, auditors seek to identify any misstatements (i.e., inaccuracies) that would be material to users of the financial statements. In audits of internal control, auditors seek to identify any weaknesses in a company’s system of controls that could allow material misstatements to go undetected. As you have likely learned in previous accounting courses, a misstatement that is material is one that is large enough to impact the decisions of the average financial statement user. Most investors would not care much about a relatively small inaccuracy in the financial statements, but they would be more concerned about a misstatement that significantly changes the amounts reported and the financial ratios calculated using the financial statements.

Assure Reliability of Financial Statements

By designing and carrying out a rigorous process for evaluating the quality of information, auditors provide significant assurance to financial statement users that the information can be relied upon. To illustrate this, consider the example in the previous section about purchasing a used vehicle. In that example, the only information you (i.e., the buyer) had was provided to you by the seller. Information asymmetry exists because the seller has more and superior information about the true condition and value of the vehicle. Consider how the dynamics of the market would change if you could verify the seller’s information by taking the vehicle to a trusted mechanic for a thorough inspection. The ability to verify information changes the dynamics of the market in several ways. For example, sellers would be less likely to lie if they knew you could discover the truth by having the information verified by a trusted mechanic. Thus, the mere existence of the mechanic, whose role it is to verify the seller’s information, can improve the quality of that information. In addition, the mechanic who is inspecting the vehicle may find problems that the seller was unaware of. In this scenario, the quality of information is improved for both the seller and the potential buyer. In the context of financial statements, companies that make unintentional errors in compiling or reporting financial information can benefit when an auditor discovers the unintentional error, allowing it to be corrected before it is disclosed to the public. In addition, management is less likely to provide misleading information knowing that the company’s financial statements will be subjected to thorough testing by skilled auditors.