Academic journal article Journal of Accountancy

The Future of Audits

Academic journal article Journal of Accountancy

The Future of Audits

Article excerpt

Auditing creates tremendous economic value. Companies benefit from a reduced cost of raising capital; if their financial statements were unaudited, they would have to pay more. That is, for debt, they would pay higher interest rates; for equity, they would have to offer their shares at lower prices. If a company with $10 million in total capitalization (debt plus equity) had to pay 1% to 3% more for capital without an audit, having an audit would save between $100,000 and $300,000. For a company with $10 billion in capital, the comparable annual savings would be $100 million to $300 million!

Despite this past and present value, we must be concerned about future value, especially because information technology--increasingly a staple in the financial community--causes great change. Information technology provides alternative information sources to those who traditionally have relied on financial statements and dramatically changes all aspects of preparing, auditing and using financial statements. Although these changes pose serious threats to the economic viability of auditing, they also offer CPAs extraordinary opportunities to strengthen the audit function. This article outlines the possibilities.

THE THREAT TO AUDITORS

The increasingly pervasive use of information technology and its growing power threaten auditors in several ways. The first threat relates to the relative importance of financial statements to investors (see exhibit 1, page 76). Early in the century, financial statements represented a large part of the information available to an enterprise's debt and equity investors. As accounting principles improved, the value of financial statements also improved. But, facilitated by information technology, other sources of relevant information are increasingly available; for example, investors can get up-to-the-minute data about companies through public and proprietary databases without waiting for quarterly or annual reports. Moreover, information technology has created new ways for businesses to become more competitive (for example, continuous quality improvement, cycle-time reduction and enhanced vendor and customer relations), the effects of which are not reflected in financial statements. Thus, financial statements describe modern companies less well than they described industrial-era companies. Because the audit franchise is tied to financial statements, CPAs' "market share" for investor-relevant data has been declining.

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Another threat derives from the fact that financial statements are such a highly compressed version of what happened to an enterprise during the year. An analyst is presented with financial statements that contain, for a typical large company, on the order of 100,000 characters of information, whereas that company's operations database might have on the order of 100 billion characters. Figuratively, the analyst using financial statements as an information source is forced to look at a company through a keyhole that permits only a small part of available information to be seen. And this despite the fact that analysts have access to enormous and growing computing power--sufficient to analyze the vast corporate databases for themselves.

The American Institute of CPAs special committee on financial reporting found investors and creditors were dissatisfied with this impoverished view and were developing ways to circumvent the keyhole effect. Some analysts met with company officials to obtain additional information. (The special committee's survey of public companies discovered many disclosed to at least some investors additional information, such as data on major investments, strategic information, operating information and financial forecasts.) From the auditor's perspective, these collateral information flows escape audit.

The audit also is threatened by the fact that annual printed financial statements may be destined for history's scrap heap because information technology permits far more frequent and timely reports. …

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