Question

(Auditing Principles & Procedures)

Explain how audits reduce the asymmetry information between owners and managers.

Answer 1

As per Agency Theory, Owners are the Principals and managers are the Agents. An agency relationship arises when one or more principals (e.g. an owner) engage another person as their agent (or steward) to perform a service on their behalf. Performance of this service results in the delegation of some decision-making authority to the agent. A simple agency model suggests that, as a result of information asymmetries and selfinterest, principals lack reasons to trust their agents and will seek to resolve these concerns by putting in place mechanisms to align the interests of agents with principals and to reduce the scope for information asymmetries and opportunistic behaviour. Here, An audit provides an independent check on the work of agents and of the information provided by an agent, which helps to maintain confidence and trust. The independent check provides the ownwers with checked information about the correctness of the accounts prepared by the managers.