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Chapter 1: Problem 15

Why do many businesses that are not regulated by the SEC elect to have their financial statements audited?

Short Answer

Expert verified
Many businesses not regulated by the SEC decide to get their financial statements audited to add credibility to their financial reports, to enhance the trust of stakeholders and to facilitate sound decision-making processes.

Step by step solution

01

Explanation of Key Terms

The term 'audit' refers to an independent examination of a company's financial statements. This is usually conducted by an accountant or an audit firm. The main goal is to add credibility to a company's financial reports. The Securities and Exchange Commission (SEC) is a government agency that oversees securities transactions, activities of financial professionals and mutual fund trading to prevent fraud and intentional deception.
02

Understanding the Benefits of Audits

One reason businesses choose to have their financial statements audited, is because it adds credibility to their reports. It assures that the financial statements adequately represent the company's financial position. This can be particularly useful when the company seeks additional funding or wants to attract investors.
03

Enhancing Stakeholder Trust

Another reason is to increase the confidence and trust of stakeholders. Whether these stakeholders are internal (like employees) or external (like vendors or bankers), audited financial statements can provide assurance that the company is financially sound, which can lead to better relationships and further support.
04

Facilitating Decision Making

Lastly, audited financial statements can greatly facilitate decision-making processes. Whether the decisions relate to expansion, investment, or simply improving financial management, having accurate and verified financial information can contribute to making educated, informed decisions.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Financial Statements
Financial statements are essential documents that present an overview of a company's financial activities. They include the balance sheet, income statement, and cash flow statement. These statements offer important insights into a company's financial health and performance.

Understanding financial statements helps businesses and stakeholders determine the value and stability of a company. They provide crucial information such as:
  • Assets and liabilities
  • Revenue and expenses
  • Cash flows
By having their financial statements audited, companies ensure that these financial records are accurate and free of material misstatements. This accuracy is vital for building trust among stakeholders and making informed decisions.
Stakeholder Trust
Stakeholder trust is an essential element for any business. Stakeholders can include employees, investors, customers, and suppliers, among others. They depend on accurate financial information to make their own decisions regarding their relationship with the company.

Audited financial statements act as a seal of approval on the accuracy of a company鈥檚 financial reports. This increases stakeholder trust by confirming that the company's management is transparent and accountable. Enhanced trust can lead to:
  • Stronger business relationships
  • Greater investment opportunities
  • Improved reputation in the market
Overall, having audited financial statements assures stakeholders that the company is reliable and financially healthy.
Decision Making
Effective decision-making is critical to business success. Good decisions are based on accurate information, which is why audited financial statements are so valuable.

These documents offer verified data regarding a company鈥檚 financial performance, aiding in the evaluation of areas such as profitability, liquidity, and operation efficiency. With precise information:
  • Management can plan strategic initiatives.
  • Investors can assess potential returns.
  • Creditors can evaluate creditworthiness.
Audits help ensure that all financial information is correct and reliable. This leads to more informed and strategic decision-making, thereby promoting long-term business success.
Securities and Exchange Commission (SEC)
The Securities and Exchange Commission (SEC) is a crucial body that ensures fair and transparent functioning of the financial markets. Though not all businesses fall under its regulation, the principles it upholds are universally beneficial.

The SEC focuses on protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. Key responsibilities include:
  • Regulating securities transactions
  • Overseeing financial professionals
  • Preventing fraud and deception
Even for non-SEC-regulated businesses, adhering to SEC-like auditing standards improves market credibility and can enhance investor confidence.
Independent Examination
An independent examination is a cornerstone of the auditing process. It involves an unbiased review of a company鈥檚 financial statements by a qualified external party such as an audit firm.

This process ensures that there is no conflict of interest, as the auditor is not involved in the day-to-day operations of the business. Benefits of an independent examination include:
  • Enhanced accuracy and objectivity
  • Identification of errors or fraud
  • Increased reliability of financial reports
Through independence and objectivity, such examinations give a credible stamp to financial statements, reinforcing the trust and confidence of all interested parties in the financial health of the business.

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Most popular questions from this chapter

Assume that you are employed by a law firm as a staff accountant. The firm has purchased four season tickets for the Colorado Rockies (a baseball franchise). Your boss, one of the partners in the firm, has offered individual tickets to you, but also asked you to pay \(\$ 10\) for each ticket. since they are \(\$ 14\) tickets, you are happy to get a bargain. You are even happier to get a chance to go to the game because tickets are in short supply. Next month, while reviewing the financial statements for your department, you are unable to find the \(\$ 40\) of cash receipts for these tickets. since you know that the firm has purchased these tickets, you wonder what happened to your \(\$ 40\) payment. After discussing this matter with several other junior staff members who had also paid the partner for tickets to Rockies' games, you guess that the partner has pocketed the money and not reported the revenue to the other partners. a. What should or would you do? Why? b. Would it make any difference if the firm were a single proprietorship and not a partnership? Why? c. Would it make any difference if all the partners followed the same procedure and pocketed the ticket money? Why? d. Is this an issue that should be reported to any other parties such as the Internal Revenue Service, the State Auditor, or the Attorney General? Why?

The accounting profession considered increasing its required disclosures and the type of information that is required from public companies. The following paragraphs appeared in The Wall Street Journal (August \(26,1993,\) p. \(A 4\) ): A key accounting group calls for a sharp increase in the amount of information companies must disclose in their annual reports. The prospect alarms corporate financial officers. If adopted, the recommendations could force companies to change the way they figure profits. It could make them disclose more data about the competitive pressures they face. They could transform the auditor's report from the current boilerplate message to a longer and much more revealing statement about the company's health. Information about changes in the firm's product prices in response to competitive price shifts would be required. The new requirements would favor more segmenting of data so that sales and profits for each company unit would be shown. More meaningful breakdowns of company data would be required. Much more data would be required from larger companies than from small companies. Write a short memo to the key accounting group noted in the article from the perspective of a company president, responding to the proposed changes in accounting disclosures.

Go to the home page of the United States Securities and Exchange Commission (SEC) located at: a. Briefly describe the role of the SEC. Which laws does it enforce? b. How many commissioners sit on the board of the SEC? Who is the current chairperson of the SEC? Who has the authority to appoint the chairperson? c. List three cities where regional or district offices of the \(\operatorname{SEC}\) are located. (Hint: Washington, D.C., is not a regional or district office.) d. Identify the principal divisions of the SEC.

What considerations are used by the FASB in setting GAAP?

Which of the following transactions or events should be recorded in the firm's accounting records? Explain your answer. a. Cash is received from a sale previously made on credit. b. A year after obtaining a bank loan, a business owes the bank interest charges. These charges remain unpaid at the end of the year. c. A professional baseball player, hitting \(.425,\) expects a bonus under his in centive contract for leading the league in hitting for the season. The bonus was "pegged"at \(\$ 1,000\) for every point that he exceeded the batting target of \(.375 .\) How much should the baseball player record in his checkbook at the end of the season? d. An employer and a labor union sign a new collective bargaining agreement. e. An item of factory equipment is removed from service. The item has a book value of \(\$ 10,000 .\) It is determined that the equipment is worthless.
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