The Demand for Auditing and Assurance
In view of the fact that many of the largest companies spend millions of dollars each year for their annual audit, it is worth asking why an entity would decide to spend so much money on an audit?1 Some might answer that audits are required by law. While true in cer- tain circumstances, this answer is far too simplistic. Audits are often utilized in situations where they are not required by law, and audits were in demand long before securities laws required them. In fact, evidence shows that some forms of accounting and auditing existed in Greece as early as 500 BC.2 However, the development of the corporate form of business and the expanding world economy over the last 200 years have given rise to an explosion in the demand for the assurance provided by auditors. In 1926, several years prior to the Securities Acts of 1933 and 1934, which required audits for publicly traded companies in the United States, 82 percent of the companies on the New York Stock Exchange were audited by inde- pendent auditors.3
Principals and Agents The demand for auditing can be understood as the need for accountability when business owners hire others to manage their businesses, as is typical in modern corporations. Until the late 18th and early 19th centuries, most organizations were relatively small and were owned and operated as sole proprietorships or partnerships. Because businesses were generally run by their owners and borrowing was limited, accountability to outside parties often was mini- mal. The birth of modern accounting and auditing occurred during the industrial revolution, when companies became larger and needed to raise capital to finance expansion.4 Over time, capital markets developed, enabling companies to raise the investment capital necessary to expand to new markets, finance expensive research and development, and fund the buildings, technology, and equipment needed to deliver products to market. A capital market allows a public company to sell small pieces of ownership (i.e., stocks) or to borrow money in the form
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1See G. L. Sundem, R. E. Dukes, and J. A. Elliott, The Value of Information and Audits (New York: Coopers & Lybrand, 1996), for a more detailed discussion of the demand for accounting information and auditing. 2G. J. Costouros, “Auditing in the Athenian State of the Golden Age (500–300 BC),” The Accounting Historian Journal (Spring 1978), pp. 41–50. 3G. J. Benston, “The Value of the SEC’s Accounting Disclosure Requirements,” The Accounting Review (July 1969), pp. 515–32. 4Also see M. Chatfield, A History of Accounting Thought (Hinsdale, IL: Dryden Press, 1974), for a discussion of the historical development of accounting and auditing. See D. L. Flesher, G. J. Previts, and W. D. Samson, “Auditing in the United States: A Historical Perspective,” ABACUS (2005), pp. 21–39, for a discussion of the development of auditing in the United States.