Note: think about how the suggestion below reflects the discussion in your text about the explanatory theories for auditing (theoretical frameworks in Chapter 1).
Financial statements are frequently relied on by outside parties such as shareholders (also called stockholders) and banks (or other providers of finance) when making decisions about an enterprise. Should equities (also called shares or stocks) be bought or sold? Should a long-term loan be given – is it likely that it can be repaid along with the interest charges?
However, financial statements are a series of representations of the management of the company. This is the origin of the financial report assertions (sometimes you might read about these as “management assertions”). As such, these statements may not necessarily be fairly presented – this is called the risk of material misstatement and it would be useful for now to read ASA 200.13(n) and A36-A43) You will learn more about them in later topics – for now, start to appreciate that auditing has its own technical language that you are going to need to become familiar with! Material misstatements may exist in the form of errors, irregularities, or illegal acts. The management might, for example, have an insufficient knowledge of generally accepted accounting principles (for example, AASBs) to produce appropriate statements. Human error or bias is also possible in the gathering and reporting of financial information. In addition, the management may have fraudulently manipulated the data in hopes of achieving some objective.
Outside parties are aware that the financial information produced by a company and its management may not always be reliable (for an initial discussion of this see ASA 200.A30 and ASA 500.A35-A38). Hence, to add credibility to this reporting process, independent experts are retained to audit the financial statements and test the underlying accounting records. These auditors then issue an opinion for the benefit of outside parties as to the fair presentation of the financial statements in conformity with generally accepted accounting principles (that is, they are fairly stated or they are not – in which case the opinion explicitly states why they are not). This added degree of assuredness allows decision-makers to rely on reported financial information.