Question

An investor is considering investing in one of two companies. The companies have very similar reported financial position and results of operations. However, only one of the companies has its financial statements audited. a. Describe what creates the demand for an audit in this situation. Include a discussion of how audited financial statements facilitate this investment transaction, and the effect of the audit on business risk and information risk

Answer 1

a. Audits add credibility to the financial statements of the company. The individual can invest in the company knowing that there is a low probability that the financial statements depart materially from generally accepted accounting principles. Audited financial statements facilitate this transaction by reducing risk related to the investment.

Specifically, audits reduce information risk--the risk that information used to make the investment decision is misstated--related to the financial statements. Audited financial statements do not directly affect business risk, which is the risk that the company will not be able to meet its financial obligations.

  Information risk is the risk that information upon which a business decision is made is inaccurate. when audited financial statement used this risk will reduced. and make right decision to investment .