An Introduction to a Conceptual Framework of Assurance

Transcription

1 An Introduction to a Conceptual Framework of Assurance Prof. Joshua Onome Imoniana EAC0229

2 Assignment Respond to the following: 1. Think of a specific example of assurance other than f/s audits. 2. Why does this form of assurance exist? Is it required through regulation or is it demanded by the marketplace? 3. Who pays for the assurance? The truster or the promiser? Discussion Class today

3 Announcements Pick your teams: (max 3, min 2) need 8 teams One team member provide me with all members by either: Those who do not inform me will be randomly assigned by me I will also combine any partial teams Group talk schedule will be posted on the course website soon.

4 Today s Objectives Why does society need assurance services? What can we learn about the demand for assurance services from today s reading?

5 The Market Game

6 Market Game This is a market of buyers & sellers. Selling teams begin by choosing a price & quality grade. I will collect these decisions & record them. Each team of buyers have an opportunity to purchase from one team of sellers at the listed grade & price. The grade can be one of the following levels: (1) Lower; (2) Middle; and (3) Higher. Better grades cost more for sellers to produce & are worth more to buyers.

7 Market Game Each buyer can purchase only one unit per period. Each seller can sell up to two units per period; the second unit costs $1 more than the first unit; unsold units incur no cost. Buyers earn money by purchasing products at a price below their value, which depends on the quality grade. Buyer Earnings = Value for Grade Purchased - Seller s Price Seller Earnings = Sales Price - Cost of Grade Produced

8 Market Game When all sellers have selected their prices & grades, I will collect these sheets and enter the prices and grade on the record table. Cards will be dealt to the buyers at the beginning of each round to determine the first buyer to make a purchase decision. After selling a unit, the seller can sell an additional unit at a cost of $1 more; if the additional unit is sold, it must be at the same price & grade as the first unit. Use the table on your sheet to calculate your earnings each period.

9 Market Game We will have a total of 8 or 10 teams: Four Buyers or Five Three Sellers or Four One Observer I will monitor the market to ensure that all teams follow the rules. At the end of each round, we will discuss the trading results & the behavior of our market. Any Questions?

10 Market Game Now let s begin! Sellers & Buyers Remember not to discuss your decisions with other sellers & buyers.

11 Market Game: Modification Grade Quality will Now be Available Only After Trading is Completed

12 Market Game Verifier Team: The Observer team will now be selected to be the Verifier Team You can market your services to Sellers or Buyers. Sellers: Verifier will post an audit report before trading begins for your team, but not for the other sellers. Buyers: Verifier will issue you an audit report about actual quality for each of the four sellers, but not for the other buyers. We will hold a public auction Highest Bid Wins

13 Market Game: Debriefing What happened? What does this have to do with assurance?

14 Market Game: Debriefing When both sellers and buyers know quality and price in advance, market forces move toward socially optimal levels of production for different quality levels. Even when both sellers and buyers know quality and price in advance, society might be better off if a grade other than highest quality is traded.

15 Market Game: Debriefing What happened when buyers did not know quality in advance? When quality is not readily observable to buyers ahead of time, they will become more reluctant to engage in trade. Did any seller try to establish a reputation for credible signaling about quality (by having fair prices)? If so, were sellers rewarded? Yes, sellers with multiple rounds of honesty were sometimes rewarded But some that weren t rewarded tried to dupe buyers in later rounds (honest behavior was fleeting)

16 Market Game: Debriefing When quality is not known in advance, the lower number of trades that do occur typically will include some buyers getting ripped off. Because buyers may still trust the seller to not sell lower quality products at prices typically associated with higher quality products. When reputations cannot be established, sellers who want to provide honest combinations of price for quality produced will pull out of the market. Sellers fear that buyers will have big doubts about quality.

17 Market Game: Debriefing The only sellers who hang around are those who want to rip off buyers. But, buyers realize this threat and so do not trade (Lemons Market). Sellers willing to sell low quality products at low prices stick around too & buyers are willing to trade with them. Do you think public companies could develop a reputation for accurate or fair reporting to an extent that the market no longer demands an audit?

18 Market Game: Debriefing What happened when we had a team of independent verifiers that could verify quality for a fee? How much should sellers and/or buyers be willing to pay for the verifier? Who would be most likely to pay the verifier? Does the market demand the highest level of financial reporting quality? Why or why not?

19 Who Pays the Verifier and Why? Promiser Knower/ Verifier Truster What arrangement exists in the financial reporting context? WHY? Hint: Think of other verifiers who pays?

20 Today s Objectives Why does society need assurance services? What can we learn about the demand for assurance services from today s reading?