Discussion of Auditor's Loss Functions Implicit in Consumption-Investment Models

Abstract

I would like to comment on problems of the accounting and auditing profession which Scott's paper illustrates. My comments deal primarily *with the issue of defining management, auditor, and investor responsibilities, and relating Scott's conclusions to this issue. As I understand Scott's paper, he makes a clear differentiation between an auditor's responsibility and an investor's risk. He calls our.attention, for example, to the fact that in the usual consumption investment model, the rate of return on assets is dependent upon all the sources of variability surrounding the client firm's economic performance. It is only one of these elements, the errors in net income or, alternatively stated, the errors in the valuation of the balance sheet assets and liabilities, for which the auditor is responsible. If I understand Scott's auditor's loss function, it is dependent upon this distinction in responsibilities. This is proper, and I would agree with such a distinction of auditor responsibilities from investor responsibilities. Unfortunately, in practical application, this distinction is not always clear. When the true of an asset as evidenced by its subsequent realization differs from the reported asset value, is the difference the result of an error or is it the result of the other variables in economic performance which determine the risky rate of return? When slow-moving inventory is disposed of, is the difference between the original carrying value and the subsequent proceeds realized due to auditor error or to economic conditions and management performance? Unfortunately, there is a trend today to require the auditors to assume a portion of the investor's risk. When a business fails, a common question asked is who are the auditors who (without the benefit of the 20-20 hind-