The Audit Expectation Gap - Example

Running header: Audit Expectation Gap Student’s name: Instructor’s name: Subject code: Date of submission Define and explain the concept of the audit expectation gap Introduction For many years, external auditors have increasingly found themselves being criticized and even at the center of litigation owing to their work as auditors. However, the criticism and litigations reached unprecedented levels since the year 2001 with the unheralded collapse of big corporates such as WorldCom and Enron which was followed by the collapse of their giant auditor Arthur Andersen. It worth noting that much of the criticism and litigation against the auditors stem from the failure of auditors to meet the public’s expectation for them. This may result from the public expectations on auditors being unreasonable or they may be reasonable though the auditors’ legal and professional requirements do not meet the expectations. To a very little extent, auditors may also fail to perform their responsibilities satisfactorily. Irrespective of the cause however, the expectation and hence resultant public’s perception of auditors owing to public dissatisfaction with auditors’ performance greatly undermines the confidence that the public has on the audit function and the audit profession at large (Glen and Jerry, 2011). This paper examines the concept of the audit expectation gap. In so doing, the paper also presents the results of a research carried out in the local community to establish whether audit expectation gap actually exists. It will be concluded that there is an expectation gap between what the public views the role of auditors is Vis avis what their actual role is in auditing a firm’s financial statement. As such, it will be concluded that there is need for public education on the actual role of the auditors in auditing the firm’s financial statements with an aim of reducing the expectation gap and hence improving public confidence in auditors as well as their audit work. The meaning of audit expectation gap The term audit expectation gap first found its use in the 1970s though issues related to it had been in existence even before. Many authors have given different definitions of audit expectation gap though literature acknowledges the existence of the problem of audit expectation gap. According to Datuk (2007), audit expectation gap refers to the disparity between the expectations on the duties of the auditor by the public Vis a Vis the scope of audit as well as the auditors own understanding of their roles and responsibilities. As such, the public has gone on to place the responsibility of catching wrong doers in the company in the auditors’ shoulders (fraud detection). According to Jabez (2011), the public has had the misconception that it is the duty of the auditors to prepare the company’s financial statements while they see the management’s role as being that of ensuring that the financial statements have been prepared in accordance to the relevant accounting standards and other statutory and regulatory requirements. This is contrally to the auditor’s actual responsibility which is that of expressing an opinion regarding whether the company’s set of accounts give a true and fair view of the organization and that they have been prepared in accordance with the relevant financial reporting framework. Thus expectation gap can be defined as the difference in expectations on the expected levels of performance as understood by both the auditor and the users of financial statements. Audit expectation gap could arise from a number of sources including performance implying the level f performance that the public would expect and the actual auditor performance. A number of factors contribute to audit expectation gap including the subjective nature of terms and concepts related to auditing for instance true and fair view, materiality, reasonableness, reliability, adequacy and relevance that have no precise definition in auditing standards but are left to the judgment of auditors. Lee (2008) attributes audit expectation gap to the complicated nature of the function , the retrospective evaluation of auditors performance, conflicting roles of the auditor, time lags in responding to the ever changing expectations as well as the self-regulation process adopted by the profession. The expectation gap could also be influenced by the ever changing audit objectives as well as roles of auditors. In this regard such contextual factors as critical historical events, social economic environment, technological developments or even courts decisions come to play. In addition, lack of public awareness and hence failure by the public in appreciating the limitations and nature of audits is also to blame for audit expectation gap. Thus, there is need for the profession to take steps aimed at increasing public knowledge on auditing and the profession in a bid to reduce the audit expectation gap. Evidence that confirms or refutes the existence of an audit expectation gap in Australia In a bid to establish evidence that confirms or refutes the existence of an audit expectation gap in Australia, I conducted a small research. The research involved asking five people about what they think it means to have the financial statements audited. In a bid to help keep their answers on track, I asked them what they think the difference would be between audited financial statements and those that have not been audited. In so doing, I avoided asking people with some accounting and auditing background such as accountants, auditors and accounting students. They mainly included friends and relatives and neighbors who have no background of accounting. I then summarized the results of my research in a table format as shown below. Note that each respondent was given a number with details of their occupation being taken. Their answers to my question were then written in the last column of the table as shown. Respondent Occupation Perception of audited financial statements 1 Police man Although I have very little knowledge about accounting, I know that audited financial statements are prepared by accountants who are not employees of the company but are prepared by auditors who are contracted by the company to prepare the financial statements to be presented to the company owners. On the other hand, unaudited financial statements are prepared by the company’s accountants. I also know that it is very hard for fraud to occur in an organization that have its statements audited. This is because auditors are supposed to detect any fraud that might have taken place in the company. If someone has stolen the company’s money, the auditors will obviously reveal this and the person will be prosecuted. 2 Retired Nurse I know that audited financial statements are very bulky. I have some shares in a number of companies and they send us their audited financial statements. The one that has the least number of pages has 74 pages. I rarely spend time reading them since I even don’t understand why financial statements have to contain so many pages. On the other hand, the unaudited financial statements prepared by my husband are only a few pages and so you don’t have to waste a lot of time reading them. I also understand that audited financial statements do not contain any errors since auditors are employed to detect and correct all the errors that the accountants of the organization may have committed. If one was looking for an investment, he we would be better off by looking at the financial statements of a company since they show the actual profits that the company has made as well as its wealth in terms of the property the organization owns and the debts it has to pay. However, the amounts contained in unaudited financial statements may not be correct since errors will not have been detected and corrected. 3 Sales girl I know that unaudited financial statements are prepared by the company’s accountants. These accountants may contain a lot of errors and sometimes people may have colluded to steal the company’s money. Mostly they are prepared by small companies. In a bid to eliminate errors and detect whether the accountants have defrauded the companies money or other resources, they employ external accountants or auditors to look at the financial statements. In other words, they act as markers or examiners for the work done by the company’s accountants. If the accountant has made any errors, the auditors will detect them and correct them. If any of the company’s items has been stolen or misappropriated, the auditors will perform some procedures and will detect this. As such, I understand the audited financial statements as being perfect or correct in that all errors have been corrected and if there is fraud, it has been reported to the management who will take the necessary action. The auditors also write a letter to the shareholders telling you whether the financial statements are correct or not. If they have not raised any issue, then you can rely on the financial statements to decide whether or not to invest in the company. 4 Farmer When a company prepares its financial statements, they are called unaudited financial statements. However, when they are given to the auditor to investigate whether what they represent is true, they are called audited financial statements. The auditor examines the financial reports by examining all the relevant documents as well as the methods used in calculation to see whether they are in line with the laid down rules by the professional regulators. If they meet the rules and regulations, the auditor will attach a letter to the report saying that the financial statements have been prepared in accordance to the rules. Also, the auditors will say whether the financial statements actually present a true picture of what they represent. Sometimes when shareholders or management suspect that fraud has been happening in the company, the auditors may be called in to investigate. 5 An officer with the immigration department Unaudited financial statements are financial statements prepared by the auditor although they have not followed the laid down accounting standards. On the other hand, audited financial statements are the financial statement that the auditor prepares and follows the accounting standards in their preparation. In this regard, unaudited financial statements may contain errors since they do not follow accounting standards. On the other hand, audited accounting standards do not contain errors. The auditors also detect any fraud that might have occurred in the company and recommend further action to the board. As such, audited financial statements are free of fraud. The following interviewees also participated in the research. However, they stated that they have no idea what the difference between audited and unaudited financial statements is. Non-respondents Occupation 1 Security guard 2 Morgue attendant 3 Teacher 4 Farmer Results analysis As can be seen from the results, a total of nine people were interviewed of which four people did not have any idea about auditing and hence they were excluded. The results indicated differing level of knowledge on what audited accounts are hence indicating differing level of expectations on the auditors. Of all the respondents, four of then placed the responsibility of detecting errors and fraud to the auditors. It is also worth noting that two of the respondents thought that it is the auditors who prepare the financial reports while one respondent thought that even the unaudited financial statements are prepared by the auditors only that they do not follow the accounting standards and principles. Majority of the respondents also indicated their expectations that the audited accounts are clean and that they contain no error or fraud with one respondent indicating that the auditors’ work is to examine and collect what the company’s accountants have done. Though the five respondents have idea what auditing is and its role, only respondent 4 seem to have knowledge on the actual responsibilities of auditors. From the results therefore, the following discrepancies from what the public expects Vis avis the auditors’ work and hence audit expectation gap can be revealed (Albert and Baah, 2013) What the public expects The reality Auditors are expected to take the responsibility of the financial statements The preparation and fair presentation of financial statements in accordance to relevance standards is the work of management That auditors certify the financial statements Auditors only express their opinion on the accounts based on the procedures they carry out That auditors are able to guarantee the accuracy of the statements The auditors only obtain reasonable assurance on the financial statements being free from material misstatements Auditors detect and correct errors Though in their work they may come across errors, auditors are not entirely responsible for error detection and correction Auditors detect fraud Auditors only identify risks existing owing to fraud that could cause material misstatements in the accounts Conclusion From the results above, it has been revealed that many people in the society are aware of the role of auditing. However, majority of them seem to place a lot of expectations on the auditors in regard to audited financial statements. As such, it can be revealed that audit expectation gap exists in Australia in a number of ways. First, majority of the public think that it is the auditors who prepare audited financial statements. They also place the responsibility of detecting and correcting errors and fraud on the auditors. Consequently, they expect audited financial statements to be perfect. Owing to the huge audit expectation gap that exists in Australia, there is need for the accounting professional body to increase efforts aimed at educating the public on the role of auditing, auditors’ responsibilities and the purpose of audit (Albert and Baah, 2013). This way, there will be better understanding and hence reduction in audit expectation gap. This way, the relationship between auditors and the public will be enhanced. References: Glen, L& Jerry, L2011, Perceptions and misperceptions regarding the unqualified Auditor’s report by financial statement preparers, users and auditors, Accounting Horizons, vol.2, no. 4, pp. 659-684. Jabez, G2011, The role of the auditor, London, Rutledge. Datuk, L2007, Auditor size and quality, Journal of accounting and economics, vol. 3, pp. 183- 199. Lee, P2011, Auditors and investors perception of the expectation gap, Accounting Horizons, vol, 15, no. 4, pp.80-92. Albert, A& Baah, K2013, An assessment of audit expectation gap in Ghana, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol.4, no. 4, pp. 112-118. Read More