Eliminating the Audit Expectations Gap - Essay Example

Introduction Auditors, particularly external auditors, play a critical role in the business world. With past and current financial scandals (such as bankruptcies or fraudulent activities) happening all over the globe, concerns have been raised on the role of the external auditors in preventing (or abetting) these scandals. Investors, government regulatory bodies and the public, in general, set such store in the auditing function that they feel cheated when the actual outcome do not meet the level of auditing that they are expecting. The result: auditors are blamed, alongside with top management, for the company's failures. This paper aims to discuss whether it is just to involve or blame the auditors for companies' failures or bankruptcies or even fraudulent activities. Are auditors really part of the blame-game or is the public just reacting on what they perceive as the auditor's failure to see and to report these bankruptcies and fraudulent activities' Is there really a gap on what the public expects auditors to do and to report and what the auditors are really tasked to do' Function of Auditing According to Robert K. Elliot (1998), the purpose of the audit is to provide assurance that the investors and the stakeholders can rely on the information presented by management in the company's financial statements and that they are not taking on undue financial risk when they invest in such a company. The auditors' report, the ultimate output of the external auditor, is meant to communicate the various claims of the auditors. These claims are: that the auditors have complied with the required auditing standards, that they are independent of the company they are auditing and that they are stating that the balances of the company (as presented in the accompanying financial statements) are free from material misstatements and are thus, reliable to the outside readers and users. Definition of Expectations Gap The website, www.abrema.net, defined expectations gap in auditing as "the gap between the auditors' actual standard of performance and the various public expectations of auditors' performance (as opposed to their required standard of performance)". The same website enumerated the various expectations of the public. These expectations include (but are not limited to the following): (1) that the auditors should have "prime responsibility for the financial statements" that they audited; (2) that auditors 'certify' the financial statements; (3) that when auditors provide a clean opinion, this means that the financial figures are accurate and free from error; (4) that auditors "should give early warning about the possibility of business failure; and (5) that auditors are "supposed to detect fraud". Another definition, according to Stanley Martens, is that this gap is "the difference between (1) what the public and other financial statement users perceive auditors' responsibilities to be and (2) what auditors believe their responsibilities entail" (2001). Mr. Martens went on to state that this expectation gap has been in existence for several years (even decades) now and may have stemmed from previous "well-publicized hearings" in a previous fraud case. Still another definition from Marianne Ojo is that is the expectations gap is "the difference between what users of financial statements, the general public perceive an audit to be and what the audit profession claim is expected of them in conducting an audit" (2006). In fact, there is also a distinction between the expectations of the audit profession of an external audit and the perception of the external auditor. Thus, even within the accounting profession, such an expectation gap exists. Components of Expectation Gap Www.abrema.net further divides expectations gap into the "requirements gap", where there is a difference between the actual performance of the auditor and what is required by the "current standards of the society" and the "feasibility gap", is the difference between "society's required standard of performance and various public expectations". On the other hand, according to Marianne Ojo, expectations gap has three components. The first one is "sub-standard performance"; that is, the auditor fails to perform quality audit and to comply with the required auditing standards. The second one is "deficient standards" which come from the auditing profession itself, and is not attributable to any individual external auditor. The last one is "unreasonable expectations" which stem from the expectations and perceptions of the public on the functions and purpose of the audit. With the above components, one can see that three things give rise to the expectations gap: (1) the public's perception and expectations; (2) the requirements of the auditing profession and (3) the actual audit performance of the external auditor. What the Accounting Profession Say The accounting profession, particularly those who are engaged in public practice, points out that these expectations (as stated in www.abrema.net) are not realistic. For one, as stated in the independent auditors' report, management is the one "primarily responsible" for the contents of the financial statements (www.abrema.net). Secondly, the auditors' report (and the work of the external auditor) provides only "reasonable assurance" (not absolute assurance) that the balances in the financial statements are not materially misstated. Thirdly, auditors only perform tests of transactions as it is not feasible to check each and every transaction of the company. The last is that assurance audit is different from a fraud audit and the former should not be taken as a guarantee that there is no fraud within the company since the audit tests performed are not designed to detect fraud. Regardless of what the external auditors and the accounting profession say, it cannot be denied that the expectation gap (if this exists) is a cause for worry within the profession. As Marianne Ojo pointed out, "the expectations gap is an issue for auditors as a greater "expectations gap" would lead to lower credibility, earning potential and prestige associated with their work. It is also an issue for the public and investors in particular since wealth creation and political stability in a capitalist economy depends significantly on confidence and accountability and external audit is supposed to provide such confidence and accountability" (2006). Evidences that Expectations Gap Exist Does the expectation gap really exist' It would appear that the answer is yes. According to Bernard Pierce and Mary Kilcommins, "there is now considerable evidence when external auditors' understanding of their role and duties is compared against the expectations of various user groups and the general public regarding the process and outcome of the external audit" (1996). The same sentiment was echoed by the Chief Executive Officer (CEO) of one of the Big4 Auditing Firms in an article in CFO.com in 2005. This CEO lamented that "investors may have unrealistically high expectations from auditors". The CEO also pointed out that "we've always had this expectation gap between what the auditor really can do and what the investing public wants the auditor to do, or wants the audit to represent." Such high expectations are felt by accountants in public practice around the world. The sources of evidence that expectations gap really exist are the various studies conducted by various individuals. One such study, conducted by Stanley Martens (2001), pointed out that "investors have higher expectations for various facets and/or assurances of the audit than do auditors in the following areas: disclosure, internal control, fraud, and illegal operations." The same study also revealed that auditors are expected to be the "public watchdogs" of the investors. Another source of evidence come from the accounting profession (particularly the auditing sector) itself. The accounting profession is now scrambling to introduce changes and new auditing standards that the profession thinks will lessen this gap. Various publications, auditing standards and exposure drafts have been introduced in the hopes of reducing, or even eliminating, this expectations gap. In 2008, the International Federation of Accountants issued the revised Code of Ethics for Professional Accountants, with the aim of providing guidance on how the accountants (particularly auditors) should conduct themselves when performing their functions. Evidence that expectations gap exists also emanates from the auditing firms. These firms are aware that such a gap exists and that the image of external auditing in the eyes of the public has been tarnished due to this gap. As such, they have taken steps to bridge the gap and increase positive public perception of the auditing profession. Such steps include coming up with stricter guidance on independence, audit documentation, audit reporting, audit policies and procedures and even fraud detection. Others have also sacrificed higher earnings by not offering both audit and non-audit services to the same client, just to avoid questions from the public on their independence and subjectivity. Conclusion In summary, there is indeed an expectation gap in auditing. Various studies, government regulatory bodies, auditing standard-setting bodies and even the auditing firms have affirmed the existence of such a gap. Whether the gap stems from misconceptions on the role and purpose of the external audit or whether this was brought about by sub-standard audit performance by the external auditor, it cannot be denied that the expectations gap is viewed as a cause for concern and an urgent issue that needs to be addressed by the accounting profession at the soonest possible time. If not addressed in a timely manner, this expectation gap will diminish (if it hasn't already done so) the value of the external auditor to the business world and the financial market and reduces the reliance placed on the external auditor's report. Thus, it is imperative that the accounting profession (and even the government regulatory bodies) work together to reduce or even eliminate this gap. References Elliot, Robert K. (December 1998) 'Audit Independence Concepts.' The CPA Journal. http://findarticles.com/p/articles/mi_qa5346/is_199812/ai_n21431513/pg_9/'tag=content;col1 (accessed April 13, 2009). 'Expectations Gap.' http://www.abrema.net/abrema/expect_gap_g.html (accessed April 17, 2009). Martens, Stanley C. (December 2001). 'Auditors' and Investors' Perceptions of the "Expectation Gap".' Accounting Horizons. http://www.allbusiness.com/accounting-reporting/ auditing/833216-1.html (accessed April 17, 2009). Ojo, Marianne (February 2006). 'Eliminating the Audit Expectations Gap: Myth or Reality'. http://mpra.ub.uni-muenchen.de/232/ (accessed April 17, 2009). Pierce, Bernard and Kilcommins, Mary (1996). 'The Expectations Gap: The Role of Auditing Education.' http://www.dcu.ie/dcubs/research_papers/no13.htm (accessed April 17, 2009). Taub, Steven (October 17, 2005). 'The Auditor - Investor "Expectation Gap".' CFO.com. http://www.cfo.com/article.cfm/5050964'f=TodayInFinance101805 (accessed April 17, 2009). Read More