Audit Expectation Gap in Auditor Responsibilities - Assignment Example

FINANCIAL SYSTEMS AND AUDITING Question The expectation gap usually refers to what the public expects or needs and what auditors can reasonably do. Users of financial reports expect auditors to provide assurances concerning material fraud, irregularities and the viability of the business and its management. Discuss the following questions with regard to the expectation gap: a) In your opinion, what are the major factors affecting the expectation gap between users of financial statements and auditors? Auditor’s independence is the primary factor affecting expectation gap between users of financial statements and auditors. Without auditor’s independence, the opinion of auditor is suspect and it is assumed that there is no need for external auditors (Salehi, Mansoury and Azary). The public also perceives the independence of auditors and expect higher audit quality and performance. The perceived independence of auditors in the mind of public and actual independence given to the auditors can directly influence the expectation gap. Unreasonable expectations of public may also influence expectation gap by widening it. Educating users of financial statements about auditor’s role is important through annual shareholders’ meeting and other such events (Ojo). Through interviews from various firms, Oje found that conflict between auditors’ dual role and reporting accountants can also influence expectation gap. The higher the conflict the more is the expectation therefore, a great focus is being by companies towards defining clear roles of auditors and accountants. The image of the company and auditors can also influence the expectations of users of financial statements and the better the image, the more are the expectations. The higher expectations of users also influence the gap (Mahadevaswamy and Salehi). The increasing auditor’s role has and changing professional standards have also influenced the public opinion and their expectations have increased. On the other hand, an auditor’s lack of interest in the expectations of shareholders and other users of financial statements can also appear as a determinant of expectations gap (Epstein And Geiger). Therefore, the perceived independence of the auditors, unreasonable expectations of users, higher expectations of users because of good of company or auditors, conflict between auditor’s role and accountants’ role, increasing auditors’ role and changing professional standards and lack of interest of auditor in understanding the expectations of users are the major factors affecting expectation gap. b) Auditors’ responsibilities have increased over recent years. In your opinion, to what extent has public pressure affected the developments in auditor responsibilities? A significant number of publically owned companies and the increasing awareness of public have largely influenced the developments in auditors’ responsibilities. The auditors which were previously responsible to assess the financial reporting of companies are today facilitating the users of financial statements in different ways. In my opinion, public pressure did play an important role in developing auditors’ responsibilities however, it should not be considered as a sole determinant. The public pressure to increase transparency, quality of information etc did insist the financial standard boards to clearly define the roles of auditors and to enhance their independence. Giacomino considers developing role of auditors as a way to reduce the expectation gap. Moreover, he has also thrown light to the fact that FASB has been facing increased pressure from academicians, government, practitioners etc. On the other hand, SAS considers only reasonable public demand as a positive contributor towards the development of auditors’ role. SAS 110 highlights that whilst fulfilling the public demand the role and responsibilities of auditors should not be seen to cave into public pressure and it should also not increase the liability of auditors than necessary (Wallis). Therefore, to reduce the gap between expectations of public and auditors’ performance, reasonable concerns raised by public have been playing a significant role in developing auditors’ role. c) Discuss the role and performance of external auditors in detecting corporate fraud, one of the areas in which they are subject to continuing public criticism due to society’s ever-increasing expectations of auditors. SAS 110 (1995) clearly states that auditors are not responsible to prevent fraud and error and directors of the company are responsible for it however, they are responsible to plan, perform and analyse their work to ensure reasonable expectation of detecting material misstatements and to determine whether they are caused by error or fraud (Wallis). The statistics provided by Resolution Trust Corporation highlights that 40% of savings and loans failures are because of fraud and auditors are usually unaware of financial irregularities such as in California between 1985 and 1986, 28 out of 30 savings and loans were filed for bankruptcy however, before filing they had received clean opinions of auditors (Farrell and Franco). Public considers auditors on fault for not reporting financial improprieties and it widens the expectation gap. In 2003, SAS number 99 highlights that in a financial statement audit, consideration of fraud is effective and auditors should adopt scepticism that a fraud or error can appear in financial statements. Moreover, throughout the audit process, they should consider the risk of fraud and finally evidences should be provided whether there are fraud indicators or not (DeLucia). From legal point of view, auditors can play a significant role in detecting corporate fraud however; they are not responsible to prevent fraud and error, which means that their traditional role is to determine fraud in financial statements. On the other hand, from public perspective, auditors are the primary actors who can highlight the fraudulent activities if companies. These assumed expectations of public and legally defined role of auditors create expectation gap. d) What type of solution and or strategies would you recommend to reduce the expectation gap in auditing? Expectation gap in auditing is created because of the differences in expectations of users and financial statements and auditors, therefore, both these groups should play their role to reduce the gap. First of all, auditors should adopt a scepticism approach to detect red flags during an audit because public has huge expectations from auditors. In this way both the ability and efforts of the auditors to detect and report fraud can play a significant role in detecting fraud. Second, SAS law should be revised on auditors’ responsibility in detecting fraud however; it does not mean that auditors will be responsible if they get unable to detect fraud but more focus should be given in encouraging the role of auditors in this regard. Third, to reduce unreasonable expectations of the public awareness should be raised in public regarding the role of auditors. Moreover, higher expectations of public than liable roles of auditors can be also reduced by educating the users of financial statements. Fourth, laws already defend the independence of auditors, however, more efforts should be made to ensure than auditors’ opinions are free from any pressure. Expansion of audit report can also contribute in bridging this expectation gap because the way the message is being communicated to public and the expectation of public can also differ. Therefore, a more simple language and a more comprehensive report should be developed to reduce this gap. Finally, more standardised methodology and approach can be used to report auditors’ analysis. e) What is the role of market regulators in reducing the expectation gap in auditing? Although there are various actors which can play an important role in reducing the expectation gap in auditing however, market regulators appear as the primary actors. In the recent years, the scandals and financial failures appear as a force, which drive change in the attitudes of market regulators and they seem more dedicated to keep financial reporting and auditing standards under their close review. Therefore, this is the right time to increase the role of these regulators in reducing this gap. Market regulators should monitor and update the standards of auditing practices as international securities market is expanding and financial crisis is increasing. They should develop a scope of audit independence and its picture should be clearly shown to public. In this way the perception of auditors’ independence in the minds of public and the actually independence given to the auditors will match, thereby contributing to lower expectation gap. Market regulators should adopt a proactive approach to anticipate the changing needs of the public and standards should be updated when required. To actually reduce this expectation gap, they should play their role in scrutinising the audit market and in enhancing the restrictions on accounting firms to ensure quality audit practices. Moreover, market regulators can also play an important role in creating the awareness on the scope and role of auditors, thereby, reducing the unreasonable expectations of users of financial statements. Question # 2 A. Identify and explain the accounting concepts and conventions which help to ensure that accounting information is presented accurately and consistently. To present a fair and true picture, some accounting conventions and concepts have been defined. The four basic accounting conventions include monetary measurement, separate entity, realisation and materiality and four selected accounting concepts include going concern, Business entity concept, accounting period, money measurement concept, dual aspect concept, cost concept, consistency, prudence and matching for accruals (Mittal and Singal). Accounting Conventions Monetary Measurement The accountants only account for the items which are in monetary terms. Therefore, every account described in accounts has some monetary value, which allows the users to easily compare all accounts. Separate Entity A business is defined as a separate entity with its own independent identity to achieve economic goals (Johnson, Mosich and Meigs). Therefore, interest of organisation is free from the interest of the owners and the performance of entity is analysed based on its own objectives. Realisation The transactions are recognised in the accounts based on their transfer of ownership and at the point of sale, when they are actually recognised rather than when their cash transaction is made. Materiality In making financial statements, various judgements are made and it is important based on convention of materiality that the judgement is significant and material to the user of the financial accounts. Since judgements can significantly vary therefore, materiality appears to be the major issue for the auditors. To ensure transparency and fairness the auditors are recommended to check the significance and materiality of the judgement. Accounting Concepts Going Concern This concept of accounting has been defined to determine the life span of a business unit. Based on this concept, it can be argued that a business is established as a going concern which means that it will operate in a long run and it will not be dissolved in the near future (Johnson, Mosich and Meigs). Consistency A consistency is ensured in the transactions and valuation methods used by the company. The consistency ensures that users of the financial statements will be able to compare the financial performance. To maintain consistency accounting standards have been defined. Prudence The concept of prudence is very significant as it restricts the companies to recognise the profits only when the sale transaction is completed. In this way, companies cannot report higher or lower profits and they have to follow the accounting concept to keep transparency. Matching Principle This accounting concept advocates that expenses recognised in an accounting period should be matched with related income and not the time when case is received (Johnson, Mosich and Meigs). Therefore, the defined conventions and concepts (selected ones) show that how accounting standards have been defined to ensure the accountability and consistency of accounting concepts. B. What accounting records do the directors of a company need to maintain? Explain the purpose of each? The directors and management of the company are responsible to maintain systems for record-keeping (Financial Services Regulatory Commission). The records usually include the entries of all accounting receipts and payments, sales and purchase of goods details, record of assets and liabilities of the company and annual stocktaking (Rikvin). According to Company’s Act 2006, the accounting records mean the records which can show the transactions made by the company, show financial position of company at any time and enable directors to ensure that records are complying with this Act (Great Britain). Keeping day to day entries is recommended because it shows what company has received and how much expenses it has incurred. This information helps the auditors to make income statement. A record of assets and liabilities is kept to see the financial position of company at a given time. The company dealing in goods have to keep a statement of stock held so that a data of production and sales can be maintained. Bibliography DeLucia, Attorney Michael. "PREVENTING FRAUD: From Fiduciary Duty to Practical Strategies." 2008. 28 October 2010 . EPSTEIN, MARC J. and MARSHALL A. GEIGER. "Investor views of audit assurance: recent evidence of the expectation gap." 1994. 27 October 2010 . Farrell, Barbara R. and Joseph R. Franco. "The Role of the Auditor in the Prevention and Detection of Business Fraud: SAS No. 82." 1999. 27 October 2010 . Financial Services Regulatory Commission. Internal Controls Systems and Maintenance of Accoutning and Other Records. November 2005. 29 October 2010 . Giacomino, Don E. "Expanding the auditors role to narrow the expectations gap." 1994. 27 October 2010 . Great Britain. Companies Act 2006: Elizabeth II, Part 46. The Stationery Office, 2006. Johnson, Charles E., et al. Financial Accounting. Tata McGraw-Hill, 2003. Mahadevaswamy, G.H. and Mahdi Salehi. "Audit Expectation Gap in Auditor Responsibilities: Comparison between India and Iran." November 2008. International Journal of Business and Management. 28 October 2010 . Mittal, RK and RS Singal. Financial Accounting. FK Publications, 2007. Ojo, Marianne. "Eliminating the Audit Expectations Gap: Myth or Reality?" February 2006. MPRA. 27 October 2010 . Rikvin. Nominee Directors Duties and Responsibilities. 29 October 2010 . Salehi, Mahdi, Ali Mansoury and Zhila Azary. "Audit Independence and Expectation Gap: Empirical Evidences from Iran." February 2009. International Journal of Economics and Finance. 27 October 2010 . Wallis, Christopher F J. "Current responsibilities of UK auditors in respect of fraudd." 1999. 27 October 2010 . Read More