Auditors and Investors' Perception of the Expectation Gap - Essay Example

Auditors are responsible analyzing the financial report of companies in order to reassure the general public that the financial information and financial reports that the companies are providing are in a prepared true and fair manner and are free of fraudulent behavior. The general public and the accounting profession have had their differences over time on how the auditor should handle the process and what type of information should be reported by auditors to the users of the financial information. The difference between what the public and other financial statement users perceive the auditors responsibilities to be and what the auditors believe their responsibilities entail is referred to as the expectation gap (McEnroe & Martens, 2001). This paper discusses different issues concerning the expectation gap by describing and analyzing the subject. The methodology, process and final output of the auditing process which auditors report remained relatively the same for the 40 year period starting in 1948 until 1988 (Strawser, 1990). During this period the users of the financial information complained a lot about the independent auditor’s report because they were not consistent in their message and their reports were at time interpreted differently by different users of a same report, a situation which should never occur since the accounting profession is based on reliability, consistency, reassurance and equal standards within the work that is performed. One of the first major breakthroughs regarding the expectation gap occurred in 1978. In that year the Cohen Commission identified several possible deficiencies in the auditor’s report which were hindering communications between the auditors and the users of the financial statements (Strawser, 1990). Some the areas which the Cohen suggested that improvement was needed were: Change the language of the report from technical accounting terms to more easily understood business language Eliminate uncertainly in what are the responsibilities of the company managers and the auditors in the process Clearly describe the work that the auditors perform in order to create the independent auditor report The auditors’ report has always been important since it provides valuable information regarding the validity of public financial information reported by companies. During the 1980’s and early 1990’s the globalization movement and the birth of the information age created a greater urgency to deal with the auditing expectation from private and public institutions. The globalization movement brought enormous opportunities for greater investments due to the free trade possibilities that came with it (Kasapidis, 1999). During this period a lot more individual and institutional investors needed the information to make reliable decisions on domestic and foreign investments. The auditing expectation became a hot subject of discussion worldwide. In the People’s Republic of China the auditing expectation gap has been very important for the transformation of the way businesses in this country are now starting to present their information to the financial users. The country’s socialism mentality historically forced managers to hide as much information as possible and regard the financial information of a company as a private matter. This has changed in the 21st century and the international accounting standards are starting to proliferate in this nation. A study performed in China obtained substantial evidence of the emergence of the auditors’ expectation gap in China, with respect to audit objectives, auditors’ obligation to detect and report fraud, auditor independence, and third party liability of auditors (Lin & Chen, 2004). The auditor expectation gap help bring improvements to auditor independence and liberation of public accounting in China. The accounting profession in particularly professionals working in the auditing industry has been greatly impacted by the public’s demand to close down the expectation gap. The expectation gap involves key issues as its applicability in international business. Among the key issues related to the expectation gap are fraud, internal control, audit methodology and business ethics. Auditors have always been told to follow specific procedures to the letter. In many occurrences, especially those involving young auditors the person performing the audit are performing procedures for which they don’t understand its purpose. This is a troubling situation because the only way to truly perform a profound audit which can have the possibility to detect unusual circumstances is for a person to utilize his intuition, personal judgment and common sense within the procedure. The reason for the complexity of the auditing requirements is due to the continuing demand to address the expectation gap (Hayes, 2006). Scandals such as the Enron and WorldCom debacles in which fraudulent behavior caused investors millions of dollars placed new pressures on the duties of auditors performing independent audits. The position of the accounting profession has always been that it should never be liable for not detecting fraudulent behavior within an audit due the fact the availability of resources and the authority to obtain information to find material errors or irregularities are hindering by factors out of their control such as managements override of internal controls, collusion, forgery, or unrecorded transactions (Hayes, 2006). Internal controls are very critical in the overall auditing process. After the Enron Scandal the government’s immediate reaction was to blame the accounting profession and they inclusively threaten the profession on imposing regulation upon them which would break centuries of tradition in which this profession has always been self regulated. The accounting profession immediately reacted and imposed new standards regarding auditing procedures to help detect fraud such as SAS. No.53, 82, 99 (Hayes, 2006). The government realized that accountants were correct as far as the role management should play in the process to try to prevent fraudulent behavior. Out of the need for more strict managerial internal controls of a company’s operation the Sarbanes-Oxley Act was born. The Sarbanes-Oxley Act was created in 2002 with the purpose of protecting the general public from inaccurate financial information and is considered by many to be an investors’ protection act (Aicpa, 2006). The Sarbanes-Oxley Act covers internal control issues such as auditor independence, corporate responsibility, superior disclosures, additional penalties for white-collar crime offenders and accountability of executive officers over financial information. The Act is a great measure which will help prevent frauds and misuse of corporate funds. The auditing expectation gap exists and the accounting profession is taking steps towards complying with the public demand. The government has also contributed its role of protecting private investors with the creation of the Sarbanes-Oxley Act 2002. It is virtually impossible for financial reports to be perfect, since the ones creating these reports are humans which are not perfect machines. Society simply wants to minimize the damages that occurred from fraudulent reports and they expect the experts in this area of study which are the accountants to put forth a greater effort in order to prevent undesirable events such as Enron and WorldCom from ever occurring again. References AICPA (2006). Sarbanes-Oxley-The Basics. Available from [Accessed 15 August 2007]. Hayes, A. (2006). Hurdle, Hurdel, Toil and Trouble. A Time to Reexamine the Curse of the Expectation Gap. Journal of Governmental Financial Management, 55(4), 68. Available EBSCOhost dababase [Accessed 15 August 2007]. Jin, J.L. and Feng C. (2004). An Empirical Study of Audit “Expectation Gap” in the People’s of China. International Journal of Auditing, 8, 94-115. Available Windows Live Academic Search database [Accessed 15 August 2007]. Kasapidis, R. (1999). The Opportunities and Dangers of Globalization. Available [Accessed 15 August 2007]. McEnroe, J. and Stanley M. (2001). Auditors’ and Investors Perception of the “Expectation Gap”. Accouting Horizons, 15(4), 58-70. Available EBSCOhost database [Accessed 15 August 2007]. Stawser, R. (1990). The New Auditor’s Report: will it close the expectation gap in communications? The CPA Journal. Available [Accessed 15 August 2007]. In a Big Four Accounting firm two employees, Fred and Barney, were in competition for a promotion in the auditing department for a supervisory position. The two candidates had similar experiences with the firm as far as length of employment and current position in the company. They were both senior auditors. Fred was just assigned to a an audit which Barney started in which the firm claimed Barney was pulled off the assignment due to a special request from a long time client of Barney’s to perform a particular job. Fred realized once he took the job that Barney was reassigned because the client had inform the audit manager that Barney was arriving late at work and he had missed a lot of important issues within the audit. Fred analyzed Barney’s work and knew that his work was excellent. He realized that the complaints of the client were not based on the alleged reasons, in reality they were based on a personality conflict. Fred had the perfect opportunity of completing a job and take credit for the work that Barney had perform knowing that Barney would never realized what actually occurred or why he was reassigned to a different assignment. Fred is facing a conflict of interest ethical dilemma. He has insider’s information on Barney and they are both candidates for a promotion. He discovered that the allegations of Barney’s poor work performance by the client were false. This is the root of his ethical dilemma. He can go about his business and perform the tasks he was asked to do or he may speak to the audit manager and revealed his findings of the client lying. The second option is not in his best interest right now since Barney looking bad and he performing an excellent job will help him in his aspirations of obtaining a promotion. Accountability is a major principle any professional in this field should follow which is required by the American Association Accounting Model for every circumstance, but in particularly in auditing jobs. Some of the key concepts which accountability covers during the audit process are illustrated in the list below: Public vs. personal interest Recognize the difference between accounting standards and principles or values Deciding in doing what is right vs. doing what is acceptable To be concern with both fact and appearance Emphasizing judgment over following a procedure checklist Trust is difficult to earn, but can easily disappear Continuous improvement is essential (Gao, 2004). A major concept which all accountants must follow is ethics. Ethics is considered the standard of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair (Weygant & Kieso & Kimmel, 2002). The financial work an accountant performs, specifically within the financial statements require full disclosure of information. The ethical standards of the profession should follow the same type of rigorous principles the profession places on economic events. In the business world businesspeople working as a part of a team who put the interest of the collective above their personal interest are seen as professional with character. Along with the two alternatives previously mentioned of sitting on the information or revealing the client false statement, Fred has other options. Fred could confront the client about his allegations and explain to them the quality of the work Barney had performed based on facts. He could also speak with Barney about the real reason he was pull off this particular assignment within one of two scenarios. He call tell him so with the condition that Barney sit on the information or he can tell him so that Barney can react to the information and defend himself against the client’s claims. Appendix A illustrates a table of Fred’s alternatives and the possible consequences of each action. The ten core values of Mary Guy decisional model are illustrated in the list below: 1. Caring 2. Honesty 3. Accountability 4. Promise Keeping 5. Pursuit of Excellence 6. loyalty 7. fairness 8. integrity 9. respect for others 10. responsible citizenship (Clowes, 1975). There core values could help Fred a lot in his decision. Out of the five alternatives routes which were illustrated in Appendix A, if Fred based his ethical decision based on these values he would have most likely chosen the alternative of revealing his findings about the client lying to the audit manager. The key core values that would influence his decision in this case are loyalty, fairness, and accountability. He would have been loyal towards his co-worker and the fair thing would be to get a promotion based on his personal merits, not based on the administration’s misconception that Barney was performing sub-par work. Appendix B compares the ten values and the alternative solutions aligned with each with each value. Both the AAA and Mary Guy models provide certain guidelines that can help professionals make ethical decision based on the models. Both of the models place importance on accountability. The Mary Guy model is more precise at describing specific values which can help people with ethical decisions. The AAA concentrates on the work duties of the employee, but implies that ethics are an important element of work affairs. References Clowes, C. (1975). A critical examination of decision making models. Available [Accessed 15 August 2007]. GAO (2006). The American Accounting Association Plenary Sesssion. Available [Accessed 15 August 2007]. Appendix A: Fred’s Alternatives and Consequences Alternative Consequence 1. Do not say anything about the client lying. 1. Fred would be acting in an unethical manner. He would be following his professional obligation of complying with full disclosure principle. If nobody learned about him sitting on the information, then Fred would benefit from staying quiet at the time of selecting a candidate for the supervisor position. 2. Fred speaks to the administration about his findings. 2. Fred tells the truth and protects the rights of his colleague. He protects the company’s best interest by informing a client is trying to manipulate the system. His decision will either help in his ascension aspiration or it will be a neutral factor. 3. Fred confronts the client in a professional indirect manner. Fred only speaks about the actual work perform without making direct accusations of any wrongdoing. 3. The client will know that Fred is into their game. The client may complaint to the firm. The firm may not be happy about Fred decision since this initiative was not part the checklist of tasks he was supposed to perform. This would be hurt him in his aspirations for a promotion. 4. Fred tells Barney with the condition of keeping quiet about his findings. 4. Fred would be a team player and protect the best interest of his colleagues. He would provide personal advice to Barney because not only did the client hurt Barney, the company did as well by not speaking to him about the issue and assuming he was guilty of wrongdoing. As far as the promotion the decision has a neutral effect on Fred, but he is indirectly benefited because the company thinks Barney did something wrong. 5. Fred tells Barney so he can defend himself if he wishes to. 5. Fred helps out a colleague. Barney may confront both the client and company and cause disruption in the relationship with the client. Fred did not follow the chain of command and reveal the information to his superiors. Fred was indirectly responsible for Barney’s reaction. The decision hurt Fred in his aspiration for a better position within the company. Appendix B: Values vs. Alternatives Values Alternatives 1. Caring Tell Barney the truth and let him decide what to do with the information 2. Honesty Tell the audit manager the truth 3. Accountability Tell the audit manager the truth / Tell the client Barney’s job was excellent 4. Promise keeping Tell Barney the truth with condition not to reveal the information 5. Pursuit of excellence Don’t tell anybody about the findings. 6. Loyalty Tell the audit manager the truth / Tell Barney the truth and let him decide what to do with the information 7. Fairness Tell the audit manager the truth 8. Integrity Tell the audit manager the truth 9. Respect for others Tell Barney the truth and let him decide what to do with the information 10. Responsible citizenship Tell Barney the truth and let him decide what to do with the information / Tell Barney the truth with condition not to reveal the information Read More