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Audit expectation gap


The aim of this writing is to present Audit expectation gap (AEG) and provide readers of this piece of work with short historical background of the AEG, definition, structure of the AEG and recommendations how it can be reduced. Each and one of these themes will be discussed in turn. Literature form renowned researchers from throughout the world will be taken into consideration. Main focal point will be on summary of previously mentioned themes on global level.

The remaining sections of this article are organised as follows: first part of this paper states briefly why AEG is important. Second part discusses historical background of the expectation gap. Section three deals with different meanings associated to the expectation gap since it was first mentioned until today. It also suggests why precise definition is important. Section four considers components and structure of the expectation gap. Section five discusses the most common recommendations for diminishing expectation gap before a conclusion is arrived.


In the past, auditors were perceived as fraud detectors who verified all the transactions and figures of companies and firms. Today, the core of the profession focuses on determining truth and fairness in financial reporting. `This transition was not followed by a corresponding change of users' expectations, creating a gap between auditors' and users' views of the profession` (Fadzly and Ahmad, 2004, p.897). This is a problem which affects auditors worldwide, threatening their reputations, as users of financial statements still assume that auditors provide perfect assurance. The discrepancy between this assumption and reality endangers the essence of the auditing profession: trust.

Moreover, collapses such as Enron (63 billion dollars in assets), WorldCom (107 billion dollars in assets) and Andersen, where investors lost billions of dollars, amplified public concerns over the integrity of the public accounting profession.

Users of audited reports generally have a higher expectation from audits and auditors than most auditors consider reasonable. This has contributed to the increased scale and frequency of lawsuits against auditors. Failure to close the expectation gap can result in the public losing confidence in the auditing profession and also losing credibility among users of audited reports. Therefore, today knowing what the gap is, its structure and ways it can be reduced is important not just for accountants, but as well for users of audit reports.


In the early civilisations, such as Egyptian and Greek, we can trace back the origins of audit (Cooper, 1886; Worthington, 1895; Brown, 1905; Woolf, 1912 in Sikka et al. 1998). The association between auditors and fraud detection, which prevails as the widest gap today, emerged during eighteen century when large manufacturing organizations were born. According to Sikka et al. (1998) at the end of nineteen century, though, there were some who argued that expecting auditors to detect frauds is unreasonable, the emerging accounting profession associated auditors with fraud detection. He goes further and explains that still at the end of nineteen century little was changed. Select Committee on Joint Stock Companies was formed and its duty was to protect `the subscriber in a new venture from the company

promoter who was either deliberately fraudulent or upon whom there were insufficient controls` (Johnes 1981 in Sikka et al. 1998, pp. 8). In 1892 a first major auditing text-book by Dicksee tried to define the scope of auditors work stating that auditors duty is to detect fraud, technical errors and errors of principle. However, it can be seen that other authors, such as Robertson and Montgomery argued that fraud detection should be auditors secondary duty (Ojo 2006). Dicksee, on one side, and Montgomery and Robertson, on the other side, sparked off debate about auditors duties which remained unresolved until 1940. During the twentieth century in Britan, Humphrey et al.(1992) noted that only responsibility that was connected to auditors duties was confirmation of truth and fairness of financial statements. However, Brown (1962) suggests that the confusion was resolved afther 1940, when it was finaly accepted that fraud detection was indeed secondary audit objective.


Since Liggio in 1974 first coined the phrase `expectation gap` till today, many authors tried to provide definition of this problem. Finding consistent meaning and precise definition of gap is crucial for understanding it.

Liggio was the first to apply the phrase "expectation gap" to auditing. He defined the expectation gap as the difference between the levels of expected performance "as envisioned by the independent accountant and by the user of financial statements" Liggio (1974, pp.27). Later in 1987 Tweedie tried to define and explain the problem as below: "The public appears to require (1) a burglar alarm system (protection against fraud).....(2) a radar station (early warning of future insolvency).....(3) a safety net (general re-assurance of financial well-being).....(4) an independent auditor (safeguards for auditor independence).....and (5) coherent communications (understanding of audit reports)" (pp.20). and concludes:"Given these concerns it is clear that the basic tenets of an audit are being miss-understood" (pp.21)

Year 1993 brought Monroe and Woodliff`s definition that the audit expectation gap is the difference in beliefs between auditors and the public view about the duties and responsibilities.

Pierce and Kilcommins (1996) said that the audit expectations gap emerge when external auditors compare their role and duties against the expectations of general public and users groups. Authors also stressed that professional accounting bodies in US, Canada and UK in 1978, 1988, and 1989 respectively recognized AEG as a very important issue for auditing profession. Since then it become a priority area of research.

The importance of the question of the 'audit expectation gap', 'a mismatch (gap) between duties society expects of auditors and what it perceives it receives from them' (Porter et al., 2003) has heightened, especially after the major corporate scandals mentioned in the introduction.


It is important to be aware of structure and composition of AEG, because it can show us where widest gap is and how it can be reduced. Several authors tried to determine and classify different parts of AEG.

According to Porter (1993, 2003) it consists of two components:

1. Reasonableness gap (the gap between what society expects auditors to achieve and what the auditors can reasonably be expected to accomplish).

2. Performance gap (the gap between what society can reasonably expect auditors

to accomplish and what auditors are perceived to achieve). The performance gap can be further divide to deficient standards gap (the gap between auditors duties defined by standards and regulations and society expectations of auditor's duties) and deficient performance gap (the gap between performance of auditor's duties expected and perceived by society).

Porter (1993) was the first to present full scope of AEG with comparing society's expectations of auditors with perceived performance of auditors. It is now logical that the gap can be narrowed even by reduction in society's expectations or with improvement in perceived performance. (Fig. 1) The study taken in New Zealand reveals that 16% of the total gap arose from sub-standard deficiency, 50% from deficient standards (most objective component) and 34% from unreasonable expectations. This helps us to better understand individual component of expectation gap and also where to focus our future efforts.

Pierce and Kilcommins (1996) in their study focus on four elements of the user misunderstanding gap (the gap between auditors' existing duties and auditors' perceived duties- look Fig. 2). This gap may be affected by any change in existing audit standards and regulation.

The elements are:

Duties- The widest gap is found to be in relation to auditor's duties. Pierce and Kilcommins (1996) found out that gap concerning auditors duties is widest in relation to detection and reporting of fraud. In addition to this Porter and Gowthorpe (2004) state that societies in both UK and New Zealand had unreasonable expectations of the auditors, especially in the area of auditors' duties. Other duties which cause the gap are preparation of accounts and selection of appropriate accounting policies and they are according to authors from 1963 Companies Act responsibility of management.

-Ethical and Legislative framework

Another significant gap concerns ethical and legislative framework. Auditor independence, auditor appointment and audit regulation was classified by majority of authors as gap in ethical and legislative framework. As perceived by Humphrey et al. (1992) key component of AEG is auditor independence.

- Liability gap

Liability gap concerns auditor's liability. As mention by Pierce and Kilcommins(1996) the public does not know to whom the auditor is liable and that is the main reason why this gap exists.

There are a lot of studies about AEG taken in many countries (UK, Malaysia, Malta, Singapore etc.). Siddiqui (2009) reveals that in Singapore, Malaysia, Malta and Egypt AEG is mostly identify in the area of auditor responsibilities while in Bangladesh AEG is mostly identified in area of auditor independence. However, the most common gap between auditor's performance and society's expectations are in fraud detection and prevention and auditor independence. Therefore these two gaps will be discussed in more detail.

- Fraud detection and prevention

There is a widespread belief (Godsell, 1992) that a person who has any interest in a company (shareholders, potential investors, public, creditors etc.) should be able to rely on its audited financial statements. Hence, if it emerges that the company is in serious financial difficulty, many people feel that somebody should be made accountable for these financial disasters, and this somebody is always perceived to be the auditors. The Association of Certified Fraud Examiners (ACFE, 2008) in its study entitled

The Report to the Nation on Occupational Fraud and Abuse reported that annual fraud costs to US companies 7 per cent of their revenues, which is approximately US $994 billion annually. For example, with a profit margin of 5%, you would need to generate an additional 1 million dollars to recover losses from a mere 50,000 dollars fraud. PricewaterhouseCoopers (PwC) global survey of economic crime for the past ten years published on November 2009 reveals that corporate crime is on the rise (accounting fraud makes 56% of all reported corporate crime), especially in developing countries, in financial services and communications, in big state-owned companies where their huge bonuses are performance-related.

As Mclnnes and Stevenson (1997) mentioned, 75 per cent of the general public, including the majority of financially knowledgeable people, think it is the external auditors' responsibility to detect fraud of all kinds. This study also found that 61 per cent of the general public think it is the responsibility of auditors to search actively for fraud. However, the auditing profession no longer accepts the detection of fraud as being a primary responsibility.

Auditors feel that detection of fraud is management's responsibility (since management had a responsibility to implement appropriate internal control systems to prevent fraud in their organisations), while users and management disagreed (Alleyne 2005). Auditors have a duty to detect a material theft of corporate assets from non-managerial employees which happened despite internal controls. After Enron and WorldCom scandals in US, Sarbanes-Oxley Act of 2002 in his section 404 requires from management and auditors to report separately on adequacy of internal controls.

Auditors only have to give reasonable assurance that financial statements do not contain any material misstatements due to fraud. On the other hand, they receive a lot of criticism from general public because they did not uncover some major corporate frauds. It is clear that companies with sound internal control system and effective audit committees are better equipped to deal with fraud.

- Auditor independence

Bather and Burnaby (2006) states that auditor independence become interesting topic when revenue figures showed that accounting firms charging in many cases more for consultancy work than for audit work. Healy et al. (2001) also agrees that audit firms rely more on management consulting than assurance services. On the other hand, people who make regulations suggest that between these two is potential conflict especially if the same management is responsible for hiring the audit firm for a consultancy. However, SEC requires from audit firms to separate their audit and consulting departments and to disclose consulting fees for each client.

For example the Cadbury Report (1992, pp.24-25) noted that: 'Although the shareholders formally appoint the auditors, and the audit is carried out in their interests, the shareholders have no effective say in the audit negotiation and have no direct link with the auditors.

Auditors have to work closely with those in management who have prepared the financial statements'. That is the main criticism of auditor's independence, because management is choosing auditors not shareholders.

The need for independent audited financial statements is greater if the split between owners and managers of companies is higher. Bather and Burnaby (2006) remind that auditors are appointed by the shareholders of the company to provide an independent view of an organisation's financial statements, which are prepared by management and approved by the board of directors.

Beattie et al. (1999, p. 71) presented ' the four principal factors believed to impact auditor independence are: the economic dependence of the auditor on the auditee, competition within the external audit market, the provision of non-audit services by the auditor, and the degree of laxity of the regulatory framework'.


Numerous authors (Gloeck and de Jager, 1993; CACA, 1992; Sikka et al., 1992 in Pierce and Kilcommnis 1996) and professional bodies argue that because of the nature of the gap it is not possible to eliminate it. Therefore, knowing that there are different kinds of expectations gap, it is obvious that only through successful combination of various measures this problem can be addressed. Summary of most common recommendations for minimizing the expectation gap is as follows:

- Education

It is suggested that users as well as auditors should be educated. Sweeny (1997) suggests that public should be educated and better informed about what the audit function entails. Koh and Woo (1998) report that wider gap exist between less knowledgeable and sophisticated users. So it is crucial to increase user`s awareness of what audit responsibilities really involve. Ojo (2006) suggests that public education about auditor's role and responsibilities could be facilitated through different events organized for this particular purpose, such as annual shareholders meetings. On the other hand, one cannot overlook the soundness of Ojo`s (2006) question whether all members of general public should be educated, as not all of them are users of audit reports. Porter and Gowthorpe (2004), Sikka et al. (1992), as well as Humphrey et al. (1992), stress that further education on this matter should be required for all auditors. The auditors should be made aware of their duties, responsibilities under corporations law and standard work they are expected to perform, etc.

However, it can be concluded that education can diminish the audit expectation gap. There are several empirical studies done till today on the effects of education on audit expectation gap. Monroe and Woodliff (1993) conducted experiment on undergraduate audit students who took 13-week auditing course. Later Pierce and Kilcommnis (1997) extended the study and performed two surveys which lasted whole semester and Fadzly and Ahmad (2004) conducted a similar study in Malaysia. All studies concluded that education has major impact on minimizing the gap.

- Expanded audit report

Koh and Woo (1998) and Pierce and Kilcommins (1996) propose expanded audit reports as a mean of gap minimization. They report that many users find these reports useful, comprehensible and particularly helpful with understanding better auditor's responsibilities, scope of auditors work, etc.

- Broader audit responsibilities and enhancement of auditor's independence

There are some suggestions that auditor's responsibilities should be expanded. Sikka et al.(1998) agrees on this but warns that before any suggestion is adopted, costs and benefits of each and one of these proposals should be evaluated. Sweeney (1997) is of the opinion that nature of audit function should be changed to meet user's expectations, for example fraud detection should be one of auditor`s duties. O`Malley (1993) also shares the same opinion and goes even further to suggest four additional responsibilities: `management and auditor evaluation of internal control systems; compliance reporting; direct reporting by auditors to regulators; and auditor association with interim financial information` (pp. 5 in Koh and Woo, 1998). Humphrey et al. (1993) stresses the importance of auditors independence and offers three suggestions: ` setting up an independent office for auditing to enhance auditor independence by overseeing the appointment of auditors of large companies and to regulate audit fees; extending auditors' responsibilities by statute so that they clearly include responsibilities to shareholders, creditors and potential shareholders; and clarifying that auditors have a duty to detect fraud` (pp. 5 in Koh and Woo, 1998).

- Unambiguous auditing standards

Ojo (2006) suggests that one of efficient ways for minimizing the gap are auditing standards. Her paper explains the role of The International Standard on Auditing, and proposes thems as guidings for auditors. Some of the guidelines are as follows: `In carrying out the above function, the auditor is expected to maintain a sceptic attitude throughout the audit despite his past experience with the entity about the honesty and integrity of management. The auditor also considers reports from the deposit taker's compliance department, legal department and money laundering reporting officer with reviews undertaken by third parties such as reports prepared under section 166 of the Financial Services and Markets Act 2000` (ISA (UK and Ireland) 240 paragraph 24 and 42) and ISA. As a reaction to major corporate scandals in US were enacted Sarbanes-Oxley act 2002 which is mandatory for all publicly traded companies, which states that it is a US federal law and has aim to protect and return investors, shareholders and public confidence.

Finally, Siddiqui et al. (2009) proposes reducing the AEG by monitoring of auditors performance, improving audit control system, modify the language in the audit engagement letters to creation of independent oversight audit agency.


It can be concluded that for reducing the AEG it is important not just for auditors to be aware of it and know how to minimize it, but a lot of effort must be put into raising public awareness and diminishing their expectations. Nevertheless, one thing is certain. Accounting profession must continue trying to reduce the gap, by means of education, expanded reports, and broader responsibilities and at the same time steps must be taken for lowering public's expectations.