The issue of an audit expectation gap in Malaysia

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An external auditor is an audit professional, who performs an audit on the financial statements of an individual, company, organization, government or any legal entity, and who is independent of the entity being. Jayalakshmy et al. (2005) explicated that the external auditors are engaged by shareholders to perform impartial and knowledgeable independent scrutiny in order to provide reasonable assurance on the truth and fairness of the entity's financial statements. This is to ensure that the directors of the entity, as stewards of the shareholders' investment, act in the best interest of their shareholders.

However, the reliability and professionalism of the external auditors has been called into question after the collapse of several spectacular international corporations, namely Enron Corporation, WorldCom and Parmalat, shortly after an unqualified audit report been issued (Lee, T., Ali, A. and Kandasamy, S., 2008). Lee et al. (2008) also indicated that the reliability and professionalism of the auditing profession in Malaysia has also been tarnished and being criticised following the financial scandals in some of the giant local corporations such as Transmile Group Berhad, Megan Media Holdings Berhad, Southern Bank Berhad and Technology Resources Industries Berhad.

In view of this, Malaysia critically needs to strengthen the audit quality and to ensure the ethical behavior of the accounting profession in Malaysia in order to level the playing field with global financial and capital markets (Izma, N., 2009). Initiatively, two new standard setting boards, namely Audit and Assurance Standards Board (AASB) and Ethical Standards Board (ESB), have been launched by the Malaysian Institute of Accountants (MIA) on 9th June 2009 to elevate the competitiveness and security of the Malaysian financial and capital markets while intensifying MIA's effort to improve audit quality and professional behavior among Malaysian accountants. The question is: Would such efforts strengthen the audit quality whilst increasing assurance and reducing the audit expectation gap?

Main Report

As mentioned earlier, the quality of audits has been consistently criticized and numerous instances where auditors fell short of fulfilling their obligations to the society have been documented by the critics (Umar, A. and Anandarajan, A., 2004). Umar and Anandarajan (2004) further suggested that the lack of quality in audits is due to the lack of the external auditors' independence which is mainly attributed by the pressures enforced by clients.

Independence is not easily defined but most professional codes require for both independence of appearance as well as independence of mind (Houghton, K. and Jubb, C., 2003). Houghton and Jubb (2003) explained that independence in appearance relates to the avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, would reasonably conclude the integrity, objectivity or professional skepticism had been compromised. Houghton and Jubb (2003) further explained that independence of mind relates to a state of mind that permits the provision of an opinion without being effected by influences that compromise professional judgment.

Houghton and Jubb (2003) suggested that provision of non-audit services such as advisory services may impair the external auditors' independence as self-review threat may occur when the external auditors review their own work. Houghton and Jubb (2003) also suggested that the provision of non-audit services may create self-interest threat due to the economic bond between the external auditors and their clients, especially when a large proportion of the audit firm's total fees are generated from a single assurance client. In the Enron scandal, Enron's external auditors, Arthur Andersen, was succumbed to the pressure from the Enron's management to ignore and to some extent, assist Enron in hiding billions in debt from unsuccessful projects. Due to the significant amount of consultation fees generated from Enron, the conflict of interest was so significant that caused Arthur Andersen to unethically applied irresponsible standards in their audits of Enron (Healy, P. and Palepu, K., 2003). Healy and Palepu (2003) stated that the audit fees and consulting fees earned by Arthur Andersen from Enron in 2000 was US$25 million and US$27 million respectively, which is equivalent to approximately 27% of the total audit fees income of Arthur Andersen's Houston office. In the aftermath, Axtman (2005) excerpted that Enron's investors lost US$74 billion in the last four years prior to the collapse of the company. Axtman (2005) suggested that more than fifty percent of the US$74 billion loss was due to fraud. Alongside with that, Arthur Andersen had been barred from auditing public companies and lost the majority of its clients, resulting in closure of the firm and 85,000 employees lost their jobs.

The independence of the external auditors may also be impaired by holding financial interest in the companies that they audited (Umar, A. and Anandarajan, A., 2004) as this may create self-interest threat. Moore (2000) highlighted the PriceWaterhouseCoopers (PWC) scandal in which the external auditors based in the United States of America or their spouses were accused of holding shares in the companies that they are auditing. As a result, the U.S. Stock Exchange Commission (SEC) had nullified the PWC's opinion on financial statements of Emcore Corporation (Emcore) which caused a costly delay on Emcore's secondary-stock offering and the dismissal of a number of PWC's partners, managers and staff (Moore, P., 2000).

Other than the two main issues mentioned above, Bakar et al. (2005) identified that the independence of the external auditors may also be influenced by the size of the audit firm as it is generally perceived that the larger audit firms are more resistant to the the pressures enforced by clients, thus could be more independence in providing better quality audits. Bakar et al. (2005) also suggested that level of competition in the audit services market, which may result in low-balling, is another major issue that could impair the independence of the external auditors. Haron et al. (2006) suggested that it is vital for the external auditors to standardize the amount of audit fees charged to the clients as a measure to prevent the clients from shopping around for the external auditors that are willing to accept the engagement for lower fees which in the long run could be damaging to the auditing profession. However, the question is: Even with the standard audit fees schedule in place, are all the external auditors conforming to it?

Besides lack of the external auditors' independence, audit expectation gap is another major problem faced by the external auditors in today's business environment. Audit expectation gap is generally defined as the difference of the public's expectation from an audit and objective acceptable to the external auditor. (Lee, T., Ali, A. and Kandasamy, S., 2008). Lee et al. (2008) further stated that audit expectation gap is critical to the external auditors as the unfulfilled public's expectations will significantly affect the credibility, earning power and the reputation of the external auditors.

In Malaysia, the issue on audit expectation gap is being extensively discussed even though the former President of Malaysia Institute of Accountants (MIA) had highlighted the public's misconception on external auditors' scope of work as well as their roles (Lee, T., Ali, A. and Kandasamy, S., 2008). Contrary to the public's expectation, the external auditors' scope of work does not include the preparation of the entity's financial statements. The preparation of financial statements is the responsibility of the entity's Directors and the financial statements have to be prepared in accordance with the appropriate accounting standards while the external auditors' responsibility is to scrutinize the financial statements in order to express their opinion on the truth and fairness of the entity's financial statements (Lee, T., Ali, A. and Kandasamy, S., 2008). Lee et al. (2008) further claimed that the audit expectation gap is unfavourable to the public and investors as well to the wealth creation process and the political stability which is dependent on the confidence in the processes of accountability.

Although researches revealed that education could reduce the audit expectation gap as educated users tend to understand the situation and to place lesser responsibilities on the external auditors, Lee et al. (2008) suggested that education may not be able to resolve the audit expectation gap issue due to the fact that it is quite impossible to educate the mass public as the not all of them have ever receive any tertiary education. Even if they do, they may not understand to scope of audit or simply not interested in understanding the audit expectation gap issue.

Lee et al. (2008) had also rescinded the empirical studies that suggested that expanded audit report is effective in reducing an audit expectation gap by providing a better understanding on the roles and scope of works of the external auditors due to the fact that external auditors are not obliged to disclosed on certain issues in the audit report. The external auditors may also not have the competency to provide the axpanded audit report. At the same time, Lee et al. (2008) explained that although the external auditors may be able to meet the audit expectation of the public by expanding their responsibilities, the additional cost should be carefully measured against the benefits from engaging the additional services, especially when the additional services is not required by the statute. On the other hand, Sweeney (1997) argued that the expanded audit report merely try to educate the public on what the audit function currently entails but may not change the nature of the audits (Hassink et al., 2009).

Expectation gap of second element is standard gap, auditor are not required responsibilities on their professional rules however public interest are reasonably expect from auditor. In point of director, their no concern material frauds when to reporting it appears on supervisory board (Hassink et al., 2009). In auditing standard, auditor required inform internal auditor, if client refuses provide material fraud detected during a statutory audit (Hassink et al., 2009). Currently professional rules, auditor should take act to resign if client reject provide redress material fraud or management fraud detected by auditor.

In point of expectation gap, can be differences in some area which are management performance, due care, fraud, going concern and independence (Haniffa. R and Hudaib M., 2007, p.181). From public users expect auditor provide them an assurance on the consistency of the audited financial report and detected deceit. In country of Saudi, Saudi Organization for Certified Public Accountants (SOCPA) is in the infancy stage and not much impact at all. And that time, SOCPA is silent on matter of fraud. During that time, SOCPA accounting procedures is weak and litigation costs are much lower (Haniffa. R and Hudaib M., 2007, p.183). According Al-Sehali & Spear (2004), no any firm were sued before, even in case of corporate failure. Info was collected expectation gap to exist with reference to fraud (Haniffa. R and Hudaib M., 2007, p.183). On other hand, reducing expectation gap with auditor about responsibility for reporting fraud and discover.

Accounting services difference in few type taxation and bookkeeping they develop from audit engagement and auditor were familiarity client's accounting procedures (Haniffa. R and Hudaib M., 2007, p.184). Audit firm provides non-audit and audit services such administrative service, enhance auditor economic interest, occur conflict of interest and intimidating auditor independence. From the opinion by auditor, this will cause performance of ancillary services may give vary on it. The research revealed that, SOCPA to increase demand for auditor, where auditor holding a degree, CPA or Chartered Accountant certificate can granted a license. At that time, Saudi national was lack of experienced and skilled. In 1992 SOCPA, license rules are faintly strict, auditor compulsory completion SOCPA qualifying test or holding a university degree in accountancy (Haniffa. R and Hudaib M., 2007, p.184). Hence, lax licensing policy in the past produced a difference in the type of auditor involved in Saudi. This licensing policy has an effect on perceptions of audit performance.

Thus, legal and political structure is concern by audit and it can limit ability provide info to public interest. While, auditing profession is not allowed to set up its own course in SOCPA, this may consider implementing by polities and exercising control (Haniffa. R and Hudaib M., 2007, p.184).

Similarly, professional bodies play an important role of review auditing in specified like legal pronouncement and to narrow down the audit expectation gap. If auditor no discover problem of current issue, it might damage reputation of professional bodies. Professional bodies should consider auditor responsibility when detecting and found reporting fraud be highly demanded by organization and bring in regulation and rules to prevent it can reduce expectation gap as well. If professional bodies no execute this action, public interest will losing confidence in audit profession. The expectation gap must work together with governance, professionalism and audit standard to alert society about auditor roles.

Although the limitation by auditor comes into view, their job is to investigate every doubt of fraud or regardless of transaction by organization. Furthermore, gaps mean auditor have to take additional training to enhance awareness on their existing audit work or prospective discuss internal consultation (Hassink et al., 2009). Besides, auditor may share with experience to junior auditor to gain knowledge and increase effectiveness to prevent fraud and detection.

Professional bodies such as ACCA are playing their roles by giving in form of education to the external auditors. External auditors are required to participle CPM requirement in order to gain their knowledge those regulations. This result expected auditor can competent exercise on statutory audit and identify the risk of fraud, build up knowledge and improving ethical standing of auditor. As MIA think that auditor can go though other way to gain knowledge and challenge of professional quality control code it called Continuing Professional Education (CPE). This Program develops a high professional standard and promotes better sharing information between all industries. In this program, professional auditor or accountant should completed 120 credit hours to learning CPE course within three years. Meanwhile, CPE hours can difference in part sixty hours is verifiable and structured another sixty hours is nature of practice. This program was requirement by law (on Professional Conduct and Ethics), thus CPE are flexible to all professional auditor, institute allows member select courses which are convenience to member as long as member successful completed CPE requirement. In case, non-MIA member participant CPE credit how they record keeping CPE credit hours? For non-MIA member a responsibility to record down CPE credit hour and keeping a copy of CPE credit hours should upload the relevant information to MIA web portal. However, non-MIA member also required to proof evidence of attendance CPE credit hours. Similarly, CPE purpose requirements are continuous lifelong learning even member are unemployed or retired. Member must fulfill CPE requirement and CPE will record abreast member profession when member taking a position advisory or directorship.

Looking at the major issues faced by the external auditors in today's business environment, the MIA's effort of launching the two new standards setting boards, i.e. the Audit Assurance Standard Board (AASB) and the Ethics Standards Board (ESB) on 9th June 2009 has been applauded to be a good initiative of the MIA. Izma (2009) explained that the implementation of the two standards is aimed at promoting and supporting high quality audit standards in order to maintain the public confidence of our capital market, especially during the bad economic times. The implementation of the two boards, which function as independent standard setting bodies under the patronage of the MIA Council, clearly demonstrated MIA's effort in meeting the stakeholders' increasing rigorous expectations of the quality of the works done by the external auditors as well as to promote the ethical behavior among the accounting profession, especially the external auditors (Izma, N., 2009).

Izma (2009) further explained that in order to serve the public interest in a better manner, MIA had set the AASB's main objective as to strengthen the accountancy profession in Malaysia. MIA intends to leverage the AASB to be one of the prominent standards setting boards within Malaysia and the region with the aim to identify and resolve the issues faced by the accountancy profession, especially the external auditors at the earlier stage or even before the issue arises (Izma, N., 2009). Izma (2009) suggested that AASB could meet this objective by setting standards that suit the characteristics of Malaysian capital market as well as developing and disseminating of the relevant guidance for auditing and assurance services. At the same time, AASB also aims to promote the development of international convergence of standards in quest to further integrate Malaysian market internationally. As MIA is encouraging the external auditors to comply with the auditing standards which are based on the ISAs, AASB will therefore abide by the International Standards of Auditing (ISAs) in measuring and monitoring compliance (Izma, N., 2009). AASB is also expected to play its role in considering and adoption of any revised or new ISAs and pronouncements issued by the International Auditing and Assurance Standards Board (IAASB) as well as reviewing and commenting on the consultative documents and exposure drafts issued by IAASB (Izma, N., 2009).

Izma (2009) explained that MIA will also depend on AASB to consider the appropriate practice guides on issues that are not covered by the currently available auditing standards to be applied by the external auditors in performing their audits. Izma (2009) stated that it is also part of the AASB's objectives to review and consider any other developments and issues in other jurisdictions which are related to the auditing practices in Malaysia. Izma (2009) also stated that AASB is also anticipated to play its role in educating the public to have a better understanding on the roles and responsibilities of external auditors and the providers of assurance services, which would at least reduce or resolve the audit expectation gap issue. Last but not least, the AASB is supposed to speak out on public interest issues where the profession's expertise is most relevant (Izma, N., 2009).

When launching the AASB, MIA had also spelled out the responsibilities of the AASB. The ASSB is required to develop and submit to the Audit Oversight Board (AOB) an annual plan that specifies AASB's strategies direction, priorities and agenda, including a report on how projects were selected and priorities set. AASB is also responsible to implement an effective working process for all projects and commission task forces, advisory groups or other groups, as appropriate, to aid in the development of auditing and assurance standards, guidelines or any other materials as well as communicating with the stakeholders and seeking for input on a timely basis. Besides advising AOB and MIA on the adequacy of human and financial resources to accomplish the AASB's objective, AASB is also required to recommend and sponsor audit and assurance research which may be relevant to the Malaysian environment.

On the other hand, Izma (2009) stated that the main objective of the ESB is to promote adherence to the high quality professional and ethical standards. ESB has a role in uplifting the audit quality by correcting and enhancing the professional and ethical behavior of the external auditors. The ESB aims to embed a strong ethical value system among the external auditors to restrain the pressures enforced by their clients. With this, the issue on the independence of the external auditors could be resolved. Izma (2009) also stated that the ethic standards to be issued by the ESB will be in converge with the IFAC standards in line with the MIA's effort to integrate Malaysia with the global market.

ESB's main objective is to serve the public interest by issuing professional and ethical standards which maximize the integrity of the accountancy profession by setting out the highest principles of professional and ethical standards. On top of that, ESB aims to promote adherence to high quality professional convergence of standards as well as to review and comment the exposure drafts issued by IFAC's International Ethics Standards Board for Accountants. ESB is anticipated to develop and issue guidance or clarification to assist with the implementation of the MIA's By-Laws and to support the efforts of the MIA in promoting greater awareness and understanding of the MIA's By-Laws. Lastly, the ESB is supposed to speak out on public interest issues where the professionalism and ethical conduct of accountants is required and relevant.

It is the responsibilities of the ESB to develop and submit to the MIA Council an annual plan that specifies ESB's strategic direction, priorities and agenda, including a report on how projects were selected and priorities set. Similar to the AASB, ESB is also responsible to implement an effective working process for all projects and commission task forces, advisory groups or other groups, as appropriate to aid in the development of ethics standards, guidelines or other materials as well as communicating with the stakeholders and seeking for input on a timely basis. Besides advising MIA on the adequacy of human and financial resources to accomplish the ESB's objective, ESB is also required to recommend and sponsor audit and assurance research which may be relevant to the Malaysian environment.