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The primary aim of an audit is to judge the correctness of financial statements and establish their reliability and supporting accounting documents for a particular period for the purpose of facilitating the users of accounting information to take economic decisions. The dominant principle of audit is the examination of the accounts or statements made by an accountable party with a view to reporting to the person to whom the account is rendered on its truth or falsity. An auditor should prove himself to be an independent person and must not compromise on important issues with his appointing authorities. The auditor's reports lend credibility to the financial information upon which reliance can be placed by various sections of the society, e.g., shareholders, creditors, trade union, governmental agencies and others possessing legitimate interest in the business. In London vs. General Bank case, Lord Justice Lindlay remarked, "An auditor must be honest, that is, he must not certify what he does not believe to be true". In view of the auditor's extensive responsibilities to third parties, the auditor must be independent of his client. He must not be influenced by the management of the enterprise under audit. Hence, it can be remarked that an auditor should approach his work independently and be free from bias and prejudice. Independence is also an attitude of mind and independent thought and action are equally as important as the independent relationship between the accountant and his client (Howard, 1971)
In the most general sense, an audit is the means by which one person is assured by another of the quality, condition or status of some subject matter which the latter has examined. The need for such audit arises because the first mentioned person is doubted about the quality, condition or status of the subject matter, and is unable personally to remove the doubt or uncertainty (Lee, T.A. 1999).
This quotation would appear to describe the shareholder's circumstances. He is in obvious need of assurance regarding the reliability of the information in the financial statements. Furthermore, there is no way in which any individual shareholder would have the opportunity to verify the content of a set of financial statements. An audit would appear to be the obvious solution to this dilemma. Auditors must be independent. They must collect evidence to support their opinion. The purpose of an
Audit is not to provide additional information. It is intended to enable users to rely more heavily upon the information which has already been prepared by others.
The primary objective of an external audit of financial statements is to facilitate an auditor to give his independent and fair opinion on the operating and financial performance of an organisation, which will help the users of the financial statement to form an opinion on the firm for the purpose of taking the right economic decisions. However, the users of financial statements are not in a position to rely on the opinion of external auditors to be an assurance for the future of the organisation or the efficiency of the management in the effective conduct of the business.
Thus, the user of the audit report must examine the financial statements to which it relates if he wishes to discover whether the company has been properly managed.
Audit Expectation Gap:
The terms "expectation gap" refer to the difference between the perception of the users of financial statement towards the role and responsibilities of external auditors and the perception of the external auditors themselves of their professional obligations. It is important to distinguish between the audit professions' expectations of an auditor on one hand and the auditors' perception of the audit on the other hand.
The external auditors assume professional responsibility in terms of giving their opinion as to the true picture of a given firm. But, however, there evidently exists a gap between external auditors' understanding of their role and the expectations of various users and the public in regard to the audit procedures and the subsequent outcomes. This has resulted into an audit expectation gap. This gap prevails due to the reason that many members of users of accounting information expect that:
The external auditors are expected by the users of accounting information to assume authenticated responsibility for the opinion on the financial statements
Auditors' certification on the financial statements
The opinion of the auditors should guarantee the accuracy of financial statements
It is the prime duty of an auditor to give a clear advice on the possible business distress of the firm.
The auditors are expected to detect fraud
.The above expectations of external auditors by the users of accounting information have resulted into the audit expectation gap.
The concept of 'audit expectation gap' was first coined into the audit literature by Liggio (1974) over a period of twenty years ago. According to Liggio (1974), audit expectation gap is the difference between expected standard of performance by the independent accountant and by the user's expectation on the independent accountant's performance. Tweedie (1987) has expressed the extent of the problem as follows:
Audit expectation gap seems to exist as it appears that the users seem to require (a) protection against the fraud and misappropriation of funds; (b) early advice on the expected financial distress of the firm; (c) a guarantee for the financial stability of the firm and (d) simplified audit reports capable of being understood by users.
Thus he has concluded that the basic tenets are being misunderstood.
Under the above context, the auditing professionals across the world have recognised the existence of expectation gap as an issue of fundamental importance. The Commission on Auditors' Responsibilities (AICPA, 1978) which was established to investigate the existence of audit expectation gap in the USA has concluded that there were considerable amount of evidence to prove that there existed such a gap.
The McDonald Commission established by the Canadian Institute of Chartered Accountant to assess the public's expectation of audits, concluded in its report that the public at large is not aware about the role and responsibilities of external auditors and those who have knowledge in this feel that their expectation on the performance of external auditors have not been fulfilled. The UK Auditing research Foundation (1989) came out with the conclusion that the expectation gap should be given higher priority for investigation and for finding a suitable remedial measure.
In 1991, an independent commission, established by ICAI, Ireland for studying the expectation gap, concluded that there was strong evidence for expectation gap and the issue should taken up for critical analysis for finding a solution for the same.
Components of the expectations gap:
Many authors who deal with the issue of expectation gap have attributed the audit expectation gap to users' misunderstanding and ignorance of the expected standard performance of external auditors (Sikka and Puxty, 2003). However, Porter has analysed the expectation gap into three separate components (Porter, 1993), namely, sub-standard performance (16%), deficient standards (50%) and unreasonable expectations (34%). As deficient standards can be easily revised, it is relatively easier
To reduce this gap. The deficient standards component can be considered the most objective component while unreasonable expectations and sub-standard performance are the most subjective components. Even though unreasonable expectations are subjective, it still constitutes a significant proportion of the expectations gap and cannot be ignored.
The audit expectation gap is an important issue for auditors since a greater expectation gap would jeopardise the integrity, income and reputation associated with their work (Sikka and Puxty, 2003). Further it is also an issue for the users of financial statements for various investment decisions since their investment decisions largely dependent on the confidence and accountability the external audit is supposed to provide.
Eliminating the expected gap
In the worlds of Sikka et al, the nature of the components of the audit expectation gap makes it difficult to eliminate. It is also difficult to measure and change the perceived performance of an external auditor. However, it is also possible to substantially reduce though it is not possible to eliminate totally.
Many recommendations have been made by different experts in auditing which deal with narrowing down the expectation gap. These suggestions include an expanded audit report offering a broader scope for informing the users of what has been done in the auditing process, reframing the standards of performance of external auditors in dealing with fraud, illegal acts which will make possible the auditors being independent (Pierce and Kilcommis, 1995). Another important suggestion is that steps must be taken for implementing auditing education as audit education would surely help reduce the expectation gap but would not be sufficient to solve the problem of all components of expectations gap. As is perceived by many audit education would partly solve the problems of unreasonable expectations gap though it would never address deficient standards of substandard performance. According to Porter, audit education to be effective, society should be educated on duties which may be expected of auditors (Porter, 1993).
According to McDonald commission, audit education did not prove to be effective for the reason that the expectations of the users of financial statements and the public at large were reasonable and within the reach of achievement.
According to Sikka et al, the expectation cap can be addressed by audit profession widening the responsibilities of auditors. The issue of implementation of any new
Standards are another matter to be resolved in this regard. In short, liability measures of auditors and the enforcement of new standards are to be sorted out.
Pierce and Kilcommins have sorted out the users' misunderstanding in the following ways:
Ethical and legislative framework
Liability ; and
There exist a widest gap in the process of detecting and reporting of fraud by external auditors. In relation to the ethical and legal frameworks are concerned, there is a big gap in respect of issues such as auditors' independence, auditors' appointment and audit regulation. As far as the liability of an auditor, there exists a gap as the users of the accounting information and the public at large are not aware of the role and responsibility of the external auditors.
However, it could also be argued that the substandard performance component of the expectations gap already embraces the liability gap as auditors are encouraged to under underperform in the absence of any statutory duty of care to third party shareholders- especially since no economic incentives exists for them to owe a duty of care to such shareholders.
The role of auditing standards in reducing the expectation gap:
The concept of materiality:
The International Standards on Auditing (UK and Ireland) 320 establishes standards and provides guidance on the concept of materiality and how this relates to audit risk. The concept of materiality is very important because any information becomes material as its omission or misstatement would lead to the influence of the economic decisions of users and the public at large that use the financial statements as the basis for their decisions. Hence, the materiality becomes the cut-off points for any economic decisions.
The assessment of materiality is based on professional judgement. In planning the audit, the auditor establishes an acceptable level of materiality in order to detect quantitatively material misstatements. In addition, both the amount and nature of misstatements need to be considered.
Examining the social framework of the audit:
Sikka et al. have argued that meanings of the audit are determined by particular social arrangements which are always subject to change and as a result it is difficult for the audit to have affixed meaning. Even though social and global changes have shaped the role of the auditor and hence the role of an audit, some components within the definition of an audit can be fixed. The advent of technology, internal control systems have definitely transformed the environment within which an audit operates. Periodical surveys should be carried out in the general public to
Ascertain what many perceive to be the role of an auditor. These surveys should be carried out only after the public has been sufficiently educated about the role of the audit.
After this, draft proposals should be made whereby public is still involved and is invited to submit their ideas or challenge any proposals. The draft proposals on the definition of an audit should be a more acceptable definition by popular consensus - as realised through the opinions received from surveys carried out on the public. There should be a relatively objective component within the definition of an audit which would be the public's reasonable expectations. These expectations could be deemed reasonable as public would already have been education about the role of auditors, nature of audits before a survey is carried out to find out what the public want from an audit. The subjective component definition of an audit would be revised from time to time - depending on the social and environment changes. The objective component would also be revised from time to time based on periodical surveys. In the absence of an imposition of statutory duty on auditors, the role and responsibility in the detection of fraud and error, auditors seem to have a role which should become a primary audit objective - as this would help bring about some form of accountability. Of course, the auditor cannot be expected to sniff out every form of fraud-only material ones. The cases of Enron and Parmalat certainly involved fuge amounts of money which are deemed significant and material from a subjective or an objective point of view. Why were the auditors involved not able to detect such material amounts? The reinstatement of fraud detection (and also error detection) as a primary audit objective which constitutes a relatively fixed component definition of an audit (as the public has every right to expect this duty from the auditor-provided issues relate to material fraud) would certainly help bring some form of accountability within the audit profession.
Audit expectation gap is a serious issue in the auditing field with the increasing level of corporate governance. Further the growing list of financial scandals, such as, Enron, WorldCom, Parmalat, etc, has focused the importance of the role and responsibility of external auditors. Under such an environment, it is very important to eradicate the expectation gap existing between the perception of the users of accounting information and the perception of the auditors on the professional obligation in order to achieve the purposes of assurance services.