Why Audit Expectation Gap has Widened

Why Audit Expectation Gap has Widened

The definition of the audit expectation gap finds its origin with Liggio who in 1974 argued that audit gap was the variance between expected performance and actual performance. Although this was the general definition in the field of auditing, Liggio’s definition marked an important foundation that was used later to establish the true definition of audit expectation gap. For example, in 1978 the audit Cohesion Commission extended Liggio’s definition and defined this gap as the variance between the ideal responsibilities of the auditors and public expectations. In 1992, AICPA defined expectation gap as the gap on the public perception on auditor roles and what auditors perceived should be their roles and duties. The AICPA definition marked the fundamental basis that has been used over the years to define what audit expectation gaps is. Based on the AICPA audit expectation gap definition; this paper strives to explore expectation gap in line with external auditing procedure and what has been done to decrease the gap. Secondly, the auditor statutory responsibilities in today’s business world. Third, how auditor responsibilities have changed over the year, especially in the last century. Fourth, examine what public and parties interested in the auditing information perceive as the roles of auditors in today’s society. Fifth, the paper will investigate why expectation gap between the public and auditors has widened over the years. Sixth, the steps, and measures being employed by the relevant auditing and statutory bodies to reduce or close the gap. In addressing the above points, the paper will consider key regulations and laws as outlined by bodies such as the UK Corporate Governance code, ICAEW, ACCA, International Standards on Auditing (ISA) and the UK 2006 Companies Act. Besides, the paper will use case examples to elaborate more on auditor responsibilities and what the public perceives as auditor responsibilities.blank

Statutory Responsibilities of an Auditor

The UK Companies Act 2006, outlines that the statutory responsibilities of an auditor comprise of carrying out an independent investigation to prepare an audit report that is based on his or her opinion (legislation.go.uk, 2012). The observance of auditor’s independence enables the auditor in determining whether the company has kept sufficient accounting records. Secondly, the auditor will establish whether the individual accounts kept by the company conform to its accounting records. Third, for the quoted companies an auditor should determine whether directors’ remuneration is in accordance with the company accounting records. In the event where an auditor finds that the company has failed to adhere to the above three requirements, then the regulation demands he or she must state those facts in the audit report (GOV.UK, 2014). This also happens when an auditor fails to obtain adequate explanation and information to enable him to make a solid opinion. Finally, the auditor is required by law to state whether the company directors have prepared accounts by putting into consideration the position of the small companies or they have relied on the ‘small companies’ exception’ when preparing the director’s report. In summing up on the responsibilities of an auditor, his essential duty involves detecting the fraud that might have occurred due to the material misstatement in the company’s books of account (ACCA, 2011, p. 14).

How Audit Responsibilities have changed over years

Just as like there have been developments in the auditing discipline as outlined by Chesterton (2006, p. 91), likewise, audit responsibilities have been changing in the last century. Before the 1920s the primary role of the auditor was to detect fraud. The era between the 1920s and 1960s was marked by the decline in the importance of fraud detection. The decline of fraud detection importance was influenced by the research that fraud and error detection was not costly. Therefore, it had little or on the economic impact on businesses. From the 1960s to 1980s auditor responsibility of detecting fraud was partly restored. Sine 1980s onward, auditor responsibility on fraud detection has been firmly established; this was highly influenced by increased public concern on corporate fraud. In the same light, in the 1980s and 1990s professional auditing bodies started reviewing the role of auditors in fraud detection, especially in fraud reporting. The Auditing Profession provided the basis that guided auditors on fraud detection but did not extend the detection roles. Based on the developments of auditing roles over a century, it is evident that the responsibility of external auditors has solely remained as fraud detection.

In the duty of fraud detection, the issues of auditor liability and assurance arise. Ideally, society, especially investors and lender perceives auditors as their watchdog. The lenders rely largely on audit reports to determine whether they can provide credit to a particular company. For example, in the case of Hedley Byrne vs. Heller Company. Hedley acted on behalf of the client Eazipower Bank and reassured Heller Company that Eazipower was in good position to be provided with a credit (Hedley Byrne v Heller & Co., 2014). However, the bank defaulted and Heller Company has held liable by the plaintiff. It was held that Heller had a duty of care, but it was not liable. Similarly, the auditors have a duty of care, but they are not liable for the losses that third parties may suffer on relying on their audit reports. However, there are instances auditors can be held liable, especially when they are aware that their audit report will be used by a particular third party to make a specific decision.

Just like the auditors cannot be held liable in certain cases. Likewise, they are not responsible for the duty of care in specific scenarios as it was held in the case of Caparo Industries Plc vs. Dickman. Caparo Industries had bought shares from Fidelity Inc. by relying on the company accounts that showed that it had a profit of £1.3 million before tax. However, Fidelity Inc. had suffered over £400,000 loss (Caparo Industries v Dickman, 2012).  Caparo Industries sued the auditors who had examined the Fidelity Inc. financial statements on the basis they were negligent in the certifying its books of accounts. It was held that auditors had no duty of care or liability owed to them since they were not aware of the Caparo existence and never knew for which purpose Caparo will use the audit report.

What is perceived as the Role of an Auditor Today?

In today’s society, the public perceives fraud and error prevention as the duty of the auditor. For example, in the event where corporate fraud has been committed, the public will perceive the auditor as the one responsible. The auditing information users’ perception widens the expectation gap since the auditor’s duty involves detecting and reporting the fraud.  Besides, the public feels that the auditor’s responsibility in fraud detection has been compromised. For example, the role of four big auditing firm, KPMG, Delloite, EY and PWC in the UK involved in Carillion collapse has been questioned (Sembhy, 2018). The investigation on Carillion found that the company had no sufficient assets to cater for the winding up costs. Secondly, the company was reported to have poor record-keeping. In addition to detecting fraud, external auditors must report that based on the company assets it will carry its business activities in the foreseeable future. The public is always concerned to know whether auditors can justify that a business is a going concern entity in relation to fall of Carillion.

Why has the Expectation Gap Widened?

Studies show that audit expectation gap has widened over time (Salehi, 2011, p. 8376). The widening gap has been attributed to the social construct created by the auditors to justify the hurdles they face in meeting the public expectations.  Secondly, the auditors have been found to focus on making sure they protect themselves from auditor litigations and auditor failures instead of serving the public interest (Jedidi & Richard, 2009, p. 2). As a result, the auditor has been using expectation gap as an excuse when they fail to execute their duties as per the expectations from the public. Finally study by Ruhnke & Schmidt (2014, p. 572) found that audit expectation has been widened by ever-increasing uncertainties in the fields of auditing and accounting. Similarly, Glover & Taylor (2014, p. 2) concluded that uncertainties in accounting and high public expectations from the auditors widens the gap further.

Measures to close the Gap

Auditors have been striving to close the expectation gap by making sure public expectations and interests are addressed appropriately (Jedidi & Richard, 2009). This approach emphasizes on protecting the economic interests of auditing information users. Secondly, increasing the rate of fraud detection and reporting the material facts as there to ensure the business is running on the going concern concept (Ojo, 2006, p. 5). Thirdly, enhancing communication between the public and the auditors. Fourth, educating the public on the duties, responsibilities and the functions of an auditor (Hasan Flayyeh Al qtaish, 2014, p. 165). Fourth, preparing detailed and understandable audit reports. Fifth, expanding auditor duties and responsibilities to meet some of the responsibilities that public attribute to the auditing profession. Finally, auditors are required to always adhere to the most recent auditing standards (ACCA, 2011).blankThe audit expectation gap has been an issue that has been going for decades. In fact, it has been a persistent phenomenon whose solution is yet to be achieved. This has been contributed by different perceptions that both auditors and public have towards the auditing profession responsibilities. Auditors perceive their duty as solely detecting the fraud and stating the facts in the audit report. However, the ability of the auditors to detect fraud independently and objectively can be compromised as it was the case with Carillion. On the other side, the public perceives that the auditor has to detect and prevent fraud. Therefore, whenever the public economic interest is threatened it shifts blame to the auditors. This paper recommends for the educating of public on the duties and responsibilities of the auditors.

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