Can The Expectation Gap Be Reduced? The aim of this essay is determine the existence of the expectation gap in auditing and the effectiveness of the approaches that have been suggested by previous researchers to reduce the gap.
1.a This essay will include primary research in order to identify the factors contributing to the existence of the expectation gap. Various studies will be critically analysed taking in to consideration the methodology used by the past researchers. The concept of the expectation gap has undermined the confidence placed in the audit function and could lead to the perception of the auditing profession having no value (Porter & Gowthorpe, 2004). Therefore the „expectation gap‟ is an integrative issue faced by the auditing profession as justified by the substantial research conducted on o n this concept.
Introduction Before assessing the previous research, it is appropriate to discuss the auditing function and the role the auditor plays. This literature review will focus on a fundamental issue affecting the auditing profession today, “The Expectation Gap”. Before assessing the previous research, it is appropriate to discuss the auditing function and the role the auditor plays. Auditing is the process of conducting an aud a udit which has been defined as the “independent examination of, and expression of opinion on the financial statements of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation” (Gray & Manson, 1989, p. 10). Porter, Simon & Hatherly (1996) have defined the purpose of an audit and emphasised the importance of providing a true and fair view. They stated the purpose of an audit is to determine whether the accounts of a business present a true and fair view of their financial situation at the year end and are in accordance with the relevant legislation. Audited financial statements may be referred to as a „stamp of approval‟ as they can help he lp reinforce the trust placed in the financial reports by the end users. Chandler, Edwards & Anderson (1993) analysed the changing role of the auditor between the period of 1840 – 1940. They stated the main concern of auditing from the 1840s was the quality of the financial reporting provided by the companies. However later in the 19th century, greater emphasis was placed on fraud detection. Chandler et al (1993) proposed this may have been in response to large number of bankruptcies occurring which were implied to have been as a result of management fraud.
However during the early part of the 20 th century it became evident that “financial reports were being used to conceal the truth from shareholders” (Chandler et al, 1993, p. 458) so statement verification was again seen as the primary audit function. Companies had become larger therefore a comprehensive review of all transactions had became harder to achieve in practice and made the process of identifying any irregularities difficult. The AICPA also stated in 1951 how the process of issuing an opinion on the accuracy of the financial statements cannot be relied upon to disclose any irregularities (Brink & Witt, 1982). Later in the 20th century various audit failures became apparent and popular due to the power of the media. For many of the companies involved in corporate scandals, auditors failed to report any misbehaviour or substantive inaccuracy (Pargano and Immordino, 2004). These audit failures have damaged auditors‟ reputation as independent experts and monitors of accounting information. This has focused the world‟s attention on accounting standards and the role of the auditors when giving an opinion on whether the accounts provide a true and fair view (Jayalakshmy, 2005). Guidance only really started to emerge from 1961 but primarily as advisory statements rather than mandatory statements. The Auditng Practices Board was established in 1991 taking over from the previous governing body the Auditing Practices Committee (APC) (Humphrey, 1997). The APB was also formed to enhance the independence of the standards setters from the accountancy profession. Approximately 50 per cent of its voting membership was made up of non-audit practitioners who represented the community of users and preparers of financial reports and members of the public sector. Auditing standards now appear in a different format and their coverage is more comprehensive than the pronouncements which were provided by the APC (Humphrey, 1997).
Literature Review This literature review will critically analyse the various theories put forward from previous researchers regarding reasons for the emergence of the „expectation gap‟ and the professions response in trying to reduce the gap. The methods suggested to reduce the gap will also be discussed considering their effectiveness.
2.1 ‘Expectation Gap’ The failure of large corporations such as Enron in the US, Parmalat in Italy and Polly Peck in the UK has again focused the world‟s attention on the role the auditors have in regards to detecting fraud (Jayalakshmy, 2005). The question that has been raised among the public is „where were the auditors?‟, as they were thought to be responsible for auditing the books of the failed companies and determining whether the financial statements were accurately stated (Moeller, 2004). It can be suggested that the society as a whole is expecting more from its auditors and getting confused by various opinions regarding the purpose and nature of the audit function. This has led to the emergence of the term „expectation gap‟, the t heory behind which may have been in existence for many years but the term was first used by Liggio in 1974. He described it as the difference between the levels of expected performance as envisioned by
the independent accountant and by the user of financial statements (Liggio, 1974, cited in Koh & Woo, 1998, p.147). The growing concerns of the public on the quality of the auditor‟s performance led to the set up of the Cohen Commission in the USA in 1978. They defined the expectation gap as “the gap between what the public expects or needs and what auditors can and should reasonably expect to accomplish” (Koh & Woo, 1998, p.147).
The diverse views regarding the audit function presented by previous researchers has led to equally diverse definitions of the expectations gap. The original definition provided by Liggio can deemed to be one of the most accurate as he used the term „users of financial statements‟ rather than referring to them as the general public. As these users would be part of the high interest group of stakeholders. There is substantial evidence from around the world of the existence of the gap. One of the earliest and most prominent studies in the USA was conducted by Baron, Johnson, Searfoss and Smith (1977). In this study they found there to be a significance difference in beliefs on the auditors‟ responsibilities and duties in relation to detecting any indiscretion or illegal acts.
2.2 Reasons for the Gap It can be argued, what has led to the emergence of the expectation gap? Porter and Gowthorpe (2004) suggested three key reasons; the society‟s expectations are unreasonable; auditors‟ professional requirements do not allow them to meet reasonable expectation from the society; and the auditors are not performing their responsibilities to a satisfactory standard deemed by the society. However Glezen and Taylor (1997) suggested the highly publicized failures of large organizations was the primary reason behind the creation of the gap. It led to high levels of criticism and litigation against auditors because they were thought to be responsible. Liggio (1974) also warned that “failure to narrow the expectation gap would result in the accounting profession being increasingly subject to criticism leading to lawsuits” (W olf, Tackett and Claypool, 1999, p. 468). Unfortunately even if the auditor is acting in compliance with the relevant auditing standards, it may not be sufficient enough to protect them from liability (Schwartz, 1998).
2.3 Response from the Profession The accountancy profession continues to grapple with the task of bridging the gap between the performance of auditors and the expectation of the users. In recent years auditing standard setters in the UK and the US have struggled to meet the public‟s expectations of the performance of the auditors. This has contributed to the increased scale and frequency of litigation against auditors (Koh & Woo, 1998). Therefore it can also be suggested the profession has failed to publicise successfully the purpose of the company audit. This coincides with the common perception found in most of
the literature regarding the key role the profession has played in the emergence of the expectation gap. It was perhaps first mentioned in The Cohen Commission report which stated the gap “was due in large part to the failure of the accounting profession to react and evolve rapidly enough to keep pace with the speed of change in the American business environment” (Wolf et al, 1999, p. 468). As stated in one committee report; “The public is not willing to accept things on faith today. Government and business leaders must demonstrate that they are worthy of trust they ask of the public” (Metcalf Committee, 1978, P. 90). This was also supported in Tricker‟s 1982 research study, where it was acknowledged the auditing profession had been too slow in recognising and reacting to constantly evolving and expanding expectations of the public (Koh & Woo,.1998) This has led to many committees‟ and organisations‟ from the profession increasing their effort on reducing the gap. For example the Accounting standards board produced new statements on auditing standards which were focused on reducing the gap (Humphrey, 1997).
2.4 Contents of the Gap Porter (1993) found the expectation gap to primarily consist of two major elements:
A Reasonableness gap, can be defined as the gap between what society expects of auditors and what auditors can reasonably be expected to accomplish. A Performance gap, was defined as the gap between what society reasonably expects of auditors and what it perceives they deliver. This element of the gap was also subdivided in two gaps, the deficient standards gap and the deficient performance gap. The deficient standards gap is the gap between the duties which can be reasonably expected of auditors and auditors existing responsibilities as defined by law and professional regulation. The deficient performance gap is the gap between the expected standard of performance of the auditor when carrying out there duties and auditors actual performance of these duties.
3. Previous Research Along with the substantial amount of research on the existence of the gap (Koh & Woo, 1998, Porter et al, 1993, Wolf et al, 1999) there have also been various studies that have examined the main approaches to reducing the gap. „If society‟s expectation of auditor‟s performance and their actual performance are closely aligned‟ the criticism and litigation would be reduced as they will be a better understanding between both parties (Porter & Gowthorpe, 2004, p. 10). One of the most popular approaches has been to expand the auditing report, (see for example Kelly and Morweis (1989) in the USA). They established that “users perception of the nature of an audit were significantly changed by wording modifications in the audit report” (Koh & Woo, 1998, p. 150). However as mentioned in Koh and Woo (1998) this popular approach has been found to be misleading as Hartherly, Innes, and Brown, (1991)
study has shown the perception of auditor‟s responsibilities are not influenced by modified wording.
Another popular approach is to educate the public in order to improve society‟s perception and bring it in line with what the auditors actual responsibility is. For example the auditing postulates which were developed by Mautz & Sharaf (1965), are thought to be the fundamental theory behind auditing. The existence of the expectation gap suggests there is a lack of knowledge of these postulates, which has led to misconceptions over the auditors role. Postulate no. 4 states “the existence of a satisfactory system o f internal control eliminates the probability of irregularities” (Mautz & Sharaf, 1965). Although this statement cannot be taken as an assurance of satisfactory internal control measures, it can be suggested auditors should have reduced liability as internal management should also share the responsibility in reporting irregularities. Humphrey, Moizer and Turley (1993) have suggested the approach of increasing the publics knowledge on auditors responsibilities would not help in reducing the gap. “They have suggested it is no good expecting the public to abandon their hopes of auditors as fraud detectives through education” (Koh & Woo, 1998, p. 151). They supported 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. The MacDonald Commission in 1988 also suggested educating the public in order to reduce the gap should not be such a critical issue as they believed that in most situations the public expectations have been achievable for the auditors (Humphrey, 1997). Porter & Gowthorpe‟s 2004 comparison study also suggested alternative appro aches including strengthening the monitoring of auditors performance, improving the quality control in audit firms and introducing new standards. Complete elimination of the gap has proven difficult to achieve in practice. Terms such as „reasonable‟ and „expected‟ are very subjective therefore there is not one perceived opinion followed by the all of society. However dividing the gap in subsections may help in reducing the gap and different factors that influence the gap can be clearly identified.
Methodology This essay will include both primary and secondary research in order to answer the question effectively. The combination of both will provide the researcher the ability to analyse the information found from the primary research and assess whether it coincides with the views presented in the previous research. Primary research will be based on questionnaires, whereas the secondary research will be based on an extensive critical literature review. The questionnaire will consist of approximately 10 closed questions based on what the auditors job is to do. These questionnaires will be distributed to various members of the
public. However it is essential that these members have no educational or professional background related to accounting. As individuals with knowledge of auditing will be aware of the expectation gap and this may affect the answers they provide. This will also ensure the researcher can obtain an unbiased view of the profession from the general public‟s perception. Therefore the questionnaires will be distributed to nonaccounting students at the university. Using closed questions will also be essential as it could determine the number of responses the researcher achieves as open questions can deter potential busy respondents from answering the questionnaire (Collis & Hussey, 2003). Open questionnaires may also prove difficult to analyse as each individual response will differ considerably. Interviewing individuals from the profession was also initially considered. Another deterrent was the time factor as well as the fact the answers provided from their responses would primarily consist of what is written in auditing guidelines and standards published by the regulatory bodies. It would also undoubtedly prove difficult to arrange enough interviews which could be effectively compared with the questionnaire respondents. The researcher aims to receive approximately 50 responses from non-accounting students. This sample will be enough to provide an opinion on the public‟s expectations on auditors. The researcher will be distributing the questionnaires in person, and collecting them as soon as they are completed. This will eliminate the possibility of non-responses and save time compared to a situation where the researcher is waiting for the responses. The main part of the research will be based on secondary research. This research primary consists of reference to journal articles, books and relevant literature, which have been mainly used in the literature review. The key aspect of secondary research is that it enables access to work that has been constructed by other scholars and specialists in the specified area. The importance of secondary research is quite significant, as it will provide the information used in order to gain a thorough understanding of the concept which will serve as a basis of the research. The journals to be discussed will primarily be obtained from journal database resources available on MyAthens website. These include Pro Quest, Emerald full text and EBSCO where phrases such „expectation gap‟, „auditor role‟ were used in order to find the r elevant material. Text books obtained from the university library will be used initially in order to get a basic understanding of the concept.
The project gantt chart below represents the schedule the researcher aims to follow. The initial part of the primary research will be conducted towards the end of may, and if need be in June. After this period the gathered set of data will be analysed and be presented in a clear context. This data found will be compared to the findings of previous
research studies. This will be followed by a critical literature review on the approaches suggested for reducing the gap. Finally the conclusion part of the essay will be written up and a final draft will be ready to hand in by 1stSeptember. This will ensure the written up and fully completed research will be reviewed several times prior to the submission date in October.
