Module Code: NBS 7076A

Name of coursework: Essay

ESsay
  ICAEW view on audit expectation gap:
As per ICAEW “expectation gap is the difference between actual doing of auditor (as
required by auditing standards and legislation) and what stakeholders think that auditor is
obligated to or they might do”. In short, the concept refers to the difference between public
expectations from the audit and actual achievement from the audit. However, ACCA explains
the concept as “the difference between what the general public thinks auditor do and what the
general public would like auditor to do”. This concept appraises the audit’s public concern.
 ACCA view on audit expectation gap including their component:
As per ACCA, the expectation gap comprises three components: Knowledge, performance,
and evolution. The knowledge gap reveals the lack of knowledge and understanding of the
public on audit. However, this component does not favour the requirement that auditors
should do better in the audit. The performance gap can be described as the work performed
by the auditor that is either not aligned with auditing standards or required regulations. This
generally happens when the auditor has different interpretations of the statute or they are not
concerned with audit quality. The evolution gap happens when auditors ignore legitimate
public expectations. In the contemporary era, audit needs evolvement and it should also
address all the legitimate concerns of the public. If the expectations gaps are properly
addressed, it will evolve the audit and fulfil the expectations of the public.
 Academic study on audit expectation gap:
One example of an academic study on the audit expectation gap is the "Auditor's Perception
of the Expectation Gap" by Knechel and Salterio (2000), published in the Journal of
Accounting Research. The study surveyed auditors from the US, Canada, and the UK to
examine their perceptions of the audit expectation gap. The study found that auditors
generally perceived a gap between the public's expectations of an audit and what an audit can
actually achieve. Specifically, auditors felt that the public expected auditors to detect all
fraud, guarantee the accuracy of the financial statements(FS), and ensure the solvency of the
company, which auditors believed was unrealistic as the audit has some inherent limitations.
Another example of a professional report on the audit expectation gap is "Audit Expectations
Gap: A Review of the Literature" by the Institute of Chartered Accountants in England and
Wales (ICAEW) in 2018. This report reviewed the literature on the audit expectation gap and
found that there is a general consensus among researchers that there is a gap between the
public's expectations of an audit and what an audit can actually achieve. The report also
identified several factors that contribute to the audit expectation gap, including a lack of
understanding of the role of an audit among the general public, unrealistic expectations of
auditors' abilities, and a lack of transparency in the audit process.
An example of a reputable financial press report on the audit expectation gap is "Why the
Audit Expectations Gap is Still a Problem" by the Financial Times in 2020. This report
highlighted the ongoing problem of the audit expectation gap and discussed the various
factors that contribute to it. The report also discussed the potential consequences of the audit
expectation gap, such as a lack of public trust in the auditing profession, and the need for
further research and action to address the gap.
Therefore, the difference between society’s perception of accomplishment of an audit and
what it can realistically accomplish is the summarized the meaning of audit expectations gap.
This gap can be because of unrealistic expectations of society, limitations of an audit, and
lack of understanding of the auditor ( Olojede, P.,2020). Hence more non-financial
information should be provided by the auditor and he should also give a clear description of
the role to create a bridge in order to reduce the gap.
 Example of Enron scandal:
One example of a scandal involving auditors is the Enron scandal in 2001 (Nelson,
K.K.,2008). Enron, an entity operating in the energy sector based in Houston, Texas, was
found to have used accounting tricks to hide billions of dollars in debt and inflate profits. The
entity's auditor, Arthur Andersen, was found to have failed to audit the entity's FS properly,
and the firm was subsequently convicted of obstruction of justice for shredding documents
related to the audit as explained in “The Guardian”. This scandal led to a loss of public trust
in the auditing profession and led to the creation of the Sarbanes-Oxley Act, which aimed to
increase transparency and accountability in financial reporting.
 Example of WorldCom scandal:
Another example is the WorldCom scandal (Lyke, 2002), a telecommunication entity which
intentionally inflated around USD 11 billion in earnings over 5 years. The auditor, Arthur
Andersen behaved negligently and failed to detect the fraud later on they got convicted for
documents related to the audit. The scandal brought additional reforms in auditing and
increased scrutiny of the role of an auditor in detecting and preventing fraud.
 Example of Wirecard scandal:
A prominent and recent example includes the Wirecard scandal (Engelen, K.C., 2021). This
German entity is used to process payments and provide financial services to customers. The
entity was a member of the DAX 30 market index and was listed in the Frankfurt stock
exchange (FSE). Financial Times published an article accusing Wirecard of accounting
irregularities which were denied by the entity. However, subsequently, it was found that the
entity has inflated the revenue as well as profits. This act was done with the help of a
complex web of transactions with 3rd party to give the impression of the entity’s success. The
auditor of Wirecard, Ernst & Young were auditing the entity since 2009 and provided the
entity with an unmodified opinion. However, it was later revealed that auditing firm EY was
negligent and failed to exercise due care and do the proper audit despite of red flags and a
potential indication of fraud, particularly in revenue and cash balance. The audit firm also
failed to check the 3rd party transactions which were fictitious and used as a tool by Wirecard
to inflate revenue and profit. This scandal resulted in the loss of society's trust in audits and
questioned about the effectiveness of applicable auditing standards in tackling fraud. German
financial supervisory authority(BaFin) investigated the scandal whereas the European
securities and market authority(ESMA) investigated the EY's role in the scandal. This scandal
reveals the need for more oversight and regulations in the audit. This scandal has raised the
need for separation in consulting and auditing services offered by audit firms to downsize the
exposure of conflict and contribute to independence. Furthermore, mandatory rotation of
auditors was introduced to tackle the association of entities with auditing firms which hurts
their independence. This scandal also led to a focus on the auditor’s role in the prevention
and detection of fraud. The international standards on auditing(ISA) is the governing body
that provides the framework for audits and guides for maintaining professional scepticism,
work with due care, and take professional judgement. However, in the case of Wirecard,
these requirements are not fulfilled which has given rise to the audit expectation gap. It is the
requirement of the audit to vouch for amounts and disclosures considering corroborative
evidence. Furthermore, the auditor is also required to get an understanding of the entity,
environment, and internal control which EY as an auditor failed to do. This clearly shows the
performance gap.
 Example’s conclusion:
These examples demonstrate the significance of the auditor's role in detecting and preventing
financial fraud and the need of time for the auditor to maintain professional scepticism, work
independently, and follow proper accounting standards, frameworks, and guidelines.
 Detailed review of audit expectation gap:
An audit is an independent examination of a company's financial statements by a qualified
professional to provide assurance that the statements are presented fairly and are free from
material misstatement. The main objective of the audit is to provide assurance to stakeholders
including regulators, investors, and creditors that FS are reliable and they can rely on the
details and disclosures given. However, society may have a different perception of what
accomplishments are made by audit. They believe and expect that an audit is a tool to detect
any fraud and prevent the entity from fraud, appraise financial health, and provide a
commitment to the entity’s future success. However, these expectations are very unrealistic
and not aligned with the design of the audit as the audit is not crafted to detect or prevent
fraud and the auditor can not guarantee the entity’s success (Ruhnke, K 2014).
The research conducted by Muhammad, P., (2012) reveals that the expectation gap exists and
it has an adverse impact on the auditing industry. Hence, steps should be taken to address the
issue and ensure it is minimized. One of the main reasons for the audit expectations gap is
society’s knowledge gap regarding the role and limitations of an audit. Furthermore, the
technical terms used by the auditor are new to the public and they are not familiar with that,
so they fail to distinguish between audit and other assurance like review or compilation. The
public is unaware that audit follows a sample-based approach where only a sample of an
entity’s transactions is considered in the audit instead of all the transactions. Hence, it is not
possible for the auditor to detect all material misstatements.
Another reason for the audit expectation gap is the unrealistic expectations of society to
prevent and detect fraud. However, the auditor is not responsible for detecting and preventing
fraud they are just liable to detect material misstatement in FS, which may lead to fraud
detection. The primary focus of the auditor is to appraise the fairness of FS. Management is
responsible for fraud detection and internal control.
The audit expectation gap has a significant impact on society and the auditing profession.
Because of unrealistic expectations with audits, society may lose trust in the audit report and
FS presented by the entity. This can ultimately result in confidence loss in the capital market
and decreased investment. Additionally, it would also increase the liability of the person
performing the audit. If society has expectations to prevent and detect fraud, then the auditor
can be held accountable for any fraud which is not detected by him. This will increase the
liability of the auditor and adds more cost to this profession.
The research done by Deepal, A. G.,(2022) finds that it is not possible to remove the audit
expectations gap entirely however it can be reduced to an extent. To reduce this audit
expectation gap, it is important to increase awareness and understanding of the role and
limitations involved in the audit. This can be done by conducting seminars, providing
education and training to the society on basis of auditing and informing them about the
difference between auditing and other assurance. Further, it should also be informed that the
detection and prevention of fraud is the primary responsibility of management. Additionally,
increased transparency and establishing proper communication with stakeholders will also
reduce the audit expectation gap. This can be managed by providing detailed information on
the process used for the audit and the result obtained from that process including the scope
applicable and findings made.
 Conclusion:
Considering the scandals in recent years, the audit industry was in the spotlight because of
some spectacular and well-publicized corporate collapses which subsequently impacted the
reporting of the auditor. These collapses resulted in the loss of public trust in the industry
which ultimately increased scrutiny and regulations in the industry. However, it is worth
noting that the auditor was not the only person solely responsible for the collapses. It was
found that management actively participated in the fraud and had misled the auditing firm.
Therefore, it is significant to consider the entity’s internal control, corporate governance, and
regulatory environment. The audit industry is surrounded by dynamic reforms and it is also
addressing the corporate collapses by taking measures like introducing international standards
on auditing(ISA), which provide guidance for effective and consistent audits. Furthermore,
PCAOB(public company accounting oversight board) was created with the objective to
oversee the work performed by the auditors to ensure whether auditors are following proper
auditing standards. These steps helped the industry to restore public trust and improve the
integrity of reporting by auditors. In conclusion, the well-publicized corporate collapses of
the past have highlighted the importance of the role of auditors in detecting and preventing
financial fraud and the need for auditors to maintain professional scepticism, independence
and to follow proper auditing standards. The audit profession has taken steps to address the
issues that led to these corporate collapses and to restore public trust in the profession.
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