Introduction
Within the current crisis of confidence in the public accounting profession after the Enron debacle and series of high profile failures of financial services firms, the issues about ‘audit expectation gap’ have never been more important. Though it would take an enormous amount of effort to address these issues, I will argue that tremendous amounts could be done in order to close the gap down. In this essay I will discuss some of these issues and in particular the strategies to reduce the gap.
Definitions
Various definitions have been proposed for the audit expectation gap. Humphrey, Moizer and Turley (1992), suggest that the common element in the various definitions of the gap is that auditors are performing in a manner that is at variance with the beliefs and desires of others who are party to or interested in the audit.
The expectation gap may be decomposed into two components: the reasonableness gap and the performance gap. The former appears when people expect more of audit than it can give in practical terms, such as detecting all instances of fraud. The latter refers to the gap between what auditors can reasonably be expected to do and what they are perceived to do. ‘Performance gap’ can be further split into two – deficient standards gap and deficient performance gap. The ‘deficient standards gap’ refers to situations when the auditors are not required by the standards to report certain issues, whilst its counterpart refers to situations when auditors have not complied with the existing standards. This dissection is particularly important when I look at each of the problems separately later on and look for the respective solutions.
The beginning
Since the early 1970s, the auditing profession has been under increased pressure and scrutiny by government and users of audit reports. The phrase ‘ Audit Expectations Gap’ was first coined when the AICPA put the Cohen Commission together in 1974 to investigate whether the ‘expectations gap’ existed. However, the history of the expectation gap goes right back to the start of company auditing in the nineteenth century (Humphrey and Turley 1992). Since then, events ranging from the collapse of Arthur Anderson to the ongoing savings and loan problems seemed to have made the gap become more and more apparent.
Strategies
I agree with Power to a certain degree that the expectations gap is ‘endemic to auditing’ – but I believe that it is possible to progressively close the gap down despite the present widening gap.
Auditors do not provide audit opinions for different levels of assurance. Therefore, auditors consider providing more or less assurance when modifying evidence for engagement risk to be unnecessary. However, auditors should be professionally responsible to accumulate additional evidence, assign more experienced personnel, and review the audit more thoroughly, particularly when a client poses a higher than normal degree of engagement risk. The auditor should also modify evidence for engagement risk when high legal exposure and other potential actions affecting the auditor
Rittenberg, Larry, Bradley Schwieger, and Karla Johnstone. Auditing. 6th ed. Mason: Thomas South-Western, 2005. 10-40.
Audited party attributes interrelated to the ability of the audited party to achieve expected goals. Implications of audited party attributes on tax audit effectiveness consist of the ability of audited party to effectively and efficiently meet the sub-goals of organization, attitude of audited party towards tax auditing and the cooperation level provided to the auditor. The auditors are required to fully and unlimitedly access to all activities, records and properties and cooperate with the audited party in order to attain an effective tax auditing work. Hence, the attributes of audited party have a positive effect towards the effectiveness of tax
Investing and lending public: These individuals and entities rely on independent auditors to carry out their “public watchdog” function rigorously, including reporting honestly and candidly on their clients’ financial statements. The integrity and efficiency of our nation’s capital markets are undermined when auditors do not fulfill their professional responsibilities. This will cause these individuals lose faith on the auditing work and might not cooperate with auditors anymore.
Proverbs 10:9 states: “People with integrity walk safely, but those who follow crooked paths will slip and fall” (New Living Translation).” This Scripture suggests that individuals who do not walk in integrity follow “crooked paths.” They walk in ways that are not morally sound, pure, and honest—but in ways that are corrupt. Clients want accountants with integrity. Thus, integrity is critical to the public trust. As a matter of fact, one of the general definitions of integrity provided by the AICPA Code is that it is a quality from which the public trust derives. Also, it is an element of character fundamental to professional recognition, and it requires members to be (among other things) honest and candid within the constraints of confidentiality (Duska, Duska & Ragatz, 2011). Integrity in the accounting profession involves adhering to the rules and principles of the profession. This includes remaining free of conflicts of interest and maintaining client relationships in which the accountant can remain objective in discharging his or her responsibilities. This requires independence in fact and in appearance as mandated under section 1.200.001.01, Independence Rule the AICPA Code. In other words, no one should be able to view the accountant as being biased with respect to a client’s financial reporting due to an improper client relationship. Lack of integrity in accounting practices has been, and continues to be, a key element in the downfall of many institutions which has hurt the public trust in the accounting
Gray, Iain and Stuart Manson. The Audit Process: Principles, Practice and Cases. London: Thomson Learning, 2008. Print.
The second general standard of generally accepted auditing standards (GAAS) is, “In all matters relating to the audit, an independence in mental attitude is to be maintained by the auditor or auditors.” The facts of the case reveal numerous issues that suggest that Andersen's independence may have been compromised. For example, Enron was one of Andersen’s biggest audit clients. It paid Arthur Andersen $7.8 million in fees for auditing the financial statements, $6.6 million for other audits required by law in other countries, and lastly $50 million for consulting, litigation support, and tax services. More than half of the fees for Enron were charged for non-audit services. The size of the fees would likely have made it hard for auditors of Andersen to challenge Enron's management team on difficult accounting issues. Nonetheless, this is one of the numerous issues that suggested that Andersen’s independence may have been compromised.
Jonathon Grenier researched auditors who have a specialised industry experience. Grenier highlighted a pattern of recognition ability for explanation of non-misstatement, leading to a reduction of PS. These auditors preempt an explanation rather that looking at each particular set of circumstances with scepticism (2016). Auditors who encounter frequently explained misstatements will collect a knowledge bank of justifications, enabling them to be able to explain away overt ratio variations. However, these ratio indicators should highlight to the auditor that further investigation or evidence is required before an explanation is accepted or rejected. Industry focused auditors tend to have an over confidence in regards to their ability to explain misstatements. They are then less likely to exercise PS in recognizing areas that need further auditing. They are reliant on their superior knowledge to conduct the audit rather than exercising their required PS (Grenier 2016). While conducting an audit, it is likely that without their use of PS, they will fail to detect areas of well concealed fraudulent activities or low probability misstatements (Grenier
professional skepticism of auditors. This report summarized the inspections on firms that audited 100 or
Professional judgement is a necessary skill for preparers, auditors and regulators of financial statements to have. A professional accountant with good judgement will be able to serve the needs of businesses, the public and investors in the best way possible. Principle-based accounting will help preparers and auditors make and document significant accounting judgement. Guidance is also provided for regulators involved in assessing key judgements, and recommendations are made for standard setters in maintaining and producing principle-based standards which provide the scope for professional judgement. The framework is intended for different sized companies. The audit committees have a key role in challenging initial judgements. They speak to the auditors and make recommendations to approve key judgements. As business transactions become more complex, the validity and usefulness of financial reporting relies on good judgement to be made. We believe that a professional judgement reinforces the quality and integrity of the judgements made and also trust in the operation of principle-based financial
This shows how a lack of transparency in reporting of financial statements leads to the destruction of a company. This all happened under the watchful eye of an auditor, Arthur Andersen. After this scandal, the Sarbanes-Oxley Act was changed to keep into account the role of the auditors and how they can help in preventing such
4) . One of the largest bankruptcies in history was enabled by accountants hiding debt and destroying the evidence to avoid implication (Buckstein, part 2 pgs. 1, 2, and 3). These unfortunate events led to the need for increased scrutiny and regulations, including the Sarbanes-Oxley Act (Buckstein, part 3 pg 1). This legislation inspired the creation of the Canadian Public Accountability Board (CPAB) (Buckstein, part 3 pg 1). These changes have led to an increased awareness of the need for auditor independence as well as higher standards for accounting and business in general (Buckstein, part 3 pg 1). While these measures have helped to reassure the public, there is still the question of why Accountancy is not a protected
The fundamental duty of an external financial auditor is to form and express an opinion on whether the reporting entity’s financial statements are prepared in accordance with the relevant financial reporting framework. In discharging this duty, the auditor must exercise “reasonable skill, care and caution” (Lopes, J. in Kingston Cotton Mill Co 1896) as reflected in current legal and professional requirements.
Paul, B & Miller, W 1985, ‘The conceptual framework: myths and realities’, Journal of Accountancy, vol. 159, issue. 3, p. 62, ProQuest Central Database, viewed 30 April 2014
...pendence, whether pro forma or substantially, the quality of professional assurance service of professional accountants will be doubted by public and that will probably lead to serious results. The factors affecting independence of external auditors are multiple. Market competition among external auditors and the imperfection of laws regulated the external auditing industry are tow of most important factors. In order to maintain and guarantee the independence of external auditors and try to avoid the scandals like Arthur Andersen, some research on how to improve and maintain the independence of external auditors are necessary. It is possible for researchers to put emphasis on how to control the market competition among auditing organizations and enhance the ability of accounting regulators to supervise and manage the professional accounting industry in the future.