Audit Expectations Gap

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. вЂ?Performance gap’ can be further split into two вЂ" deficient standards gap and deficient performance gap. The вЂ?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 вЂ?endemic to auditing’ вЂ" but I believe that it is possible to progressively close the gap down despite the present widening gap. It has been argued that because of the nature of the expectations gap it will possibly never be entirely eliminated (Gloeck and de Jager, 1993). Porter analyses the total expectations gap into three separate components namely sub-standard performance (16%), deficient standards (50%) and unreasonable expectations (34%). Sub-standard performance comes from the individual auditors; deficient standards from the audit profession and unreasonable expectations from the public. It is useful to dissect into each of the components to understand the factors underlying the audit expectations gap and thus look the respective solutions.

(1) Deficient standards, the more objective component of the three, can be revised and is therefore comparatively easier to reduce this component. This gap exists where statutes and professional standards fail to properly reflect the appropriate standard of performance deemed appropriate by the courts of law. This gap may only be narrowed by establishing professional standards and legislation that anticipates the feasible demands of society. Furthermore, unambiguous wordings within accounting standards should be avoided and clearer definitions provided to give the auditor a better understanding about his duties. When the ICAEW’s guidance on the auditor’s responsibility for detecting fraud and other irregularities was published in 1990, nobody was much closer to understanding the actual responsibilities of auditors because of the subjectivity of terms such as �materiality’ and �reasonable’. It is important that further clarification in relation to these terms is provided as the roles of auditors depend on the interpretation of these terms. There are positive signals that this component of the gap is being addressed. Post-Enron reforms which led to the Auditing Practices Board being responsible for settling standards on objectivity, integrity and independence should improve the standard setting process and provide more consistency to the way standards are interpreted. More efforts should be concentrated on looking at the reforms of auditing standards since this represents half of the expectations gap.

(2) The reasonableness gap, one of the more subjective components of the gap, is caused by society’s increasing and often unrealistic demands for accountability. This gap can be narrowed by improving and increasing public education so as to demonstrate to the public that existing professional