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Definition And Implications Of Audit PerformanceExpectation Gap

Accounting Essay
Since the 1960s, an increasing number of big companies declared bankruptcy,
and as a result externalauditors have always been under attack by litigation
regarding the quality of their professionalperformance. Investors turned to
auditors and expected compensation from them. Indeed, auditorssinsufficient
performance could potentially mislead public and fail to give a true and fair view.
However,even although there were also some cases in which external auditors
had done what was required atthat time, it is curious that the public continued
blindly blame those external auditors for the lack of quality of audit reports and
independence. Generally, it is said that the reason for this situation is thatthe
auditors work failed to satisfy the public. Therefore, to get a better knowledge of
publicsexpectations, the concept of an audit performance-expectation gap was
proposed by Liggio (1974),which defines it as the difference between the levels
of expected performance as envisioned by theindependent accountant and by
the users of financial statements. It was then extended minorly by theCohen
Commission (1978) and Porter (1993). Since the concept of the gap was
introduced, it hasbeen considered to be one of the toughest issue for audit
profession and regulators (Humphrey etal.1992). Through studying the audit
performance expectation gap, this will probably improve thequality of auditing
and prevent auditors from unreasonable charges. In this essay, firstly the
meaningand manifestations of audit performance-expectation gap will be
discussed. Further, the reasons for theexistence of gap will be explained. Finally,
this essay will discuss the effectiveness of steps that havebeen taken by
professional bodies and regulatory bodies in terms of going concern and
frauddetection, which are the main areas of expectation gap.
The definition and implications of audit performance-expectation gap
As for the explanation of audit performance-expectation gap, besides the
definition by Liggio, manyscholars and experts have proposed their definitions.
For example, the MacDonald Commission (1988)in Canada states that the gap is
between what society expects and what the auditors should bereasonably
expected to do. However, most of the definitions are quite unilateral which have
little helpwith improving auditors performance but give them excuse to
avoid reasonable penalizations. Thusthis essay adopts the definition given by
Porter (1993) who defines the audit performance-expectationgap as the gap
between what society expects of auditors and what it perceives it receives
them.Ref erred to Porters theory, there are two components of the gap: (a) a
gap between what societyexpects auditors to achieve and what they can
reasonably be expected to accomplish ( designated thereasonableness gap);
(b) a gap between what society can reasonably expect auditors to
accomplishand what they are perceived to achieve (designated the performance
gap). The component,performance gap, can be subdivided into two parts which
are deficient standard and deficientperformance. Based on Porters concept,
relationships among those subjects are depicted in followingfigure.
Figure 1. The structure of the audit expectation gap
According to the above definition, there is a mutual effect of both auditors and
the society onexpectation gap.
Manifestations of audit performance-expectation gap
Commonly there are three principal subjects in the study of expectation gap,
which are the auditors,the public and the auditing standards. Specifically, the
audit performance-expectation gap mainlyoccurs: A) between
auditors performances and existed auditing standardsHow well the auditors
work in accordance with existed auditing standards is the evaluation criteria
of auditors performance. However, auditors are probably influenced by their
ability, heavy workloads or their working environment so that auditors may
deviate from auditing standards to a variable extent.B) in the demarcation of
auditors responsibilities and internal accountants responsibilitiesThe purpose of
the audit is to express an opinion with a reasonable assurance that the
financialstatements give a true and fair view, and it is not to give a legal
warranty that they are completelycorrect and without error. The Company Act
(2006) clearly states that the responsibilities of auditedcompanies cannot be
replaced by auditors duties. The audited companies should be responsible
for the integrity and truth of financial statements. However, even although it has
been declared that theauditors are not responsible for fraud detection, if auditors
failed to detect fraud, the users of financialstatements always blame the
auditors.C) in the scope of information disclosureNormally, the public considers
how much the audit reports can help them reduce informationasymmetry and
investment risk but rarely think about how auditors work. The public investors
pin their hopes on auditors disclosing as much information in the reports as
possible, but actually disclosure iswithin the prescribed scope that public might
be unaware of.D) in what auditors responsibility be Auditors indeed have duty to
detect any misstatement, manipulation and fraud in financial statements,but the
extent to which the auditors should be responsible for the omission of those
mistake has beenan issue hotly debated in the auditing profession. The public
believes that if the financial statementswere audited, the auditors opinion
equates to an error-free guarantee. Nevertheless, auditors declarethat their
opinions cannot ensure absolute accuracy because of the use of audit sampling
andmateriality. Moreover, auditors explains that as long as they disclosed fatal
errors in financialstatements, they have already met the auditing standards.
Reasons for the audit performance-expectation gap
Illustrated by figure 1, Porter has concluded three reasons for the gap, which
are:Deficient performanceWhen it is in auditing process, there are numbers of
auditing postulates and objective uncertainties thatneed a considerable
judgment ability and experience. However, in real auditing, there is quite a
largepercentage of auditing practitioners who have not
any qualification. According to the research, over 18% of auditors surveyed in UK
appear uncertain or in error about their existing responsibilities (Porter,2004).
Moreover, business activities are more complicated than the abilities of auditing
technologies.Particularly if the complication is connected with fraud, most of
auditor may have difficulties in dealingwith the problem. The auditors
performance also depends on professional ethics. Auditors areappointed by
public shareholders in theory, however, senior management of audited
companies areclients who auditors work for in fact, because auditors get
payment from those companies. As they aresupposed to be economic rational,
auditors may help audited companies hide some minor mistakes or even commit
fraud to keep the contracts and to maximize their own profits.B) deficient
standardThe excessive cost of auditing may not be in the interest of society as a
whole. Therefore the auditing

standards are not only used to regulate auditors behaviour but also ascertain a
risk level that can beaccepted by society. Besides, a number of ambiguous
auditing standards may widen the gap. For example, it is illegal that auditors
charges for the auditing assurance, but nothing is linked with theother business
of auditors such as consultation. It would be inevitable to affect auditors
independence.C) unreasonable expectationBecause of information asymmetry,
society sets high hopes on auditors. To make the best investmentdecision,
investors hope auditors can guarantee that the financial statements and reports
of auditedcompanies are free of errors and manipulation. Idealistically, it is best
for the economy. In fact, it isnearly impossible. The respective comments by the
AICPA secretary in 1939 can give an explanation:We find that the public has
believed that the CPA was an infallible superman; that the signature of aCPA
invariable meant that everything was perfect; that it was unnecessary to read
the accountantscertificate or the financial statements to which it was appended
as long as the three major letters werein evidence.....Whether through its own
fault or not, the accounting profession seems to have been over sold. Its
limitations have been overlooked, while its abilities have emphasized. Now the
public has beensomewhat shocked to find that even auditors can be fooled by
clever criminals. (quoted in Miller,1986,p.35)Moreover, information is very scarce
and valuable within the market. However, accounting and auditinginformation is
an exception. Public users of those reports can use it completely for free.
Therefore,society naturally always ask for unreasonable quality of audit reports.
However, auditors have toconsider the cost of auditing such as time cost in order
to maximize their own interest, becauseincreasing charges of audit is not always
an option for auditors.
Assessment of approaches used to narrow the expectation gap
Sikka (1998) says the expectation gap is an inevitable consequence due to the
internal contradictionsof capitalism. Although the gap might not be closed,
the gap can be substantially narrowed. Manypractical steps have been taken by
regulatory and professional bodies to do this. Some of steps havebeen taken will
be discussed in the following.In terms of the reasonableness gap, it is the most
intractable component. Common unreasonableexpectations include detecting all
fraud and even assuring business success in the future.Unreasonable
expectations of the public could be reduced through education of the public, the
users of financial statement specifically, about the role of the auditor and the
auditing standards relating to hisrole. In ISA 200 (2009), the overall objectives of
the independent auditor are stated very clearly whichcan facilitate public
understanding of audit profession. FRC also did a revision to ISA 700,
whichrequires the auditors report to address risks of material misstatement,
materiality and a summary of the audit scope. This revision would make
the company-specific application of the auditing standardsmore transparent and
could offer public investors a basis for engagement about the audit. To
someextent, this may help the public to understand more fully what auditors
really do. According to ISA 240,acknowledging the expectations related to fraud
prevention is a more active way for auditors takingresponsibility to narrow the
reasonableness gap, as it extends the duty of auditors. The auditor is
alsoexpected to maintain professional scepticism throughout the audit and also
the audit quality. As for the deficient standards, ambiguous wordings in auditing
standards should be avoided andclearer definitions should be given to the
auditor for a better understanding about his duties. For example, materiality
has been interpreted in professional guidance as the degree of tolerable
or acceptable error in financial statements but like the term reasonable
expectation it is not beyond this.It is important that further clarification in
relation to these terms are provided as the question to whether auditors have a
responsibility to detect fraud depends on the interpretation of these
terms( Power,2000). After the Enron case, Auding Practices Board (2004) started
to set standards on audit objectivity,integrity and independence in Ethics
Standards 1, which gives more consistency of interpretation of

auditing standards.The deficient performance component may possibly be

reduced by expanding responsibilities of auditors. As mentioned above, ISA 240
probably keeps auditors remain sceptic throughout the auditbecause there is a
greater possibility for auditors to be punished because of their acts with
negativeinfluences (Sikka, 2003). By comparison, Huepkes (2005) argues that
the threat of lawsuit may resultin the the trend towards defensive auditing,
where by auditors tend to interpret rules prescriptivelyrather than exercising
subjective judgment. Humphrey (1993) describes that the issue of
auditor independence as going to the heart of the audit expectations debate.
His notion of independence isextremely essential to public confidence in auditing
reports. As discussed above, profits coming non-audit services for audit clients
have taken over 70% of audit firms total profits. It is hard to say if auditors still
can be independent when their revenues are connected with audited company
so closely.Thus, in the USA, the audit firms are not allowed to offer non-audit
services for their audit clients.The going concern assumption was introduced by
FRC in ISA 570 (2009) to address the riskassessment. Auditors need to prepare
their report in a going-concern basis, which requires auditors toperform risk
assessment procedures, evaluate managements assessment and report the
likelihood of entitys ability to continue as a going concern. The auditors should
obtain sufficient audit evidenceregarding the appropriateness of managements
use of the going concern assumption in thepreparation of the financial
statements (ISA 570, 2009). In other words, auditors need to give aprudential
view of financial statement. This probably help auditors avoid involvement of
business fraudso that it could narrow the reasonableness gap and deficient
performance gap.
The audit performance-expectation gap can generally be divided into
performance gap andreasonableness gap. They are conflicts between audit
profession and the society. As mentioned earlier,the gap cannot be eliminated
but possibly be narrowed to some extent. With the increaseunderstanding
of audit profession, the societys expectation becomes more objective
and reasonable.With the development of auding technologies and anti-risk
ability, the performance gap can benarrowed.This essay discusses some sample
remedies taken by regulators. Besides facilitating the publiceducation of
auditing, most of the steps try to narrow the gap through improving audit quality
andspecifying the auditors responsibilities, particularly in related to fraud
detection and going concern.Furthermore, narrowing the expectation gap helps
auditors provide higher quality audit reports, andaudit profession can be
improved because expectation gap exists.

Liggio (1974a) defines it as the difference between the levels of expected performance as envisioned
by the independent accountant and by the user of financial statements. The Cohen Commission
(1978) on auditors responsibility extended this definition by considering whether a gap may exist
between what the public expects or needs and what auditors can and should reasonably expect to

ii)According to Guy and Sullivan (1988), there is a difference between what the public and financial
statement users believe accountants and auditors are responsible for and what the accountants and
auditors themselves believe they are responsible for.

iii)Godsell (1992) described the expectation gap as which is said to exist, when auditors and the
public hold different beliefs about the auditors duties and responsibilities and the messages conveyed
by audit reports.

iv) Jennings et al. (1993), in their study on the use of audit decision aids to improve auditor adherence
to a standard, are of the opinion that the audit expectations gap is the difference between what the
public expects from the auditing profession and what the profession actually provides. Monroe and
Woodliff (1993) defined audit expectation gap as the difference in beliefs between auditors and public
about the duties and responsibilities assumed by auditors and the messages conveyed by audit

v)According to AICPA (1993), the audit expectation gap refers to the difference between what the
public and financial statement users believe the responsibilities of auditors to be; and what auditors
believe their responsibilities are.

vi)Epstein and Geiger (1994) defined audit expectation gap as: differences in perceptions especially
regarding assurances provided between users, preparers and auditors.

vii)The ASCPA and ICAA (1994) observe that the term expectation gap should be used to describe
the difference between expectations of the users of financial reports and the perceived quality of
reporting and auditing services delivered by the accounting profession.