AUDITING AND ASSURANCE SERVICES
ANOTHER PIECE OF THE “EXPECTATION GAP”:
WHAT DO INVESTORS KNOW ABOUT AUDITOR INVOLVEMENT WITH INFORMATION IN THE ANNUAL REPORT
LECTURER’S NAME :MDM. NOR HAFIZAH ZAINAL
SHAKIRA AHMED KAMIL1033268
NUR NABILAH MAHMOOD1014786
NUR ATIQAH MOHAMMAD MIZAN0924758
NUR DALILA ASSANAH1011466
NURFAZLINA MOHD JAFFAR SADIQUE1029088
I. What is the main issue being addressed in the paper?
The main issue that is being addressed in this paper by Bedard, Sutton, Arnold and Phillips is the expectation gap among the professional and non-professional investors about the presumption of audited and non-audited information. Professionals in this research comprise of financial services firm workers currently working in a position that requires them to evaluate the investments such as venture capitalist, fund manager and financial analyst. Non-professionals in this research are participants with income greater than $75,000 with readily available assets over $50,000 and a current portfolio investment. This paper analysed the investor’s belief regarding areas on information used to make decisions whether they are being audited or not. It is not disclosed anywhere which part of the annual report and what information is being audited. This knowledge only comes with experience and technical knowhow in the auditing field. From the results obtained in this research, it can be seen that most professional investors are able to identify which items are not audited. The major concern here is that professionals with audit background belief that quarterly summary in the 10-k is being audited when in fact it is not. Too much time and workforce is required for the auditing of quarterly summary in the 10-k and companies do not want to waste their resources on this. This information is usually used internally and is not required to be audited. Just as how professionals belief that the quarterly summary in the 10-k are audited, the non-professionals also belief this too. The amount of non-professionals that belief it is audited is at an alarming rate of 64%. This belief needs to be changed fast. Another category that a lot of non-professionals belief is audited is the business data and risk factors. Business data and risk factors are not being audited due to the fact that it is statistical and the figures are obtained from the company itself. The company engages in depth analyses to obtain risk figures and this calculation is difficult to be audited. Business data is also not audited due to the fact that transparency of most companies is very high and chances of creative accounting in this area is very tough. In an article by Porter, O Hogartaigh and Baskerville (2012), the expectation-performance gap which is now referred to as expectation gap has been around since the mid-1980s. Back then, the external financial statement auditors are said to be having liability and credibility crisis. In that article also, the authors further explain that with recent cases in the 21st century, the expectation gap has become a serious concern. Some cases below are a reason why expectation gap needs to be tackled. Enron (United States)
WorldCom (United States)
Barings Bank (United Kingdom)
Equitable Life (United Kingdom)
Three causes have been identified from past researchers done by Porter, O Hogartaigh and Baskerville (2012) which are; Society has unreasonable expectation of auditors that go beyond auditors responsibilities Society has expects something beyond the legal and professional responsibilities of auditors Society believes auditors are not doing up to their expected standard As a result, to reduce the expectation gap, ISA 700 was implemented as of December 15, 2009. With ISA 700, auditors are required to clarify the auditor’s responsibilities as opposed to the management’s responsibilities. The nature, scope and procedures of auditing also need to be stated (Gold, Gronewold & Pott, 2012).
II. Why is this issue important to the practicing auditors?
The issue of expectation gap is important to the practicing auditors because it affects the perception of the audited annual reports as highlighted by Bedard, Sutton, Arnold, & Phillips (2012). The study concludes that there are a low number of non-professionals that are aware of which categories of the annual reports are audited. It suggests that an over-reliance on some information provided by companies in the annual report happens because of the perceived audited information. This is important because it will affect the credibility of the audited reports provided by the auditors to the investors’ opinion. Since the investors are not familiar with the levels of the audited information, they may make wrong decisions with regard to their investment, which will trigger them to blame to perceived inaccurate information in the annual report. The issue is detrimental to the auditing profession as emphasised by Sikka, Puxty, Willmott, & Cooper (1998) that the greater the gap of expectations, the lower is the credibility, earning potential and prestige associated with the auditors’ work. An external audit of financial statements is considered to be important because it adds credibility to the financial statements. Any incorrect perception about the degree of the audited information can be harmful to the public, investors because in capitalist economy, the process of wealth creation depends heavily upon the confidence in the process of accountability of the information as highlighted by Sikka et al. The paper by Bedard et al also accentuate the importance of auditors to fulfil the demands for audits of the information that is currently unaudited so as to minimise the potential costs to the investors particularly in the usage of the MD&A. Hence, this issue can possibly change the auditor’s reporting model where they may have to increase the work scope of the audit to include other parts that are not audited before. However, as Bedars et al has stated the PCAOB currently is focused on the changes to the wording of the audit opinion, rather than the changes in the auditor’s responsibility. Their intention is to educate and inform the investors on the scope and limitation of the audit job as to minimise the expectation gap.
III. What are the findings of the paper?
The results of the study lead to the conclusion that there is an expectations gap with regard to annual report components. This is supported by three evidences provided in the research study: 1) Non-professional investors are significantly less knowledgeable about variation in levels of assurance than are professional. 2) More investors assume that unaudited information is audited rather than the reverse. 3) There is unmet demand for audits of information that is currently unaudited. Firstly, the study shows that non-professionals are less knowledgeable than professionals in using relevant information to make investment decision. The statistic in the study shows that fewer non-professionals are aware of the audited status of the financial statement, footnotes and internal control. Hence, this suggest that there is a greater tendency of nonprofessional investor to over-reliance on some information provided by companies, leading to the existence of expectation gap regarding the extent of assurance obtained from auditing procedure. Secondly, the expectation gap with respect to auditor activities is also occur as a result of more investor assume that unaudited information is audited rather than reverse. Consequently, the investor’s beliefs affect their use of information provided outside of the financial statements. The above finding was supported by evidences shown in the article, whereby non-professionals who believe that the Management Discussion and Analysis (MD&A) information is audited, use more such information than those who do not or are uncertain. Furthermore, non-professional investors who believe that all financial statements are audited use that information more extensively as compared to those who believe that the information is not audited. Hence, this shows a linkage between the extent of information used by investors and their belief about whether that information is audited. Thirdly, the unmet demand for audits of information that is currently unaudited also leads to the existence of expectation gap. The results show that professional investors seem to have more accurate perceptions of the differences in the audited status of 10-K components. Among professionals, all differences between ‘should be’ and ‘is’ audited responses are higher than the corresponding figures for non-professionals, suggesting greater unmet demands in that investor group. IV. What are the implications of the findings from the study on the audit profession? An opposing view of the expectation gap was raised by Jedidi and Richard (2009). According to them, the expectation gap is a social construct created by auditors as a rationale or an excuse to the market. Their investigation of the France market from 1966 to 2007 showed a widening of the expectation gap. They argued that the role of an auditor was extended in the late 1900s resulting in an ideologist’s view of an auditor as protector of public interest. Thus, the expectation gap idea was introduced to explain the inability of auditors to meet public demand and to justify its existence. It is undeniable that their opinion is markedly different from the practitioners (i.e. auditors) in their view of the expectation gap. However, this study implied that there might be a need for auditors to rebrand themselves. Saying that auditors protect the interest of the public is only true to a certain extent. They are bounded by not only the standards but also the costs constraint of the business which determines the depths of procedures or work done. It is a trade-off in deciding the audit procedures that would best serve the various stakeholders. Maybe, in justifying the existence and usefulness of an audit, an erroneous perception formed in the mind of the public. Thus, it is time to clarify that the auditors role and responsibility and to clarify that this profession is not there to protect investors from management foolhardy decisions or fraud but to ascertain if there is any material misstatements in the financial statements. Erroneous perception led to an unreasonable expectation. There is lack of knowledge of the users over the audit functions. This misunderstanding then leads to unreasonable and unrealistic expectation and belief by the public which undoubtedly breads the public dissatisfaction with the performance of auditors, while eroding trust and confidence of the users of audit reports. Perceived performance of auditors is an element which is difficult to measure as it changes consistently. It is however possible to substantially reduce but not to totally eliminate it (Olowookere, 2010). There is an argument that the unqualified audit opinion is wrongly seen as a certification that the firm is solvent, liquid and has the capacity to adapt to the dynamics of the environment which continuity of existence implies, Asien (2007). This lack of understanding on the part of the public makes it difficult for them to know who has responsibility for financial statements preparation and the continued existence of the enterprise. Unreasonable expectation is said to have harmful implications on the auditing profession as the public may not be able to recognize the contribution of auditors to society and thereby undermining the value of audit function and limit auditors work (James &Izedonmi, 2010). In general, the unreasonable expectations towards auditors can affect the profession as the public may not able to recognize the contribution if the auditors and even undermine the value of audit function. Public usually view audit from a common perspective while the auditor see it from a technical perspective. Public often think that auditor have to prepare the accounts, check through all the transaction which is really unreasonable to auditors. This is true as the main role of auditors is only to provide reasonable assurance of a company, which implies that the audit opinion formed is not absolute and it is still subject to minor errors where the auditors could not be held liable to. The findings of this study are also detrimental to the auditing profession as it has negative influences on the value of auditing and the regulation of auditors in the modern society. Another implication of the findings of this study is that the independence and credibility of audit profession may be questioned. There is a conflict of perception between auditors and the public hold about the auditors’ duties and responsibilities towards the public. There is also a concern on the messages conveyed by audit reports that might cause the end users to eventually lose their trust in audit reports all together, and hence blaming the credibility and the quality of the audit profession as a whole. Therefore, it can be said that the auditing profession, which was once highly regarded and whose members were among the most credible professionals, later became shrouded by mistrust and scepticism. In addition to that, public misperceptions are a major cause of the legal liability crisis facing the auditing and accounting profession especially with the emergence of corporate failures due to accounting fraud and misrepresentations. The cause of misjudgement and unending blame heaved on auditors and the entire accounting profession each time a firm is reported to have gone bankrupt is also evident. Public trust is very essential in audit profession and hence, when such trust among the public disappears or is eroded in any way, the outcome is likely to involve skepticism and the depletion of value attributed to such profession. This also explains why the auditing profession, which was once the toast of investors with members classed among the most credible professionals, has of late become a victim of mistrust and crises of confidence (Salehi, 2007; Adeyemi & Uadiale, 2011).
Another finding indicated that there is an unmet demand for audits of information that is currently unaudited. One possible implication for this is an expansion of an auditor’s responsibilities and performance to bridge the expectation gap of the public. It was recommended by ICAA in its report on meeting the market expectation in 2003 that auditors should be encouraged to expand the scope of audit to include extended audit services like management discussion and analysis, performance audits and continuous audit (Teck, Azham and Shamini, 2008). The argument for the expansion lies on the fact that users rely on both on audited and unaudited statements in the annual report and thus, the audit procedures should extend to cover other disclosed information in the annual report and company’s websites. However, Teck, Azham and Shamini (2008) argued that the expansion would increase the cost to the company to cater for the demand of free rider, the public. There is also the issue of competency of an auditor to provide additional services due to lack of experience and knowledge as it is not part of the audit education as mandated statute or professional bodies. The expansion would also add liability to the auditor as he assumes more responsibility. The distinction between audit and business failure would be blurrier since the auditor would now be expected to audit more information and assertions of the management. Expansion of the information to be audited would add extra workload to the auditors as the limited workforce of professional auditors would lead to the current auditors having to add to their already huge responsibility.
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