The Existence of Audit Expectation Gap

The Existence of Audit Expectation Gap:
Bangladesh Perspective - Perceptions of Naïve Investors, Students and Professionals Regarding the Audit and Role of Knowledge Affecting the Gap.

Abstract:
The study investigates the existence of audit expectation gap in relation to society’s unreasonable expectations out of auditing in Bangladesh. This also identified the effects of auditing knowledge on the gap. Among all the classes of our society the accounting graduates are expected to have more knowledge on auditing, who represented 60% proxy of the users. For the purpose of the study, the four groups who are chosen as sample users are: (1) General investors (naive) (2) Students not completing any audit course (3) Students completing two (2) courses (Audits I&II) (IV) Articled students either level I or level II. The questionnaire comprised of two parts, were sent regarding three aspects: audit liability, audit reliability and materiality of audit opinion. It is found that the respondent who are closer to auditing concepts expect reasonably out of the auditors than the others. The knowledge in the respective fields affected the expectations both positively and negatively.

Keywords: Expectation gap; audit liability; audit reliability; materiality of audit opinion; audit knowledge.

Introduction:
“Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria: Auditing should be done by a competent and independent third person” (Arens and Loebbecke 1988). The auditor in an audit opinion, certifies that the financial statements represent a true and fair view and are prepared in accordance with GAAP (Generally Accepted Accounting Principle) followed by the industry.
The collapse of Lehman Brothers, an American bank with $691 billion in 15th September of 2008 along with subsequent bankruptcy of Washington Mutual Bank [$327.9 billion] in September 26, 2008; General Motor [$91 billion] and CIT Group [$71 billion] in 2009 put the auditing profession and auditing itself into a severe challenge.
Auditors’ prudent person concept or underperformance of the auditors and society’s over expectation individually or simultaneously result into audit expectation gap.

Objectives of the Study Regarding Perpetual Expectation Gap:
Expectation Gap was termed by Liggio in 1974 for the first time. Since then it is the significant differences regarding perceived materiality level between auditors and users of financial statements. The AICPA acknowledged the fact that -‘after considerable study of available evidence’ that ‘such a gap does exist’ (Cohen commission Report, AICPA 1978).
From the subsequent definition provided by Arrington et al (1983), Monroe and Woodcliff 1993, the two major component was identified by Porter (1983 and 1993): (i)’reasonableness gap’ and (ii)’performance gap’. Reasonableness gap is the difference between what the society does expect the auditors to achieve and what they can reasonably expect to accomplish. Thus point of unreasonable expectation comes. Performance gap is the difference between the responsibilities society reasonably expects out of audit and auditors’ performance. These gap widens as the role of audit increases. Now this study proceeds to answer the questions- who are the users feeling their expectations are not met and are those expectations reasonable in Bangladesh perspective?
The study further tended to discover the impact of audit knowledge in reducing or increasing the gap. It is evident that more knowledgeable the users the closer gap. Reasonably naïve investors are expected to seek more from audit report.

Literature Review:
From the birth of expectation gap, several studies have been conducted by the concerned specialists around the world. The findings were also centered to perpetual expectation gap however this was wider in some cases.
In 1977, Baron et al investigated the differences in perceptions between auditors & users of financial statement regarding auditor’s fraud detection duties & revealed significant differences.
In 1988, low et al conducted a study on audit expectation gap & found difference in the area of fraud prevention, guaranteeing the accuracy of the financial statements, effective use of government funds & management efficiency.
In1992 & 1993, Humphery et al conducted a study regarding auditors’ role through a series of unstructured interviews, questionnaires & mini case studies & revealed insignificant differences audit functions but significant differences in regard to role of auditors.
In June 2004, Javed Siddiqui & Taslima Nasreen conducted a study “Audit expectation gap in Bangladesh: Perceptual differences between Accounting professionals & students” and found a significant audit expectation gap. (Journal of Business Studies, University of Dhaka)
In December 2004 the above specialist along with Al-amin conducted another study named “The Presence of a Reasonableness Gap? Students’ Perceptions Regarding Audit and the Role of Audit Education in Bangladesh” (Journal of Business Studies,Vol.xxv, No.2, December2004) and concluded somehow differently like –Knowledgeable students expected more unreasonably out of auditing.

Methodology of the study:
For the purpose of the study, the questionnaire method was applied .The questionnaire method despite its inherent shortcomings chosen appropriate for this study. Here four groups were selected. 20 questionnaires were sent to investors who are in general naive. Similar questionnaires were sent to 10 professionals who are under knowledge or Application level, to 10 students of Dept. of Accounting &Information Systems (AIS), University of Dhaka (DU) who have just completed two Audit courses and another 10 questionnaires were sent to students who have no idea under same discipline.
The issue of perceptions regarding audit is about measuring attitudes. For the purpose of this study, the seven-point Likert scale was used. Prior studies have used the Likert scale for measuring the audit expectation gap in different countries (for example Schelluch 1996; Best et al 2001 etc.)
The response scale used for this study was-
1. Strongly agree
2. Moderately agree
3. Slightly agree
4. No opinion
5. Slightly disagree
6. Moderately disagree
7. Strongly disagree

Strongly agree Strongly disagree
1. An auditor is a watchdog, not a bloodhound. 1 2 3 4 5 6 7
2. Auditor is responsible for audit failure, not for audit risk. 1 2 3 4 5 6 7
3. Auditor is responsible for detecting all fraud. 1 2 3 4 5 6 7
4. Auditing exists only because of legal binding. 1 2 3 4 5 6 7
5. The auditor is responsible for soundness in internal control 1 2 3 4 5 6 7
6. The auditor is liable for maintaining accounting records. 1 2 3 4 5 6 7
7. The auditor is unbiased and objective. 1 2 3 4 5 6 7
8. Auditor should provide absolute assurance about the material misstatements in financial statements. 1 2 3 4 5 6 7
9. The audit report provides assurance about the entity’s future performance. 1 2 3 4 5 6 7
10. The auditor agrees with the accounting policies of the entity. 1 2 3 4 5 6 7
Analysis and Findings:
Survey Analysis:
Assessment Point-1: “The auditor is a watchdog, not a bloodhound”
‘Watchdog means a person or a group of people whose job is to check that companies are not doing anything illegal or ignoring people’s rights’ (www.oup.com)
Bloodhound means person or group of people who find any inconsistency regarding the concerned areas.
The BSAs contain objectives, requirements & application and other explanatory material that are designed to support the auditor in obtaining reasonable assurance. The BSAs require that the auditor exercise professional judgment and maintain professional skepticism throughout the planning and performance of the audit & among other things:
 Identify and assess risks of material misstatement, whether due to fraud & error, based on an understanding of the entity & its environment, including the entity’s internal control.
 Obtain sufficient appropriate audit evidence about whether material misstatement exists, through designing and implementing appropriate responses to the assessed risks.
 From an opinion on the financial statements based on conclusions drawn from the audit evidence obtained. (BSA 200; Para-7)
Therefore it is evident that this statement contributes to gap between auditors & users of financial statement.

Assessment Point-2: The Auditors are responsible for Audit failure, not for audit risk.
Audit failure occurs when the auditor issues an erroneous audit opinion as the result of an underlying failure to comply with the requirements of generally accepted auditing standards (GAAS). Audit risk represents the risk that the auditor will conclude that the financial statements are fairly stated and an unqualified opinion can be issued when, in fact, they are materially misstated. Because auditors are able to gather evidence only on a test basis & detecting well-concealed frauds can be extremely difficult, there is always some risk that the auditor will not uncover a uncover a material fraud even though the auditor complied with GAAS. (Arens & Loebbecke)
So, the statement affects audit expectations gap.

Assessment Point-3: ‘The auditor is responsible for detecting all the fraud’.
BSA 200, “Objective and General Principles Governing and Audit of Financial Statements,” clearly states the objectives of an audit-
The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework. An audit conducted in accordance with BSAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. (Paragraph 2, BSA 200)

Assessment Point-4: “Audit exists only because of legal bindings”.
Section 210 of the Company Act, 1994 describes-
‘Every company shall, at each annual general meeting appoint an auditor or auditors to hold office from the conclusion of that meeting until the next annual general meeting and shall within seven days of the appointment, give intimation thereof to every auditor so appointed:
Provided that, no person can be appointed auditor of any company unless his written consent has been obtained prior to such appointment or re-appointment.’
The section seeks for statutory audit that must be complied.
A twenty four (24) years study of Wanda A.Wallace on “The economic role of the Audit in free & regulated market: A look back & A look forward”, revealed that beyond legal requirement, the audit is very much significant. She clarified her argument from three (3) points of view- i) Stewardship hypothesis or Agency theory ii) Information Hypothesis & iii) Insurance Hypothesis. Still 77% of the companies audit their financial statements. So it is expected to audit financial statements beyond legal bindings.

Assessment Point-5: ‘The auditor is responsible for soundness in internal control structure of the entity.’
“Internal control system” means all the policies and procedures (internal controls) adopted by the management of an entity to assist in achieving management’s objective of ensuring, as far as practicable, the orderly and efficient conduct of its business, including adherence to management policies, the safeguarding of asset , the prevention and detection of fraud and error ,the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information (BSA 400). However, during the course of the audit, the auditor has to assess the entity’s internal control system in order to identify audit risk.

Assessment Point-6: ‘The auditor is liable for maintaining accounting records.’
It has been made clear that it is not the responsibility of the auditor to prepare or to maintain the clients’ accounts. The audit report is also required to contain a paragraph specifying the responsibilities of the auditors-The report should include a statement that the financial statements are the responsibility of the entity’s management and a statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit (BSA700). Therefore, it affects the expectation gap as from naïve point of view the statement seems accurate.

Assessment Point-7: ‘The auditor is unbiased and objective.’
Paragraph 1.1 of the Code of Professional Ethics (2001) states –
A professional accountant should be fair and should not allow prejudice or bias, conflict of interest or influence of others to override objectivity. Therefore, a society should reasonably expect the auditor to be unbiased objectivity.

Assessment Point-8: ‘Auditor should provide absolute assurance about the material misstatement in financial statements.’
The primary objective of audit is to draw a conclusion on the fairness of the Financial Statements. The secondary objective is to detect errors and frauds. (BSA 200)
The objective of an audit of financial statements is to enable the auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. The form the audit conclusion takes is that auditors state whether the financial statement give a true and fair view. This is an expression of reasonable assurance. (ICAB Manual)
BSA 200, specifying the objectives of audit clearly mentions that the auditors only provide reasonable assurance and not absolute assurance regarding the absence of material misstatements.

Assessment point 9: ‘The audit report provides assurance about the entity’s future performance.’
When the auditors express an opinion, they only guarantee the absence of material misstatements and the conformance with accepted accounting practices. However, this is not an assurance regarding the future or current performance of the entity. As stated in BSA 200
Although the auditor’s opinion enhances the credibility of the financial statements, the user cannot assume that the opinion is an assurance as to the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity.

Assessment point 10: ‘The auditor agrees with the accounting policies of the entity.’
As auditors provide opinion regarding true and fair representation of financial statements and therefore issue four types of audit report-(i) Standard unqualified Audit Report (ii) unqualified Audit Report (iii)Adverse Audit Report and (iv) No Report. In first and second cases the auditors agree with the accounting policies of the entity.

Assessment point-11: ‘What do you expect from audit report?’
Naïve (general) investors expect:……………..
Professional under level i and level ii expect :….

Findings of the study:

Table-1: Responses of naïve (general) investors.

Assessment points Reasonableness score Mean Deviation
1. An auditor is a watchdog, not a bloodhound. 7.00 2.72 4.28
2. Auditor is responsible for audit failure, not for audit risk. 7.00 4.44 2.56
3. Auditor is responsible for detecting all fraud. 7.00 4.12 2.88
4. Auditing exists only because of legal binding. 7.00 6.03 0.97
5. The auditor is responsible for soundness in internal control 7.00 5.36 1.64
6. The auditor is liable for maintaining accounting records. 7.00 5.57 1.43
7. The auditor is unbiased and objective. 7.00 5.68 1.32
8. Auditor should provide absolute assurance about the material misstatements in financial statements. 7.00 5.23 1.77
9. The audit report provides assurance about the entity’s future performance. 7.00 6.80 0.20
10. The auditor agrees with the accounting policies of the entity. 7.00 4.39 2.61

The table shows significant difference in the assessment point no: 1, 2,3,10. It reveals that naïve investors seek or do believe auditor makes way for their decisions, i ,e; the general investors rely much on the auditors’ decision not critically analyzing the opinion but from a naïve point of view.

Table 2: Responses of Students not completing any audit course.

Assessment points Reasonableness score Mean Deviation
1. An auditor is a watchdog not a bloodhound. 7.00 4.09 2.91
2. Auditor is responsible for audit failure, not for audit risk. 7.00 3.19 3.81
3. Auditor is responsible for detecting all fraud. 7.00 4.92 2.08
4. Auditing exists only because of legal binding. 7.00 3.77 3.33
5. The auditor is responsible for soundness in internal control 7.00 5.66 1.44
6. The auditor is liable for maintaining accounting records. 7.00 6.57 0.43
7. The auditor is unbiased and objective. 7.00 3.92 3.08
8. Auditor should provide absolute assurance about the material misstatements in financial statements. 7.00 2.41 4.59
9. The audit report provides assurance about the entity’s future performance. 7.00 4.49 2.51
10. The auditor agrees with the accounting policies of the entity. 7.00 4.04 2.96

The table shows that statistically significant differences exist from the view point of students having no audit idea in terms of the assessment point no: 2,3,4,8. It indicates that they expect unreasonably from the auditors regarding their responsibilities of detecting and preventing all frauds and also auditors’ agreement with the entity’s accounting policies.

Table 3: Responses of Students completing two (2) courses (Audits I&II).

Assessment points Reasonableness score Mean Deviation
1. An auditor is a watchdog not a bloodhound. 7.00 5.64 1.36
2. Auditor is responsible for audit failure, not for audit risk. 7.00 4.98 2.02
3. Auditor is responsible for detecting all fraud. 7.00 3.87 3.13
4. Auditing exists only because of legal binding. 7.00 5.11 1.89
5. The auditor is responsible for soundness in internal control 7.00 4.89 2.11
6. The auditor is liable for maintaining accounting records. 7.00 6.01 0.99
7. The auditor is unbiased and objective. 7.00 4.92 2.08
8. Auditor should provide absolute assurance about the material misstatements in financial statements. 7.00 4.59 2.41
9. The audit report provides assurance about the entity’s future performance. 7.00 2.59 4.41
10. The auditor agrees with the accounting policies of the entity. 7.00 5.58 1.42

Table 3 presents the study results out of students who completed two audit courses. Significant gap was found in the point that audit report provides prediction of future performances of any entity. Again in detecting and preventing all fraud of any entity. In respect of some of the six audit threats, the auditors’ objectivity and neutrality was questioned resulting in some expectation gap.

Table 4: Responses of Articled students either level I or level II.

Assessment points Reasonableness score Mean Deviation
1. An auditor is a watchdog not a bloodhound. 7.00 6.81 0.19
2. Auditor is responsible for audit failure, not for audit risk. 7.00 6.80 0.20
3. Auditor is responsible for detecting all fraud. 7.00 2.02 4.98
4. Auditing exists only because of legal binding. 7.00 5.24 1.76
5. The auditor is responsible for soundness in internal control 7.00 5.91 1.09
6. The auditor is liable for maintaining accounting records. 7.00 0.89 6.11
7. The auditor is unbiased and objective. 7.00 6.87 0.13
8. Auditor should provide absolute assurance about the material misstatements in financial statements. 7.00 1.31 5.69
9. The audit report provides assurance about the entity’s future performance. 7.00 4.81 2.19
10. The auditor agrees with the accounting policies of the entity. 7.00 2.11 4.89

The table shows the survey results from professional students who are from level I and level II of professional accountancy. Here the respondents were in line to set a expectation ceiling.

Table -5: Showing the deviations between four respondent groups.

Assessment points Deviation
Table-1 Deviation
Table-2 Deviation
Table-3 Deviation
Table-4
1. An auditor is a watchdog not a bloodhound. 4.28 2.91 1.36 0.19
2. Auditor is responsible for audit failure, not for audit risk. 2.56 3.81 2.02 0.20
3. Auditor is responsible for detecting all fraud. 2.88 2.08 3.13 4.98
4. Auditing exists only because of legal binding. 0.97 3.33 1.89 1.76
5. The auditor is responsible for soundness in internal control 1.64 1.44 2.11 1.09
6. The auditor is liable for maintaining accounting records. 1.43 0.43 0.99 6.11
7. The auditor is unbiased and objective. 1.32 3.08 2.08 0.13
8. Auditor should provide absolute assurance about the material misstatements in financial statements. 1.77 4.59 2.41 5.69
9. The audit report provides assurance about the entity’s future performance. 0.20 2.51 4.41 2.19
10. The auditor agrees with the accounting policies of the entity. 2.61 2.96 1.42 4.89

We the group ‘CRYSTAL HEART’ conducted this study to address whether the perpetual audit expectation gap between the auditors and the users of financial statements is reasonable and how audit knowledge provided by Dept. of Accounting and Information Systems of University of Dhaka affected this gap. The study were mainly concentrated on identifying audit expectation gap in the areas of audit liability of the auditors, audit reliability from the viewpoint of naïve (general) investors, students who have no audit knowledge or have taken at least two audit courses and professionals and materiality of audit report to them. The study revealed the presence of audit expectation gap in Bangladesh. In the area of auditors’ responsibilities the naïve (general) investors putting the audit knowledge less students second in row expected much more i,e; unreasonably out of the auditors. The professionals’ responses indicated their responsibilities were defined in different standards. Another area of this study regarding audit reliability showed a wide gap from each of the four (4) respondent groups. As the auditors work on sampling base, and audit risk is subject to well-organized fraud from the past if the management. Also self-interest threat, review threats are still considerable, the gap in the sense of reliability comprised of a big portion.
The other sector of the survey- audit report’s materiality revealed that the decision makers out of the society did not depend much on audit report i,e; the majority portion lacks analysis ability who constitute the expectation floor much away from the ceiling set by the audit assurance providers. Although almost significant portion of respondent considered audit report’s materiality contributing to widen the gap. We also found knowledge on auditing helps in some regard but not to the extent that professionals considered.
Conclusion: The study attempted on addressing audit expectation gap in Bangladesh. Further, it assessed whether and how much knowledge on the concerned field affects this gap. The students of University of Dhaka under Dept. of Accounting & Information Systems and students under ICAB were proxied on behalf of the users, on the presumption that they are most knowledgeable among the society. The findings of the study reveals the existence of expectation gap, some how it is wider in some aspects and predict a much more gap in terms of the people of the society. It also indicated that so far the students go away from their courses they merge gradually with the general people that predict future expectation gap to be wider. So, future studies should concentrate on clarifying the riskiness of audit by identifying clear sectors of audit expectation gap.