Essay on

Audit Expectation Gap

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Executive summary

A statutory audit is legally required for an entity to assess the financial stability,

reliability, transparency and objectivity of the accounting data provided by the company’s

management. The fiscal year audit is usually conducted by recognized audit firms based on the

generally accepted principles (GAAP or IFRS), statutory regulations and audit standards. The

expert audit opinion plays a determinant role for the stakeholders whether they likely to invest in

a particular company. But problem arises when stakeholder’s expectation of audit outcome does

not match with what the audit committee provides. In this case analysis, the nonconformity of

the audit outcome from the general people’s perception has been discussed in details. In later part

of the essay, the ways to reduce the gap has also been pointed out along with the consequences

of the gap.

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Definition of audit

The term ‘audit’ usually refers the act of conducting financial statement audit of a

company by a recognized audit firm with a view to attaining the authenticity, accuracy,

transparency and objectivity of the financial data. The audited financial data depicts a true and

fair view to the investor about how the company is performing and reflected in the share price.

There are two types of audit; one is external audit and the other one is internal audit. External

audit is referred to the third party audit and is required by the investor of the company. On the

other hand, internal audit is done by internal employees and is required by company

management. While external auditors mainly examine the financial data of the company, internal

auditors are more involved with operational process, internal control system and detection of

fraudulent activity. (Tuovila A., 2020)

Roles and responsibilities of the auditors

Referring to external auditors, their main goal is to assess the validity of the company’s

financial statements to identify accuracy and transparency and then submit the report to the

stakeholders. So their core responsibility includes reviewing the general ledger, financial reports,

purchasing records and inventory of the company and gives expert opinion. They are responsible

to identify any mistake, loop hole or fraud done in the company’s financial figures and reports

accordingly. External auditors also assess the accuracy and process of the financial statements in

comparison with general standards like GAAP or IFRS. (Thakur M., 2021)

On the other hand, internal auditors are employed by company management and work for

the company’s internal reporting purpose. Their core responsibility refers to assessing the system

and business process, identification of risk and find out any operational loop holes. They are also
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accountable for assuring asset safeguard, investigating fraud, communicating findings to the

management and recommending improvement or modification of internal control. An internal

auditor also has to ensure that the company is following relevant laws and regulations. They also

promote ethics in the work culture and reduce any improper conduct. (Clarke I., 2019)

Audit Expectation Gap

While discussing on expectation gap in audit, it mainly demonstrate the external audit

profession. The expectation gap in audit can be defined in various ways, but as a general

definition, it is the difference between what the general public expects from the auditors and

what the external auditors actually delivers in their reports. According to ACCA (the global

accounting body), the expectation gap is the variance between what the general public thinks an

auditor does and what they would like the auditor to deliver. (Professional insight report, 2019)

For example, during an inventory testing of a public limited company, the external

auditors conduct testing based on sampling basis. The sample size is not large enough to cover

all the possible variance in terms of inventory quantity and value. Therefore, if it happens that

the sampling audit count does not result any deviation though which is supposed to be in the

inventory financial data, then there will be audit expectation gap resulted in the general audit

report. (Jan I., 2018)

Though historically the expectation gap has been perceived by some accountant as

differences arises solely due to the lack of technical knowledge and proper understanding of

general public regarding the auditor’s report, it should not be the sole reason. Now a day, the

audit gap is a much broader term with several causes and related to public concern. The gap may

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arise in line with the broader scope of audit work since expectation from general public will also

rise. (Professional insight report, 2019)

History of audit expectation gap

Several corporate scandals and stock market crash had driven the necessity of corporate

governance and auditing the financial data of the enlisted companies. The world saw great

inflation in 1970s which undermined the public confidence in stock market. Then there was

financial crash in 1980s which started from Asia and spread across through North America and

Europe. Again after a decade, huge corporate scandals like Enron and WorldCom shocked the

world. All this incidents led to strong internal control, corporate governance, auditing regulations

and standards. There was also a new act enforced named ‘Sarbanes Oxley Act’ to protect the

interest of general public and stakeholders. (Stanford GSB staff, 2003)

In 2007-2008 the world witnessed another financial crisis. As consequence, the

international financial reporting and auditing standards evolved more with a view to attaining

rigid requirements for financial performance audit and therefore boosting stakeholder

confidence. There was also mandatory requirement of audit firm rotation, strict guideline on

what to disclose in financial reports as well as obligatory audit committee to review the quality

of audit. Auditors were also given in charge to evaluate risk assessment, error or fraud detection,

report any financial manipulation and quality of management team. Increased requirements and

more responsibilities of external auditors eventually raised the public expectation regarding audit

outcome. Public anticipated more effectiveness and efficiency from the auditors than what

should be the outcome in the practical scenario considering limitation. Thus the expectation gap

in auditing arose. (Stanford GSB staff, 2003)

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Components & causes of audit expectation gap

There are several gaps regarding audit expectation. The overall gap can be summarized

as, what the general public thinks auditors do and what they want auditors to do. Expectation gap

in auditing can be divided into three major components; knowledge gap, performance gap and

evolution gap.

Knowledge gap is the difference between what the general public thinks auditors do and

what the auditors actually do. The knowledge gap arises mainly due to insufficient knowledge,

misunderstanding or misrepresentation of general public regarding audit work. Though

knowledge gap is based on public’s lack of understanding rather than any legitimate concern, it

actually frustrates the audit work if not properly addressed. Also it does not invalidate the need

to do more or demonstrate the audit work more precisely to the general people. (ACCA, 2019)

As for example on knowledge gap, we can consider changes in IFRS lease standard from

2019. Previously IFRS lease was classified as operating and finance lease where only finance

lease was recognized in the balance sheet as lease liability. But from 2019, all type leases was

transformed into one lease category in IFRS 16 and recognized in the balance sheet as liability.

A general public might not aware of the changes in IFRS 16 and may misinterpret the audit

report assessment of a particular company regarding IFRS 16 new regulation due to knowledge

gap.

Performance gap is the difference between what an auditor is supposed to deliver and

what an auditor actually delivers. Performance gap arises mainly due to lack of concern on audit

work quality, failure to meet certain complex audit standards, audit time constraint or difference

in interpretation of audit standards and requirements between audit team and regulators.

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Performance gap is based on deficiency on work quality and audit standard issue, so this needs to

address seriously by the audit committee to gain public confidence. (ACCA, 2019)

As an example of performance gap, an audit team decides to count a company’s

inventory on sampling basis. It may happen that the sample stock count does not cover a major

stock variance and counting result yields no variance at all. It might happen due to sampling

error and time limitation to count larger inventory sample which causes performance gap.

Evolution gap generates mainly from the need of evolution of audit work. The need for

evolution of audit work is the result of general public demand regarding expanding expectation

of audit, advancement in technology and how the audit can add more value. To determine what

needs to evolve in audit work, addressing the performance as well as expectation gap is a crucial

step. When the actual problem regarding insufficient knowledge of general public or poor audit

standard is rectified, the dimension for evolving audit framework for value addition will

automatically be guided. (ACCA, 2019)

As for example, arising awareness of environment sustainability has expanded the

expectation of audit declaration on environmental factor and non-compliance issues regarding

environment, health and safety regulations while the previous audit expectation was solely

financial. Thus the expectation has evolved a lot in consequences of time.

In summary, we can say that audit expectation gap has several major reasons which

include ignorance, misconception and lack of knowledge from general public on audit attributes

and regulations, quality issue of audit, failure to meet audit standards, unreasonable public

expectation, changes in public expectation, time rigidity on responding to evolution and

expansion of audit expectation. (Olojede P., Erin O., Usman M., 2020)

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Audit expectation gap and its consequences

Audit expectation gap has some negative impacts on the society, the audit firm and the

organization. An audit report is a measure of public confidence, trust and reliability for both the

auditor and the audited company. If any expectation gap arises based on logical reason, it

undermines the credibility, transparency, status as well as earning potential regarding audit work.

In fact, the course of wealth creation and political steadiness depends on the level of confidence

people have in the process of accountability. The emergence of expectation gap is detrimental to

the users of financial data, regulators, stakeholders and also for government. Again any

insufficient and misinformation regarding the audit report may cause erosion of value for the

audit work. (Olojede P., Erin O., Usman M., 2020)

For example, a public listed company does not disclose all mandatory information in the

financial statement regarding its share market and profitability. But the audit team fails to

identify the problem due to either lack of professional knowledge or by mistake. Whenever this

audited report is disclosed to the investors and they get to know the problem, it might result in

loss of trust for both the audit practitioner and the listed company. General public will lose

confidence on buying that company shares and as a result the stock price is likely to fall. The

audit firm will be accountable for not identifying the mistake and as a practitioner its credibility,

rank and status will also fall. Besides, failure to identify any financial manipulation in the

statutory report will question the professional ability of the audit firm to carry out the auditing

service. Again, if the gap is due to evolution of expectation or lack of proper knowledge among

the public, it is still enough to detriment the trustworthiness of the audited company as well as

the audit firm it not explained or resolved properly. (Olojede P., Erin O., Usman M., 2020)

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Reducing the audit expectation gap

To reduce the audit expectation gap, addressing the knowledge gap should be given most

priority. Reducing the knowledge gap involves all the relevant stakeholders like regulators, the

audit firm and the committee, professional accountancy bodies, investors as well as the media. In

order to narrow the gap, all the relevant parties have some commitment to inform the public

regarding reliability, credibility and transparency of the audited documents and the audit

standard in a coherent and logical manner. The message to the general public should be clear-the

audited data is fully reliable and is fully in compliance with standard requirements and

regulations. The successful communication to the general public about accuracy and efficiency

of the audit standard might regain the trust. (ACCA, 2019)

To narrow down the performance gap, it is the obligation of the audit committee to

appraise the auditor’s technical and professional competency periodically. Any sort of technical

incompetency during auditing needs to be resolved. Professional training including updated

regulations may help auditors to mitigate technical knowledge gap. Also the regulation setters

need to create standards as clear as possible and should not create requirements that arises need

for judgement biasness or foster objectivity. Reducing the performance and knowledge gap will

clearly demonstrate what the public wants to evolve. A detailed discussion among stakeholders

such as regulators, audit committee, investors, government association, accounting bodies and

the general public will identify what the public wants to evolve and how to evolve the auditing

standards to meet the stakeholder expectation. (ACCA, 2019)

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Bibliography

 Tuovila A., Aug 15,2020, Audit (Corporate finance and accounting; Investopedia), from
https://www.investopedia.com/terms/a/audit.asp
 Thakur M., 2021, External audit; WallStreetMojo, from
https://www.wallstreetmojo.com/external-audit/
 Clarke I., May 1,2019, What is an internal auditor and why should you hire one;
linford&Co llp from https://linfordco.com/blog/what-is-an-internal-auditor/
 Professional insight report, May 09, 2019, Closing the expectation gap in audit, ACCA
official website, from https://www.accaglobal.com/in/en/professional-insights/global-
profession/expectation-gap.html#:~:text=What%20is%20the%20expectation%20gap,the
%20auditing%20profession%20actually%20provides'.
 Jan I., Dec 09, 2018, Expectation gap, from https://xplaind.com/613213/expectation-gap
 ACCA, May 2019, Closing the expectation gap in audit; from pi-closing-expectation-
gap-audit%20.pdf
 Stanford GSB staff, Oct 15, 2003, what led to Enron, WorldCom and the like? From
https://www.gsb.stanford.edu/insights/what-led-enron-worldcom
 Olojede P., Erin O., Usman M., April 23, 2020; Audit expectation gap, an empirical
analysis, from
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