A Series of Fraud-Related Articles Focusing on the Balance of Trust.
Each article will examine the areas in which we place our trust, and will suggest safeguards that we can implement easily. Topics will include the concept of "tone from the top," segregation of duties, elder abuse, compensation, and the expectation gap between management and auditors. Each topic is different, but all will answer the same question: what is the ideal balance of trust?
We place our trust in various people, systems, and professions throughout our daily lives. However, this trust is often misplaced because of an expectation gap. This gap reflects a perceived difference between what others expect you to accomplish and what you personally believe must be accomplished. In this article we will focus on the expectation gap in auditing.
The expectation gap - auditing
One of the first discussions of an expectation gap relating to financial statements was written by C.D. Liggio in the Journal of Contemporary Business in 1974. Liggio was concerned that the quality of financial statements was under attack and suggested two reasons:
- a greater willingness to hold others, especially professionals, accountable for perceived misconduct; and
- the expectation gap - the difference between expected performance from the accountant's perspective and what the user of the financial statements expected from the audit.
Examples of the expectation gap in auditing
The auditing expectation gap results from the difference between the auditor's actual standard of performance and the public's expectations of the auditor's performance, as opposed to the required standard of performance. The following chart illustrates what many members of the public expect versus existing auditing standards.
| Public's Expectation | Auditor's Standard of Performance |
| Auditors should accept the primary responsibility for the financial statements | Management is responsible for the preparation and fair presentation of the financial statement in accordance with Canadian generally accepted accounting principles GAAP. |
| Auditors certify financial statements | Auditors express an opinion on the financial statements based on their audit work. |
| A clean opinion guarantees the accuracy of financial statements | The auditor obtains reasonable assurance that the financial statements are free from material misstatement. |
| Auditors perform a 100% verification | The auditor performs procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected vary according to the auditor's judgment. |
| Auditors should give early warning about the possibility of business failure | Only when the auditor has a concern that the entity will be unable to realize its assets and discharge its liabilities in the normal course of business will the auditor be required to document:
|
| Auditors are supposed to detect fraud | The auditor is only required to identify the risks that exist due to error and fraud that could give rise to the risk of material misstatement in the financial statements. |
Current environment - history
The gap between the role of an auditor - as perceived by the auditor - and the expectations of the users of financial statements is a common and growing problem and derives from two root causes: communications and performance.
The communications gap is caused by the public's expectation that all fraud will be discovered by a statutory audit and the performance gap is the difference in perception of the steps auditors are expected to perform versus what is actually required by their professional code of conduct; GAAP and GAAS. The auditors' requirements have evolved in recent years in an attempt to address the expectation gap and to prevent fraud.
Over the last decade, the media and courts have been overflowing with corporate collapses, investment schemes and bankruptcies due to fraud. Clients, judges, shareholders, bankers and other parties expect auditors to take steps to detect fraud during the audit. When undetected fraud is uncovered without warning, by accident, a tip, or other, the users of the financial statements and the courts look first to the auditor to place blame.
Why is it so hard? They're only numbers, aren't they?
Auditing has become increasingly difficult and challenging, with new rules and regulations combined with the complexity of the business world. The new standards require auditors to enhance their efforts to detect fraud during an audit. However, these requirements are based on terms like "reasonable," "material" and "professional scepticism," which are open to interpretation, professional judgment and misunderstanding by the users of the financial statements. An auditor may determine the extent of procedures to be performed based on professional standards and their assessment of risk, while the client may expect more work and investigation as part of the engagements. The auditor will only perform audit procedures to address perceived risk, which will include the identification of fraud "red flags."
In a standard audit, the auditor may well discover that "needle in a haystack" (fraud) through the procedures performed. On the other hand, in a forensic audit the auditor has identified that there is a potential needle (fraud) and will perform steps and procedures to uncover this needle. That is the distinction that is missing in the public's perception of the auditor's role to identify fraud in a standard audit.
What can we do?
No one person is at fault for the existence of this expectation gap. It stems from a variety of factors including, but not limited to, interpretation of professional standards, lack of communication, and misplaced trust. As a result of the nature of the factors involved, it is difficult to eliminate them all. The following items are suggestions for narrowing the gap:
- Read and understand the auditor's engagement letter.
- Read and understand the auditor's report, which specifically outlines both management's and the auditor's responsibilities.
- Discuss and understand the auditor's perception of your business and its risks.
- Ensure you have implemented appropriate internal controls, have addressed issues and risks identified by the auditor during the audit, and pay attention to the "tone from the top."
- Trust that your auditor is adhering to professional standards, but do not do so blindly. Make sure you understand what those standards are
Tune in next time as we explore how the expectation gap is not specific to your corporate auditor, but rather exists within the various people, systems, and professionals in our daily lives.
About the authors
Tyna Jallet is a Partner with Collins Barrow Montreal and has been with the firm since 1989. She specializes in the areas of audit and business advisory as well as forensic accounting.