The concept of an audit “expectation gap” has existed for decades. In recent years, due to many corporate failures and frauds, the expectation gap has widened. These incidences have raised questions about the role and responsibility of auditors, effectiveness of corporate governance mechanism and regulatory system. These incidences have also highlighted the widening expectation gap in audit.

Background

The underlying objective of an audit of financial statements is to add credibility to financial statements prepared by the management of the entity. An independent audit of financial statements is a vital service to various participants of the financial reporting ecosystem e.g. shareholders, management, those charged with governance, creditors, lenders, government, regulators, investors and other stakeholders. The result of an audit is the opinion of the auditor about the truth and fairness of the financial statements audited. The auditor communicates his opinion through the audit report. However, as with any other profession, which is not an exact science, there are certain misconceptions tagged with the auditing profession especially those relating to objective and scope of an audit, responsibilities of auditors, expected outcomes of an audit etc. This results in an Expectation Gap between the various stakeholders and the auditor.

What is Expectation Gap

The concept of “expectation gap” has been defined and described in several ways. There is no universally accepted definition of this concept. In general terms, the expectation gap is the difference between what users of audited financial statements expect from the auditor and the financial statement audit, and the reality of what an audit is.

1.1 Components of Expectation Gap

There are three main components/elements of expectation gap though there can be several other elements. These components are discussed below:

  1. Knowledge Gap: There is a difference between what auditors are actually supposed to do and what the public thinks auditors do. The role and responsibilities of the auditor is misunderstood by public as well as the objective of financial statements audit is not clear to most of them. Knowledge gap is sometimes also referred to as “information gap”.
  2. Performance Gap: Most of the time, the Standards on Auditing or regulatory requirements need interpretation while applying it to practical situations. At times, these interpretations taken by regulators and auditors are different. This difference of interpretation creates the Performance Gap i.e., “what regulators expect and what auditors do”. Performance gap is sometimes also referred to as “delivery gap”.
  3. Evolution Gap: Evolution Gap occurs due to evolving technological, financial, and business environment. It relates to the areas of audit that need evolution.

Examples of Components of Expectation Gap

Examples of Components of the Expectation Gap1
Aspects that could possibly be addressed by Standard-Setting, including Support MaterialsAspects that require Further Consideration
Knowledge Gap
  • The nature, extent and limitations of the auditor’s responsibilities in relation to fraud and going concern may be unclear in the auditor’s report.
  • The description of a material uncertainty in both accounting and auditing standards with regards to an entity’s ability to continue as a going concern is inconsistently understood and applied.
  • Some users of financial statements do not understand what an audit entails (i.e., the nature, extent, and limitations of the auditor’s procedures to obtain evidence to support an audit opinion).
  • Some may have unreasonable expectations of what auditors ought to do compared to what auditors are actually capable of doing due to the inherent limitations of an audit.
  • The public thinks the role of the auditor is to detect fraud, including non-material fraud.
  • Differences of view as to the meaning and implication of material uncertainties and the going concern concept.
Performance Gap
  • Aspects of some standards may not be clear such that there is inconsistent application or confusion as to how to apply them.
  • There is insufficient guidance and support materials to assist with effective application.
  • The auditor is pressured, either by management or by tight deadlines, resulting in lower quality audit work.
  • Auditors may not be adequately trained.
  • The firm may not have clear policies and procedures with regards to audit quality or they are not applied appropriately.
  • The auditor is pressured to accept less transparent company disclosures and/or not to include going concern uncertainties in the auditor’s report because of fears that such disclosures/reporting will be a self-fulfilling prophecy.
Evolution Gap
  • Audits may not have evolved to meet changing expectations due to developments within the environment, for example:
    • Stakeholders seek more insight into a company’s future viability than is currently provided for in accounting and auditing standards.
    • Environmental influences encourage more transparency from auditors which is not forthcoming because it is not required.
  • The environment is evolving at a more rapid pace which may necessitate different, and more robust, procedures targeted at ongoing changes.
  • Users of financial statements are looking for enhanced procedures in relation to fraud and going concern that is not currently provided by the requirements of the auditing standards.
  • In the current environment, the auditing standards may not be robust enough when a possible fraud is identified.
  • Shareholders are seeking more information from entities’ auditors, however, there are insufficient opportunities for the auditor to formally engage with shareholders and the public.
  • The expectation of audit committees and those charged with governance has increased with evolving environmental influences, for example there is a greater emphasis on setting tone and monitoring culture.
  • There is a call for a broader and more holistic view of the auditor’s role beyond what the audit delivers, for example separate engagements on an aspect of the audit where stakeholders are looking for more.

1 Source: “Fraud and Going Concern in an Audit of Financial Statements: Exploring the Differences between Public Perceptions About the Role of the Auditor and the Auditor’s Responsibilities in a Financial Statement Audit” – Discussion Paper issued by the International Auditing and Assurance Standards Board (IAASB) in September 2020.

1.2 Analysis of Expectation Gap Based on Participants Involved

Various participants of financial reporting ecosystem have their own perspective regarding expectation gap. So, the expectation gap may also be analysed based on the perspective of participants involved. This is discussed below.

Expectation Gap: Perspective of Users of Audited Financial Statements

Users generally are not aware about the auditing framework, particularly the following aspects:

  • They do not have knowledge about the inherent limitations of audit and the concept of reasonable assurance.
  • They believe that audited financial statements are free from all misstatements.
  • They believe that audit is a guarantee as to the future viability of the entity.
  • They believe that an audit is a guarantee as to the efficiency and effectiveness with which the management of the entity has managed the affairs of the entity.
  • They are not aware about the difference between audit and special audit/ investigation/forensic audit.
  • They believe that it is the responsibility of auditor to detect and report all frauds.

Expectation Gap: Perspective of Management

Management generally have the following perspective w.r.t. audits and role of auditors:

  • Auditors are responsible for preparation of financial statements with required disclosures.
  • Auditors are responsible to detect all errors and fraud.
  • Engagement letter and management representation letter are meant to transfer the auditor’s responsibility to management.
  • Certain information required in the course of audit may be unnecessary and burdensome.
  • Audit takes business time and interferes in regular functioning of the entity.

Expectation Gap: Perspective of Auditors

Auditors generally quote the following challenges faced by them in conducting audits:

  • Increasing complexity and frequent amendments in auditing standards.
  • Frequent legislative changes in laws, regulatory requirement and accounting standards.
  • Tight deadlines to complete audits.
  • Non-cooperation from auditee during course of audit.
  • Inspection and administration by multiple regulators.
  • Increasing audit costs on staffing, training, technology etc. without corresponding increase in audit fees.

1.3 Understanding Key Concepts of Standards on Auditing w.r.t. Expectation Gap

In order to understand the concept of expectation gap better, it is important to understand the key concepts of Standards on Auditing (SAs) w.r.t. expectation gap e.g. purpose of audit, premise on which an audit is conducted, reasonable assurance, inherent limitations of audit. These concepts have been prescribed in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”.

Purpose of Audit

The purpose of an audit of financial statements is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

The Premise on which an Audit is Conducted

The financial statements subject to audit are those of the entity, prepared and presented by management of the entity with oversight from those charged with governance. SAs do not impose responsibilities on management or those charged with governance and do not override laws and regulations that govern their responsibilities. However, an audit in accordance with SAs is conducted on the premise that management and, where appropriate, those charged with governance have responsibilities that are fundamental to the conduct of the audit. The audit of the financial statements does not relieve management or those charged with governance of those responsibilities.

Reasonable Assurance

As the basis for the auditor’s opinion, SAs require the auditor to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Reasonable assurance is a high level of assurance. It is obtained when the auditor has obtained sufficient appropriate audit evidence to reduce audit risk (i.e., the risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated) to an acceptably low level. However, reasonable assurance is not an absolute level of assurance, because there are inherent limitations of an audit which result in most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive.

Inherent Limitations of an Audit

The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute assurance that the financial statements are free from material misstatement due to fraud or error. This is because there are inherent limitations of an audit, which result in most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive. The inherent limitations of an audit arise from:

  • The nature of financial reporting;
  • The nature of audit procedures; and
  • The need for the audit to be conducted within a reasonable period of time and at a reasonable cost.

Possible Panacea for Minimising Expectation Gap

The expectation gap can be minimized through various measures listed below:

Updating the Auditor’s Knowledge

Enriching and updating the auditor’s knowledge and expertise can assist in reducing the expectation gap. The auditors should keep themselves abreast with the latest developments in the field of auditing standards and techniques. For this purpose, it is necessary that they should undergo continuous training and professional development in order to improve their skills and knowledge.

Effective Communication

  • Communication between auditor and auditee: An effective communication between the auditor and the auditee can act as catalyst in minimizing the expectation gap. This can be achieved by various ways like defining clearly the scope of the audit, discussion on the findings of the audit, and explaining the auditee about the limitations of the audit. The auditor should also ensure that the auditee understands the audit process and the expectations of the auditor.
  • Communication in auditor’s report: One significant change with the Auditor Reporting Standards is the new Standard on Auditing (SA) 701, “Communicating Key Audit Matters in the Independent Auditor’s Report”. The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed. Other significant changes include a new section in auditor’s report w.r.t. “Material Uncertainty Related to Going Concern” introduced by SA 570(Revised), “Going Concern” and a new section in auditor’s report w.r.t. “Other Information” introduced by SA 720(Revised), “The Auditor’s Responsibilities Relating to Other Information”.

Educating Stakeholders on “What is an Audit”

Stakeholders should be educated on the subject of audit covering aspects like importance of audit, objective and scope of audit, role of auditors. This can be done by conducting awareness campaigns and programmes. This will enable trust and confidence of stakeholders in the audit process.

It is important to note that these measures can only help in minimizing the expectation gap in audit. The expectation gap cannot be completely eliminated as there will always be some level of difference between the expectations of stakeholders from audit and the actual performance of the auditor.

Steps Taken by AASB to Bridge Expectation Gap

The Auditing and Assurance Standards Board (AASB) of ICAI has taken various steps to bridge the expectation gap. Major steps taken by AASB are given below:

  • Implementation Guides: AASB has been issuing various Implementation Guides on Standards on Auditing to help auditors in effective implementation of Standards on Auditing. These Implementation Guides explain the various principles of Standards on Auditing in simple language by way of FAQs, case studies, templates etc.
  • Awareness & Professional Enhancement Programmes: AASB organises various Seminars/Workshops/Webcasts/Virtual CPE meetings/Refresher Courses (both physical and virtual mode) for awareness and professional enhancement of the members. These programmes are aimed at creating awareness among the members on, inter alia, the following aspects:
    • Engagement and Quality Control Standards.
    • Reporting requirements of Companies Act, 2013.
    • Audit of banks.
    • Industry specific auditing issues.
    • Audits of various items of financial statements.
    • Recent developments and emerging issues in auditing.

    These programmes focus on various practical aspects of auditing and provide a suitable platform to auditors to get solutions for practical challenges faced by them. During last year, AASB organized 131 programmes attended by around 1,95,000 participants.

  • Online Panel for Bank Branch Audits: Every year, during the bank audit season, AASB constitutes an online panel of experts to address queries of bank auditors related to bank branch audits.
  • Statutory Audit Expert Panel: AASB has constituted an expert panel for addressing auditing queries related to statutory audits of the financial year 2022-23. The panel will address queries from April 17, 2023 till September 30, 2023. This panel was also constituted by AASB in the last year.
  • Regulatory Interaction: AASB has regular interaction with various regulators (RBI, SEBI, MCA, NFRA) to discuss matters impacting the audit profession.
  • Guidance on Emerging Areas: AASB has been developing and issuing guidance on emerging areas in audit and assurance. Recently, AASB has issued the below cited publications:
    • Technical Guide on Disclosure and Reporting of Key Performance Indicators (KPIs) in Offer Documents.
    • Implementation Guide on Reporting under Rule 11(g) of Companies (Audit and Auditors) Rules, 2014.
    • Technical Guide on Digital Assurance.

Author may be reached at: sanjeevsinghalca1997@gmail.com and eboard@icai.in