Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

The University of Greenwich Business School Audit and Assurance (ACCO 1125) coursework RELEVANCE OF AUDITS IN TODAYS BUSINESS ENVIRONMENT; MANAGING THE EXPECTATION GAP UoG-SEGI NG KIM SOON 000580777 12th of January, 2012 Course Leader: Izette Kluever

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Contents Coursework Header Sheet..1 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 Introduction...4 Statutory Audit..5 Truth and Fairness.7 Relevancies of expressed opinion.9 Fitness for purpose..10 Limitations..11 Expectation Gap..12 Conclusion..14 Lists of references...15

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

1.0

Introduction

In this contemporary business environment, an audit is indicated as a monitoring and verification activities of accounting records and financial information with systematic process, consultations and the identification of opportunities that enhances the value of a company in order to certify its financial statement (Louwers et al. 2011). Therefore, it was perceived that the role of an auditor is to add value on the financial statement by expressing their opinion on its truth and fairness in order to enhance its reliability and credibility and their role was facilitated since they are delegated by the law to perform statutory audit by the local standards, acts and regulations (Tagesson and Eriksson 2011).

However, questions had been raised among the stakeholders regarding the professionalism, independence and relevancies of the audit in this rapid changing business environment subsequent to the few notable corporate failures, frauds and collapse. Debates on reforming the auditing world has been made between commentators so that it would be fit for purpose to adequately produced trust and assurance to the related stakeholders (Humphrey 2007). This has resulted to the passing of new acts and code of conducts such as Sarbanes-Oxley Act and Cadbury Code in order to strengthen and restore the public confidence on auditing (Tackett 2004). Nevertheless, other dilemmas such as uneducated users regarding auditing, doubts about auditing process and the misused of accounting standards for self-opportunities has worsen the audit expectations gap which impedes the
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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

regulators from covering the gap (Humphrey 2007). Hence, the relevancies and independence of audit are still under scrutiny albeit there is a passing of new regulations and various commitments by the regulators and authorities (Tackett 2004).

2.0

Statutory Audit

Certain law has indicated that statutory audits are compulsory for every company but certain regime has grant an exemption from audit if the company has fulfilled the legal requirements provided and a qualified external auditor will perform it to ensure the compliance with the established accounting principles and standards, laws and regulations so that an expressed opinion on the truth and fairness of the financial reporting can be provided after ascertaining and verifying the accounting records and financial information. Therefore, the scope of tasks and duties, requirements, audit practices, licensing of, responsibilities, objectives, liabilities and the rights of an auditor was governed under the act and legislation of a regime. Furthermore, the appointment, resignation and removal of an auditor are assured to be exercised in accordance of legal and professional prerequisites (Baker et al. 2001).

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Tabone and Baldacchino (2003) had commented that the statutory audit was to resolve the inherent agency conflicts where there is a separation between ownership and management which causes the information asymmetry. Statutory audit will increase the credibility and reliability of the financial reporting by testifying its information to the owners and safeguarding the interest of the related third parties. Furthermore, it is required to maintain the accountability, disciplines and standards of a companys accounting systems, procedure and reporting to facilitate the published of financial statements adherence to the users and legal requirements.

In UK, statutory audit was made compulsory for all companies under The Companies Act 2006. It is a legislation that gives the auditors the rights and duties to facilitate the carrying out of effective and independent audit (Marriott et al. 2011). It was stated under section 475(1) where an annual account of a company must be audited to certify its truth and fairness unless it was exempted under section 477 and section 488 which is respectively a small companies and dormant companies. Furthermore, the functions of an auditor and audit reports was provided in between section 495 to section 509 of which it includes the duties and rights of an auditor and its noncompliance to the act if the directors are not providing necessary information to the auditors. The act has also specified the independencies, requirements, qualifications and eligibilities of an individual in conducting a statutory audit beginning from section 1209 and the consequences of violating it (UKGPA 2006).

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

3.0

Truth and fairness

The financial reporting regulations in UK requires the financial reports to give a true and fair value (TFV) of presented information but however, US standards requires it to be presented fairly in accordance of GAAPs. However, both requirements are synonymous in auditors perception (Albu et al. 2009). The terms of TFV was uncertain but according to the research done on large audit firms, auditors has distinguish the word true as factual, material and adherence to the rules and fair as not misleading, comprehensible and represents reality. Therefore, an auditor will only express their opinion on the truth and fairness of financial reports provided by the directors when the reports are producing accountable, understandable, reliable, relevant and comparable information with compliance of the accounting standards and concepts and statutory requirements since this is the main purpose of audit (Jayalakshmy 2005).

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

An unqualified audit report will be produced by the auditors to present their opinion to the users especially shareholders on whether the financial reports are truly and fairly disclosing the assets, liabilities, financial position, financial and operational performances and profitability of the company at the end of the year. Their opinion will be inclusive of their professional and independent judgements on whether the financial reports are in accordance of accounting entries and records without any exclusion of pertinent materials, the accounting books are recorded in adherence to the regulations and the financial reports are presented in good faith of accounting principles such as going concern, accruals, prudence and consistency (MacLullich 2003). Hence, an accurate, unbiased, objective and proper judgement are required to be exercised critically with the gathering of audit evidence since their expressed opinions signals the reliability, credibility, usefulness and whether there are any material errors in the financial reports based on the users requirements. Therefore, the auditors are not guaranteeing or certifying but to provide reasonable assurance on the truthfulness and fairness of the financial reports (Kirk 2006).

4.0

Relevancies of expressed opinion

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Jayalakshmy (2005) contended that the auditors might reluctant to issue a qualified report regarding their discoveries and detections for their own interest or pressurised by their clients especially when non-auditing services is becoming crucial for every audit firms which leads to the rendering of biased opinion and ignoring the illegalities albeit the audit failures is not directly attributable to the notable corporate failure such as Enron, WorldCom and Tyco but it was an offence if the auditors are being ignorance towards such corporate wrongdoings. Hence, the opinion was perceived as a used of misleading the publics by providing a fictitious confidence and conceal their immoral actions for corporate opportunities (Ram 2002). It has suggested that there should be a proper regulations or overhaul for this vague concept of TFV in order to strengthen the relevancies of such expressed opinion which triggered the enactment of Sarbanes-Oxley Act 2002 and the amendment of UK Companies Act (Smieliauskas et al. 2008). However, Smieliauskas et al. (2008) still condemned that the expressed opinion was not argumentative and thoughtful by neglecting the prediction of future risks as contemporary corporate structure are getting more complicated and challenging. Moreover, the audit fees was perceived as significant financial burden and unnecessary for some companies since the opinion expressed by an auditor was equivalent and repetitious of what the management has prepared (Tabone and Baldacchino 2003).

5.0

Fitness for purpose

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Auditing was alleged as fit for purpose when the statutory auditors are enabled to provide a qualified opinion regarding the truth and fairness of a corporate financial statements by exercising their professional judgement in order to secure the corporate transparency, ensure the corporate accountability and safeguard the interests of the stakeholders with a provision of reasonable assurance (Humphrey et al. 2011). However, the authors commented that threats such as deteriorated quality of audit process, non-auditing services, auditors misbehaviour and superseded self-regulations has put the purposes and relevancies of audit into a question whether it is still able to protect the investors and public interests during this accelerated business environment especially financial crisis since accounting scandals are still arise even a clean audit opinion has received (Humphrey et al. 2011).

6.0

Limitations
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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Smieliauskas et al. (2008) opines that auditing indicates an auditors state of knowledge but it is still depends heavily on the auditors judgement which is subjected to a certain inherent risks such as material misstatements, computation errors and environmental uncertainties which is inevitable within the audit practice. Since it is impossible for an auditor to attest every account or maybe due to an auditors overconfidence, visual perception and efforts reduction behaviour, auditors are just testifying the accounts randomly or based on sampling. Hence, they sometimes might overlook certain details that could lead to possible bias or material misstatements since there are various ways to hide the illegalities such as collision and deceit which increases the difficulties to form an accurate opinion (Hall et al. 2010). Such limitations are compensated by exercising professional scepticism and improving the quality of evidence by requiring the management to prove the information provided and the auditors should built self integrity and be professional in rejecting non persuasive information. The scrutiny of materials and information provided by their clients are gradually replaced with audited firms internal control in stages and hence, auditors are required to improve their communication with the firms internal control (Jayalakshmy et al. 2005).

7.0

Expectation Gap
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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Different commentators had a different view on audit expectation gap. For instance, Schelluch and Gay (2006, p654) defines audit expectation gap as difference between the public perceptions of the roles and responsibilities of the auditor and auditors of these roles and responsibilities. Furthermore, Porter (1993 citied by Lee et al. 2009) defines the gap as the different anticipations of the public or as envisioned by the user of a financial statement on what auditors should have or perceived to achieve. The gap existed due to the societal and stakeholders exaggerated beliefs that an auditor is trustworthy when their responsibilities are encompassing the monitoring, identification, detection and exposures of any accounting frauds and misbehaviour which is in contrast of the auditing professions view that the sole responsibility of an independent auditor was to provide their opinion and commenting on the fairness of financial statements based on their skills and expertise by scrutinising and certifying the fairness of the financial reports (Lee et al. 2009). The gap has been segregated into a few issues which are the auditors responsibilities, auditing constitutions and reliability of the audited financial statements with auditors opinions (Schelluch and Gay 2006) However, this gap was exacerbated due to the ignorance of unsophisticated users regarding the characteristics and limitations of auditing, minimal government regulations and standards such as selfregulation and auditors misbehaviour which causes the deterioration of audit quality (Salehi 2011).

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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

Various efforts and recommendations had been made in order to narrow the gap. The auditors had tried to improve their communications with the users by reconsidering and simplifying the wordings of their audit report to enhance the readability of the report by including a clear indication of the roles and responsibilities of an auditor (Schelluch and Gay 2006). Furthermore, Salehi (2011) had been a proponent of educating the users regarding the nature, functions and limitations of audit through mass communication, free seminars by the regulators and authorities and a brief explanation during the Annual General Meeting since a an unnecessary burden on the auditors can be reduce as users are getting sophisticated. Moreover, the audit regulations and standards should be overhauled or augmented since the existing standards has been criticised of being superseded and the publics are being vague of the term statutory audit. For example, the implementation of new standards such as ISA 240, The Auditors Responsibility to Consider Fraud in an Audit of Financial Statements and ISA 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement in US in the aftermath of Enrons collapse (Salehi 2011). It also invokes the legislators in UK to amend their law by legally extended the roles of auditors in monitoring and corporate governance under section 496 and section 497 of Companies Act 2006 (Porter 2009).

8.0

Conclusion
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Relevance of Audits in Todays Business Environment; Managing the Expectation Gap

It is undeniable that statutory audit are still imperative in this business environment since at least, it is maintaining the corporate reporting standard, mitigating the agency conflicts and information asymmetry, upholding the qualities of auditors and providing a reasonable assurance for the public. Efforts and changes to strengthen the credibility and reliability of audit has been done by the regulators and professions during the post-Enron era but the basic auditing model and its effectiveness was criticised of allowing the clients in publishing shady financial reports by violating the laws and regulations. The notable incident will be the collapse of Lehman Brothers which has misused the Repo 105 transactions but its auditing firm, Ernst and Young alleged it as an accounting treatment (Hines 2011). The issues arises is not due to the fact that audit is not playing any relevant role in this business environment but due to the fact of auditors independency and integrity which is not aligning with the objective and showing no interest of bridging the existing expectation gap. Such gap can be bridged with the development of communications between the auditors, audit committee and internal auditors to further strengthen and aligned in order to mitigate the occurrence of frauds and hazardous activities. A profound reformation must be done on the existing standards and regulations and it is not only the rules and auditing model that should be reform, education, perception and the behaviour of publics and auditors should be developed as well. This is to be aligned with European Commissions objective of the auditing reformation which is changing not for the sake of change but ignores the real needs (Humphrey et al. 2011, p439). 9.0 List of references

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Albu C.N., Albu N. and Alexander D. (2009), The true and fair view conceptin Romania: A case study of concept transferability, La place de la dimension europenne dans la Comptabilit Contrle Audit, pp1-32 (WWW) Available from: http://papers.ssrn.com/sol3/papers.cfm? abstract_id=1770000 [Accessed: 19th November 2011]

Baker C.R., Mikol A. and Quick R. (2001), Regulation of the statutory auditor in the European Union: a comparative survey of the United Kingdom, France and Germany, European Accounting Review 10(4), pp763-786 (WWW) Available from: Hall T.W., Pierce B.J., Price K.H. and Skousen C.J. (2010), Haphazard Selection: Is it Time to Change Audit Standards?, Available from: Hines C., Kreuze J. and Langsam S. (2011), An analysis of Lehman Brothers bankruptcy and Repo 105 transactions, American Journal of Business 26(1), pp40-49 (WWW) Available from: Humphrey C., Moizer P. and Turley S. (2007), Independence and Competence? A critical questioning of auditing, Independent Accounts: The Possibilities for Auditor Independence in the Age of Financial Scandal Advances in Public Interest Accounting 12, pp149-167(WWW) Available from: pp1-43 (WWW)

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Humphrey C., Kausar A., Loft A. and Woods M. (2011), Regulating Audit beyond the Crisis: A Critical Discussion of the EU Green Paper, European Accounting Review 20(3), pp431-457 (WWW) Available from: Jayalakshmy R., Seetharaman A. and Khong T.W. (2005), The changing role of the auditors, Managerial Auditing Journal 20(3), pp249-271 (WWW) Available from: Kirk N. (2006), Perceptions of the True and Fair View Concept: An Empirical Investigation, ABACUS 42(2), pp205-235 (WWW) Available from: Lee T.H., Ali A.M. and Gloeck J.D. (2009), The audit expectation gap in Malaysia: an investigation into its causes and remedies, Southern African Journal of Accountability and Auditing Research 9, pp57-88 (WWW) Available from: Liggio, C. 1974. The expectation gap: the accountants Waterloo, Journal of Contemporary Business 3, p27-44 citied in Lee T.H., Ali A.M. and Gloeck J.D. (2009), The audit expectation gap in Malaysia: an investigation into its causes and remedies, Southern African Journal of Accountability and Auditing Research 9, pp57-88 (WWW) Available from: Louwers T.J., Ramsay R.J., Sinason D.H., Strawser J.R. and Thibodeau J.C. (2011), Chapter 1 - The contemporary auditing environment, Auditing and Assurance Services, pp1-65 (WWW) Available from:
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MacLullich K.K. and Watt H. (2003), The true and fair view construct in the context of the Polish transition economy: some local insights, European Accounting Review 12(3), pp465-487 (WWW) Available from:

Marriott N., Telford B., Davies M. and Evans J. (2011), Students Perceptions of Work-Based Training and Examination-Based Learning Relating to the Professional Competence of Auditors and the Impact of Regulatory Changes on Audit Training in the UK, Accounting Education: An International Journal 20(2), p133-151 (WWW) Available from: Porter B. 1993. An empirical study of the audit expectation-performance gap, Accounting and Business Research 24(93), pp49-68 citied in Lee T.H., Ali A.M. and Gloeck J.D. (2009), The audit expectation gap in Malaysia: an investigation into its causes and remedies, Southern African Journal of Accountability and Auditing Research 9, pp57-88 (WWW) Available from: Porter B.A. (2009), The audit trinity the key to securing corporate accountability, Managerial Auditing Journal 24(2), pp156-182 (WWW) Available from:

Ram T. (2002), Irreconcilable Legal and Accounting Views of A True and Fair View: An Emerging Alternative from Australian, Journal of Law and Financial Management 44, p44-52 (WWW) Available from:

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Salehi M. (2011), Audit expectation gap: Concept, nature and trace, African Journal of Business Management 5(21), pp8376-8392 (WWW) Available from: Schelluch P. and Gay G. (2006), Assurance provided by auditors reports on prospective financial information: implications for the expectation gap, Accounting and Finance 46, pp653-676 (WWW) Available from: Sikka P. (2009), Financial crisis and the silence of the auditors, Accounting, Organisations and Society 34, pp868-873 (WWW) Available from: Smieliauskas W., Craig R. and Amernic J. (2008), A proposal to replace true and fair view with acceptable risk of material misstatement, ABACUS 44(3), pp225-250 (WWW) Available from: Tabone N. and Baldacchino P.J. (2003), The statutory audit of ownermanaged companies in Malta, Managerial Auditing Journal 18(5), pp387398 (WWW) Available from:

Tackett J., Wolf F. and Claypool G. (2004), Sarbanes-Oxley and audit failure - A critical examination, Managerial Auditing Journal 19(3), pp340350 (WWW) Available from: Tagesson T. and Eriksson O. (2011), What do auditors do? Obviously they do not scrutinise the accounting and reporting, Financial accountability and management 27(3), pp272-285 (WWW) Available from:
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UKGPA (2006), Companies Act 2006, pp1-798 (WWW) Available from: http://www.legislation.gov.uk/ukpga/2006/46/contents [Access from: 20th December 2011]

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