Executive Summary
Since the early 1970s, external auditors have increasingly been the target of criticism and litigation. This reached an unprecedented level in 2001/2002 following the unheralded collapse of the giant corporates Enron and WorldCom and their auditor, Arthur Andersen.
Criticism of auditors, and litigation against them may result from auditors failing to meet society's expectations of them. It may be that society's expectations are unreasonable, or that society's expectations are reasonable but that auditors existing legal and professional requirements do not fulfil these expectations. Alternatively, it may be that auditors do not perform their existing responsibilities to a satisfactory standard. Whatever the cause of the gap between society's expectations of auditors and its perception of auditors performance (termed the audit expectation-performance gap), the resultant dissatisfaction with auditors performance serves to undermine confidence in the auditing profession and the external audit function.
Research objectives and methodology
In 1989 Porter, recognising the adverse consequences of the audit expectation-performance gap, conducted research in New Zealand (NZ) to ascertain the structure, composition and extent of the gap. Towards the end of 1999, the authors of this report undertook two interlinked studies to investigate the audit expectation-performance gap in the United Kingdom (UK) and NZ, respectively studies that essentially replicated Porters 1989 research . More specifically, the objectives of the current research were:
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to investigate the structure, composition and extent of the audit expectation-performance gap in the UK and NZ in 1999;
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to compare the structure, composition and extent of the gap in the two countries and to identify, and tentatively explain, any differences that could be discerned (a cross-cultural study);
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to compare the structure, composition and extent of the gap in the UK and NZ, respectively, in 1999 with that in NZ in 1989 (a longitudinal study).
Although the legal, social and economic environments of the UK and NZ are not identical, the researchers consider that they are sufficiently similar to allow meaningful comparisons of the audit expectation-performance gap in the two countries to be made.
The research was conducted by means of a questionnaire that was mailed to 1,610 randomly selected members of four broad interest groups (auditors, auditees, and audit beneficiaries from inside, and from outside, the financial community) in the UK and 1,534 members of these groups in NZ. The survey instrument in the two countries was identical apart from minor modifications necessitated by differences in terminology, institutions and regulations. The questionnaire contained a list of 51 suggested responsibilities of auditors and respondents were asked to indicate, in respect of each:
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whether the responsibility was, or was not, an existing responsibility of auditors, or whether they were not sure;
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if the responsibility was an existing responsibility of auditors, how well it was performed;
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whether the responsibility should be a responsibility of auditors.
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This research report details the results of the research , focusing in particular on the findings of the UK portion of the project. However, in order to permit a comparison of the structure, composition and extent of the audit expectation-performance gap in the UK in 1999 with that in NZ in 1999 and in 1989, the results of the NZ portion of the research are also reported in summary form.
Definition of the audit expectation-performance gap
For the purposes of the research , the definition of the audit expectation-performance gap proposed by Porter (1993) is adopted. This gap is defined as that between: (i) society's expectations of auditors; and (ii) auditors performance as perceived by society. This gap comprises two major components:
1. the reasonableness gap the gap between what society expects of auditors and what auditors can reasonably be expected to accomplish;
2. the performance gap the gap between what society can reasonably expect of auditors and what it perceives they deliver. This may be subdivided into:
(a) the deficient standards gap the gap between the responsibilities society reasonably expects auditors to perform and auditors actual responsibilities, as defined by statute, case law, regulations and professional promulgations; and
(b) the deficient performance gap the gap between the expected standard of performance of auditors carrying out these responsibilities and auditors actual performance of these duties.
Research findings
Structure, composition and extent of the audit expectation-performance gap
The extent of the audit expectation-performance gap in the UK and NZ in 1999, is remarkably similar with a difference of less than 2%. However, the contribution of the gaps components differs quite markedly in the two countries: in the UK , the reasonableness, deficient standards and deficient performance gaps constitute 50%, 42% and 8%, respectively, of the audit expectation-performance gap; in NZ, the comparative proportions were 41%, 53% and 6%. Similarly, while in the UK the reasonableness, deficient standards and deficient performance gaps comprise 23, 10 and 7 actual or suggested responsibilities of auditors, respectively, the equivalent components of the audit expectation-performance gap in NZ consist of 18, 14 and 5 responsibilities.
In 1989 in NZ the reasonableness, deficient standards and deficient performance gaps contributed 31%, 58% and 11%, respectively, to the audit expectation-performance gap and the gaps comprised 9, 10 and 5 responsibilities, respectively. Thus, over the decade from 1989 to 1999, the composition of the audit expectation-performance gap has changed significantly. It appears that auditors performance of their responsibilities has improved but that the narrowing of the deficient performance and deficient standards gaps has been more than offset by an increase in society's unreasonable expectations of auditors and a resultant widening of the reasonableness gap.
Reasonableness gap
As may be seen from above, in 1999 the reasonableness gap constituted half (50%) of the audit expectation-performance gap in the UK and a significant proportion (41%) of the gap in NZ and is the most rapidly expanding component of the audit expectation-performance gap.
Since 1989, in both the UK and NZ, significant companies have collapsed unexpectedly frequently accompanied by revelations of misconduct by their senior officials and, as a result, the government, regulators, and the public have demanded that companies be made more accountable and that they implement measures to secure responsible corporate governance. Auditors have been identified as potential key players in these domains and, as a consequence, society's expectations of auditors in these regards have increased significantly. However the greater incidence of corporate scandals in the UK compared with NZ, has resulted in UK society having greater expectations of auditors playing a role in the corporate governance and corporate accountability arenas. Hence, the reasonableness gap is wider in the UK than in NZ.
Nevertheless, the reasonableness gap was comprised of some responsibilities that were found to not be cost-effective for auditors to perform. Thus, society's expectations of auditors, particularly in the UK , outstrip what is reasonable to expect of them. This may, at least in part, be a function of society's lack of knowledge about the audit function and the work of auditors. Each of the four broad interest groups (including the auditor group) in both the UK and NZ displayed a knowledge gap with respect to auditors existing responsibilities a gap that was wider the greater the distance of the group from the audit function. In the UK and NZ, 52% and 59%, respectively, of audit beneficiaries from outside the financial community were in error or uncertain about auditors existing responsibilities. This compared with 38% and 39% of audit beneficiaries from the financial community, 31% and 27% of auditees, and 18% and 20% of auditors in the UK and NZ respectively. The extent of the lack of knowledge about auditors existing responsibilities should be of concern to the auditing profession as it indicates, inter alia, that criticism of auditors is likely to be misinformed and that the chance of informed debate about the role of auditors in society is not high.
The impact of society's lack of knowledge about auditors responsibilities on the reasonableness gap was reflected in the fact that in both the UK and NZ around 40% of the society group (that is, all non-auditor respondents) signified that they expected auditors to guarantee that audited financial statements were completely accurate and that an auditee whose financial statements received an unqualified audit report was financially sound . It was also pertinent to note that all of the responsibilities that featured as elements of the reasonableness gap in NZ in 1989 reappeared in 1999 in this component of the audit expectation-performance gap in both the UK and NZ. This should be of concern to the auditing profession in both countries as it suggests that, despite the introduction of the long-form audit report since 1989, no progress has been made in educating auditors interest groups about the audit function and the responsibilities that it is reasonable to expect of auditors.
Deficient standards gap
In 1999, the deficient standards gap the gap constituted by responsibilities reasonably expected but not currently required of auditors accounted for more than half (53%) of the audit expectation-performance gap in NZ and a significant proportion (42%) of the gap in the UK. The difference in the extent of the deficient standards gap in the UK and NZ resulted primarily from three responsibilities that contributed to the deficient standards gap in NZ and therefore not a current requirement, but were actual responsibilities of auditors in the UK . (Two of these related to auditors reporting matters of concern discovered during an audit to an appropriate authority when it was in the public interest to do so; the other matter was reporting on the reliability of information presented in the auditees annual report about its directors and senior executives remuneration policy and record.) Once allowance was made for these, the extent and composition of the deficient standards gap in the UK and NZ in 1999 were strikingly similar. Most of the responsibilities comprising this component of the audit expectation-performance gap related to auditors disclosure of information in the audit report or to an appropriate authority about matters of concern (in particular, fraud or other illegal acts) discovered during an audit. Other responsibilities included reporting in the audit report on the effectiveness of the auditees internal financial controls, the reasonableness of financial forecasts included in the annual report and reporting to the auditees directors on the adequacy of the company's risk management procedures.
Deficient performance gap
The deficient performance gap relates to the existing responsibilities of auditors that are perceived by society to be performed deficiently. This was the smallest component of the audit expectation-performance gap in both the UK and NZ and also narrowed markedly between 1989 and 1999. (In 1989 in NZ, the deficient performance gap constituted 11% of the audit expectation-performance gap; in 1999 it contributed 8% of the gap in the UK and 6% in NZ.) This narrowing of the gap can largely be attributed to the introduction of more effectual monitoring of auditors performance by the professional bodies in both the UK and NZ (accompanied by the imposition of sanctions for deficient performance), and a revision of the Going concern auditing standard. In 1989, the society group in NZ adjudged auditors performance of their responsibility to disclose in the audit report doubts about the continued existence of the auditee to be particularly unsatisfactory (37% of the group signified that auditors perform this responsibility poorly). In 1999, following the introduction of a revised auditing standard, which sets out auditors responsibilities in this regard more clearly and stringently, auditors performance of the responsibility was perceived by society to have improved significantly with only 23% of the society group in the UK , and 20% of the group in NZ, indicating that auditors perform the responsibility poorly .
Notwithstanding the narrowing of the deficient performance gap between 1989 and 1999, the same five responsibilities that constituted the gap in NZ in 1989 reappeared as elements of the gap in both the UK and NZ in 1999. Additionally, in the UK , two other responsibilities (that are not existing responsibilities of auditors in NZ) contributed to the deficient performance gap. These were auditors reporting privately to an appropriate authority the theft of auditee assets, or other illegal acts by the auditees directors or senior management.
As might be anticipated, in both the UK and NZ, audit beneficiaries from the financial community the group most likely to rely on the outcome of auditors work was the group that was least satisfied with auditors performance of their existing responsibilities. Auditees are the next most critical, followed by audit beneficiaries from outside the financial community. The auditor group was the least dissatisfied with the performance of their existing responsibilities.
Narrowing the audit expectation-performance gap
If society's expectations of auditors, and auditors performance, were more closely aligned (that is, the audit expectation-performance gap were narrowed), it is highly probable that criticism of auditors and litigation against them, would decrease and confidence in the auditing profession and the work that it does would increase. The research findings detailed in this report provide an insight into the structure and composition of the audit expectation-performance gap and how it has changed over the decade from 1989 to 1999. From these findings, five measures have been identified that could be implemented to narrow this expectations gap.
1.Strengthening the monitoring of auditors performance
The apparent success of the monitoring of auditors performance in effecting improved performance, suggests that this activity should be continued and strengthened, for example, through less leniency being granted where breaches of auditing or other professional standards are found, and more stringent sanctions being imposed when sub-standard performance is encountered.
2.Improving the quality control in audit firms
The monitoring of auditors performance has helped to effect improved performance, but to ensure that all auditing practitioners perform their work to a satisfactory standard on every audit, effective quality control systems within audit firms are needed. In the UK in September 2000, the Auditing Practices Board issued a revised Statement of Auditing Standards (SAS) 240: Quality control for audit work. This provides clear and exacting guidance on the quality control policy and processes audit firms are to implement.
A revised International Auditing Standard 220: Quality control for audit engagements , which closely follows the UK s SAS 240, is in the course of development and, once finalised, will be incorporated, in all its essential requirements, in New Zealand s auditing standards.
3.Enhancing the education of auditing practitioners
The research findings suggest that the enhanced education of auditors is required. It was noted that auditors were found to have a knowledge gap in respect of their existing responsibilities. It is therefore suggested that further education, possibly through compulsory professional development sessions, be required of all existing, as well as trainee, auditors about their responsibilities under statute and case law, quasi -governmental regulations and professional promulgations, and also about the standard of work that is required .
4.Introducing new auditing standards
In order to narrow the deficient standards gap, auditing standards need to embrace the responsibilities that can reasonably be expected of auditors but are not yet required. As noted most of these involved auditors reporting either in the audit report, or to an appropriate authority, matters of concern such as fraud and/or other illegal acts encountered during an audit. Other areas for consideration include: examining and reporting on the effectiveness of auditees internal financial controls; the reasonableness of financial forecasts included in annual reports; the adequacy of risk management procedures; and in the case of listed company auditees, the compliance with all corporate governance requirements.
If the auditing profession were willing to broaden its responsibilities through the issue of new and/or revised auditing standards to embrace these duties that can reasonably be expected of auditors, the audit expectation-performance gap would be narrowed significantly. However, it seems that the willingness of the profession to accept any extended responsibilities is hampered by concerns about the perceived potential increase in exposure to legal liability rather than encouraged by the potential benefits to be gained from better meeting society's expectations and be thereby enhancing the value of the audit function in society.
5. Educating society about the audit function and the work of the auditor
From the research findings, especially those in respect of the reasonableness gap, it is evident that society, in both the UK and NZ, needs educating about the audit function and what auditors can reasonably be expected to achieve. However, given the apparent ineffectiveness of the long-form audit report introduced in both the UK and NZ during the early 1990s to educate financial statement users about the respective responsibilities of an auditees directors and auditors for its financial statements, the level of assurance provided by the audit report, and the key elements of the audit process, it is not easy to identify the means by which education of society at large may be accomplished. One possible means is to use the opportunity afforded by an infamous fraud and/or unexpected corporate failure that reaches the media headlines to explain the audit function and the work of auditors. At present, when untoward company events occur, journalists, or others seeking to lay the blame at someone's door seem to raise uninformed questions (or allegations) about the relevant auditors apparent failure to fulfil what the journalists or others presume to be their duties. The professions usual response in such circumstances appears to be a formal and rather technical statement, by a senior representative, rebuffing the allegations. Such a statement does little to correct society's misconceptions about the audit function or to restore confidence in the profession. Such occasions could be used to explain, in a non-technical, easily understandable language, the auditors role in those particular circumstances and placing those circumstances in the broader context of the audit function and the role and responsibilities of auditors in general.
An alternative, and perhaps more effective way to educate society, is to seek opportunities to educate influential journalists, formally and informally, about the audit function and the work of auditors. If they begin to understand the work of the profession better, they may report adverse events affecting auditors in a more informed and less sensational manner.
Conclusion: Auditors role in narrowing the audit expectation-performance gap
Limperg (1933, reproduced in Limperg Instituut 1985) observed that auditors have a dual responsibility: not to arouse in the sensible layman greater expectations than can be fulfilled by the work done, and to carry out the work in a manner that does not betray the expectations evoked. Limpergs analysis highlights the fact that, if auditors fail to identify society's expectations of them, or to recognise the extent to which they meet (or, more pertinently, fail to meet) those expectations, then not only will they be subject to criticism and litigation but also, if the failure persists, society's confidence in the audit function will be undermined and the audit function, and the auditing profession, will be perceived to have no value.
The findings reported in this research report provide some insight into society's expectations of auditors, the perceived standard of their work, and the extent to which these expectations are not being fulfilled. The report also makes some recommendations on how auditors might better satisfy society's reasonable expectations of them and alter those that are not reasonable. Thus the research contributes in a meaningful way towards narrowing the audit expectation-performance gap. Once auditors performance, as perceived by society, is better aligned with society's expectations of them, the liability and credibility crises facing auditors should abate and confidence in the auditing profession and the work that it does, should gradually be restored.
ISBN 1 904574 04-1
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