Question Tag: Audit Expectation Gap

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  • 5 Marks

AA – Nov 2020 – L2 – Q1a – Audit Failure and Expectation Gap

Discuss factors that account for the audit expectation gap.

In recent years, some well‐publicized corporate failures and its subsequent implication of the reporting auditors have highlighted the audit expectation gap. Public misperceptions are a major cause of the threat of legal challenges facing the accounting profession. One of the key challenges facing assurance providers is understanding and tackling the expectation gap in assurance.

Required:
Discuss what factors account for the expectation gap.
(5 marks)

The expectation gap results from the public’s wrong perception of what they think auditors should do as opposed to what the auditor actually does in accordance with legal and professional requirements. Factors that account for the expectation gap are:

  • Performance gap
  • Some auditors may perform below the expectations of users.
  • Liability gap
  • Many users do not know to whom the auditor owes a responsibility and therefore may want to sue the auditor when they are not supposed to do so.

(5 marks)

  • 20 Marks

AAA – Aug 2022 – L3 – Q1 – Professional responsibility and liability | Practice management

Discuss the audit expectation gap, recommend ways to close it, and evaluate client acceptance decisions for a new audit client.

The potential liability of auditors has become an important topic in recent years, due to the growing complexity of the audit business environment and an increase in legal actions against auditors. One argument put forward to explain the high number of legal actions against auditors is the “expectation gap”.

i) Explain the Audit Expectation Gap and the elements in the Gap.
(4 marks)

ii) Recommend TWO (2) ways of closing the audit expectation gap.
(2 marks)

b) International Standards on Auditing (ISA) defines professional scepticism as an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatements due to error or fraud and a critical assessment of audit evidence. It explicitly requires auditors to plan and perform an audit with professional scepticism recognising that circumstances may exist that may cause financial statements to be misstated.

Required:

Recommend FOUR (4) approaches or ways that the professional practice firms and auditors could adopt to create the awareness of the importance of professional scepticism and its application.
(4 marks)

c) Opelee Partners, a firm of Chartered Accountants is considering the acceptance of a new client, The Monkoo Group Plc (The Group).

The Group is a listed company, and it has a total of 14 subsidiaries, 10 of which are foreign subsidiaries. The Group is a food processing company and each of its foreign subsidiaries provides a particular ingredient used in the Group’s main processing plant, which is based in Ghana. The subsidiaries produce raw ingredients including corn, wheat, vegetables, and nuts.

If Opelee Partners decides to accept the appointment, it will perform the audit of the Group’s consolidated financial statements, and that of the financial statements of some of the individual subsidiaries. The Group audit committee has suggested that, in order to keep the audit fee as low as possible, Opelee Partners could audit the companies based in Ghana but the foreign subsidiaries would be audited by local firms. These foreign subsidiaries contribute 60% to the Group’s total assets.

As the Managing Partner of Opelee Partners, you have also obtained the following information from an internet search regarding the Group:

  • Local protestors: One subsidiary, Konti Plc, has been accused of environmental damage, due to its operations impacting on the rainforest and causing harm to wildlife. There have been some protests by concerned citizens in the country where Konti Plc is located. Digital recordings of these protests have spread world-wide on social media.
  • Expansion of operations: The Group has recently expanded its operations in a certain country by acquiring a large area of land on which to grow wheat. To receive government approval for the acquisition, a significant ‘incentive payment’ was made to a government minister. This has been reported widely in the media.

Required:

Evaluate the matters Opelee Partners should consider before accepting the audit of The Group under the following areas:

i) The audit firm’s capabilities
(4 marks)

ii) Ethical issues
(4 marks)

iii) Client integrity
(2 marks)

a)
i) Audit Expectation Gap
The expectations gap is the difference (or ‘gap’) between:

  • What the users of financial statements and other members of the public think that the auditors should do and what the auditors are actually required by the law and the profession to do.

There are three main elements in the expectations gap:

  1. A standards Gap: This occurs because of a perception that auditing standards are more prescriptive than they actually are, and that auditors have wide-ranging rules that they must follow.
  2. A performance Gap: This occurs because of a perception that audit work has fallen below the required standards.
  3. A liability Gap: This arises from a lack of understanding about the auditor’s liability and who the auditor may be liable to.
    (4 marks)

ii) Closing the Expectation Gap
To reduce the frequency and cost of legal action, and to maintain the image of the audit profession in the mind of the public, the profession can take steps to close the expectation gap by:

  1. The profession should attempt to improve the general level of knowledge and understanding about the audit process.
  2. Controls over the auditing profession are important in enhancing public confidence.
    (2 marks)

b) Professional Skepticism
Professional skepticism within the engagement team is influenced by actions at both the firm and engagement levels, such as:

  1. Auditors must consider the integrity of the principal owners and management during engagement acceptance.
  2. The auditor must consider the reasonableness of significant assumptions used by management for accounting estimates giving rise to significant risks.
  3. ISA 240 notes that the auditor must maintain an ongoing questioning mind and be alert to the possibility of fraud.
  4. When considering going concern, the auditor must consider the reasonableness of assumptions and whether management’s plans are feasible in the circumstances.
    (4 marks)

c) Client Acceptance Decision – The Monkoo Group PLC
i) The Audit Firm’s Capabilities
Opelee Partners should consider the following:

  1. Competence to perform the engagement, capabilities, resources, and time availability.
  2. The complexity and size of The Monkoo Group PLC as a multinational listed company with many subsidiaries.
  3. The need for industry-specific knowledge or the potential need to bring in staff with relevant experience.
  4. The implications of fee pressure from the client, especially in relation to resource allocation.
    (4 marks)

ii) Ethical Issues
Opelee Partners should consider the following ethical issues:

  1. Pressure to maintain a low audit fee, which could affect audit quality and create an intimidation threat to auditor objectivity.
  2. The use of component auditors for foreign subsidiaries and whether sufficient appropriate audit evidence can be obtained.
  3. Understanding the group management’s rationale for appointing component auditors for subsidiaries, especially when they contribute significantly to the Group’s assets.
  4. Evaluating the competence of component auditors due to the specialized nature of The Group’s operations.
    (4 marks)

iii) Client Integrity
Opelee Partners should consider the following:

  1. Allegations of environmental damage by a subsidiary could raise concerns about The Group’s business ethics.
  2. A significant ‘incentive payment’ made to a government minister for land acquisition raises questions about the integrity of The Group’s management.
    (2 marks)

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