Audit Expectation Gap: An Empirical Review of the Literature
An Empirical Study of Audit Expectation Gap in Nigeria
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Transcript of An Empirical Study of Audit Expectation Gap in Nigeria
An Empirical study of Audit Expectation Gap in Nigeria
By
Muhammad Tanko (PhD, ACA)
Kaduna State University
0802-915-1213; 0807-726-2667
1
1. Introduction
The act of record keeping keeps the track of transactions in an organization and this in a way
serves as the basis upon which information is passed to the end users. But before it reaches them
there is the need for someone to authenticates the correctness of such records, and that is exactly
what the auditing procedure is all about. Rostami (2009), opined that it is the auditor that
authenticates the correctness of financial information that is passed to the end users, and he does
that based on his professional code of ethics and regulation. Therefore, auditors occupy the
central role in bridging the communication gap between the management of an enterprise, and
the end-users of the published financial reports.
The term audit is a word that is derived from the latin word ‘to hear’ and the term auditor means
‘hearer’. These terms follow the function of the auditor as it is expected that the preparers of
financial statements need to go through some impartial and experienced persons, normally
judges who used to hear the accounts prepared by the persons in charge and express their
opinion. (2009) opined that in the early 1990s auditors were primarily engaged to provide almost
absolute assurance against fraud and intentional
The role of the auditor is generally understood by the general public to be the detection of fraud
and error in the financial statements. This is because it is the auditor that comes to light in any
matter that effects the investigation of fraud or misappropriation in companies. Not until 1989
when the LJ Lopes of the appeal court stated in the case of Re Kingdom cotton mills (1896) that
the auditor was a watchdog not a bloodhound. Clearly, this decision brought to light the primary
role of the auditor to exclude the decision of fraud detection. Therefore, the definition of what an
audit is by the user’s of financial statements, the general public and the auditors, is what
cumulates to bring about the term “audit expectation gap“. The concept can better be understood
when we have a close look at the following issues: The audit profession’s expectation of an
audit; the auditor’s perception of an audit; and the general public/user’s of financial statements
perception of the audit
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Marianne (2007) observes that, if users of financial statements and the general public were
educated to think that the auditor's role embraces the detection and prevention of fraud,
especially in relation to material items, the fraud and error detection role of an audit could be
relatively objective. However, absolute objectivity cannot be guaranteed since “materiality” and
“material significance” are subjective concepts which require further clarification by the
Auditing Practices Board. A return to the primary role of detection and prevention would also be
welcomed since there are at present, not sufficient measures to hold the auditor liable for
negative consequences of his actions. Some sources of academic literature assume that the
meaning of an audit is not ‘objective’ that is not ‘fixed’ whilst other sources such as contents of
audit reports assume that the meaning of an audit is ‘fixed’. In relation to the latter assumption,
there is the belief that the expectations gap could be significantly reduced –if not possible to
eliminate.
Pierce and Kilcommins (1996) using the external auditors as their bench mark as against the
bench mark of the audit profession tried to define the audit expectation gap. To them when the
external auditors’ understanding of their role and duties is compared against the expectations of
user groups and the general public then we expects to see audit expectation gap. Liggio (1974),
on the other hand, defined the audit expectation gap as the difference between the levels of
expected performance as interpreted by the independent accountant and the user of financial
statements. On the other hand, where we try to look at the expectation gap with the audit
profession in mind or as bench mark, there will be less subjectivity in the understanding and
definition of the expectation gap and which will narrow the expectation gap.
Much has been written about the possibility of an audit expectations gap. In an attempt to
address the problem, especially as to do with the role and responsibilities of auditors, have led to
the establishment of several government and professional investigations, which form an
important part of the expectation gap literature. These include the Cohen Commission (1978);
Metcalf Committee (1976); and Treadway Commission (1987); in the United States, the Cross
Committee (1977); and Greenside Committee (1978); in the United Kingdom and the Adams
Committee (1977) and MacDonald Commission (1988) in Canada.
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While Cohen Commission in 1978 considered whether a gap might exist between what the
public expected and what auditors could reasonably expect to accomplish, poter (1993), in his
empirical study of the audit expectation gap, sees the definition of the gap as failing to mention
the possibility of sub-standard performance by auditors. It is against this backdrop that it is
imperative to study the issue of expectation gap. The next section explains the objective of this
paper.
1.1 Objective of the Research
The objective of this paper as stated above is to establish that there exist the expectation gap at
least in Nigeria, and that those areas of concern, (areas that brought about the creation of
misunderstanding between the public and the audit profession) could be identified and measures
could be taken to either eliminate them or reduce them to the bearest minimum. Furthermore, the
research intends to identify the effect of social framework on the definition of the audit
perception. The paper will make policy recommendations based on the outcome of the research.
More specifically the paper will address the following issues:
(i) Whether the expectation gap exists in Nigeria
(ii) Whether the areas of the gap could be identified
(iii) Whether it is possible to eliminate the gaps
(iv) whether it could be reduced in cases where it could not be eliminated
(v) Examine and differentiate the fixed and variable definition of the audit
(vi) Determine the extent which the social framework affects audit definition and
perception.
(vii) Make policy recommendations as to ways of improving the reduction of the
expectation gap
The next section contains the theoretical framework and the literature review that were employed
in the research.
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Literature Review
The literature has explicitly accepted the existence of the problem of expectation gap. This can
be seen by the definition of the term by pierce and kilcommins (1996), who observe that the
audit expectation gap exist when the external auditor’s understanding of their role and duties is
compared against the expectations of user group and the general public. Tricker (1982) viewed
the expectation gap as the result of a natural time lag in the auditing profession identifying and
responding to continually evolving and expanding public expectations. Other authors argued that
it was the consequence of the contradictions in a self-regulated audit system operating with
minimal government intervention as evidenced in Hopwood (1990) and Humphrey (1991).
Loggio (1974) further sees the expectation gap as the difference between the levels of expected
performance as interpreted by the independent accountant and the user of financial statements.
The two definitions above have established the existence of the problem of the expectation gap.
This has been echoed by the recent happenings in the financial reporting scandals of the Enron,
WorldCom, and Parmalat. Furthermore, Sutton (2002) observe that financial reporting is once
again at the cross road. Incidentally, both government and the auditing profession have reacted to
these developments. The Sarbanes Oxley act of 2002, the American institute of certified public
accountants statements of 2002 (AICPA, 2002a; SAS 99; AICPA, 2002b) are testimonies.
The next area of concern is to identify the areas of those expectation gaps as identified in the
literature. McEnroe and Martins (2001) have identified several expectation gaps between the
“audit partners” and the investor’s perception of the auditors’ responsibilities involving various
dimensions of the audit. They observe that the investing public does not want auditors to issue an
unqualified audit opinion unless every item of importance to investors and creditors have been
reported or disclosed, the financial statements are free of misstatements resulting from
management fraud, auditors have been public watchdogs, internal controls are effective, the
financial statements are free of misstatements intended to hide the firm, and has not engaged in
illegal operations. They therefore, identified the following areas of the expectation gap as:
i. Full Disclosure
ii. Public Watchdog
iii. Effective internal controls
iv. Management Fraud
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v. Employee fraud and
vi. Illegal acts
The expectation gap generally, stems from the differing expectations of the function of
independent audit between the auditors and the public. Sweeney (1997) listed out the areas
where difference in expectations mostly arises: going concern, fraud and illegal acts,
independence, and duty of care.
The empirical study by Humphrey (1991) with reference to England is an extension of first
studies and the main conclusions include expectations gap in auditors’ role in fraud detection; the
extent of auditors’ responsibility to this party; the nature of balance sheet valuation; threats to
auditors’ independence; and auditors’ ability to cope up with risk and uncertainty. He also adds
“If any topic can be classified as going to the heart of the audit expectations debate, it is the issue
of auditor independence.” Humphrey et al. (1992) stated that the “auditor independence is a key
element of the audit expectation gap”.
In an attempt to find solution to the issue of the expectation gap McEnroe and Martins (2001),
suggested that “the appropriate action to reduce these expectations might be in public education”
They suggested two approaches to the public education. First, the inclusion of a uniform
explanation of what the attest function is designed to accomplish in the annual report. This is
expected to include a condensed summary of the authoritative guidance regarding auditors’
responsibility. Secondly, auditors provide a similar explanation at the annual shareholders’
meeting. This might include a question and answer session regarding the nature and scope of the
audit. Therefore, it is expected that educating stakeholders on what an audit is designed to
accomplish and communicating what the auditor’s responsibilities are, will reduce the gap
between what stakeholders expect the auditor to achieve and what they can reasonably achieve.
Porter (1993) opined that the two strategies are appropriate corrective actions for the
reasonableness gap component of the expectation gap.
Furthermore, in the search for a solution to solving the problem of the expectation gap, Sikka et.
al., (1992) identified independence as the main cause to reduce the expectation gap. He stated
“as a first step towards reducing the expectation gap, auditing standards and hence audit
objectives should be shaped by open, democratic, accountable bodies, independent of the
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accountancy profession”. Continuing arguments on reducing audit expectation gap, he
recommends one of the steps to be taken by the profession to reduce the expectation gap as
reform relating to auditor independence. Directly related to the independence issue is auditor
appointment and the role of directors and senior management in that appointment.
Sutton (2002) suggest that the auditing profession has, in the past, taken the following
chronological approach to addressing expectation gaps
i. Deny the existence of deficiencies (as it relates to deficient standards)
ii. Entertain suggestions for improvements
iii. Agree to accept some proposed suggestions
In the empirical literature, Garcia-Benau and Humphrey (1992) investigated the expectation gap
in both the UK and Spain. Auditors, finance directors and users were asked, inter alia, whether
audit firms should not provide NAS to their audit clients. In both countries, the average response
was close to neutral for all groups except UK auditors who expressed strong disagreement.
The Beattie et al., (1988; 1999) study examined a large set of 45 economic and regulatory factors
that could impair or enhance auditor independence, using questionnaire surveys of UK audit
partners, finance directors and financial journalists. At a level of 50 per cent of audit fee, the
corresponding threat rankings were firth, tenth and seventeenth and at the level of 25 per cent of
audit fee they dropped to fourteenth, eighteenth and twentieth ranks. NAS fees also increased
economic dependence generally, and all groups ranked various measures of economic
dependence among the top threat factors. A survey taken up by Lin (2004) in China with respect
to audit objectives, auditor's obligation to detect and reporting frauds and third party liability of
auditors. The study evidenced the emergence of the expectation gap in China and the majority of
audit independence by reducing governmental control or intervention and moving towards self-
regulation of the profession. This study has a limitation in the sense that it should cast light on
understanding of the institutional setting and updated development of independent audits in
China and may also serve as an annotation to the recent accounting reform debates in the western
world. This study investigated the views of natural shareholders regarding the role of the effects
on independence due to the audit firm also providing non-audit services to their audit client. A
total of 615 questionnaires were received with an overall response rate of 37.50 per cent.
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Shareholders were asked whether they agreed that the independent audit enabled them to rely on
financial information of profits, dividend yield/payout ratios and assets/liabilities. The responses
of shareholders generally confirmed that the independent audit was important in their use of
financial accounting information. Similarly, the reliability factors for the audit report of the
independence of auditors and audit firm reputation were tested. Both were believed to add
credibility to the auditors’ report.
Further discussion involved shareholder perception of audit independence in three separate
instances: audit firm receiving substantial consultancy fees; the auditor holding shares in the
audit client and the same auditor had been retained for over seven years. Shareholder opinions
revealed that auditor independence was perceived to have been impaired by the substantial
consultancy fees paid, but to a lesser extent by share ownership. Long-term audit contracts were
not perceived to impair auditor independence. This study also refutes the idea that auditors could
maintain their independence when receiving substantial consultancy fees. Overall, the findings of
this research suggest that natural shareholders place a strong reliance on regulatory matters such
as the accounting standards and the corporation’s law for accounting information.
Alleyne et al., (2006) investigated the appearance standard by empirically exploring both
auditors’ and users’ perceptions of auditor independence in Barbados. Firstly, the study
contributed to the existing body of knowledge in terms of providing a better understanding of the
nature of auditor independence in small developing countries. Secondly, this study could inform
policy makers, governments and professional accounting bodies as to how auditor independence
policies and frameworks could be structured to ensure adequate regulation of the capital market.
Thirdly, their study would serve to educate users and auditors about the contextual factors
surrounding the role of auditor as well as the possible threats and enhancements factors affecting
auditor independence. The survey instrument was divided into two sections: section one dealt
with demographic factors and section two focused on 39 audit-related issues categorized under a
number of generic factors. The sampling respondents identified comprised several groups such
as auditors, financial directors, credit managers, investment analysts, fund managers,
shareholders and government departments. The sample respondents comprised 66 auditors and
148 users. The findings of the study revealed that economic dependence of auditor on the client,
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the provision of non audit services, high competition, small firm size, being a sole practitioner,
lengthy tenure and the size and closeness of Barbadian society were found to negatively affect
perceptions.
Conclusively, we can understand from the literature that the problem of audit expectation gap is
a phenomenon that has been widely recognized. Therefore, an attempt to document the extent of
its existence and the way forward for its correction in Nigeria will be a welcome idea. The
methodology to be used in the research will be explained in the next section of this paper.
2. Methodology
The main objective of this research is to establish whether there exist the audit expectation gap
and that those areas of concern, (areas that brought about the creation of misunderstanding
between the public and the audit profession) could be identified and measures could be taken to
either eliminate them or reduce them to the beeriest minimum. In order to achieve the above
aforementioned objective the following procedure is followed.
3.1 Research design
The paper develops questionnaire based on the method used in Best et al (2001) who studied the
expectation gap in Singapore, Nazri et al (2004) in Malaysia, Chowdhury et al. (2005) in
Bangladesh and the study of Salehi et al. (2009) in Iran. The process ensures that data is
collected for the public’s expectation on the issues of the expectation gap and subsequently and
side by side we shall compare the issues with the audit authorities required or expected
perspective.
In collecting the data for the research the questionnaire method will be used; specifically the
questionnaire contains three parts namely;
Part A, which contains the respondents’ bio-data, this will help in measuring the
competence of those respondents to the questionnaire and in a way depicting the
reliability of the outcome of the research.
Part B, which contains questions on areas of the audit gap. They are targeted at
establishing the major reasons why the gap exists. Therefore issues such as the
importance of the audit are raised. Furthermore, the sections ask questions on the
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importance of financial reports, directors and company profile, and the level of auditor
independence.
Part C, the conceptualization of the social framework and the definition the audit is
analyzed here. The section tries to see the issue of the fixed and variable aspects of the
audit definition.
The distribution of the questionnaire will cover the following respondents that comprised of
several groups such as the auditors, financial directors, credit managers, investment analysts,
fund managers, shareholders and government departments. The sample respondents will
therefore cover almost all the facets of the expected areas of the audit expectation gap.
3.2 Methods of data analysis
The measure instrument of the statements is a five-point likert type scale anchored by a five scale
from “strongly disagrees” to “strongly agree”. To test for the significant expectation gap between
the two parties of respondents, both the parametric and non parametric statistical tests would be
used. In terms of the distribution of the questionnaire, we shall use both the mailing approach
and direct approach. We shall make two tests for non-response bias via the “wave technique” as
it treats the two approaches as separate waves of responses (Stanley 2001; Kanuk and Berenson
1975; and Hawkins 1975). In the analysis the Mann-Whitney U test using a two tailed test would
be used as a non parametric statistical tool which is considered appropriate for ordinal
measurement, such as the likert scales that will be employed in this study. It tests whether the
two independent samples are from the same population. The parametric test of t-test is also used
as a compliment to test for the efficiency and reliability of the outcome of the study.
3.3 Justification for the use of the techniques
The method that will be used is quit adequate to allow for a conclusion on the investigation as is
scientific and ensures the capture of all variables in the study. The method ensures the inclusion
of all possible behavior expected from the variables and subjects used in the investigation.
3. Conclusion
The objective of this paper as stated earlier is to establish that there exist the audit expectation
gap in Nigeria and that those areas of concern could be identified and measures could be taken to
10
either eliminate them or reduce them to the bearest minimum. Furthermore, the research intends
to identify the effect of social framework on the definition of the audit perception. To achieve
this, the paper develops questionnaire based on the method used in the literature. The process
ensures that data is collected for the public’s expectation on the issues of the expectation gap on
the one hand. Subsequently and side by side we compare the issues with the audit authorities
required or expected perception.
The data collected is analyzed using a five-point likert type scale anchored by a five scale from
“strongly disagrees” to “strongly agree”. To test for the significant expectation gap between the
two parties of respondents both the parametric and non parametric statistical tests would be used.
In terms of the distribution of the questionnaire we shall use both the mailing approach and direct
approach. The Mann-Whitney U test using a two tailed test would be used as a non parametric
statistical tool which is considered appropriate for ordinal measurement, such as the likert scales
that will be employed in the study. It tests whether the two independent samples are from the
same population. The parametric test of t-test is also used as a compliment to test for the
efficiency and reliability of the outcome of the study. It is expected that whatever the outcome of
the research would be, policy recommendations based on the outcome of the research will help
policy makers, government and the general public in shaping their taught on how to specifically
forward the audit profession forward and generally the accounting profession to higher heights.
The accounting profession can benefit from the research work by developing either a manual that
will guide the operation of the auditors or promulgate enactments and policies that will make
auditors more responsive to their work, by so doing, it will help the auditors to protect them the
more against litigation and the public from the negligent performance of the auditors in the
discharge of their duties.
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