An Empirical Study of Audit Expectation Gap: The Case of...

AN EMPIRICAL STUDY OF AUDIT EXPECTATION GAP 1

Running head: AN EMPIRICAL STUDY OF AUDIT EXPECTATION GAP

An Empirical Study of Audit Expectation Gap: The Case of

Lithuania

By

Vitalija Bogdanovičiūtė

Master student,

MSc in Finance and International Business

Department of Business Studies

Aarhus School of Business, University of Aarhus

Supervisor Dominyka Sakalauskaitė

May, 2011


Abstract

Associate with men of good quality if you esteem your own reputation; for it is better to be alone than in bad company. By George Washington

This study analyses the extent of an audit expectation gap among auditors and users of audited financial statements in terms of audit responsibility and reliability, objective, duties in detecting and reporting frauds and irregularities, and liability to the third parties in the Lithuanian business environment. The following four propositions are developed in order to be able to address the research question: 1) responsibility and reliability of audited financial statements differ substantially among auditors and users; 2) objective of auditing differ substantially among auditors and users; 3) auditor’s duties in detecting and reporting frauds and irregularities differ substantially among auditors and users; 4) auditor’s liability to the third parties in relations to auditors’ negligence and audit failure differs substantially among auditors and users. In order to explore the topic a survey is created based on methods used in Fadzly and Ahmad (2004), Lin and Chen (2004), Porter (1993) and Monroe and Woodcliff (1994). The results confirm that audit expectation gap exist in Lithuanian business environment, especially in the areas related to auditors reliability and responsibly, fraud detection and liability to third parties. Nevertheless, the results also show that auditors themselves have different perception regarding fraud prevention and detection, assurance and usefulness of the audited financial statements. This may be attributable to increased attention from the government and regulatory bodies regarding the role and supervision of auditors in order to regain investors trust and confidence after the corporate scandals and financial crisis.

Keywords: audit, expectation gap, attest function, fraud

Data availability: Please contact the author concerning the data availability


Table of contents

1 Introduction ..................................................................................................................... 5

2 Audit, fraud and expectation gap .................................................................................... 8

2.1 Audit function, objectives and development ........................................................... 8

2.1.1 Development of auditing practise ..................................................................... 8

2.1.2 Standards and legislation ................................................................................ 12

2.2 Fraud as audit function .......................................................................................... 15

2.2.1 Definition of fraud .......................................................................................... 16

2.2.2 Audit role in the area of fraud ........................................................................ 21

2.3 Audit expectation gap ............................................................................................ 23

2.3.1 Development of audit expectation gap ........................................................... 24

2.3.2 Audit expectation gap: Global evidence ......................................................... 26

3 Audit function and audit expectation gap in Lithuania ................................................. 32

3.1 Audit practice development in Lithuania ............................................................... 32

3.2 Role of Auditors and other institutions .................................................................. 35

4 Research of the extent of audit expectation gap in Lithuania ....................................... 39

4.1 Study propositions ................................................................................................. 39

4.2 Research methodology ........................................................................................... 41

4.2.1 Pretesting of the Questionnaire ...................................................................... 42

4.2.2 Data Analysis .................................................................................................. 43

4.3 Results .................................................................................................................... 43

4.3.1 Proposition 1 ................................................................................................... 44

4.3.2 Proposition 2 ................................................................................................... 48

4.3.3 Proposition 3 ................................................................................................... 50

4.3.4 Proposition 4 ................................................................................................... 52

5 Discussion and conclusion ............................................................................................ 53

5.1 Limitations ............................................................................................................. 56

6 Appendices .................................................................................................................... 57

7 References ..................................................................................................................... 68


Abbreviations

ACFE - Association of Certified Fraud Examiners

EU – European Union

EUR - Euro

E&Y - Big-Four audit Firm Ernst & Young

FASB - The Financial Accounting Standards Board

FCIS - Financial Crime Investigation Service

FEE - General Assembly of European Federation of Accountants

GAAP - Generally accepted accounting principles

GDP – Gross domestic product

IASB - The International Accounting Standards Board

IFAC - International Federation of Accountants

IFRS - International Financial Reporting Standards

ISA – International Standards on Auditing

KPMG - Big-Four audit Firm KPMG

LCA - Lithuanian Chamber of Auditors

MSL - minimum subsistence level amounts

OLAF - European Anti-Fraud Office

PWC – Big-Four audit Firm PricewaterhouseCoopers

SPSS - computer program used for statistical analysis


1 Introduction

Fraud1 has been one of the most problematic and prevalent issues for business

worldwide for a long time; however, there has been much more attention and research

dedicated to the topic after the scandals such as Enron, WorldCom and others. The 5th

Global Economic Crime Survey performed by PwC (2009) reports that fraud remains a

pervasive business risk and almost every firm is subject to occupational fraud in their daily

business, leading to huge losses for business and society. Increase in occupational fraud and

number of corporate scandals had an important impact on understanding and analysing

fraud and in turn on audit and its regulation.

Prior studies on fraud investigation, detection and prevention indicate that the

deepening economic recession leads to even greater levels of fraud (PwC, 2009). The

mentioned findings and losses incurred by corporate scandals resulted in the increasing

public attention paid to auditors, who were expected to attest the accountability and

accuracy of the company’s financial statement. As mentioned in Salehi and Rostami (2009)

many users misunderstand the nature of the attest function of audit, as ‘users believe that an

unqualified opinion means that the entity has foolproof financial reporting’. Users’

expectations go beyond the responsibility required by the professional regulations and

standards, presenting subject of misconceptions especially in terms of auditors being able to

provide absolute assurance about the accuracy of financial statements and in turn create a

gap between auditors’ and users’ expectations of the audit functions. Additionally, if the

company appears to face serious financial difficulties without any warning, public usually

perceives that auditors are the ones to be made accountable for any losses experienced

(Koh&Woo, 1998). This go beyond the regulatory requirements which have been changed

over time, however currently claim that the main responsibility for fraud related items rest

with the management of the company (IFAC: IAASB, 2009a)

Fraud detection was considered the primary objective of audit process until

approximately the middle of 20th century. Later, however, the main objective changed

1 As a legal concept, fraud is broad and covers a wide range of activities. This study focuses on the category of fraud, known as occupational fraud, which is defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets” (ACFE, 2010). ACFE identifies three primary categories of occupation fraud: 1) asset misappropriation; 2) corruption; and 3) fraudulent financial statements. This study focuses on the two categories of occupational fraud — asset misappropriation and fraudulent financial statements, as only these two types of misstatement are relevant to the auditors (ISA No. 240, paragraph 2).


from fraud detection to ‘verification of financial statements’ (Chandler, Edwards &

Anderson, 1993). Such shift in audit objectives and responsibilities created dissatisfaction

of companies’ stakeholders, including shareholders, current and potential investors,

creditors, etc.

Recently much attention paid to control issues and systems in order to narrow the

audit expectation gap, however, the actual level of fraud and financial damages has not

decreased (KPMG, 2009). The reason for this may be difficult and challenging audit

processes, as new rules and regulations require auditors to enhance the effort in terms of

fraud prevention and detection. A major issue of fraud detection is related to the difficulty

of identifying the fraud soon after it occurs. Quite often fraud is well hidden from auditors,

investors and other stakeholders and might only be discovered by chance (Plesis &

Koornhof, 2002). Besides, new rules and regulations followed by auditors when performing

audit contain terms like “reasonable”, “material”, “professional scepticism”, whose

meaning differ from auditor to auditor (Zikmund, 2008; personal communication March 3,

2011).

European Commission believes that mapping out society’s expectations of the role

and duties of auditors is crucial in taking steps to meet the expectations with auditors’

performance and fighting fraudulent activities (European Commission, 2010b). A few

studies have examined the audited expectation gap in Europe. However, to the best of my

knowledge no research has been done to examine directly the audit expectation gap in

Lithuania. In Lithuania, however, if such a gap does exist it might be presented as a result

of different situations and beliefs. Thus, the main task of this study is to investigate the

extent of an audit expectation gap among auditors and users of audited financial statements

in terms of audit responsibility and reliability, objective, duties in detecting and reporting

frauds and irregularities, and liability to the third parties in the Lithuanian business

environment. Therefore, four propositions are developed in order to be able to test the

hypothesis of existence of audit expectation gap among auditors and users.

The paper is based on the survey which presents the analysis of factors that form the

different expectations between the society and auditors and is designed and developed upon

the methods used in Fadzly and Ahmad(2004), Lin and Chen (2004), Porter (1993) and

Monroe and Woodcliff (1994). The research also highlights problems attributable to the


existing audit expectation gap and identifies possible topics for further research. Due to a

void in research in this area in Lithuania, these findings are important to stakeholders in the

financial reporting process, including auditors, the society, investors, creditors, accounting

academics, and other parties involved in audit regulation and rule making.

The paper is structured in the following way. The next part gives an historical

overview of audit process, its functions and objectives, including background on fraud

detection and audit expectation gap. The third section introduces literature review and

empirical evidence of the audit expectation gap in different parts of the world. The forth

section describes the audit and fraud detection process in Lithuania and introduces the

model used to test the extent of audit expectation gap in Lithuania. The last section

provides research implications and conclusions, including suggestions for further research.


2 Audit, fraud and expectation gap

Any enterprise worldwide relies on two very important and integral components –

accounting and auditing. The former one tracks all transactions of the firm and provides

information via financial reporting, while audit is performed to indicate the correctness of

this track and to ascertain the validity and reliability of information. The purpose of audit is

‘to enhance the degree of confidence of intended users in the financial statements <…> by

expression of an opinion on whether the financial statements are prepared, in all material

respects, in accordance with an applicable financial reporting framework’ (IAASB, 2010a).

The role of auditors in the financial statement has been and continues to be an

important issue for the auditing profession. According to Leung, Coram, Cooper, Cosserat

and Gill (2004) auditing practice has undergone various important evolution stages. During

the early 1990s, the detection of fraud was the primary purpose of external financial audit

(Rezaee&Riley, 2010). With time, Lee and Ali (2008b) claims that auditing practice

became more related to ‘enhancing role’, with special focus on integrity and credibility of

the information provided in financial statements; while Boynton, Jonson and Kell (2005)

declare that, besides enchasing credibility of financial statements, auditors nowadays are

providing other services such as reporting on irregularities, identifying business risks, and

management consulting on internal controls. In other words, auditors suppose to bridge the

communication between the managers of the company and final users of published

financial reports through authentication, reliability and correctness of financial reporting

(Salehi&Rostami, 2009).

2.1 Audit function, objectives and development

2.1.1 Development of auditing practise

External auditing plays an important role in bridging the effectiveness and efficient

functioning of business environment by adding credibility to financial statements

(Rezaee&Riley, 2010). Such assurance is needed to stakeholders of the company, usually

including not only shareholders but other parties as well (e.g. tax authorities, banks,

regulators, suppliers, customers and employees). Audits are not required by law but are

obligatory in many EU member states, as they help to decrease the costs of information


asymmetry by increasing the possibility that a material misstatement is detected by audit

procedures (European Commission, 2010b).

It is said that auditing is a social function, and the role of auditors is subject to shift

in accordance with the needs and demands of society (Porter, Simon&Hatherly, 2005). The

objective and techniques of auditors have changed significantly over time and can be

divided into several phases (Lee&Ali, 2008b).

Auditing until 1840. Auditing can be found as early as in the ancient civilisations of

China, Egypt and Greece. Lee and Ali (2008b) reports that all auditing objectives prior

1840 were similar to ancient civilisation, where a special audit officers had to make sure

that enterprises properly accounted for revenue and expenditure transactions. Interestingly

that even the name of the person hired to exanimate the transactions and prevent fraudulent

actions was derived from the Latin world “audire”, meaning to hear (Lee&Ali, 2008b). In

the period before 1840, auditors were obligated to perform detailed verification of every

transaction, where auditing procedures did not include any concept of testing or sampling.

In other words, during this period the main audit objective was to verify the honesty of

persons charged with fiscal responsibilities.

Auditing between 1840s-1920s. Industrial revolution established new grounds for

auditing practises (Chandler et al, 1993). The establishment of large factories and machine-

based production relied on the extensive amount of capital. As the market was poorly

regulated and highly speculative, investors were ‘in dire need of protection’ (Porter et al.,

2005) and this stimulated the emergence of the auditing profession and main procedures.

Some research (Brown, 1962, Queenan, 1946) states that during this period, auditors were

performing total checking of transactions with littler attention paid to internal controls.

Additionally, the concepts of materiality and sampling techniques were established as

auditors were not able anymore to verify all transactions conducted by the large

corporations and enterprises. According to Porter et al. (2005) analysis, during the years

1840-1920 the main responsibilities of the auditors were not exactly identified and their

focused on to detect fraud as well as verification of balance sheet to present the proper

company’s solvency (or insolvency). As to Chandler et al (1993) there are evidence that

auditors working with in large industries (such as banking, insurance and railway)

continued see balance sheet verification as the main objective of audit. For other


companies, which remained relatively small in that period, the objective and role of

auditors was perceived as fraud detection. Such predominant auditors’ role of fraud

detection resulted mainly because users of audited financial statements appreciated the

doubtless investment opportunity. In addition, the emphasis on fraud appeared from high

level of corporate bankruptcies experienced during the 1860s and 1870s, when ‘first hand

experienced of the causes and effects of poor or fraudulent management <…> coloured

their (auditors) attitude towards other aspects of their work’ (Chandler et al, 1993).

Above described disagreements imply the different views regarding fraud

prevention and detection as the primary auditor’s role during the engagement until

approximately middle of 20th century. However, after the McKesson & Robbins’ fraud

scandal in 1938 practitioners agreed that fraud prevention and detection should not be

considered as the primary auditor’s objective (Albrecht et al., 2001, Scott and Frye, 1997).

Different users and auditors perceptions related to fraud prevention and detection

encouraged the AICPA to issue several valuable additions to auditing standards, including

SAS No. 53 in 1988 (The Auditor’s Responsibility to Detect and Report Errors and

Irregularities), SAS No. 82 in 1997 (Considering of Fraud in a Financial Statement Audit),

and finally SAS No. 99 in 2002 (Considering Fraud in a Financial Statement Audit)

(AICPA, 1988, AICPA, 1997, AICPA, 2002). International Standards on Auditing also

included similar requirements, known as (ISA) No.240, The Auditors Responsibility to

Consider Fraud in an Audit of Financial Statements (IFAC: IAASB, 2007).

Auditing between 1920s-1960. The rapid development of the capital market and the

economic growth of the USA caused the shift in the role and objective of audit. According

to Porter et al. (2005), such development created the need to convince the participants in

the financial market about the financial statements provides true and fair picture of the

company’s financial position. Therefore, auditors were asked to provide credibility to the

financial statements prepared by company managers for their shareholders (Lee&Ali,

2008b). In other words, the auditors needed to assess the truth and fairness of the

companies’ financial statements rather than prevent and detect fraud and error (Lee&Ali,

2008b). Porter et al. (2005) states that audit focused mainly on the following

characteristics:

• Company’s internal controls


• Sampling techniques

• Audit evidence through internal and external sources

• Emphasis on the truth and fairness of financial statements.

Auditing between 1960-1990s. This period was marked with significant shifts in the

technology and economic development; however, auditors continued to play an important

role. The key role was to enhance the credibility of financial information used in the capital

market (Leung et al. 2004), leading to the fact that the role of auditors stayed similar to the

previous period. Porter et al. (2005) identifies that auditing practice continued to focus on

advanced computing auditing tools to improve audit procedures. Besides, everyone focused

audit evidence examination and usage of risk-based auditing to focus on areas most likely

to contain errors. In addition, so called one-stop shops emerged (Leung et al. 2004),

meaning that besides auditing services auditors started advising audit clients for a number

of services.

Auditing from 1990 to present. The overall audit objective remained the same over

time. The main purpose of audit is to express an opinion on whether the information

presented in the financial statements reflects the true and fair picture of the financial

position of the organisation at a given date. An audit is the independent examination of and

expression of opinion on company’s the financial statements by an appointed auditor in

compliance with any relevant statutory obligation. An auditor may express qualified

(accounts do not present a true and fair view) or unqualified (no significant concerns)

opinion (European Commission, 2010b). Statutory obligation, known as a duty imposed by

the law, is important to users of audited financial statements as they want to be sure that an

auditor has checked whether the company follows the laws and policies and keeps the

adequate records. Valuable addition to regulation and requirements has been corporate

scandals and failures, including Enron and WorldCom scandals, which has led to

discussions and debates considering the changes in the audit practice. According to Leung

et al. (2004) few dramatic implications might come into the force: it is expected that

auditors are refocusing on public interest, changing the audit relationship, ensuring the

integrity of financial reports, separating of non-audit functions and other advisory services.

In addition to this, the audit methods are expected to focus more on risk attention, fraud


awareness, objectivity and independence, in order to satisfy the needs of users of audited

financial statements (Lee&Ali, 2008b).

Currently, the market of audit practice is highly concentrated, with the leading

players been called Big-Four Audit firms2. It is estimated that the total market share of Big-

Four Audit firms account for more than 90% in terms of revenues or fees received from all

listed companies (European Commission, 2010b). Such strong concentration creates

barriers for non Big Four companies to compete in the market due to the lack of recognition

and reputational endorsement. Besides, European Commission (2010b) reports that ‘such

concentration might entail an accumulation of systematic risk and the collapse of a

‘systematic firm’’. Therefore, more attention is paid to the regulation of audit practise.

2.1.2 Standards and legislation

Quality of financial information, reliability, and transparency are the key factors of

the efficient capital markets. A collapse of big corporations such as Lehman Brothers,

WorldCom and Enron together with the extent of fraud activities resulted in concerns about

the value-adding activities of public companies' corporate ethics and governance.

Therefore, extensive reforms in various countries are directly addressed to examine the role

and responsibility of external auditor in fraud detection (Leung et al., 2004). The lack of

public trust and investor confidence in corporate world and its financial reports has

continued to adversely affect the vibrancy of the capital market forcing business leaders to

change their culture, behaviour, and attitudes to restore public confidence and trust in

business (European Commission, 2010b, European Anti-Fraud Office, 2010). To fight such

situation, large accounting firms first of all separated their consulting services from

auditing ones and announced about strict rules and measures taken to improve

independence and audit quality (European Commission, 2010b). Additionally, accounting

bodies, governments, stock exchange commissions and academics took different actions

including reforms of the legislation and standards to strengthen the audit practice (Leung et

al., 2004). One of the most important changes in auditing practice is known as The

Sarbanes-Oxley Act, which was implemented in the USA after the fall of Enron. The Act,

containing 11 sections ranging from additional corporate board responsibilities to criminal

2 Deloitte & Touche, Ernst & Young, PricewaterhouseCoopers and KPMG


penalties, includes the issues such as auditor independence, corporate governance, internal

control assessment, and enhanced financial disclosure (Sarbanes-Oxley Act of 2002).

According to the Act, there is a special Board assign to observe and check audit firms, their

procedures and the enforcement of accounting standards. There are, however, other

documents and governmental bodies which strongly regulates audit and its practise.

The International Auditing and Assurance Standards Board (IAASB) is ‘an

independent standard-setting body that develops auditing and assurance standards and

guidance for use by all professional accountants under a shared standard-setting process’

(IAASB, 2010b). The board generally meets four times a year and develops its standards

and practice statements. It is said that impact of financial crisis has been strongly felt

around the world, including auditing practise. According to IAASB, ‘the crisis has

amplified financial reporting challenges and has led to heightened attention on the role of

the audit and the broader accounting profession and <…> it [IAASB] has an important

responsibility to ensure that its work remains relevant as debates in this area evolve’

(IAASB, 2010b). As of today, IAASB has issued International Standards on Auditing

(ISAs) that deal with the independent auditor's responsibilities when conducting an audit of

financial statements.

ISAs contain objectives, requirements, application and other explanatory material,

which have to be fully understood by the auditor in order to recognize the objectives and to

apply the requirements properly. Note that IAASB completed the Clarity Project in March

2009, with the aim to promote greater understanding and consistency of application of the

ISAs (IAASB, 2010b). As a result IAASB released a set of 36 clarified ISA and the

clarified International Standard on Quality Control (ISQC) 1, which regalement functions

and standards of auditing practice. Interestingly, that even before the final release of

clarified ISAs and ISQC, there were 126 jurisdictions around the world, which had adopted

ISAs or used them as a basis for the national standards (IAASB, 2010b). ISAs covers the

independent auditor's overall responsibilities when conducting an audit of financial

statements in accordance with ISAs (ISA 200), as well as quality control (ISA 220), proper

audit documentation (ISA 230), responsibilities relating to fraud (ISA 240), materiality

(ISA320), sampling (ISA 530), related parties (ISA 550) and others (the list of ISAs is

provided in Table 10 in Appendix). Note that auditors in some countries are following


national auditing standards, yet in many cases they are based on ISA’s. For example, the

European Court of Auditors (2011) reports that auditors within the EU are obligated to

respect and follow the Court Audit Policy and Standards, ECA Audit Manuals and all audit

procedures adopted by the ECA. European Court of Auditors in turn is performing audits in

accordance with the IFAC and INTOSAI International Auditing Standards and Codes of

Ethics, which are based on ISAs (European Court of auditors, 2011).

Differently from some large countries (e.g. the US), the research among EU

stakeholders in 2009 indicated the overall support of an adoption of the clarified ISAs and

ISQCs at EU level (European Commission, 2010b, p.10). Currently, the majority of the EU

Member States have adopted or are in process of adopting ISAs. Significant support for

such action is that major international auditing firms are also applying these standards.

Such market harmonization is believed to contribute to ‘harmonised and qualitative audits

which in turn support the quality and credibility of the financial statements’ (European

Commission, 2010b, p.10). The EU governmental bodies stress the importance of the

governance and independence of the audit firms. According to the Directive on Statutory

Audit (2006/43/EC) it is important to ensure that auditors are following principles of

professional ethics and independence. These principles oversee different considerations of

auditing firms, including ‘appointment and remuneration of auditors, mandatory rotation,

non audit services, fee structure, publication of financial statements, organisational

requirements, revisiting ownership rules and the partnership model, group audits (European

Commission, 2010b).

Standards and regulation of audit also sets guidelines for accounting practice, which

is also strictly regulated and is subject to convergence of financial reporting standards.

There are different financial reporting standards, however, the latest statistics indicates that

over 120 nations and reporting jurisdictions permit or require International Financial

Reporting Standards (hereinafter IFRS) for domestic listed companies (AICPA, 2011).

Note that IFRS framework is based on ISAs and relevant ethical requirements, which

enable auditors forming the opinion on whether the financial statements are presented

fairly, in all material respects, and give a true and fair view.

A global survey conducted by the International Federation of Accountants in 2007

also highlights the importance of the convergence of financial reporting standards: a


majority of accounting leaders perceives a single set of international standards as an

important factor for the economic growth (IFAC, 2009). As a consequence, the IFRS

Foundation indicates that the number of countries that require or allow the use of IFRS for

the preparation of financial statements has been growing continuously. Some examples

includes the USA, where the growing acceptance of IFRS results from the convergence

with GAAP; Australia, New Zealand and Israel, where IFRS has been adopted as national

standards; Canada, which will adopt IFRS, in full, effective 2011 (IFAC, 2009). IAASB,

auditors and users of audited financial statements are expected to benefit from the

convergence of financial reporting standards into a single set of international standards.

Described development of audit’s roles and objectives lead to the presumption that

the primary auditors’ role has been shifting over time mainly due to the external events.

Moreover, based on current standards and legislation there are signs that public expectation

differs from auditors view especially in terms of responsibilities and obligations related to

fraud detection. Therefore, the next part presents the analysis of fraud as a function of audit.

2.2 Fraud as audit function

Fraud for a long time has been one of the key elements in the discussion regarding

the role and objective of auditors. As to the previous section, the main role of the auditors

was to detect and to prevent fraud in the company’s, however, the economic growth and

development of capital market resulted in the shift of the role of auditors. Fraud was left

aside when concept of materiality and fairness was introduced. Currently, a new trend has

been observed. ‘The reliability of auditing functions and the professionalism of the auditing

profession was, however, called into question after some spectacular and well publicised

corporations (for example Enron and WorldCom in the US) collapsed shortly after an

unqualified (in other words: “clean”) audit report had been issued’(Lee, Ali&Kandasamy,

2008c). Therefore, the society raises the question what the fraud is and whose responsibility

is to detect fraud and to prevent from it?


2.2.1 Definition of fraud

As a legal concept, fraud is a broad concept and covers a wide range of activities.

Due to the full FASB and IASB convergence effort, this study focuses on the category of

fraud, known as occupational fraud, which is defined as ‘the use of one’s occupation for

personal enrichment through the deliberate misuse or misapplication of the employing

organization’s resources or assets’ (ACFE, 2010). The definition of occupational fraud is

very wide, encompassing a number of activities covering any misconduct by employees at

every organizational level. Thus in order to understand the roots of how and when fraud can

be observed, one can rely on the simple occupational fraud and abuse classification system

(see Figure 1 below), there fraud is be divided into three main groups (ACFE, 2010):

• Corruption - wrongful use of influence and power to achieve a benefit

contrary to their duty to their organization;

• Asset misappropriation - theft or misuse of assets;

• Fraudulent statements - Falsification of financial statements and/or other

organizational documents.

Fraud has been one of the most problematic and prevalent issues for business

worldwide for a long time; however, there has been much more attention and research

dedicated to the topic after the sandals such as Enron, WorldCom and others. The 5th

Global Economic Crime Survey performed by PwC (2009) reports that fraud remains a

pervasive business risk and almost every firm is subject to occupational fraud in their daily

business, leading to huge losses for business and society. To understand the huge risks that

exist due to economic crime it is important to look at the scale of the global financial

marketplace. It has been estimated that on each and every day around EUR 2.8 trillion is

moved across the globe. For comparison, in 2009 the Gross Domestic Product (GDP) of

Lithuania was EUR 27 billion and the GDP of Germany was EUR 2.4 trillion. This implies

that an amount moving around the world’s financial systems on a daily basis is far larger

that the GDP of Lithuania and about the same size as the Germany GDP. Report to the

Nation on Occupational Fraud and Abuse published by ACFE (2010) indicates that

constantly increasing fraudulent activities corresponded into the potential total fraud loss of

more than EUR 2.03 trillion in 2009, which equalled to around 5% total global GDP or the

GDP of the United Kingdom.


Figure 1: Occupational Fraud and Abuse Classification system

Source: Adopted from Association of Certified Fraud Examiners (2010) Occupational Fraud and Abuse Classification System presented above provides a

picture of the main items included in the system. Yet, it is important to understand what

hides behind each item.

Corruption. Corruption is related to the abuse of trust and responsibility, especially

of those who are being in-charge tried or succeeded to benefit himself or herself.

Corruption, according to ACFE, can be divided into several items, including conflicts of

interest, bribery, illegal gratuities and economic extortion (ACFE 2010). Illegal payments

as such usually had a motive behind and at some point the person having the ultimate

authority on the decisions is most likely subject for the corruption (Wells, 2003). To deal

with this issue is not so easy, as ‘bribes and grease payments to foreign officials used to be

considered standard operating procedure for many global enterprises’ (Keefe, 2011). Yet

the growing intolerance for corruption is expected to succeed after the enforcement of

Foreign Corrupt Practices Act beyond the economic arena (Keefe, 2011). The most

common type of corruption is explained in the table below.

Asset Misappropriation

Cash Non-cash

Fraudulent Statements

Non-financial Financial

Asset/Revenue Overstatement

Employment Credentials

Internal Documents

External Documents

Asset/Revenue Understatement

Corruption

Conflicts of Interest

Economic Extortion

Bribery

Illegal Gratuities


Table 1: Type of corruption

Type of corruption Definition Example Conflicts of interest Situations where undisclosed

personal or economic conditions may affect financial results of the enterprise

Agreement between the representative of the company and supplier on the purchasing price, higher than the market price

Bribery Bribes used to achieve the desired outcome, related to legal acts, business solutions or similar

Manipulation of prices in the cashier or the disclosure of sensitive information for the payment agreed in advance.

Illegal gratuities Situation where the person give/accepts grease payments for the desired outcome, related to legal acts, business solutions or similar

During the negotiation process opponents pay for the holiday expenses for one of the most important party on the other side in order to have better negation position.

Economic extortion Situation where power, fear or economic conditions are used to reach the desired outcome

The person threatens to sign the important agreement if his/her condition is not met.

Source: Adopted from Mosquera & Scifo (2004) and Association of Certified Fraud Examiners (2010)

Asset misappropriation. Asset misappropriations include the misuse or theft of

assets belonging to a company and, according to the ACFE, the majority of internal fraud

schemes involve an asset misappropriation element (ACFE, 2010). Besides, it is estimated

that asset misappropriation is the most common type of occupational fraud, accounting for

78% of all fraud cases. Asset misappropriation can be cash and non-cash based. Cash based

asset misappropriation can be divided into several sub-sections. Two of them known as

skimming and cash larceny include falsification of cash receipts (revenues or accounts

receivables for example). The remaining five sub-sections categorised as fraudulent

disbursements are the most common ones affecting the cash the entity has on hand (ACFE,

2010). Therefore, Table 2 below presents examples and explanations of fraudulent

disbursements.


Table 2: Cash based asset misappropriation (Fraudulent Disbursements)

Type Definition Example

Billing Schemes Situations may include shell company, non-accomplice vendor or personal purchases

Employee may create shell company and bill the employer for the falsificated services

Payroll Schemes Situations may include ghost employees, commission schemes, workers compensation, or falsified wages

Employee may hire unreal person as the new employee of the company or may falsified the hours worked

Expense Reimbursement Schemes

Situations may include mischaracterized expenses, overstated expenses, fictitious expenses, or multiple reimbursements

Employee may pay falsified bills from the company account

Check Tampering Situations may include forged maker, forged endorsement, altered payee, concealed checks, or authorized maker

Employee steals empty checks and fills them in afterwards in such a way receiving money in his/her bank account

Register Disbursements

Situations may include false voids or false refunds

Employee may speculate the information in the register and appropriate money into his/her account


Non-cash based asset misappropriations covers the theft or misuse of non-cash

assets, including items such as non-current assets, inventory, investments, intellectual

property and other, however the loss of such type of asset misappropriations are estimated

to be of smaller loss (ACFE, 2010).

Table 3: Non-cash based asset misappropriation

Type Definition Example Inventory Situations may include stealing or not

appropriate use of non-cash asset of the company, including inventory, equipment and others

Employee may steal the asset from inventory or use them for personal need

Information Situations may include stealing or disclosure of company’s confidential information or trade secrets.

Employee may sell company’s sensitive information to the competitor

Shares or obligations Situations may include stealing of companies shares, obligations or other securities

Employee may fraudulently transfer the shares of the company into a personal account


Fraudulent Statements. This type of fraud is related to the financial statements

which may be falsified. According to Table 4, fraudulent statements can be classified into


financial and non-financial ones. The later one is mainly related to the misuse of

employment credentials, internal and external documents. However, currently severe losses

have been created by exploiting financial types of fraudulent statements. The examples

include the bankruptcy of Enron and the fraudulent accounting of WorldCom in order to

reduce tax payables, increase revenues, share price and etc. The table below provides detail

information on types of fraudulent statements based on financial actions.

Table 4: Fraudulent statements: financial

Type Definition Example Timing Differences Situations may include false accounting

for revenues and expenses in terms of the actual period they were achieved

The company may record the revenues in the year 201X while the expenses will be included into the accounts in the year 201X+1

Fictitious Revenues Situations may include falsified sale of goods and services

The sale of inventory to the clients which do not exist or the real client invoicing while the good and services are not delivered (the sales are credited back during the next period)

Concealed Liabilities and Expenses

Situations may include false accounting for expenses and liabilities

Financial statements may exclude important expenses/liabilities or the expenses required to achieve the current level of sales are capitalized.

Improper Disclosures Situations may arise when management decides not to disclose important information

Financial statements may not include information about off-balance sheet or contingent liabilities, which may significantly affect the financial position of the company

Improper Asset Valuations

Situations may arise when the asset of the company is not values properly

The accounting may include incorrect way of depreciation of assets, inventory may be written off incorrectly or trade receivables may be falsified


It is important to measure the costs of occupational fraud, yet the costs can be, at

best, an estimate to present the ‘pandemic and destructive nature of white-collar crime’

(ACFE, 2010). Despite the recent attention to control issues and systems, the actual level of


fraud and financial damages has not decreased (KPMG, 2009). One reason for this trend

may be insufficient emphasis on fraud prevention and detection. Studies also show that the

deepening economic recession could lead to even greater levels of fraud (PwC, 2009). A

major issue of fraud detection is related to the difficulty of identifying the fraud soon after

it occurs. Quite often it is well hidden from auditors, investors and other stakeholders and

might only be discovered by chance (Plesis & Koornhof, 2002). Auditors, for example, find

it complicated and increasingly difficult to detect fraud with analytical procedures

requested by audit standards for at several reasons. When performing their tasks, auditors

mainly rely on management explanations not challenging or testing the explanations about

the business development (Hirst & Koonce 1996). Additionally, auditors simply lack a

sufficient understanding of certain business, thus it is difficult for them to recognized

unusual trends and ratios within the financial statements in one or another business

(Erickson et al. 2000). Even though traditional analytical procedures may lead to the

success in identifying fraud, however, this success is highly limited as financial statement

data tend to have to high rates of misclassification (Hogan et al. 2006, Erickson et al. 2000).

On the other hand, the society views such explanations in a different way. Therefore, the

auditors anyway are expected to play an important role in fraud detection and prevention.

2.2.2 Audit role in the area of fraud

European Commission (2010a) reports that the methods of detection of fraud vary

between Member States. Nevertheless, in 2009 the vast majority of cases (75%) were

detected by means of either primary national inspections or post-clearance control audits.

Primary inspections are used in particular in Denmark, Slovenia, Romania, Malta and

Greece, while the remaining Member States mostly uses ‘ex-post controls’ to detect

irregularities (European Commission, 2010a). ‘Ex-post controls’ refers to audit of the

accounts, commission inspections, inspections by anti-fraud services, inspection visits,

national post-clearance audits and tax audits.

According to Lord Justice Lopes (2004), ‘An auditor is not bound to be a detective,

or … to approach his work with suspicion, or with a foregone conclusion that there is

something wrong. He is a watchdog, not a bloodhound’. However, there are a number of

discussions regarding fraud, especially in terms of the extent of auditor responsibility for


the fraud prevention and detection. Following the development of auditing practice and

new standards to be issued, auditor responsibility for fraud detection has remained a low

priority (Jones, 2009). Following the standards defining auditing practise in terms of fraud

detection one has understand the scope and objective of ISA 240. This ISA deals with the

auditor’s responsibilities relating to fraud in an audit of financial statements, which presents

the real picture of the role of auditors in terms of fraud detection.

According to ISA 240, there are two types of intentional misstatements are relevant

to the auditor, namely misstatements resulting from fraudulent financial reporting and

misstatements resulting from misappropriation of assets (IFAC: IAASB, 2009a). Note that

the main factor which allows distinguishing between fraud and error is the underlying

action, intentional or unintentional, which finally results in a misstatement of the financial

statements (IFAC: IAASB, 2009a). Auditors following ISA guidelines are expected to deal

with the mentioned types, however, ISA 240 makes it clear that the main responsibility for

the prevention and detection of fraud rest with the management:

The primary responsibility for the prevention and detection of fraud rests with both

those charged with governance of the entity and management. It is important that

management, with the oversight of those charged with governance, place a strong

emphasis on fraud prevention, which may reduce opportunities for fraud to take

place, and fraud deterrence, which could persuade individuals not to commit fraud

because of the likelihood of detection and punishment (IFAC: IAASB, 2009a).

The auditor while conducting an audit, on the other hand, is responsible for

‘obtaining reasonable assurance that the financial statements taken as a whole are free from

material misstatement, whether caused by fraud or error’ (IFAC: IAASB, 2009a). This

implies the fact that an external audit on the financial statements does not indicate that

financial statements are entirely free from misstatements. According to the European

Commission (2010b), unqualified auditors opinion means that the financial statements give

a true and fair view in accordance with the relevant financial reporting framework. In other

words, auditors provide ‘reasonable assurance3’ about financial statements as a whole being

free from material misstatement caused by fraud or error (European Commission, 2010b).

3 Reasonable assurance means high but not absolute level of assurance


ISAs also indicate the actions of the auditors in case of risks of material

misstatements due to fraud. If significant risks of material misstatements due to fraud are

identified, the auditor shall ‘determine whether there is a responsibility to report the

occurrence or suspicion to a party outside the entity’ (IFAC: IAASB, 2009a). Note that

most of the audit engagements are confidential and the conflict between the client and

auditor may arise; however, the auditor’s legal responsibility may overcome the

professional duty to maintain client’s confidentiality (IFAC: IAASB, 2009a). According to

the European Commission (2010b), statutory audits, however, have changed their focus

from verification of revenues, costs, assets and liabilities to a ‘risk-based approach’. In

other words, auditors are more concern about the reasonable assurance in terms of

applicable financial reporting framework rather than providing true and fair view of the


Occupational fraud has a large impact on the audit and its reputation from the users’

perspective. The mentioned actions taken by the regulatory bodies to react to the corporate

scandals imply the significance of mapping out auditors and society’s expectations towards

role and responsibilities of auditors work. However, the number of research indicates that

this aim is hard to achieve and thus there exists rather extensive audit expectation gap in the

certain parts of the world. Therefore, the next part provides the analysis of development and

empirical evidence of audit expectation gap.

2.3 Audit expectation gap

Public expectations on deficient performance and duties of auditors sometimes go

behind the reality and legal framework (Porter, 1993; Porter & Gowthorpe, 2004; Lee,

Gloeck & Palaniappan, 2007). There are several reasons for that. Firstly, any investor,

creditor or generally speaking the public, expects that entities, where they invested money,

are held fully accountable for the use of that money. Managerial bodies of course handle

the prime responsibility for ensuring that money is used with absolute integrity and spent

wisely. Audit is a supplementary instrument to trace accountability, uncover irregularities

in financial matters, and establish public confidence that money is being properly spent.

Additionally, external auditors may have a direct and positive influence on the way

organisations and people discharge their responsibilities. From the users’ perspective


auditors working within public bodies may help to promote better management and

decision-taking, and thus a more effective use of taxpayers’ resources (Mackevicius, 2001).

However, just a few users of audited financial statements realize that the reality is different.

Representative from one of Big-Four Audit firm reveals that the audit profession has

consistently failed to explain itself properly (personal communication, March 3, 2011). The

ultimate responsibility in any case stays with management, mainly because only a

reasonable amount of testing is performed during audit procedures. Therefore, even if the

audit profession explains itself properly, the immediate next questions from the general

public would be why auditors charge money for such services and whether these services

are needed at all? These questions would arise as the society does not (or does not want to)

understand that in order to perform a wider role than it is done currently, audit companies

would need to have a permanent presence in public companies and to function as some kind

of public representative safeguarding society's interests, which would cost a lot (personal

communication, March 3, 2011). But nobody would be willing to pay for it.

In view of the contributing factors and expectations it is not surprising that that

auditors and public have different expectation of the audit function and deliverables. Those

different views create audit expectation gap, which, unless significant actions are taken to

decrease this gap, enlarges with time.

2.3.1 Development of audit expectation gap

Historically, Humphey and Tyrley (1992) claims that some hints of expectation gap

can be found back in 19th century together with the introduction of companies auditing,

while Liggio research paper The expectation gap: The Accountant Waterloo (1974) brought

the term ‘Audit expectation gap’ into the audit literature. According to Liggio (1974), the

expectation gap concept presents the difference between the expected performance “as

envisioned by the independent accountant and users of the financial statements.”

Meanwhile, the Cohen Commission (1978) in the US referred the expectation gap

introduced by Liggio (1974) as the different view between (a) what the society names as

auditors’ responsibilities and (b) what auditors believe their responsibilities are.


Porter (1993) criticized the definition of Liggio (1974) and Cohen Commission

(1978) as being too narrow. Thus she presented the more extensive way of analyzing the

gap, which included two main components: reasonableness gap and performance gap (see

the figure 2).

Figure 2: Audit expectation gap

Source: Adopted from Porter (1993)

Note: * - Duties defined by the law and professional promulgations ** - Duties which are cost beneficial for auditors to perform

The model has been extensively used to test the existence and uncover the causes of

audit expectation gap in number of countries. According to the model, performance gap

refers to the different perception between “what society can reasonably expect auditors to

accomplish and what they are perceived to achieve” (Porter, 1993, p 50). This later

component then is divided further and are presented by deficient standards (“a gap between

the duties which can reasonably be expected of auditors and auditors’ existing duties as

defined by the law and professional promulgations”) and the deficient performance (“a gap

Auditors’ Existing Duties*

Auditors’ Perceived

Performance Audit Expectation-Performance

Society’s Expectation of Auditors

Performance gap Reasonableness gap

Deficient Performance

Unreasonable Expectations

Deficient Standards

Duties Reasonably Expected of Auditors**


between the expected standard of performance of auditors’ existing duties and auditors’

perceived performance, as expected and perceived by society) (Porter, 1993, p.50).

Reasonableness gap is known as the difference between ‘what society expects

auditors to achieve and what they can reasonably be expected to accomplish’ (Porter, 1993,

p. 50). In other word, it is related to the complication and misunderstanding of nature,

purpose and capacities of an audit function as observed by the society. Humphrey (1997)

report that audit expectation gap exists mainly because of the subjective nature of terms and

concepts in auditing such as the true and fair view, reasonable, materiality, adequacy,

reliability and relevance which are not defined precisely in the Accounting and Auditing

Standards but are left for the auditors’ judgment. Lee and Ali (2008b) add that it is also

influenced by the dynamic objective of auditing and role of auditors, where contextual

factors such as socio-economic environments, critical historical events, courts or even

technological developments play an important role.

2.3.2 Audit expectation gap: Global evidence

Jedidi and Chrystelle (2009) reports that the basis for the research of audit

expectation gap in different part of the world can be found in the early works of Lee, Beck,

and Liggio, who investigated the role and responsibilities of auditors as perceived by the

users of audited financial statements. Afterwards, many others investigated the existence of

an audit expectations gap, identified its causes and made suggestions how to minimize it.

Despite a variety of research instruments used to identify audit expectation gap in different

countries, the survey or questionnaire dominated. Countries such as the US, the UK and

Canada have prevailed other countries in terms of research for audit expectation gap as this

topic was considered to an important issue for auditors especially after a number of

corporate failures (Jedidi&Chrystelle, 2009).

The financial crisis and number of collapse resulted in the new wave of questions

addressing the role and responsibilities of auditors, especially the ones to the stakeholders

of the company. Auditors have been criticized heavily on disclaiming responsibility for the

detection of fraud (Humphrey, Turley&Moizer, 1993) and interested parties (e.g. investors,

shareholders, creditors, government agency) had strong doubts about the auditors’ role in

term of audit client failure (Hassink et al, 2001). Over the period for more than 30 years up


to 2006, it became clear that mapping out the expectations is important especially in terms

of fraud detection. The users of audited financial statements expect much more from

auditors as compared to the legal acts regulating auditors work. Besides, public expects

auditors not only to provide audit opinion but also interpret the financial data of the

company in such a way that people are able to make a decision whether it is a good idea to

invest into one or another company (Salehi&Rostami, 2009).

Prior studies of the audit expectation gap presents different perceptions between

auditors’ and society’s view regarding the roles, objectives and responsibilities. In context

of the US, the research started as early as late 1970s. Auditor’s responsibilities to detect

material errors, irregularities and illegal acts are examined by Barton, Johnson, Searfoss,

and Smith (1977). The results indicate that auditors and users of financial statements had

different perceptions on the extent of auditors’ responsibilities. Such conclusions results

from miscommunications between the auditors and users, where the later devoted more

responsibility for the auditors to detect and disclose errors and irregularities. By analyzing

the extent of audit expectation gap in various dimension of the audit attest function,

McEnroe and Martens (2001) surveyed auditors and investors. The results indicate that

auditors and investors tend to agree about the meaning and importance of the specific

terminology, however, opinion differs with respect to actions to be done prior issuing

unqualified opinion. Investors expects that unqualified opinion is not issued unless 1) every

item of importance to investors and creditors has been reported or disclosed, 2) auditors

have been ‘public watchdogs’, 3) the internal controls are effective, 4) the financial

statements are free of misstatements resulting from management fraud, 5) the financial

statements are free of misstatements intended to hide employee fraud, 6) the firm has not

engaged in illegal operations (McEnroe&Martens., 2001)

The examination of the development of audit objectives in Britain during the period

1840-1940 by Chandler et al. (1993) reveals that external events tend to change public

perceptions towards auditor’s role thus creating the roots for audit expectation gap to

enlarge. Humphrey el at (1993) reports that chartered accountants, corporate finance

directors, investment analysts, bank lending officers and financial journalists possess

different view regarding the nature of audit and perceived performance of auditors. In

addition, the main contribution towards existing audit gap was mainly related to auditors’


roles and responsibilities in terms of fraud detection, liabilities to the third parties,

independence and methodology issues.

Similar findings were identified in less developed countries as well. In Malaysia for

example, Fadzly and Ahmad (2004) reports that general public opinion differs significantly

from the auditors regarding the auditors’ role and actions performed during the

engagement. Research findings were similar evidence provided by Porter (1993) who

investigate audit expectation gap in the UK and Porter and Gowthorpe (2004) who tested

the extent and development of audit expectation gap in the UK and New Zealand. Besides

the empirical evidence that audit expectation gap exist in Malaysia, analysis by Fadzly and

Ahmad (2004) also indicated that public expects more than auditors are obliged to do

unless they have proper education. The effect of education on perception of the meaning of

audit reports and responsibilities has been tested by a number of studies, most of which

concluded that expectation gap between auditors and students who have completed audit

courses exists but is of the lesser extent (Lee&Ali, 2008a). Research in China for example

was carried out by Lin and Chen (2004) who showed that the most important contributing

factors expanding audit expectation gap were different perceptions of audit objectives,

obligations regarding fraud detection and reporting as well as independence and liability.

Current research by Hassink et al (2009) also showed that, despite action taken to

narrow audit expectation gap, the business managers and bankers have higher expectations

of the duty of auditors than auditors considered their duties to be. Besides, they have

unreasonable expectations concerning auditor responsibilities to detect non-material fraud

or fraud from collusion. One may argue that audit expectation gap presents ‘diverse views

about audit function’ (Lee&Ali, 2008b). However, the majority of researchers name the

same contributing factors to the audit expectation gap, including complicated nature of an

audit function, conflicting role of auditors, hindsight evaluation of auditors’ performance,

time lag in responding to changing expectations, and self-regulation process of the audit

profession (Lee&Ali, 2008b). All this contributed to the mismatch between the expected

and actual performance, where it is said auditors ‘may fall short of the expected

performance’ (Salehi&Rostami, 2009). It is empirically tested and supported by a number

of studies in different countries. For example, the evidences of deficient performance of


auditors, or in other words underperformance, are identified in the research by Porter

(1993), Porter and Gowthorpe (2004), and Lee, et al. (2007) (see Table 5).

Table 5: Deficient performance of auditors

Porter (1993) Porter and Gowthorpe (2004) Lee, et al. (2007)

• Detect theft of corporate assets by non-managerial employees.

• Detect theft of corporate assets by company directors/senior management.

• Disclose in the audit report deliberate distortion of financial information.

• Disclose in the audit report misappropriation of company assets by company directors/senior management.

• Detect illegal acts by company officials which directly affect the company’s accounts.

• Express doubts in the audit report about the company’s continued existence.

• Disclose in the audit report illegal acts which directly affect company’s accounts

• Disclose in the audit report doubt about auditee’s continued existence.

• Detect theft of a material amount of the auditee’s assets by its directors/ senior management

• Detect theft of a material amount of the auditee’s asset by non-managerial employees.

• In the absence of regulated industry duty, report to an appropriate authority illegal acts by auditee officials.

• Detect illegal act by audit officials which directly impact on the auditee’s financial statements.

• Disclose in the audit report deliberate distortion of the auditee’s financial statements.

• In absence of a regulated industry duty, report to an appropriate authority, embezzlement of auditee’s assets by directors/senior management.

• Detect deliberate distortion of the figures in the company’s financial statements

• Report privately to a regulatory authority: • Theft has been committed by non-managerial employees. • Company directors/senior management has misappropriated company assets. • Information presented in the financial statements has been deliberately distorted. • Suspicious circumstances are encountered in the audit suggesting that theft or deliberate distortion of financial information may have occurred in the company

• Disclose in the published auditor’s report: • Company director/senior management have misappropriated company assets. • Information presented in the financial statements has been deliberately distorted.

• Illegal acts committed by the company’s management which directly impact on the company’s accounts.

Source: Adopted from Porter (1993), Porter and Gowthorpe (2004), and Lee, et al. (2007)


The table above, presenting the evidence of deficient performance of auditors,

signals about the potential problem that may be caused with a limited incentive to provide a

service at a level of quality that exceeds the minimum level that the public will accept.

Reasonableness gap, on the other hand, is based on the misconception of the nature,

purpose and capacities of auditing practice (Salehi&Rostami, 2009). This gap is believed to

be based on unreasonable expectations, which should be distinguished from reasonable

ones. Lee and Ali (2008b) claim that it is important to assure that enough attention is paid

to the reasonable expectations while unreasonable ones should be eliminated. Porter (1993),

Porter and Gowthorpe (2004) and Lee, et al. (2007) have revealed the duties which are

considered to be unreasonable expectations of auditors and has to be eliminated from the

public expectations (see table 6).

Table 6: Unreasonable expectations on the duties of auditors

Porter (1993) Porter and Gowthorpe (2004) Lee, et al. (2007)

• Guarantee financial statements are accurate and auditee company is solvent

• Report breaches to tax laws to IRD and theft of corporate assets by non-managerial employees to a regulatory authority

• Disclose in report theft of corporate assets by non-managerial employees and illegal acts which do not directly impact on company’s accounts

• Detect illegal acts by company officials which do not directly impact on company’s accounts

• Examine & report on fairness of non-financial information, efficiency & effectiveness of company’s management and verify every transaction of audited company

• Guarantee financial statements are accurate

• Guarantee auditee is financially sound

• Report breaches of tax law to Inland Revenue Department

• In the absence of regulated industry duty to do so, report to an appropriate authority, theft of auditee’s assets by non-managerial employees

• Disclose in the audit report theft of auditee’s assets by non-managerial employees

• Detect illegal acts by auditee’s official which only indirectly impact on the auditee’s financial statements

• Disclose in the audit report illegal acts by auditee’s officials

• Examine and report on reliability of financial information presented in auditee’s annual report

• Examine and report on the efficiency and effectiveness of auditee’s management and administrations

• Prepare the company’s financial statements. Guarantee the complete accuracy of audited financial statements

• Verify every accounting transaction.

• Prevent fraud and errors in the company.

• Detect all fraud and errors in the company.

• Plan the accounting and internal control system

Source: the table adopted from Porter (1993), Porter and Gowthorpe (2004), and Lee, et al. (2007)


Described existence and development of the audit expectation gap imply that users

of audited financial statements from different regions misunderstand the primary auditors’

role and thus possess different expectation on auditors. There are minor differences among

users in different part of the world; however, most of the users possess higher expectation

related to fraud prevention and detection as well as legal auditors’ liability from the

stakeholders’ perspective. Sometimes the gap is based on unreasonable expectations, which

should be distinguished in order to possess success when narrowing it. In Lithuania if such

gap does exists there may be different contributing factors. Thus the next section presents

the historical development of the audit function in Lithuania, which is the basis for the

analysis of the existence of audit expectation gap in Lithuania.


3 Audit function and audit expectation gap in Lithuania

3.1 Audit practice development in Lithuania

Prior to 1991 Lithuania was a part of the Soviet Union. After the regain of

independence, the lack of control and weak legislation system forced Lithuanian

government to focus on creation of own legislation system and its enforcement. Thus, the

grounds for Lithuanian audit practice are found in early 1990s, when the Association of

Lithuanian Accountants and Auditors was established (Mackevicius, 2001). This institution

was engaged in the creation of Auditing Practice Standards in Lithuania, which

unfortunately was not approved by the government.

Despite the lack of applicable legislation and legal grounds, auditing practice was

expanding in Lithuania, mainly with the entrance of the international network of audit firms

in Lithuania (Mackevicius, 2001). To mention a few, Arthur Andersen & Co as well as

KPMG, Price Waterhouse, Coopers and Lybrand were established during the period 1992-

1994. This in turn forced the creation of Lithuanian auditing firms. In addition, the growth

of private sector pushed the greater request for audit. The need for audit was fuelled by

growth of commercial enterprises, dishonest businessmen, and low qualification of

accountants working in private enterprises (Mackevicius, 2001).

Lithuanian Auditors Association established in 1997 was responsible for creating

legal grounds for auditing practice, supervise auditing standards creation projects and

recommend improvements, ensure and develop the professional auditors’ skills and

increase public recognition (LAA, 2011). It is important to note that Lithuanian auditing

system was based on the ‘bottom-up’ approach, meaning that it was created and

improvements were suggested by the public organizations engaged in audit practices with

limited governmental support. The government, however, paid an important role by issuing

the Republic of Lithuania Law on Audit in June 1999 (Lithuanian Parliament, 1999). This

document determined the establishment of the Lithuanian Chamber of Auditors (hereinafter

LCA), which in turn had to supervise of the activities of audit enterprises, issue, suspend

and terminate the auditor’s certificates, handle the register of audit enterprises and perform

other functions (Mackevicius, 2001). After the Law on Audit came into the force, it was


important to create the proper audit methodology, thus LCA approved 11 National Auditing

Standards (hereinafter NAS) and Auditors’ Professional Code of Ethics in June 2000.

Today, LCA as a public legal entity unifying all certified auditors of Lithuania shall

act in conformity with the Constitution of the Republic of Lithuania, Civil Code of the

Republic of Lithuania, the Law on Audit, the Law of Associations of the Republic of

Lithuania other legal acts of the Lithuania and European Union (hereinafter EU) and the

present Statute of LCA (LCA, 2010). Besides, it supervises the activities of auditors and

audit companies in Lithuania, develops the audit methodology and recommendations for

the Lithuanian auditors, translates ISAs, the Code of Ethics and other documents issued by

the International Federation of Accountants (hereinafter IFAC). According to statistics, on

1st May 2011 the LCA unified 399 certified auditors and 188 audit firms of Lithuania

(LCA, 2011). Approximately 62 % of these certified auditors worked in public practice,

providing a wide range of services to clients. Other 38 % work in various areas such as

industrial, governmental and educational institutions. Note that in 2003 LCA became an

associated member of IFAC and in 2004 the General Assembly of European Federation of

Accountants (hereinafter FEE) approved the LCA membership as a member correspondent.

In 2008 LCA became a true member of IFAC and FEE (LCA, 2010).

Mackevicius (2001) notes that there are three key elements which guarantee stable

and reliable auditing system. These elements are legal, methodological and control

frameworks. In Lithuania legal framework is based on the Law on Audit and by the

Auditors’ Professional Code of Ethics. These two documents regulates the main areas of

audit practice, defines the independence, responsibility, relations with clients. Even though

it took almost 10 years to prepare those legal documents, it is expected that properly

prepared they have to influence positively most of the areas, including audit practice,

quality, responsibility, trust, and stimulate the qualification improvement. Methodological

framework is based on the NAS, which establish the base for audit methodology and

regulate auditors’ actions in different audit engagement stages. Back in 2000, ISAs with

some minor adjustments were translated into Lithuanian language and named NAS

(Mackevicius, 2001). Besides NAS, other methodological material is important for auditors

and users of audited financial statements, including explanation of the Law on Auditing and

Auditors’ Professional Code of Ethics, the dictionary of audit terms and concepts


(Mackevicius, 2001). Audit control framework ensures flexible and effective regulation and

control of auditing practice. This is endured by active supervision of LCA which analysis

and propose possible improvements to existing auditing standards as well as control of

regulatory bodies, including General Assembly of European Federation of Accountants. In

Lithuania all three frameworks are based on the EU eight directives, Green Papers, ISAs

and other legal documents. According to the Law on Audit, audits starting from 1 January

2009 and later shall apply ISAs and the Code of Ethics of Professional Accountants issued

by IFAC (LCA, 2010).

As of today, the auditing function is mainly required to ensure the compliance with

government business legislations/regulations in order to maintain the truthfulness and

legitimacy of accounting records in individual business entities (Lee&Ali, 2008b;

Lin&Chen, 2004). According to Lithuanian regulations, all joint-stock companies are

entitled to perform audit of financial statements. The same is applicable for the limited

liability companies if two out of the following three requirements are fulfilled:

1. Revenues for the financial year are larger than EUR 2.9 million

2. The total book value of assets is larger than EUR 1.45 million

3. The average number of employees is higher than 50 (Lithuanian Parliament,

2000a)

The development of the Law on Audit in Lithuania may be presented in the

following steps: the first Law on Audit in Lithuania was issued in 1999, after several

amendments the New Law on Audit came into force on 1 September 2008 and mainly

implemented the following legal acts of the EU (LCA, 2011):

• 78/660/EEC: fourth Council Directive of 25 July 1978,

• 83/349/EEC: seventh Council Directive of 13 June 1983,

• Directive 2003/51/EC of the European Parliament and of the Council of 18

June 2003,

• Directive 2006/43/EC of the European Parliament and of the Council of 17

May 2006

Described development of audit’s roles and objectives in Lithuania allows

presuming that audit practice is rather young and still developing in Lithuania to keep with

the recent updates and changes in audit rules and regulations (Mackevicius, 2001). In order


to guarantee stable and reliable attest function for the stakeholders, government as well as

other public institutions have similar aims and work in line with auditors in order to

eliminate all potential occupational fraud.

3.2 Role of Auditors and other institutions

According to the Lithuanian Law on Audit, an auditor is a person who passed

auditing exams, has auditor’s certificate and is a member of LCA (Lithuanian Parliament,

1999). High and demanding requirements for qualification determine several features

which are the key elements to be a successful auditor. To mention a few, a good auditor has

to be honest, objective, professional, independent, prudent and cautious, polite, tactic,

diligent and possess good analytical skills (LCA, 2010). Yet the most important feature is

responsibility, mainly because the auditor is seen as a ‘watchdog’ of the company which

has to increase the level of assurance provided by the company to the stakeholders

(Mackevicius, 2001). The responsibility can be divided into three groups: specific, ethical

and informal responsibility (Lee, 1986, Dunn 1996). Specific responsibility relates auditor

to the shareholders of the company; ethical responsibility provides boundaries for being

liability for the profession and society; while informal responsibility builds the bridge

between the auditor and the user of the audited financial statements.

Auditors’ responsibility becomes one of the key issues in the developed countries.

According to European Commission (2010b) and European Anti-Fraud Office (2010), the

question considering if auditors should have limited liability is getting more attention,

especially in the light of increasing number of occupational fraud. The users of audited

financial statements are expected auditors to do more, especially in detecting and

preventing frauds. Therefore, the redrafted ISA 240 is a good example of the results of such

concerns. According to Jones (2009), ISA 240 (redrafted), effective from 15 December

2009, concludes that ‘audit role as that of a “watchdog, not a bloodhound” is no longer

valid in the context of the requirements of the redrafted and revised ISAs’. This results

mainly because redrafted ISAs deny the traditional ‘passive philosophy’ towards auditor

responsibility for fraud detection and mark a significant shift away from a ‘monitoring’ role

and towards the requirement for a very keen ‘sense of smell’ (Jones, 2009).


Since audits are not mandatory for all companies in Lithuania (with exception to

joint stock companies and some limited liability companies which meet the requirements of

the Law on Audit), the governmental control of the entities is limited as compared to the

countries such as Denmark, Australia and other where auditing at some point is almost

mandatory to all market players.

Even though Lithuanian government sets strict guidelines on audit requirements,

there are ways and examples when companies were not following the rules. According to

the representative of the Big-Four audit firm, enterprises are sometimes manipulating

financial data, especially if accounting figures (e.g. revenues, asset book value of number

of employees) are close to the level to be entitled to perform the audit (personal

communication, April 12, 2011). On the other hand, Lithuanian regulation system has

many underdeveloped issues which correspond to misconduct in terms of legislation. For

example, the Centre of Registers, a legal entity collecting financial statements of all legal

entities in Lithuania; fails to check if all companies are presenting the correct data.

Sometimes management of the company hires a person or firm with doubtful reputation and

qualification to review, sign and express the auditor’s opinion on the financial statements of

the company. Afterwards, these financial statements are presented to the Centre of

Registers, which due to the lack of time does not review all documents (personal

communication, April 12, 2011).

Law on Company (Lithuanian Parliament, 2000a) states that the head of the entity is

liable for the drawing up of an entity’s financial statements and timely submission thereof.

Legal documents also foresee liability and punishment on deceptive of negligent

accounting, forgery of documents and other violation of accounting rules. These documents

are the Law on the Approval and Entry into Force of the Criminal Code (Lithuanian

Parliament, 2000b) and the Code of the Violation of the Administrative Rights (Lithuanian

Parliament, 1985). According to the summary of the Criminal Code and Code of the

Violation of the Administrative rights, the fines range from as little as warning to up to

EUR 12,000, including confiscation of falsified or illegally obtained goods and services.

Accounting errors and fraud on the other hand, are not limited to fine. The penalty may

include public works, restriction of freedom or imprisonment for up to 3 years (see Table

11 and 12 in Appendix).


Such means to prevent occupational fraud seems to perform poorly in Lithuania.

Several studies have documented the increasing incidence and cost of fraud in firms in

Lithuania. The representative of the Big-Four Audit Firm highlights increasing fraudulent

activities in Lithuanian business environment especially during and right after the global

financial crisis (personal communication, March 3, 2011). The same trend is indicated by

the Ministry of the Interior of the Republic of Lithuania which recorded 49% growth in

fraudulent activities in 2009 (FCIS, 2010).

The society expects auditing firms to be one of the most important means to detect

and report fraud in developed countries (Mackevicius, 2011). In Lithuania, however, other

institutions also are investigating different cases of oppositional fraud. One of the most

important institutions is Financial Crime Investigation Service (hereinafter FCIS). The

main aim of FCIS is to protect the state financial system by disclosing criminal actions and

other violations of law. Following the goal to minimize criminal activities against the State

financial system, FCIS is implementing the National Programme of Crime Prevention and

Control, the National Programme of Combating Corruption. Additionally it prepares the

Development Strategy of the Public Relations (FCIS, 2010).

It is noticeable that FCIS focuses on the disclosure, investigation and prevention of

the criminal acts, related to money laundering, VAT embezzlement, illegal receipt, and use

of the funds for the financial support from the European Union and foreign countries. These

criminal acts make the great damage to the State Budget and form the negative image of the

state.

Table 7: FCIS investigation results, in million EUR

No / EUR’000 2004 2005 2006 2007 2008 2009 2010 Legal entities and private individual checked 1,245 1,162 780 542 542 503 386

Reported violations of law 1058 1636 2566 3745 5899 2938 1672 Detected violations of administrative law 535 456 275 200 163 184 142 Amount of Value Added Tax embezzlement 11,387 16,679 13,120 14,176 9,567 23,076 13,625 Amount of temporarily restrict property right 12,115 11,957 32,438 24,585 21,007 21,060 29,466

Source: Adopted from FCIS (2010)


According to the latest statistics, the highest number of illegal acts or violations of

law was reported in 2008 (there were almost 6 thousand cases were identified after

investigating 542 enterprises and individuals), while the year 2009 were marked with the

largest Value Added Tax embezzlement (more EUR 23 million). In 2010, the number of

violations of law and Value Added Tax embezzlement decreased significantly, yet it still

accounted for almost EUR 14 million (FCIS, 2010). Such statistics proves that Lithuanian

government faces serious problems which have to be solved in order to enjoy county’s

development and economic growth. One of those areas is improving of audit practice which

is expected to bring positive effect on and will help to minimize the level of occupational

fraud on the individual as well as public level (European Parliament, 2010).

The analysis indicates that occupational frau is not exception in Lithuania. The

more society hears about the occupational fraud, the more accurate it gets. Thus it is

expected that currently, especially after the global financial crisis and wave of corporate

scandals, any stakeholder (investor, creditors, employee, government, etc.) is more concern

about occupational fraud. For example, Algirdas Semeta, the Lithuanian economist and the

European Commissioner for Taxation and Customs Union, Audit and Anti-Fraud,

highlights the importance of independence, efficiency and effectiveness of the activity of

European Anti-Fraud Office (hereinafter OLAF) in fighting fraud and corruption in the EU

(European Parliament, 2010). Therefore, the next section presents the analysis performed

on the investigation of the extent of audit expectation gap in Lithuania.


4 Research of the extent of audit expectation gap in Lithuania

The research emphasises the aspects of auditor’s responsibility, reliability and

usefulness of financial statements. Previously mentioned studies have prove that there is an

audit expectation gap in terms of fraudulent activities in well developed countries (e.g. the

US, the UK, the Netherlands) as well as in developing countries (Malaysia, China,

Bangladesh). In Lithuania, however, if such a gap does exist it might be presented as a

result of different situations and beliefs. Thus, the main task of this study is to investigate

the extent of an audit expectation gap among auditors and users of audited financial

statements in terms of audit responsibility and reliability, objective, duties in detecting and

reporting frauds and irregularities, and liability to the third parties in the Lithuanian

business environment. Therefore, four propositions are developed in order to be able to test

the hypothesis of existence of audit expectation gap among auditors and users.

4.1 Study propositions

The gap is the reflection of different understanding among auditors and the public

over the meaning of the nature, objectives and outcomes of the audit. These beliefs or

perceptions are determined by the role of auditing function in a given society and are tend

to change over time (Lee & Ali, 2008b). The restoration of auditing in Lithuania has only a

short history (Mackevicius, 2001). In the light of economic boom during 2000-2007, and

then economic turmoil in 2008-2010, it is believed that the reliability of accounting

information is crucial. Reliable information is believed to facilitate decision-making of the

users of audited financial statements, especially today when the welfare of a wide range of

society including bankers, investors, government is affected by the audit function. Auditors

on the other hand, following the legislation and legal acts, would stress ISA 500, which

‘explains what constitutes audit evidence in an audit of financial statements, and deals with

the auditor’s responsibility to design and perform audit procedures to obtain sufficient

appropriate audit evidence to be able to draw reasonable conclusions on which to base the

auditor’s opinion’ (IFAC: IAASB, 2009c). To say it differently, the number of interested

parties should recognize auditors more reasonable and reliable than they see themselves.

Hence, the first proposition is presented as:


Proposition 1: The perceptions concerning the responsibility and reliability of

audited financial statements differ substantially among auditors and users of financial

statements.

Looking further, it is important to determine if any significant differences in the

perceptions of audit objectives among users and auditors in Lithuania exist. Any significant

expectations or differences of the preferred audit objectives should be examined further, so

that these reasonable objectives reflect the needs of various interest groups. Thus the simple

question rises how the society perceives the audit objective? Are there any disagreement

between Lithuanian users of audited financial statements and auditors upon the audit

objectives? These questions are significant in order to appraise the value of public

accounting in Lithuania and leads to the second proposition:

Proposition 2: The perceptions concerning the objective of auditing differ

substantially among auditors and users of financial statements.

The majority of studies stress the main issue in audit expectation gap is the

obligation to detect and communicate errors, frauds, and irregularities in auditing practices

(McEnroe&Martens, 2001; Fadzly&Ahmad, 2004; Lin&Chen, 2004). Auditors had

traditionally been equipped with a wide range of legal rights and duties in order to facilitate

government control of business operations. Under government regulations, auditors had to

detect, stop, and report frauds, inefficiency, and irregularities in clients’ operations

(Lin&Chen, 2004). However, in recent years, it becomes more complicated to bear all

obligations for fraud detection due to increasing litigation exposure. On the other hand,

users of the audited financial statements may be reluctant to accept this view. Hence

another proposition specifically addresses the perceived auditor’s responsibility for fraud

detection and reporting in Lithuanian business environment.

Proposition 3: The perceptions concerning auditor’s duties in detecting and

reporting frauds and irregularities differ substantially among auditors and users of financial

statements.

As it was stated previously, many related parties such as present and potential

investors, creditors, and government authorities are interested in audited financial

statements, mainly because of the practice to rely upon audit results to evaluate business

performance and make a variety of decisions. General public sees auditors as an


independent body that may help to mitigate the risk related to the investment into the

company. Moreover, the public expects that auditors should be liable for losses suffered by

third parties owing to auditor negligence or audit failure (Fadzly&Ahmad, 2004, Monroe

and Woodcliff, 1994). However, it is important to remember that auditors and the manager

of the company are working under one engagement. This is true because the management

of the company chooses the auditors for the company review, thus both parties are evolved

under one contract. Thus the public expectations on the third party liability (auditors’

liability) are an important factor underlying the expectation gap (Fadzly&Ahmad, 2004,

Lin&Chen, 2004, Erickson et al, 2000).

Proposition 4: The perception concerning auditor’s liability to the third parties in

relations to auditors’ negligence and audit failure differs substantially among auditors and

users of financial statements

4.2 Research methodology

Quantitative analysis (a survey of auditors and users of audited financial statements)

was designed and developed based on the method used in Fadzly and Ahmad (2004), Lin

and Chen (2004), Porter (1993) and Monroe and Woodcliff (1994). It allows measuring the

perception and assessment of audit expectation gap and answers the research question and

provides evidence for the four propositions raised above. The questionnaire is constructed

as follows (see the full questionnaire in Table 13 in Appendix): the first block of questions

asks for the opinion on issues of audit role and objectives, auditors’ obligation for fraud

detection, and auditors’ legal responsibilities. The second section, namely the background

information, is also included into questionnaire to collect the demographic data of

respondents, such as education, job specification, work experience, gender, and age.

The semantic differential scale is used for the scenario evaluation. The seven-point

scale is chosen owing to the fact that this scale has the advantages of allowing neutrality of

the answer to the question (when choosing the middle number) and has enough gradation to

give meaningful data (Malhotra, 1993, p.268). The end-points of this scale are associated

with bipolar labels. In other words, each scale ends up by two bipolar adjectives, such as

“just” and “unjust”. Moreover, one can notice that reverse construction sometimes appear

on the left side of the scale and sometimes on the right (e.g. Statement 2, ‘The auditor is not


responsible…’). This helps to control the tendency of some respondents with very positive

or very negative attitudes and also for the ones who mark the right or left hand sides

without reading the labels. According to Malhotra, this scaling is very popular while

studying the advertising market (1993, p. 272).

4.2.1 Pretesting of the Questionnaire

The questionnaire was originally prepared in English and translated into Lithuanian

language for distribution in Lithuania. In order to launch the survey and to have the valid

data, we perform a pretesting of the questionnaire. The principal purpose of this pre-test is

to avoid ambiguity or misunderstanding of any item and to resolve any possible problems

with the selected scenarios. 12 randomly selected people were approached (8 auditors (4

men and 4 women) and 4 business people) of different age (from 18 to 50) and asked to fill

in the questionnaire. If the respondents had questions or misunderstood something,

additional information was provided in order to explain what exactly the point of interest

asking the particular question was. Afterwards, the discussion on how statements/questions

could be changed in order to be more comprehensible was held. After the pretesting was

finished and some minor modifications included into the questionnaire, the e-version of

questionnaire was launched. The data was gathered over the period of 2 months, starting

from 1 March 2011 to 1 May 2011.

To measure the extent of the audit expectation gap in Lithuania, the survey was

conducted among auditors and users of audited financial statements. The number of

research investigated the expectation gap among auditors and “sophisticated users”

(Humphrey et al., 1993, Monroe&Woodliff, 1994). Since there is no published study on the

expectation gap in Lithuania, this study seeks to expand the literature on the issue by

providing the evidence on the expectation gap in Lithuania between auditors and

‘sophisticated users’. Auditors from Big-Four Audit Firms and local Lithuanian audit

companies were selected to represent the opinion of audit profession, while bankers and

financial consultants were selected as the users of financial statements. These users were

selected for several reasons. First of all, it is important to note that bankers and financial

consultants are more informed about the auditing process and are more knowledgeable

about the duties of auditors as they day-to-day work is related to the audited financial


statements in one or another way (Humphrey et al., 1993). Secondly, these users are

expected to have a greater information asymmetry and thus in turn different expectations of

the role and responsibilities of the auditors (Hassink et al, 2009). Besides, greater efforts

from auditors might be expected due to lack of cost-benefit analysis, as these users do not

pay for auditing services (Hassink et al, 2009).

4.2.2 Data Analysis

To analyse the data, SPSS statistical software is used. To begin with, the sample is

analysed according to the main characteristics such as gender, age, experience, and area of

work. The frequency analysis allows seeing how representative our sample is compared to

Lithuania society. Afterwards, mean comparison is performed to measure the gap between

the auditors and users of audited financial statements. The significance of the gap is

measured using T-tests.

Tables 8 and 9 give the review of average scores and the level of significance of the

audit expectation gap (for more detail analysis of survey results please see Table 14, 15 and

16 in Appendix). Table 8 presents the opinion of the auditors, bankers and financial

consultants with respect to the two first propositions, namely 1) the perception concerning

the responsibility and reliability of audited financial statements and 2) the perception

concerning the objective of auditing. Table 9 shows the responses to the statements

regarding the auditors’ duties in fraud cases and liability to the third parties. More

precisely, Table 9 indicates whether there is difference among 3) the perceptions

concerning auditor’s duties in detecting and reporting frauds and irregularities and 4) the

perception concerning auditor’s liability to the third parties in relations to auditors’

negligence and audit failure.

4.3 Results

Online survey resulted in 152 responses. As stated in the methodology part, this

survey focuses on auditors and users of financial statements, representing respectively 47%

(71 auditor) and 53% (80 users) of all respondents.

The total population of Lithuania was 3.3 million as of 1 January 2010; however,

the target group is adjusted based on the age factor, assuming that inhabitants start working

after graduation until the retirement (Lithuanian Statistical Department, 2010). In order to


be confident with the sample size, the confidence interval of the sample is checked. The

number of respondents (152) shows that the maximum (assuming conservative 50%

response distribution) statistical error, at the 95% confidence level, would reach the level of

8.0 (Creative Research Systems, 2007).

To examine how representative the sample is a general description of quantitative

data gathered is analyzed. There are 152 respondents who filled the online survey, 67 of

them are men and 84 are women. The sample presents the comparable trend of the number

of men and women in the market. Distribution of men and women in the sample is 45% and

55% respectively. Total target population in Lithuania amounted to 2.3 million as of 1

January 2010 where men population corresponded to 46% while there were 54% women of

total group of people with the age between 21 and 65 (Lithuanian Statistical Department,

2010). Of the returned questionnaires, 40 came from financial consultants, 41 from bank

officers, and 71 from auditors. The majority of the survey respondents help post-graduate

degrees. About 22% of the respondents have work experience of more than 10 years, while

64% of the total respondents have been working in the sectors of interests from more than a

year up to 10 years. The age of respondents fluctuates between 22 and 55, with the mean

fluctuation around 32 years for the users of audited financial statements and 29 for the

auditors.

Work experience of auditors indicates the trend that auditors are not changing they

profession. Most of them, contrary, are industry focused and try to pursue their career

aspiration while practising auditing.

The following parts present the analysis of the perception of auditors and users

based on the four propositions identified before.

4.3.1 Proposition 1

The basis for audit expectation gap may rest in the standards gap components. This

means that society may expect auditors to be responsible for more than it is indicated in the

professional rules and standards which are used as a basis in audit engagement.

The analysis of the Lithuanian situation indicated that auditors and users relatively

agree that the auditors should be unbiased and objective (Statement 1) when performing the

engagements (means ranging from 1.268 to 2.000); however, there is significant difference


in the level of agreement. Note that the difference is mainly due to the bankers lesser

agreement on the statement of the auditors being unbiased and objective, which is probably

caused by scepticism of the reliability of financial statements. Further analysis of bankers

indicates that this scepticism increases with work experience (correlation of 0.03). In other

words, the longer a person works in the bank the less he or she relies and believes into

audited financial statements.

Significant differences between the auditors and users on the issue of internal

control structure of the company were identified (Statement 2). This is similar to the

finding of Best et al. (2001) and Fadzly and Ahmad (2004), where users of audited

financial statements expected auditors to be responsible for internal control system. Even if

auditors tend to claim that internal control system is management responsibility users

believe that this responsibility should be shared between auditors and the management. The

difference is mainly attributable to lesser agreement among bankers (mean of 5.073),

meaning that they expect auditors to be responsible for the soundness of the internal control

structure of the company. Interestingly, that auditors’ mean accounts for 3.563, which is

close to the midpoint. It may reflect that auditors are uncertain about their role in terms of

internal control. Such uncertainly may have occurred from the increasing pressure on

auditors to provide absolute assurance and protection against fraud and irregularities in all

cases (Fadzly&Ahmad, 2004). The general role and objectives of the audit is to ensure

fairness and completeness of the presentation of financial information. Looking from

auditing practice point of view, there is simultaneous effect. On the one side, auditors are

performing detail check of financial information, however, at the same time they are

sharing information with management.

Users tend to agree with auditors that an auditor should not take the accounting

policies used by the company for granted (Statement 3); however, users had higher

expectation towards the issue. Auditors’ mean accounts for 5.070, meaning that auditors are

likely to challenge and critically evaluate the accounting policies used by the company. If

any inconsistency is identified or expected, the auditing standards require taking certain

actions to apply the proper accounting policy, which eventually may result into qualified

audit opinion (IFAC: IAASB, 2009a). Expectations of financial consultants and bankers,

whose mean rates at 5.625 and 5.488 respectively, reveal a greater level of agreement that


any company has to use the proper accounting policy. If it is not the case, those companies

should be challenged by the auditors.

The results in Table 8 also confirm the findings of Fadzly&Ahmad (2004) that the

audit reports do not present the clear extent of assurance provided by the auditors

(Statement 4). As to Fadzly&Ahmad (2004), this is due to miscommunication between

users and auditors, which differently perceive auditor’s explanation of high but not absolute

level of assurance (IFAC: IAASB, 2004). In Lithuania, auditors and users relatively agree

that the level of assurance is clearly indicated in the audit report (means rate from 1.775 to

3.197); however, the analysis indicates the significant difference in the level of agreement.

Interestingly, auditors have the lowest level of agreement among all survey participants

(mean of 3.197 as compared to bankers’ mean of 2.756 and financial consultants’ mean of

1.775). This may imply that auditors again are uncertain about the extent of assurance

indicated in the audit report due to current increasing pressure on audit practice. According

to European Commission (2010b), continuous effort to explain the audit limitation to the

users of audited financial statements remains the most vulnerable issue to both parties

engaged (auditors and users) and does not bring the desired solution. Additionally, financial

instability in the last few years forced interested parties to take audit function more

seriously by to questioning and analyzing auditors’ role, scope and more importantly

contribution to increase financial stability. According to different institutions in the EU,

audit expectation gap is basically engendered due to the difficultly to understand the

reasonable, material soundness ad other audit limitations should be minimized and

addressed properly via a comprehensive debate (European Commission, 2010b). In this

context, the auditors may have been facing different believes and expectation on how the

profession will develop in the nearest future.


TABLE 8: Audit expectation gap in terms of responsibility and reliability and objectives

Overall mean

Auditors Bankers Financial consultants

Overall users

GAP

Bankers vs. Financial consultants

Statements Mean (st. dev)

Mean (st. dev)

Mean (st. dev)

Mean (st. dev)

Mean difference

Statements regarding Proposition 2 1. The auditor should be unbiased and objective while performing the engagement

1.559

1.268 (0.585)

2.000* (0.894)

1.625* (0.705)

1.815* (0.823)

YES 0.375

2. The auditor is not responsible for the soundness of the internal control structure of the company

4.164

3.563 (2.353)

5.073* (1.490)

4.300 (1.572)

4.691* (1.570)

YES 0.773

3. The auditor should agree with the accounting policies used in the financial statements

5.329

5.070 (1.783)

5.488 (1.434)

5.625 (1.125)

5.556 (1.285)

NO -0.137

4. The extent of assurance given by the auditors is clearly indicated in the audit report

2.704

3.197 (2.394)

2.756 (1.758)

1.775* (0.733)

2.272* (1.432)

YES 0.981

5. The audited financial statements are useful for decision-making 2.487

2.169 (1.595)

3.341* (1.726)

2.525 (1.132)

2.938* (1.511)

YES 0.816

6. The audited financial statements provide an assurance regarding the performance of the entity

3.191

2.732 (1.146)

3.854* (1.606)

3.325 (1.492)

3.593* (1.563)

YES 0.529

7. The audited financial statements are useful in monitoring the company’s performance

2.480

2.127 (1.287)

3.195* (1.860)

2.775 (1.368)

2.988* (1.639)

YES 0.420

Statements regarding Proposition 2 8. An auditor conducting an audit is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error

2.211

2.437 (1.811)

2.171 (1.243)

1.850 (0.834)

2.012 (1.066)

NO 0.321

9. An audit is to ensure fairness and completeness of financial statement presentation

2.382

2.310 (1.272)

3.024* (1.557)

1.850 (0.700)

2.444 (1.342)

NO 1.174*

10. An audit is to prevent and deter frauds or irregularities, inefficiency and wastage in clients’ operations

3.342

3.634 (1.742)

2.488* (1.362)

2.600* (1.277)

2.543* (1.314)

YES 0.112

Responses to the survey questions are donated on a Likert scale of 1 to 7, the lowest score representing the strongest agreement and the highest score standing for the strongest disagreement. Neutral view to each question is indicated by the score of 4.

Note: * - 5% significance level Source: SPSS output. Summary of mean comparison test


Users’ level of agreement that audited financial statements are useful in decision

making (Statement 5) is similar to perception of company performance monitoring

(Statement 7). The results indicate that bankers (mean rating of 3.341) are more critical and

careful to make any decisions based on the financial statements (Statement 5). Not

surprisingly that such perceptions influence the belief in the audit assurance level regarding

the performance of the entity (Statement 6). The overall users’ mean of 3.593, which is

close to the midpoint, may indicate that users are uncertain whether they can or cannot to

accept the assurance regarding the performance of the entity as indicated in the audited


It should be noted that there is the greater extent of differences in perceptions

between the auditors and users of audited financial statements in terms of decision-making

(Statement 5) and performance monitoring (Statement 7). Auditors assess the useful of

audited financial statements in decision making and performance monitoring, with mean

accounting for 2.169 and 2.127 respectively. On the other hand, users do not expect audited

financial statements to be of the highest value. Users collectively present neutral view on

the trustworthiness of the financial statements. In terms of company performance

monitoring, however, lower level of agreement among bankers (mean of 3.195) may reflect

the lessons learned from the recent bankruptcies and scandals related to the large

corporations (e.g. Enron and Andersen). The correlation (correlation = 0.10) between

Statement 7 and Statement on auditors objectivity (Statement 1) indicates that users who

are more confident about the auditors objectivity tend to trust audited financial statements

more when monitoring company’s performance.

4.3.2 Proposition 2

Auditors and users tend to agree on the role of auditors regarding the fact that

audited financial statements taken as a whole are free from material misstatement, whether

caused by fraud or error (Statement 8), with mean of the ranging from 1.850 for financial

consultants to 2.437 for auditors. This indicates that both groups, auditors and users, are

familiar with one of the main topic defined in ISA 240. However, several significant gaps

were still identified in existing roles and objectives.


There is no statistically significant difference between the perception of auditors

and users with respect to the audit objective to ensure fairness and completeness of

financial statement presentation (Statement 9). Overall mean of users corresponds to 2.444,

while the mean of auditors accounts for 2.310. There is statistically significant difference

between users of audited financial statements. Table 8 reveals that the mean of bankers,

amounting to 3.024, is higher by 1.174 than the mean of financial consultants (1.850). The

difference is statistically significant at 5% significance level and may result from the

different nature of work. For example, bankers are entitled to accept more risk than

financial consultants, when dealing with different companies. Having limited access to

companies’ financial information which is accessible by auditors, they expect that auditors

ensure fairness and completeness of financial statements, but also challenge the company

and identify other risks (existing or potential) which may limit the bank’s risk-exposure. If

such actions are not taken, this may result in large losses for the bank, especially in cases

where the bank is providing financial support for large companies. Financial consultants, on

the other hand, depending on the scope of work, have access not only to audited financial

statements but also to managerial accounts. They are looking for different risks and issues

relating the company they are working in or with. For example, financial consultants may

provide services for companies in terms of divesture, acquisition, merger or similar actions,

thus the risk financial consultants are accepting is limited to a certain strategic move of the

company rather than the amount of money invested (personal communication, April 12,

2011).

The qualitative results (Table 8) provide a statistical gap in terms of the view to

prevent frauds, irregularities, inefficiency and wastage in clients’ operations (Statement

10). The results indicate that auditors tend to remain neutral regarding this statement, with

the mean accounting for 3.634. Overall users of audited financial statements have higher

expectations of auditors when it comes to preventing and deferring fraud and irregularities

(mean 2.543 implies that users agree that the objective of auditors is to prevent and deter

fraud, irregularities, inefficiencies and wastage in company’s operations). These

perceptions are reasonable since the standards require auditors to investigate suspicious

actions and potential actions to cause fraud. The distinction between material and

immaterial fraud is a result of such different perceptions (Hassink et al., 2009). Financial


consultants or bankers expect auditors to perform their work in the best way possible,

regardless the type and influence of fraud. In the meantime, auditors tend to remain neutral

in cases where the effect of fraud is uncertain or immaterial (Hassink et al., 2009).

4.3.3 Proposition 3

Results in Table 9 indicate the lesser extent of differences in belief between the

auditors and users than in previous statements. With the exception of the Statement 11,

users and auditors present relatively similar opinion on the statements. For example, users

as well as auditors agree that the audit report should disclose uncovered frauds, inefficiency

or irregularities hidden by the management (Statement 12). Auditors mean rates at 1.831,

while the analysis of users’ perception resulted in the mean of 1.926. The difference is

mainly attributable to lesser agreement among bankers, whose mean accounted for 2.200.

The results are in line with the findings of McEnroe and Martens, 2001 who found that

existing society’s expectation are higher than auditors when the later are issuing unqualified

audit opinion.

All three groups present the same perception on the statement regarding the fact that

the audited entity is free from fraud and/or other irregularities (Statement 13). It was

expected that users as well as auditors would indicated the disagreement with this

statement, mainly due to auditors explanation that audit may provide ‘high, but not absolute

assurance” (IFAC: IAASB, 2009b). Besides, after the collapse of several large audited

firms and global financial turmoil, everyone is more suspicions and careful in terms of

financial health of all firms. Therefore, the results the means of al free groups fluctuate

within the same range, from 6.225 to 6.338.

Statement 11 shows that bankers reported lesser agreement, with the mean

accounting for 2.293 while the auditors and financial consultants rated this statement on

1.718 and 1.875 respectively. This may be attributable to the belief that ‘while the role

played by banks, hedge funds, rating agencies, supervisors or central banks has been

questioned and analyzed in depth in many instances, limited attention has been given to

how audit function could be enhanced in order to contribute to increased financial stability’

(European Commission, 2010b).


TABLE 9: Audit expectation gap in terms of fraud prevention and detection, and liability to third parties

Overall mean Auditors Bankers

Financial consultants

Overall users

Bankers vs. Financial consultants

Statements Mean (st. dev)

Mean (st. dev)

Mean (st. dev)

Mean (st. dev) GAP

Mean difference

Statements regarding Proposition 3 11. The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management

1.914

1.718 (0.814)

2.293* (0.844)

1.875 (0.648)

2.086* (0.778)

YES

0.418

12. Auditors should disclose in the audit report the uncovered frauds, inefficiency or irregularities reliability of financial statements hidden by management

1.882

1.831 (0.878)

2.220 (1.061)

1.625 (0.667)

1.926 (0.932)

NO

0.595*

13. The audited entity is free from fraud or/and other irregularities

6.289

6.338 (1.055)

6.268 (0.895)

6.225 (0.698)

6.247 (0.799)

NO

0.043

Statements regarding Proposition 4

14. The auditor is legally responsible only to the shareholders of the audited company

4.855

3.873 (2.042)

5.976* (1.294)

5.450* (1.616)

5.716* (1.477)

YES

0.526

15. Auditor is responsible if the company goes bankrupt due to fraud

3.474

4.732 (1.859)

2.488* (1.630)

2.250* (1.127)

2.370* (1.400)

YES

0.238

16. Auditors are liable for losses of interested parties if failed to disclose potential fraud in audit report

4.046

5.634 (1.606)

2.780* (1.573)

2.525* (1.414)

2.654* (1.493)

YES

0.255

Responses to the survey questions are donated on a Likert scale of 1 to 7, the lowest score representing the strongest agreement and the highest score standing for the strongest disagreement. Neutral view to each question is indicated by the score of 4.

Note: * - 5% significance level Source: SPSS output. Summary of mean comparison test


4.3.4 Proposition 4

Based on the current legislation framework, the survey results imply that bankers

and financial consultants tend to blame auditors if the fraud-related business failure occurs.

The results reveal that auditors are seen as legally responsible to all stakeholders (Statement

14) (Monroe&Woodcliff, 1994, Lin&Chen, 2004, Erickson et al, 2000). This is confirmed

by the overall users’ mean of 5.716. Rather small disagreement between the bankers (mean

of 5.976) and financial consultants (mean of 5.450) indicates that bankers tend to judge

auditors severer, as this may influence the success and return of the money invested into the

company (e.g. loans provided to large entities). In the meantime, auditors’ mean rating at

3.473 is close to the midpoint. The results are similar to the one achieved by Fadzly and

Ahmad (2004), who concluded that such tendency reflects the reasonable rating of legal

responsibilities, which are ‘in-between the shareholders and the “remote third” parties’.

The greater extent of differences in belief between auditors and users of audited

financial statements is observed in the statements related to the company’s bankruptcy

(Statement 15) or losses of the interested parties if the audit failed to disclose potential

fraud (Statement 16). There is a tendency among bankers and financial consultants (the

mean of 2.488 and 2.250 respectively) to blame auditors for audit failure to detect fraud

before the company goes bankrupt. Even if the company does not go bankrupt, the users

perceive auditors reliable for losses which are experienced by the interested parties in cases

where auditors fail to disclose potential fraud (bankers’ mean rates at 2.780 and financial

consultants’ mean rates at 2.525). Currently auditors disagree that they are accountable for

the cases mentioned above, with mean standing at 4.732 for Statement 15 and 5.634 for

Statement 16. As to the European Commission (2010b) such expectations could be based

on the need of better communication by auditors to stakeholders. One of the key issues

pointed in the Green Paper is the fact that users desire a very high level of assurance on the

components at the balance sheet date. Therefore, auditors are expected to provide a ‘true

and fair view’ by ensuring that ‘substance prevails over form’ (European Commission,

2010b). Additionally, it is expected that by challenging management from the users’ point

of view, which could be called as ‘professional scepticism’ and would express the proper

‘emphasis of matters’ in the audit report. Such action may also pay a significant part in the

fraud detection and prevention mechanism.


5 Discussion and conclusion

The purpose of this research is to evaluate to what extent the audit expectation gap

in relation to auditor’s responsibility and reliability, objective, duties in detecting and

reporting frauds and irregularities, and liability to the third parties in the Lithuanian

business environment. To be more specific, the goal of the research is to identify the

possible presence and the nature of the audit expectation gap among the auditors and

sophisticated users, namely bankers and financial consultants, of audited financial

statements in Lithuania.

Consistent with prior studies, the results of this research revealed substantial

evidence of the expectation gap in Lithuania on issues concerning auditors’ roles and

responsibilities. The results showed that 11 out of 16 statements provided empirical

evidence for audit expectation gap to exist. The study is designed and developed based on

the method used in Fadzly and Ahmad (2004), Lin and Chen (2004), Porter (1993) and

Monroe and Woodcliff (1994). The research question is addressed by four propositions.

The first proposition, testing whether perceptions in relation to the responsibility

and reliability of audited financial statements differ substantially among auditors and users

of financial statements, indicated that bankers and financial consultants have different

perception regarding auditors’ responsibility and reliability. The results show that 6 out of 7

statements addressing this issue indicate the gap. Bankers and financial consultants who

believed that there is the extent of assurance is clearly indicated in the audited financial

statements do not have the same understanding of auditors roles. Users of audited financial

statements do not trust and/or believe that auditors are objective and unbiased during the

engagement. Besides, the gap increases even more if you ask this person working in the

bank for a longer time period. In addition, bankers are the proponents of the view that

auditors are responsible of the soundness of the entity’s internal control structure. The study

also provides evidence that users of financial statements do not purely trust audited

financial statements, when it comes to companies monitoring, decision-making or

performance valuation. Bankers presented more severe view on these issues, which may be

the reflection of lessons which the bankers learned from the recent bankruptcies and

corporate failures. The findings related to proposition 1 are similar to the ones implied by

the studies of Hassink et al (2009) and Humphrey et al (1993), who evidenced that different


expectation towards responsibility and reliability are related to users having a greater

information asymmetry and lack of cost-benefit analysis. Fadzly&Ahmad (2004) also stress

that such findings imply miscommunication between users and auditors, which differently

perceive auditor’s explanation of high but not absolute level of assurance (IFAC: IAASB,

2004).

Proposition 2, addressing the perceptions concerning the objective of auditing differ

substantially among auditors and users of financial statements, reveals that Lithuanian

bankers and financial consultants tend to agree upon the auditors objectives. First of all, all

three groups of respondents shared the view that audit ensures fairness and completeness of

financial statements presentation, Additionally, the study evidenced the same understanding

among respondents as it implied in the regulations: perceived auditors responsibility when

obtaining reasonable assurance that the financial statements taken as a whole are free from

material misstatement, whether caused by fraud or error (IFAC: IAASB, 2009a). The

empirical evidence, however, showed that the disagreement exists whenever fraud and

other types of irregularities are addressed. The latter disagreement regarding fraud may

occur due to terms such as “reasonable”, “material”, “professional scepticism”, and

“brainstorming”, the meaning of which differs not only among users but also among

auditors (Zikmund, 2008).

Prior research reports that one of the main issues in audit expectation gap is the

obligation to detect and communicate errors, frauds, and irregularities in auditing practices

(McEnroe&Martens, 2001; Fadzly&Ahmad, 2004; Lin&Chen, 2004). According to the

third proposition addressing the perceptions concerning auditor’s duties in detecting and

reporting frauds and irregularities differ substantially among auditors and users of financial

statements in Lithuanian similar trend has been revealed. Users of audited financial

statements agree that the primary responsibility rest with entity’s management, however,

they also believe that auditors would disclose in their report any uncovered frauds,

inefficiencies irregularities hidden by the management. Answers received from auditors

imply the same trends.

Last but not least, the most significant gap in Lithuanian appears in relation to

auditors’ legal responsibility. The proposition 4 investigated the different perception

concerning auditor’s liability to the third parties in relations to auditors’ negligence and


audit failure among auditors and users of financial statements. As it was stated previously,

general public sees auditors as an independent body that may help to mitigate the risk

related to the investment into the company. Moreover, the public expects that auditors

should be liable for losses suffered by third parties owing to auditor negligence or audit

failure (Fadzly&Ahmad, 2004, Monroe and Woodcliff, 1994). Lithuanian bankers and

financial consultants expects auditors also to be legally responsible not only to shareholders

but to all other interested parties whose decisions are based on the audited financial

statements. Additionally, they (auditors) are expected to be blamed if the company after the

expression of unqualified opinion goes bankrupt and probably sued for the losses suffered

by the third parties.

Summing everything, the research indicated there are several over-expectations of

users of audited financial statements regarding the attest function. While external auditors

play a vital role, the deterrence and detection of fraud is, however, not only auditor’s

responsibility (NCFFR, 1987). According to the auditing standards, the primary

responsibility for fraud prevention and detection rests with the management of the company

(IFAC: IAASB, 2009a). An auditor, however, in accordance with ISAs is responsible for

‘obtaining reasonable assurance that the financial statements as a whole are free from

material misstatement, whether caused by fraud or error’ (IFAC: IAASB, 2009a). Global

trend, however, shows that external auditors on average were responsible for up to 5% of

fraud detection (ACFE, 2010). Lithuanian users, on the other hand, expressed diversified

view. The results indicated that bankers as well as financial consultants in Lithuania partly

agree with previously mentioned statement, however if the entity eventually goes bankrupt

auditors are the ones who are blamed for such default.

Additionally, the study provided some evidence that auditors themselves do not

have the same perceptions in relations to role and responsibilities of the auditors. The

analysis indicated that issues in relation to fraud prevention and detection, assurance and

usefulness of the audited financial statements are one of the most uncertain even for

auditors. This may be attributable to increased attention from the government and

regulatory bodies regarding this issue. Additionally, discussions and open debates

encouraged by the European Commission on the European level (European Commission,

2010b) on the role of auditors, governance and independence of audit firms as well as


stricter supervision of auditors in order to regain investors trust and confidence after the

corporate scandals and financial crisis does not add additional confidence to auditors’

perception.

In general the results indicate that there is extensive audit expectation gap in

Lithuania, mostly due to different expectations regarding fraud detection and legal

liabilities towards third parties involved. In line with prior research certain actions should

be considered in order to narrow this gap. Over-expectations of users of financial

statements regarding the functions of the auditor and lack of knowledge about auditor’s role

and responsibilities should be addressed properly.

Considering the analysis there are issues that the further research could analyse

deeper. Firstly, it would be valuable to expand the analysis over the CEE region or even the

whole EU; in other words, to evaluate whether similar audit expectation gap exists in

member states which follows the same legislation and regulation system. One more

interesting sphere is the analysis of the main contributing factors towards the extension or

narrowing the audit expectation gap extent. In addition to that, it would be valuable to study

the behaviour intention of company’s management to perform occupational fraud knowing

that external audit statistically reveals up to 5% of fraud (ACFE, 2010).

5.1 Limitations

One limitation is that only two groups of users of financial statements were included

in the sample and the distribution may not reflect the real proportion of these two groups in

Lithuania. Additionally, analysis is based on the 16 statements chosen to represent audit

expectation gap. There is a probability that different statements or different research

approached would resulted in different findings. This is one of the limitations of the

research which could be developed later on. The third limitation may be attributable to all

questionnaire studies with several factors playing a significant role. The factors include

socially desirable behaviour and a non-response bias (Hassink et al, 2009). Finally,

technical limitations of the research are related to surveys and time. The questionnaire was

placed in the Internet; however, other type of data collection could have brought additional

value.


6 Appendices

Table 10: Summary of ISAs (redrafted) issued by International Federation of Accountants (IFAC): International Auditing and Assurance Standards Board

No Issues covered

ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing

ISA 210 Agreeing the Terms of Audit Engagements

ISA 220 Quality Control for an Audit of Financial Statements

ISA 230 Audit Documentation

ISA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements

ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements

ISA 260 Communication with Those Charged with Governance

ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management

ISA 300 Planning an Audit of Financial Statements

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment

ISA 320 Materiality in Planning and Performing an Audit

ISA 330 The Auditor's Responses to Assessed Risks

ISA 402 Audit Considerations Relating to an Entity Using a Service Organization

ISA 450 ISA 450, Evaluation of Misstatements Identified during the Audit

ISA 500 Audit Evidence

ISA 501 Audit Evidence-Specific Considerations for Selected Items

ISA 505 External Confirmations

ISA 510 Initial Audit Engagements-Opening Balances

ISA 520 Analytical Procedures

ISA 530 Audit Sampling

ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures

ISA 550 Related Parties

ISA 560 Subsequent Events

ISA 570 Going Concern

ISA 580 Written Representations

ISA 600 Special Considerations-Audits of Group Financial Statements (Including the Work of Component Auditors)

ISA 610 Using the Work of Internal Auditors

ISA 620 Using the Work of an Auditor's Expert

ISA 700 Forming an Opinion and Reporting on Financial Statements

ISA 705 Modifications to the Opinion in the Independent Auditor's Report

ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report

ISA 710 Comparative Information-Corresponding Figures and Comparative Financial Statements

ISA 720 The Auditor's Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements

ISA 800 Special Considerations-Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks

ISA 805 Special Considerations-Audits of Single Financial Statements and Specific Elements, Accounts or Items of a


Financial Statement

ISA 810 Engagements to Report on Summary Financial Statements

ISQC 1 Quality Controls for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements


Table 11: Summary of accounting errors and fraud in a legal assessment of the Republic of Lithuania Code of Administrative Violations, EUR

Article Name Comment Fine

413 Illegal work A penalty shall incur to employers or their authorized persons for each person employed illegally

from 869 to 2,896

414 Infringement of the wage calculation and/or payment procedure

A penalty for employers or their authorized persons shall incur if there is: 1. Infringement of the wage calculation and/or payment procedure, established by the Republic of Lithuania Law on employment payment, collective agreement or a collective employment contract, not related the fault of the employee; 2. Intentional infringement of wage calculation and payment procedure, established by the Republic of Lithuania Law on employment payment, employment or collective agreement, or payment of wage and other employment-related benefits not included in the accounting records.

1. from 145 to 1,448 2. from 2,896 to 5,792

505 Violation of the shareholders, agricultural companies, cooperative societies' rights

A penalty shall incur to the Presidents of the Board , board members and executive heads if the following valuations are present: 1. Avoidance to call on time the meeting of the members of limited liability companies, including companies that operate as banks, agricultural companies, cooperative societies (cooperatives); 2. Incompliance with the meetings conduct procedures; 3. Obstruct the members of the agriculture companies, cooperative societies (cooperatives) attend the meetings; 4. Failure to present information r in accordance with the law to shareholders, agricultural companies, cooperative societies (cooperatives) or violation of non-property right as well as property rights as defined by the law

from 579 to 2,896

506 Creditors' rights violation

A penalty shall incur to administrators or managers of the companies and institutions if the violation of the creditors' rights appear (the fulfilment of the creditors' claims, failure to present the declaration of bankruptcy to court, failure to call the creditors' meeting in cases defined by the law)

from 1,448 to 2,896

1637 Mismatch of the money supply related to personal accounts or accounts not included into the cash register, as well as accounts included in the cash register

The penalty shall occur to: 1. Persons who are required to issue cash slip if there is a mismatch of the money supply by more than 20 LTL in enterprises, institutions and organizations where it is required to use cash-registers with people paying for goods and services in cash, mismatch including holding of personal or not included into cash-register money, as well as money included into cash-register; 2. Managers of enterprises, institutions, organizations or departments (branch) in case of the failure to take steps to ensure that cash records into the cash register as well as to ensure the accounts included in cash-register and cash on hand match the money supply in the enterprises, institutions and organizations which are required to use cash-registers with the residents paying for the goods or services in cash.

1. from 14 to 29 2. from 290 to 579


1721 Violation of the procedures and tax evasion based on reports and documents on individual, enterprises, institutions or organizations' income, assets, profits and taxes

The penalty shall occur to anyone who is engaged in infringement of the submission of the reports and documents about the individual, enterprise, institution or organization's income, assets, profits and taxes or submissions of incorrect data on income, assets, profits and taxes including reports and documents from individuals, institutions or organizations, senior executives and financiers (accountants), individual business owners, persons authorized to manage the affairs of partnerships, limited liability companies, agricultural and cooperative societies, State and Municipal Enterprises, companies in bankruptcy.

Warning or fine from 58 to 145

1731 Violation of accounting rules

The penalty shall occur to anyone who is engaged in: 1. Violation of the accounting transactions, money and material assets accounting rules 2. Negligent accounting treatment when it is paid for from thirty to fifty minimum subsistence level amounts (MSL) of tax that should have been paid under the law for the period being examined; 3. Deceptive accounting in order to hide or hiding from ten to fifty MSL tax rate, which had to be paid in accordance with the laws for the control period; 4. Negligent accounting treatment resulting into more than 50 MSL unpaid tax rate, which had to be paid in accordance with the laws for the control period; 5. Deceptive accounting in order to hide or hiding more than 50 MSL unpaid tax rate that should have been paid under the law for the period being examined

1. from 29 to 58 2. from 869 to 1,448 3. from 2,896 to 2,792 4. from 1,448 to 2,896 5. from 5,792 to 11,585

1733 Sale of goods without documents and forgery of documents

The penalty shall occur to anyone who is engaged in the sale of goods without document (excluding the retail sale), recording of false information into document, issue of such document, forgery of a document, and also intentional use of counterfeit document

from 29 to 1,448, including goods acquired without document or with falsified on confiscation

17311 Infringement of personal income tax payment

The penalty shall occur leaders (owners) and chief financiers of enterprises in case of violation of the personal income tax payment

from 290 to 869


Table 12: Accounting errors and fraud in a legal assessment of Republic of Lithuania: Law on the Approval and Entry into Force of the Criminal Code

Article

Name Comment Fine

182 Fraud The penalty shall occur to those who for its own or others benefit fraudulently acquired foreign asset or property right, avoided future liability or revoked it

Public works, fine, restriction of freedom or imprisonment for up to 3 years

183 Asset misappropriation

The penalty shall occur to those who appropriate foreign assets or property right entrusted to him or his possession.


186 Property damage caused by fraud

The penalty shall occur to those who was fraudulently reluctant to pay for work performed, goods and services received or was avoiding compulsory contributions, which in turn resulted into a large financial loss for the other person


220 False information on income, profits or assets

The penalty shall occur to those who in order to avoid taxes used knowingly false information about the company or its income, profits, assets in the tax declaration, other the approved report or other document and sent them to a competent authority

Withdrawal of the right to work in a job or pursue a particular business, fine, restriction of liberty, arrest or imprisonment of up to 3 years.

222 Deceptive record keeping

The penalty shall occur to anyone who fraudulently managed corporate accounts or hidden, destroyed or damaged accounting records, if it is not possible completely or partially establish the entity's economic, commercial, financial condition, results or evaluate the property,


223 Negligent record keeping

If it is not possible completely or partially establish the entity's economic, commercial, financial condition, results or evaluate the property, the penalty shall occur to those who had to handle, but did not manage the accounting in accordance with the law or negligently managed accounting, or was not guarded the accounting records for the time defined by the law


300 Document forgery or possession of a forged document

The penalty shall occur to anyone who has made a false document or forged it or kept, transported, shipped, and used knowingly false or falsified document

Fine, arrest or imprisonment of up to 3 years


Table 13: Survey questionnaire

Questions related to audit expectation gap4 1 2 3 4 5 6 7

1. An auditor conducting an audit is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error

2. An audit is to prevent and deter frauds or irregularities, inefficiency and wastage in clients’ operations

3. An audit is to ensure fairness and completeness of financial statement presentation

4. The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management.

5. Auditors should disclose in the audit report the uncovered frauds, inefficiency or irregularities reliability of financial statements hidden by management.

6. The auditor is legally responsible only to the shareholders of the audited company

7. Auditor is responsible if the company goes bankrupt due to fraud

8. Auditors are liable for losses of interested parties if failed to disclose potential fraud in audit report

9. The auditor is not responsible for the soundness of the internal control structure of the company

10. The auditor should be unbiased and objective while performing the engagement

11. The auditor should agree with the accounting policies used in the financial statements

12. The audited financial statements provide an assurance regarding the performance of the entity

13. The audited financial statements are useful for decision-making

14. The audited financial statements are useful in monitoring the company’s performance

15. The extent of assurance given by the auditors is clearly indicated in the audit report

16. The audited entity is free from fraud or/and other irregularities

4 Responses to the survey questions are donated on a Likert scale of 1 to 7, the lowest score representing the strongest agreement and the highest score standing for the strongest disagreement. Neutral view to each question is indicated by the score of 4.


Demographical information

Age ____________

Gender Female □ Male □

Area of work Banking □ Financial consultant □ Auditing □ Investor □ Other _________

Education Secondary □ Undergraduate studies □ Graduate studies □ Technical □ Other __________

Total work experience Less than a year □ From 1 to 5 year □ From 6 to 10 years □ From 11 to 15 years □ More than 16 years □ None □

Experience in auditing (if any) Less than a year □ From 1 to 5 year □ From 6 to 10 years □ From 11 to 15 years □ More than 16 years □ None □


Table 14: Descriptive statistics

Mean Std. Deviation Std. Error 95% Confidence Interval for Mean

Lower Bound Upper Bound Statement 1

Fin. consultants 1.625 0.705 0.111 1.400 1.850 Bankers 2.000 0.894 0.140 1.718 2.282 Auditors 1.268 0.585 0.069 1.129 1.406

Statement 2 Fin. consultants 4.300 1.572 0.249 3.797 4.803 Bankers 5.073 1.490 0.233 4.603 5.543 Auditors 3.563 2.353 0.279 3.007 4.120















Source: SPSS output. Descriptive statistics


TABLE 15: Anova test among three groups5

Mean diff.

Std. Error Sig.

95% Confidence Interval

Lower Bound

Upper Bound

Statement 1 Financial consultant Banker -.375 .158 .057 -.76 .01 Auditor .357* .141 .036 .02 .70

Banker Financial consultant .375 .158 .057 -.01 .76 Auditor .732* .139 .000 .39 1.07

Auditor Financial consultant -.357* .141 .036 -.70 -.02 Banker -.732* .139 .000 -1.07 -.39

Statement 2 Financial consultant Banker -.773 .436 .234 -1.83 .28 Auditor .737 .388 .178 -.20 1.68

Banker Financial consultant .773 .436 .234 -.28 1.83 Auditor 1.510* .385 .000 .58 2.44

Auditor Financial consultant -.737 .388 .178 -1.68 .20 Banker -1.510* .385 .000 -2.44 -.58

Statement 3 Financial consultant Banker .137 .343 1.000 -.69 .97 Auditor .555 .305 .213 -.18 1.29

Banker Financial consultant -.137 .343 1.000 -.97 .69 Auditor .417 .302 .509 -.31 1.15

Auditor Financial consultant -.555 .305 .213 -1.29 .18 Banker -.417 .302 .509 -1.15 .31

Statement 4 Financial consultant Banker -.981 .425 .067 -2.01 .05 Auditor -1.422* .378 .001 -2.34 -.51

Banker Financial consultant .981 .425 .067 -.05 2.01 Auditor -.441 .375 .726 -1.35 .47

Auditor Financial consultant 1.422* .378 .001 .51 2.34 Banker .441 .375 .726 -.47 1.35


Banker Financial consultant .816 .339 .052 .00 1.64 Auditor 1.172* .299 .000 .45 1.90








Statement 8 Financial consultant Banker -.321 .325 .975 -1.11 .47 Auditor -.587 .289 .132 -1.29 .11

Banker Financial consultant .321 .325 .975 -.47 1.11 Auditor -.266 .287 1.000 -.96 .43

Auditor Financial consultant .587 .289 .132 -.11 1.29 Banker .266 .287 1.000 -.43 .96

Statement 9 Financial consultant Banker -1.174* .276 .000 -1.84 -.51 Auditor -.460 .245 .188 -1.05 .13

Banker Financial consultant 1.174* .276 .000 .51 1.84 Auditor .715* .243 .012 .13 1.30

Auditor Financial consultant .460 .245 .188 -.13 1.05 Banker -.715* .243 .012 -1.30 -.13

5 Table 16 presents the ANOVA test. To test the hypothesis of equal means between more than two groups, an ANOVA test is to be applied. In the following a one-way ANOVA test shows, whether the perception of bankers and financial consultants in Lithuanian is equal to the one of auditors.


Table 15: Anova test among three groups (Continued)

Mean diff.

Std. Error Sig.

95% Confidence Interval

Lower Bound

Upper Bound

Statement 10

Financial consultant Banker .112 .341 1.000 -.71 .94 Auditor -1.034* .303 .003 -1.77 -.30

Banker Financial consultant -.112 .341 1.000 -.94 .71 Auditor -1.146* .301 .001 -1.87 -.42

Auditor Financial consultant 1.034* .303 .003 .30 1.77 Banker 1.146* .301 .001 .42 1.87

Statement 11

Financial consultant Banker -.418 .174 .053 -.84 .00

Auditor .157 .155 .938 -.22 .53

Banker Financial consultant .418 .174 .053 .00 .84 Auditor .574* .153 .001 .20 .95

Auditor Financial consultant -.157 .155 .938 -.53 .22 Banker -.574* .153 .001 -.95 -.20

Statement 12

Financial consultant Banker -.595* .196 .009 -1.07 -.12 Auditor -.206 .175 .721 -.63 .22

Banker Financial consultant .595* .196 .009 .12 1.07

Auditor .389 .173 .079 -.03 .81 Auditor Financial consultant .206 .175 .721 -.22 .63

Banker -.389 .173 .079 -.81 .03 Statement 13

Financial consultant Banker -.043 .207 1.000 -.54 .46 Auditor -.113 .184 1.000 -.56 .33

Banker Financial consultant .043 .207 1.000 -.46 .54 Auditor -.070 .182 1.000 -.51 .37

Auditor Financial consultant .113 .184 1.000 -.33 .56 Banker .070 .182 1.000 -.37 .51

Statement 14

Financial consultant Banker -.526 .391 .542 -1.47 .42 Auditor 1.577* .348 .000 .74 2.42

Banker Financial consultant .526 .391 .542 -.42 1.47 Auditor 2.102* .345 .000 1.27 2.94

Auditor Financial consultant -1.577* .348 .000 -2.42 -.74 Banker -2.102* .345 .000 -2.94 -1.27

Statement 15

Financial consultant Banker -.238 .363 1.000 -1.12 .64 Auditor -2.482* .323 .000 -3.26 -1.70

Banker Financial consultant .238 .363 1.000 -.64 1.12 Auditor -2.245* .320 .000 -3.02 -1.47

Auditor Financial consultant 2.482* .323 .000 1.70 3.26

Banker 2.245* .320 .000 1.47 3.02 Statement 16

Financial consultant Banker -.255 .344 1.000 -1.09 .58 Auditor -3.109* .306 .000 -3.85 -2.37

Banker Financial consultant .255 .344 1.000 -.58 1.09 Auditor -2.853* .304 .000 -3.59 -2.12

Auditor Financial consultant 3.109* .306 .000 2.37 3.85 Banker 2.853* .304 .000 2.12 3.59

Note: * -The mean difference is significant at the 0.05 level.5 Source: SPSS output. Summary of mean comparison test (Anova test)


Table 16: Auditors vs Users (Mean comparison)

Sum of Squares df

Mean Square F Sig.

1 Between Groups 11.329 1 11.329 21.749 .000 Within Groups 78.138 150 .521 Total 89.467 151

2 Between Groups 48.139 1 48.139 12.349 .001 Within Groups 584.749 150 3.898 Total 632.888 151








9 Between Groups .685 1 .685 .400 .528 Within Groups 257.183 150 1.715 Total 257.868 151

11 Between Groups 5.127 1 5.127 8.115 .005

Within Groups 94.761 150 .632 Total 99.888 151

12 Between Groups .341 1 .341 .414 .521 Within Groups 123.527 150 .824 Total 123.868 151

13 Between Groups .314 1 .314 .365 .546 Within Groups 128.949 150 .860 Total 129.263 151



16 Between Groups 335.878 1 335.878 140.417 .000

Within Groups 358.800 150 2.392 Total 694.678 151

Note: that “groups” means the difference between auditors and pooled results of users (bankers and financial consultants together) Source: SPSS output. Summary of mean comparison test


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