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The theories of audit expectations and the expectations gap

Title: The theories of audit expectations and the expectations gap

Seminar Paper , 2007 , 12 Pages , Grade: 75% (1,0)

Autor:in: Ecaterina Volosin (Author)

Business economics - Miscellaneous
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Summary Excerpt Details

This essay deals with the demand for audit functions and the resulting expectations in auditors’ work. The credibility of mandated disclosure of financial statements is the central issue for regulatory bodies attempting to protect the public interest. This requirement gives rise to a demand for auditing services. Since the beginning of the audit profession theories were made in order to specify and determine the audit functions. The ‘agency-theory’ is associated with the conflicting interests of shareholders and management of a company, suggesting that the less-informed party (shareholders) will have a demand for information that monitors the behaviour of the better-informed manager. Thus, audits of financial reports would be one form of such information, providing the shareholders with independent assurance about the ongoing developments. The ‘lending credibility theory’ is similar to the agency-theory and states that audited financial statements can enhance stakeholders’ faith in management’s stewardship. Another theory is the ‘theory of inspired confidence’, whereby stakeholders demand accountability from the management as an exchange for their contribution to the company. The last discussed theory is the ‘policeman theory’ which narrows auditor’s responsibilities to prevention and detection of fraud. All these theories describe the expectations the stakeholders have of the auditors, including protection against fraud, warning of future insolvency, general reassurance of financial well-being, safeguards for auditor independence and understanding of audit reports. Although these expectations seem to be rather natural, however, an audit expectations gap does exist based mostly on the diversity of views about the audit function. The gap exists between what the public expects the auditor to do and what the auditor can and should do. Several suggestions were made to narrow the expectations gap, as well as providing statutes in order to describe audit functions especially concerning the responsibility to detect and report errors and fraud.

Excerpt


Table of Contents

1. Introduction

2. The Demand for Auditing

3. Audit Expectations and the Expectations Gap

4. Conclusion

Research Objective and Core Themes

The primary objective of this paper is to illustrate the nature of audit expectations and explore the underlying causes of the audit expectations gap, specifically focusing on the divergent interests of various stakeholders and the role of auditors in society.

  • The historical development and theoretical foundations of audit functions.
  • The relationship between information asymmetry and the demand for independent auditing.
  • Analysis of the expectations gap between public perception and professional auditor responsibilities.
  • Strategies and measures for narrowing the gap in audit accountability and performance.

Excerpt from the Book

Audit Expectations and the Expectations Gap

The theory of Limperg stated that the auditor, while performing his tasks, “should be governed by rational expectations of those who may use the audit report” (Soltani, 2007). In the early 1940s the audit was required to be performed according to the generally accepted auditing standards, but the US Securities and Exchange Commission (SEC) also allowed the accounting profession to set these standards. Then, the audit profession was believed to prevent and detect fraud. From that time up to the present, the auditor’s duties developed from accurate examination of every transaction to testing only a sample of a company’s transactions. In other words, the auditor’s responsibilities shifted from fraud detection towards the verification of the true and fair view of the financial statement (Porter, 1997). This development caused many discussions about audit expectations among auditing circles, discussions also concerned the so-called “expectations gap”.

The term was first introduced in 1974 by Liggio meaning the difference between the levels of expected performance as defined by the independent accountants and by the users of financial statements. Thus, the gap between performance and expectation does exist, and it is not just the ignorance of users of the audit information, for they generally have reasonable expectations of the auditor’s abilities. Tweedie (1987) specified public expectations as follows: “The public appears to require (1) a burglar alarm system (protection against fraud)...(2) a radar station (early warning of future insolvency)...(3) a safety net (general re-assurance of financial well-being)...(4) an independent auditor (safeguards for auditor independence)...and (5) coherent communications (understanding of audit reports)”.

Summary of Chapters

1. Introduction: Outlines the essential role of auditing in public interest and introduces the research aim of illustrating audit expectations amidst conflicting stakeholder demands.

2. The Demand for Auditing: Explores the economic and theoretical justifications for auditing, including agency theory, the lending credibility theory, and the information hypothesis.

3. Audit Expectations and the Expectations Gap: Examines the evolution of auditor responsibilities and analyzes the persistent gap between what the public expects and what auditors are legally required to deliver.

4. Conclusion: Summarizes the necessity of the audit function in the business world and suggests that defining roles more clearly could mitigate future liabilities and public misunderstanding.

Keywords

Auditing, Audit Expectations Gap, Agency Theory, Information Asymmetry, Financial Statements, Auditor Independence, Fraud Detection, Corporate Governance, Stakeholders, Public Interest, Professional Accountability, Audit Quality, Stewardship Hypothesis, Lending Credibility Theory, Policeman Theory

Frequently Asked Questions

What is the primary focus of this research?

The paper examines the fundamental role of auditing, the theoretical justifications for the demand for audit services, and the nature of the "expectations gap" between the public and the audit profession.

Which theoretical frameworks explain the demand for auditing?

The work discusses the agency theory, the lending credibility theory, the information hypothesis, the insurance hypothesis, the theory of inspired confidence, and the policeman theory.

What is the audit expectations gap?

It refers to the discrepancy between the level of performance expected by the users of financial statements and the performance as defined or delivered by the accounting profession.

How does information asymmetry influence auditing?

Information asymmetry occurs when managers possess more information than shareholders, creating a need for an independent auditor to add credibility to financial reports and reduce conflict.

What is the main finding regarding auditor responsibility for fraud?

While the public often expects auditors to detect all fraud, the paper notes that auditors have responsibilities to consider fraud, but they do not have an absolute duty to detect every instance of it.

Which keywords characterize this study?

Key terms include Audit Expectations Gap, Agency Theory, Information Asymmetry, Auditor Independence, and Fraud Detection.

How has the role of the auditor evolved since the 1940s?

The role has shifted from a focus on the detailed examination of every transaction to a sampling-based approach emphasizing the verification of the "true and fair view" of financial statements.

What measures are suggested to bridge the expectations gap?

Proposals include broadening audit responsibilities in fraud detection, strengthening independence, improving audit reporting, and increasing public education regarding the limitations of audits.

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Details

Title
The theories of audit expectations and the expectations gap
College
University of Glamorgan  (Business School)
Course
Issues in Auditing
Grade
75% (1,0)
Author
Ecaterina Volosin (Author)
Publication Year
2007
Pages
12
Catalog Number
V116911
ISBN (eBook)
9783640192045
ISBN (Book)
9783640192311
Language
English
Tags
Issues Auditing
Product Safety
GRIN Publishing GmbH
Quote paper
Ecaterina Volosin (Author), 2007, The theories of audit expectations and the expectations gap, Munich, GRIN Verlag, https://www.grin.com/document/116911
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