Do you know what happens during an audit? Many of us don’t, which is where the concept of the expectation gap in auditing comes into play. Investors, lenders, and business owners often believe it’s the auditor’s responsibility to uncover accounting irregularities and fraud. But this isn’t necessarily the case. Here’s how to manage those expectations and close the gap.
What is the expectation gap?
The audit expectation gap arises as a fundamental difference between what the general public expects from auditing and what a financial audit actually involves. In some cases, this gap isn’t the result of a lack of auditing knowledge, but more from what the public wishes auditors would do. In either of these cases, there’s a gap between expectation and reality.
The problem with this gap is that it leads to concern about the auditing process in general. One of the most common expectations businesses have is that the auditing process will uncover financial irregularities or instances of fraud in their statements. But this isn’t necessarily the role of an audit, which comes with its own limitations. As a result, a business owner might be unhappy that the audit isn’t as far-reaching or comprehensive as expected.
Expectation gap examples
As we’ve touched on above, a few different situations could be used as expectation gap examples:
Knowledge gap – this describes situations when the entity being audited doesn’t understand what happens during an audit and is unaware of the usual policies and procedures.
Performance gap – this describes the difference between the types of tasks the public believes the auditor is required to perform and the level of work that auditing standards actually require.
Liability gap: this type of expectation gap describes misunderstandings regarding an auditor’s legal liability, as in the case of detecting fraudulent activity.
Some gaps focus more on the audit quality, while others are centered on the interpretation of generally accepted auditing standards (GAAS). Each of these expectation gap examples must be handled slightly differently.
Understanding the role of the auditor
Auditors must operate according to GAAS standards and regulations. These come with certain limitations. One example is the use of sampling, in which an auditor tests a subset of transactions rather than testing all financial records. This opens up the possibility that the sample doesn’t reflect the full financial picture, which the audited firm might believe is being explored.
An auditor will often use his or her judgment during the audit process, taking evidence into account. However, if this evidence is inconclusive, their assessment may not be entirely correct.
These limitations are part of what drives the expectation gap in auditing. No audit is entirely infallible, so in most cases, audits won’t uncover all irregularities in financial statements. This is where things can go wrong. Investors might sue the auditor over a loss suffered due to audited financial statements, but audited statements aren’t always 100% free from liability.
How to manage the audit expectation gap
Managing the expectation gap is an ongoing discussion in the industry, but there are some ways to help close it. It’s helpful to look at both the knowledge and performance components of this gap. Audit professionals can educate stakeholders about an auditor’s specific responsibilities, clarify the details of the role, and point them in the direction of GAAS regulations.
Writing a letter of engagement helps spell this out before the audit process begins. This document should be carefully read and signed by all parties. Written documents of this nature explain that detecting and preventing fraud is the role of company management, as auditors will only find the irregularities that materially impact financial statements. Overall, clear communication is the best way to close the expectation gap.
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