Expectation Gap

Question 1

Monday

Answer 1

#### Introduction
The audit report is the conclusion of the external audit process, where the auditor expresses their professional judgement on whether the financial statements present a “true and fair view.” This report is influenced by national legislation and International Standards on Auditing (ISAs), such as:
- ISA 700 (Revised): 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

The audit report serves as the primary direct communication between the auditor and the users of the financial statements, who are primarily, but not exclusively, the shareholders. However, there is often an “expectation gap” between what the public expects from an auditor and the auditor’s actual legal responsibilities.

Expectation Gap Explained:
The public’s perception of the auditor’s role and responsibilities often exceeds the auditor’s statutory duties. Some common misunderstandings include:
- The belief that the audit opinion is a “certificate” that the financial statements are entirely correct and can be used for all decision-making purposes.
- The assumption that auditors are responsible for preventing and detecting all fraud.
- The expectation that auditors test 100% of the transactions during the accounting period.

Misunderstanding 1: Audit Opinion as a Certificate
Imagine a company called “Techtronics Ltd.” The public might believe that because the auditor provided an unqualified opinion, all figures in Techtronics Ltd.’s financial statements are 100% accurate. However, the auditor’s opinion only indicates that, based on a reasonable level of assurance and the audit procedures performed, the financial statements are free from material misstatement.

Misunderstanding 2: Auditor’s Responsibility for Fraud
Consider a scenario where an employee at “Global Corp” commits fraud. The public might expect the auditor to have detected the fraud during their audit. However, the auditor’s role is to assess the risk of material misstatement due to fraud, not to uncover every instance of fraud.

Suppose an auditor tests transactions using a sampling method. If there are 10,000 transactions and the auditor decides to test a sample of 200 transactions (2% of the total), they use statistical techniques to extrapolate the results. If no errors are found in the sample, the auditor might conclude, with reasonable assurance, that the financial statements are free from material misstatement. However, this doesn’t guarantee that the remaining 9,800 transactions are error-free.

Let’s say the total monetary value of all transactions is $1,000,000, and the auditor tests a sample worth $20,000 (2%). If errors are found in the sample worth $1,000, the auditor might project the errors to the entire population:
[ \text{Projected Error} = \left( \frac{\text{Error in Sample}}{\text{Sample Size}} \right) \times \text{Total Population} = \left( \frac{1,000}{20,000} \right) \times 1,000,000 = 50,000 ]
The auditor might then conclude that potential errors in the financial statements could amount to $50,000.

By addressing the expectation gap and providing clear, practical examples, auditors can help users of financial statements better understand their roles and limitations. If you have any specific questions or need further clarification, let me know!