The expectation gap in auditing
Hian Chye Koh
There is concern that audi-
tors and the public hold
different beliefs about the
auditors’ duties and responsi-
bilities and the messages
conveyed by audit reports. In
recent years, some spectacu-
lar and well-publicised corpo-
rate collapses and the subse-
quent implication of the
reporting auditors have high-
lighted the audit expectation
gap. Apparently, public mis-
perceptions are a major
cause of the legal liability
crisis facing the accounting
profession. Given the signifi-
cance of the expectation gap,
it is not surprising therefore
that prior research on the
expectations problem is
substantial. The objective of
this paper is to review the
literature on the audit expec-
tation gap along the following
lines: definition of the expec-
tation gap; nature and struc-
ture of the expectation gap;
and ways to reduce the
expectation gap. It is hoped
that such an attempt can
provide insights into the audit
expectation gap.
Managerial Auditing Journal
13/3 [1998] 147–154
© MCB University Press
[ISSN 0268-6902]
Associate Professor, Nanyang Business School, Singapore
E-Sah Woo
Auditor, Price Waterhouse, Singapore
Introduction
The audit expectation gap has a long and
persistent history. There is widespread con-
cern with the existence of the “expectation
gap” between the auditing profession and the
public. The term “expectation gap” was first
applied to auditing by Liggio (1974). Since
then, cumulative evidence has increasingly
indicated the presence of an expectation gap
(Godsell, 1992). The expectation gap exists
when auditors and the public hold different
beliefs about the auditors’ duties and respon-
sibilities and the messages conveyed by audit
reports. Apparently, there is a gap between
what the public expects and what it actually
gets.
In recent years, the auditing profession has
been involuntarily placed in the spotlight,
particularly because of some spectacular and
well-publicised corporate collapses and the
subsequent implication of the reporting audi-
tors. As mentioned in Godsell (1992), there is
a widespread belief that a person who has any
interest in a company (shareholders, poten-
tial investors, take-over bidders, creditors
etc.) should be able to rely on its audited
accounts as a guarantee of its solvency, pro-
priety and business viability. Hence, if it
transpires, without any warning that the
company is in serious financial difficulty, it is
widely felt that somebody should be made
accountable for these financial disasters, and
this somebody is always perceived to be the
auditors. These misperceptions by the public
feed the legal liability crisis facing the
accounting profession (Maccarrone, 1993).
However, any “accountability vacuum” is not
something that can be placed on the auditors’
shoulders alone, for the nature and objectives
of auditing are differently perceived by differ-
ent parties (Lim, 1993).
Prior research on the expectations problem
is substantial. This is not surprising given
that the expectation gap between auditors
and financial statement users has existed for
the past 100 years although the term has been
introduced to the auditing scene only during
the last 20 years or so (Humphrey et al., 1992).
This paper aims to review the literature on
the audit expectation gap. The issues that
have been discussed in the literature can be
classified into three main categories:
1 definition of the expectation gap;
2 nature and structure of the expectation
gap; and
3 ways to reduce the expectation gap.
It is hoped that this paper can provide
insights into the audit expectation gap.
Definition of the expectation gap
The definition of the expectation gap varies
among researchers. Liggio (1974) was the first
to apply the phrase “expectation gap” to
auditing. He defined the expectation gap as
the difference between the levels of expected
performance “as envisioned by the indepen-
dent accountant and by the user of financial
statements”. The Cohen Commission (Com-
mission on Auditors’ Responsibilities, 1978)
extended this definition by considering
whether a gap may exist between what the
public expects or needs and what auditors
can and should reasonably expect to accom-
plish.
Monroe and Woodliff (1993) defined the
audit expectation gap as the difference in
beliefs between auditors and the public about
the duties and responsibilities assumed by
auditors and the messages conveyed by audit
reports. Jennings et al. (1993), in their study
on the use of audit decision aids to improve
auditor adherence to a “standard”, are of the
opinion that the audit expectation gap is the
difference between what the public expects
from the auditing profession and what the
profession actually provides. This definition
is also advocated by Lowe (1994) in his
research on the expectation gap in the legal
system.
Porter (1993) did an empirical study of the
audit expectation-performance gap and
defined the expectation gap as the gap
between society’s expectations of auditors
and auditors’ performance, as perceived by
society. It is seen to comprise two
components:
1 reasonableness gap (i.e. the gap between
what society expects auditors to achieve
and what the auditors can reasonably be
expected to accomplish); and
[ 147 ]
Hian Chye Koh and E-Sah Woo 2 performance gap (i.e. the gap between
The expectation gap in what society can reasonably expect audi-
auditing tors to accomplish and what auditors are
Managerial Auditing Journal perceived to achieve).
13/3 [1998] 147–154
The performance gap is further subdivided
into “deficient standards” (i.e. the gap
between the duties which can reasonably be
expected of auditors and auditors’ existing
duties as defined by the law and professional
promulgation), and “deficient performance”
(i.e. the gap between the expected standard of
performance of auditors’ existing duties and
auditors’ performance, as expected and per-
ceived by society).
As with the definition of expectation gap,
there are also different underlying explana-
tions offered for the continuing presence of
the expectations problem. Tricker (1982)
viewed the expectation gap as the result of a
natural time lag in the auditing profession
identifying and responding to continually
evolving and expanding public expectations.
Other authors argued that it is the conse-
quence of the contradictions in a self-
regulated audit system operating with mini-
mal government intervention (see Hopwood,
1990; Humphrey, 1991; Humphrey et al., 1992;
Sikka et al., 1992). They based this view on a
number of studies that have found that users
of financial statements generally hold reason-
able expectations of auditors’ abilities and
the nature of the audit assurances (e.g. Cana-
dian Institute of Chartered Accountants
(CICA), 1988) and on the fact that some of
these issues have persistently dominated the
expectations literature.
Nature and structure of the
expectation gap
Empirical studies on the nature and struc-
ture of the expectation gap aim to elicit the
actual as well as the perceived roles and
responsibilities of auditors and attempt to
uncover the factors contributing to the expec-
tation gap.
Most of the studies ascertain the auditors’
and the public’s view of the roles and respon-
sibilities of auditors through the use of ques-
tionnaire surveys. In the USA, Baron et al.
(1977) examined the extent of auditors’ detec-
tion responsibilities with respect to material
errors, irregularities and illegal acts. They
attempted to establish whether there are any
differences in the perceptions regarding
auditors’ detection and disclosure duties
between the auditors and users of accounting
reports (financial analysts, bank loan officers
and corporate financial managers). They
found that auditors and users of accounting
reports have significantly different beliefs
[ 148 ]
and preferences on the extent of auditors’
responsibilities for detecting and disclosing
irregularities and illegal acts. In particular,
users held auditors to be more responsible for
detecting and disclosing irregularities and
illegal acts than the auditors believed them-
selves to be.
Jennings et al. (1991) asserted that auditor
liability depends on the attitudes of judicial
litigants towards the auditing profession. In a
slightly different perspective and in an
attempt to contemplate how an expectation
gap could have legal implications for the
profession, Lowe (1994) compared the percep-
tions of auditors and judicial litigants regard-
ing their expectations of the auditing profes-
sion. It was found that an expectation gap
exists between the auditors and judicial liti-
gants and that judges systematically expect
more from auditors than auditors believed
they provide.
Epstein and Geiger (1994), conducted a
survey of investors to gather information on
various aspects of financial reporting issues,
in particular on the level of assurance they
believed auditors should provide with respect
to error and fraud. The survey results sug-
gested that investors seek very high levels of
financial statement assurance and there
exists an expectation gap between auditors
and investors on the level of assurance an
audit provides.
In the UK, Humphrey et al. (1993) examined
the expectation gap by ascertaining the per-
ceptions of individuals of audit expectations
issues through the use of a questionnaire
survey comprising a series of mini-cases. The
issues investigated include the following:
what is and should be the role of the auditor?
What should be the prohibitions and regula-
tions placed on audit firms? And what deci-
sions could auditors be expected to make?
The respondents included chartered accoun-
tants in public practice, corporate finance
directors, investment analysts, bank lending
officers and financial journalists. The survey
revealed a significant difference between
auditors and the respondents (representing
some of the main participants in the company
financial report process) in their views on the
nature of auditing. The results confirmed
that an audit expectation gap exists, specifi-
cally in areas such as the nature of the audit
function and the perceived performance of
auditors. The critical components of the
expectation gap were found to include audi-
tors’ fraud detection role, the extent of audi-
tors’ responsibilities to third parties, the
nature of balance sheet valuations, the
strength of and continuing threats to audi-
tors’ independence, and aspects of the
Hian Chye Koh and E-Sah Woo
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conduct of audit work (e.g. auditors’ ability to
cope with risk and uncertainty).
Chandler et al. (1993) looked at the various
aspects of the development of the audit func-
tion in the UK and sought to explore the
nature of auditors’ responsibilities and the
public’s perception of the auditors’ role. A
review of the evolution of audit objectives
over the period 1840 to 1940 suggested that
statement verification was the primary con-
cern of auditors in relation to public compa-
nies in the period 1830 to 1860, after which
more emphasis was placed on fraud detection
in the late nineteenth century. In the early
part of this century, the primary audit objec-
tive reverted to statement verification. The
study showed that audit objectives and prac-
tices tend to follow external events and that
the profession has encountered great diffi-
culty in reconciling public expectations with
the practicalities of auditing. It also
suggested that general confusion over the
role of auditors has existed to such an extent
that it has been difficult even for the profes-
sion to reach agreement on the main purpose
of company auditing and the message to be
sent to the investing public.
In a similar context, Low (1980) examined
the expectation gap in Australia. The extent
of auditors’ detection and disclosure respon-
sibilities concerning errors, irregularities
and illegal acts as perceived by auditors and
non-auditor groups was investigated. It was
found that both groups differed significantly
in their perceptions of the extent of auditors’
detection and disclosure responsibilities, and
that an expectation gap existed between the
two groups. This finding is consistent with
that of Beck (1974), who reported that share-
holders had higher expectations of auditors
than what most auditors would consider
reasonable.
Porter (1993) conducted an empirical study
in New Zealand to test the postulated struc-
ture of the audit expectation-performance
gap and to establish the composition and
extent of the gap and its constituent parts.
The research is an extension of those con-
ducted by Lee (1970) and Beck (1974), who
investigated the duties which auditors were
expected to perform in the late 1960s in
Britain and early 1970s in Australia, respec-
tively. Using a mail survey, Porter ascertained
the opinions of auditors’ interest groups
(auditors, officers of public companies, finan-
cial analysts, auditing academics, lawyers,
financial journalists and members of the
general public) regarding auditors’ existing
duties, the standard of performance of these
duties, and the duties that auditors should
perform. The findings from the survey
revealed that 50 per cent of the gap is
attributable to deficient standards, 34 per cent
from society holding unreasonable expecta-
tions of auditors and 16 per cent from per-
ceived sub-standard performance by audi-
tors.
Cameron (1993) explored the relationship
between public accountants and their small
business clients in New Zealand by seeking
the opinions of public accountants, small
businesses and associated third parties
(bankers, business consultants and enter-
prise agencies) with respect to the roles that
auditors are expected to perform and those
that they actually perform. The results
revealed that the three groups expected audi-
tors to provide compliance services, give
accounting-related advice, show concern for
clients’ financial health, actively seek out
client problems, and give general business
advice. Auditors were perceived as actually
providing all of the services expected of them
except the service of actively seeking out
client problems. In relation to the other func-
tions, the actual performance of chartered
accountants was generally perceived to fall
below the expected levels.
McInnes (1994) reviewed Gloeck and Jager’s
(1993) study on the audit expectation gap in
the Republic of South Africa and found three
areas (independence of auditors; role of audi-
tors, in particular relating to fraud and going-
concern issues; and compulsory audit of
small owner-managed companies) in which
an expectation gap exists between auditors
and non-auditors.
In Singapore, Low et al. (1988) examined the
extent of the expectation gap between audi-
tors and financial analysts on the objectives
of a company audit. The results indicated that
both groups perceived the traditional objec-
tive of the audit (i.e. expressing an opinion on
financial statements) as one of the primary
audit objectives. However, besides this objec-
tive, respondents possessed an array of
beliefs as to what they considered as audit
objectives. Financial analysts perceived an
audit as setting a seal on the accuracy of the
financial accounts of the company. Further,
their perceptions of fraud prevention and
detection responsibilities of auditors are
more demanding than those that the auditors
believed they themselves should possess.
As can be seen from the literature review,
evidence of the existence of an audit expecta-
tion gap is substantial.
Reducing the expectation gap
Public accounting firms have been the targets
of litigation for decades. This reflects a
change in public opinion concerning the role
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[ 150 ]
of auditors (American Institute of Certified
Public Accountants, 1984; Dopuch and King,
1992; Guy and Sullivan, 1988), resulting in a
wider expectation gap between the public and
the audit profession. In an attempt to narrow
the gap, various approaches have been exam-
ined and suggested by researchers and profes-
sional bodies.
Expanded audit report
Several studies have investigated the mes-
sages communicated by audit reports and the
public expectations of auditors. These studies
are based mostly in the USA, UK and Aus-
tralia. In the USA, Nair and Rittenberg (1987)
concluded that users’ perceptions about the
relative responsibilities of management and
auditors are changed with an expanded audit
report. Kelly and Mohrweis (1989) also found
that users’ perceptions of the nature of an
audit were significantly changed by wording
modifications in audit reports. Miller et al.
(1990) reported that bankers found expanded
audit reports to be more useful and under-
standable than the short form reports. In
general, these studies provided evidence that
an expanded audit report gives a fuller under-
standing of the scope, nature and significance
of the audit and influences the reader’s per-
ceptions concerning the audit and the audi-
tor’s role. That is, an expanded audit report
has reduced the audit expectation gap in one
way or another.
In the UK, Holt and Moizer (1990) found that
accountants and sophisticated users differ in
their perceptions of the meaning of audit
reports. In a slightly different context, chang-
ing the wording of the auditor’s report
resulted in different perceptions of the mean-
ing of audit reports for 140 part-time MBA
students. In Hartherly et al.’s (1991, 1992)
studies, however, the perceptions of manage-
ment’s and auditors’ responsibilities were not
significantly influenced by the modified
wording.
Hanks (1992) expressed concern about the
level of assurance that investors may assume
from the financial reports. He suggested that
the audit report should be expanded to con-
vey more specifically what an audit entails
and implies. Also the public should be edu-
cated on the meaning of the audit report and
the scope of work required to express an opin-
ion.
In Australia, Gay and Schelluch (1993)
found that audit reports based on the revised
Statement of Auditing Practice AUP 3 has
significantly increased users’ understanding
of the audit process, the auditor’s role, the
nature and limitations of financial reports
and, to a lesser extent, the directors’ responsi-
bility for material errors and the basis of
forming an audit opinion. Monroe and
Woodliff (1994) also studied the impact of the
wording changes in the revised AUP 3 on the
expectation gap. Their findings confirm the
existence of an expectation gap between audi-
tors and various user groups under the old
report. However, the modified wording in the
revised AUP 3 has a significant impact on the
beliefs about the nature of an audit and the
auditors’ and management’s responsibilities.
The researchers suggested that wording
changes in the audit report that address the
specific areas of the expectation gap should
be considered in closing the gap.
Education
Some studies have found evidence to support
the belief that knowledge of the users influ-
ences the size of the expectation gap. Hence,
some researchers advocate education in nar-
rowing the expectation gap. Bailey et al. (1983)
did a study in the USA, and found that more
knowledgeable users placed less responsibil-
ity on auditors than less knowledgeable
users, implying that a larger gap exists
between auditors and less sophisticated
users. Similarly, Epstein and Geiger (1994)
found that more educated investors (with
respect to accounting, finance and investment
analysis knowledge) are less likely to demand
higher auditor assurance. Hence, they pro-
posed that one way to narrow the expectation
gap is through increased public awareness of
the nature and limitations of an audit. And to
increase users’ knowledge and awareness it is
important to communicate the merits and
limitations of an audit at every available
chance (e.g. shareholder meetings). Another
way is have the audit report explicitly indi-
cating reasonable assurance. But Epstein and
Geiger (1994) noted that the fundamental role
of an audit in society must be re-examined by
both the audit profession and financial users
and they must all agree to close the gap.
Monroe and Woodliff (1993) examined the
effect of education on students’ perceptions of
the messages communicated through audit
reports in Australia. The research instru-
ment was administered to two groups of stu-
dents (final-year auditing students and final-
year marketing students) at the beginning
and end of a semester and to auditors. It was
found that auditing students’ beliefs about
the responsibilities of auditors, reliability of
financial information and assurance about
the future prospects of the company changed
significantly over the semester. At the end of
the semester, they believed that auditors
assume a much lower level of responsibility,
financial information is more reliable, and
less assurance is placed on the company’s
future prospects as conveyed by the audit
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report. Hence, the results suggest that educa-
tion may be an effective approach to narrow
the expectation gap. However, the study added
that further research is needed to reveal the
quantity and content of public education
required to educate financial information
users about the nature of auditing.
In another study, Monroe and Woodliff
(1994) reported that differences in percep-
tions between sophisticated users and audi-
tors were smaller than that of unsophisti-
cated users (in particular, shareholders and
students) and auditors. Again, they suggested
education as a means to increase the sophisti-
cation level of user groups in order to reduce
the audit expectation gap.
Structured audit methodologies
Increased use of auditor decision aids is one
of the responses made by some audit firms to
narrow the expectation gap with the hope of
eventual reduction in the legal liability of
auditors. By adopting more structured meth-
ods of operation, these firms hope that consis-
tently high-quality audits can be rendered.
Purvis (1987) looked into the effectiveness of
using structured and semi-structured meth-
ods of data collection and concluded that the
imposition of structure can have functional
and dysfunctional aspects. Likewise, Boritz et
al. (1987) also concluded that structured audit
methodologies do not lead to greater intra-
firm consensus. Jennings et al. (1993) empiri-
cally addressed the legal impact of the
increased use of audit decision aids and
structured audit approaches in the audit
environment. Findings revealed that decision
aids are used as surrogate standards of the
auditors by jurists. That is, jurists do accept
and use audit decision aids as a method to
increase or at least maintain auditing stan-
dards.
Expansion of auditor’s responsibilities and
enhancement of auditor independence
Humphrey et al. (1993) also suggested other
ways to close the expectation gap. They stated
that it is no good expecting the public to aban-
don their hope of auditors as fraud detectives
through education, or modifying the length of
the audit report, or pretending that highly
publicised audit failures are exceptions.
Instead, they offered three suggestions: set-
ting up an independent office for auditing to
enhance auditor independence by overseeing
the appointment of auditors of large compa-
nies and to regulate audit fees; extending
auditors’ responsibilities by statute so that
they clearly include responsibilities to share-
holders, creditors and potential shareholders;
and clarifying that auditors have a duty to
detect fraud. However, the magnitude of the
expectation gap and the costs and benefits of
these suggested solutions need to be carefully
assessed before any solution is implemented.
O’Malley (1993) also agreed to imposing
additional responsibilities on auditors, espe-
cially with regard to detecting fraud. He pro-
posed four additional responsibilities which
the profession might consider: management
and auditor evaluation of internal control
systems; compliance reporting; direct report-
ing by auditors to regulators; and auditor
association with interim financial informa-
tion. However, he stated that these proposals
will increase the threat of liability unless the
liability crisis is dealt with. Any expansion of
auditors’ responsibilities will not be feasible
as long as the liability system operates as a
risk transfer mechanism, with auditors as
the prime transferees. Lochner (1993) also
believed that it is not fair to expect auditors
to resume more responsibilities without
sufficient insurance provided to them against
possible litigation.
Knutson (1994) proposed a standard for
addressing the expectation gap. His opinion
is that the fairest standard is to hold auditors
responsible for what they should have known,
and not to the impossibly high standard of
what they could have known. Furthermore,
the reliance of the audit report should not be
restricted only to the board of directors and
shareholders but to potential shareholders as
well. Similarly, Rabinowitz (1996) noted a few
deficiencies in the audit process which have
resulted in the reduction of public confidence
in the profession. The solutions to compen-
sate for these deficiencies are: enhancing the
control structures surrounding top managers
and executives; matching auditors in terms of
experience and training to the entities being
audited; increasing internal-external audit
interaction; revising employment practices;
developing more effective audit procedures;
and strengthening audit committees.
In a research study on financial reporting
and auditing undertaken jointly by the Aus-
tralian Society of Certified Practising
Accountants and The Institute of Chartered
Accountants in Australia in 1994, the working
party reviewed the recommendations of pre-
vious studies in other countries and came up
with some solutions to close the expectation
gap. These include the following: the manage-
ment of reporting entities should be required
to report on the effectiveness of its internal
control over financial reporting and auditors
should report on this assertion; a review
partner should be appointed for the audit of
all reporting entities and he/she should coun-
tersign the audit report; and all reporting
entities should be required to produce
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[ 152 ]
audited half-yearly and quarterly financial
reports.
Others
Porter (1993) provided new insights into the
structure, composition and extent of the audit
expectation-performance gap and advocated
that her research signalled a rational and
comprehensive approach towards narrowing
the gap. She suggested that once the public
criticise auditors’ performance of (or absence
of performance of) a duty, the duty in ques-
tion should be analysed to identify which
component of the gap (i.e. deficient standards,
deficient performance or unreasonable expec-
tations) it represents. Appropriate corrective
action should then be implemented. The
study urged the profession to adopt this
approach in order to narrow the audit expec-
tation-performance gap.
Conclusion
The concept of an audit expectation gap sug-
gests that the public expects auditors to act in
ways which are different from what auditors
themselves would expect to act. In the studies
mentioned above, users generally have a
higher expectation of audits and auditors that
what most auditors would consider reason-
able (e.g. Epstein and Geiger, 1994). That is,
the auditor is perceived by non-auditors more
as a policeman than a reporter of the state of
a company’s affair.
This has contributed to the increased scale
and frequency of litigation against auditors.
The persistence of a damaging expectation
gap is not new and it seems to be growing to
the detriment of the profession’s standing
with the public (Chandler et al., 1993).
Responses to a potentially widening expecta-
tion gap have come from both researchers
and the accounting profession. Researchers
are concerned with investigating the factors
contributing to the expectation gap and
proposing solutions to narrow the gap (e.g.
Humphrey et al., 1993). Some researchers
have also examined the effectiveness of
certain solutions in narrowing the gap (e.g.
Jennings et al., 1993; Monroe and Woodliff,
1993).
The accounting profession in various coun-
tries have attempted to address the expecta-
tion gap and public criticism and increase
audit quality by various approaches. In the
USA, for example, the profession attempted to
narrow the gap by adopting nine new expec-
tation gap auditing standards in 1988. In the
UK, the Auditing Practices Board (APB)
responded to the expectation gap by promot-
ing debate regarding the role and scope of the
audit in view of changing expectations (APB,
1992), expanding the standard audit report
(APB, 1993a), and discussing the differences
between the various services provided by
auditors (APB, 1993b).
In Australia, the Auditing Standards Board
(AuSB) enhanced and clarified the status of
the statements of auditing practice (AUPs) by
reissuing all AUPs as standards. In New
Zealand, a new standard AS-10 was issued in
1994 as a step towards reducing the expecta-
tion gap. The new standard favours the long
form report, is consistent with the Financial
Reporting Act 1993, and eliminates the “sub-
ject to” audit opinion.
In Singapore, the Institute of Certified Pub-
lic Accountants of Singapore (ICPAS), in the
pursuit of quality in auditing and enhance-
ment of auditors’ reputation, implemented
the practice review programme. This is
implemented by examining a cross-section of
audit files in every practice at least once in
every three years. The appointment and roles
of the audit committee were also enhanced to
improve transparency, the standard of
accountability and corporate governance
under the new chapter 9B in the SES (Stock
Exchange of Singapore) listing manual.
To conclude, researchers and the account-
ing profession have responded, in one way or
another, to the expectation gap. However, it
must be noted that the expectation gap arises
from a combination of excessive expectations
and insufficient performance (Knutson,
1994). Steps must be taken to lower the pub-
lic’s expectations as well as to improve the
auditors’ performance. Misconceptions and
differences in expectations will persist unless
effective and timely solutions are imple-
mented. Given the current situation, it is
likely that the audit expectation gap will
continue to be a major concern for many
more years to come.
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