Understanding financial metrics and business risk, Financial Management

Controlling is an essential management function as efficient control mechanisms ensure that the performance of the company increases over time through the incorporation of feedback in strategic planning process. One of the most basic tools for analyzing the performance of any company is the trend analysis of the key ratios of the company.

Auditor not being able to detect the fraud going on the company has always been of lot debate in the corporate world. This paper is about TOY LOCAL ltd which was involved in accounting scandal and it auditor Deloitte was in center of huge controversy as it was not able to detect the whole gap.(The Audit-Expectation Gap, 2011) It is very important to understand that audit expectation gap has been of huge debate and TOY LOCAL ltd is a critical and important example of the same. TOY LOCAL had a inbuilt accounting system which was incapable of recording foreign transactions properly and foreign exchange transactions were conducted in an environment which had bad internal control problems. (Financial Fraud- AWA Ltd)

There are certain components of audit expectation gap. These components are:

: This gap exists because of what society expects the auditor to achieve and what actually auditor can achieve. This gap arises due to miscommunication, less education, less information about the audit process. In short limitations of the audit findings are not properly communicated.

: All audit process is governed by standards and in some cases there are no standards to map with. This deficiency in mapping due to unavailability of enough standards can create one component of the gap.

: This gap is of serious nature and the auditor can be blamed for this part of the gap. As an auditor of the firm certain standards need to be maintained and any loop hole in such methods and standards will led to performance of the audit going down and quality of audit being hampered. This component of the gap is termed as performance gap. (The Audit-Expectation Gap, 2011)

Audit expectation gap is the gap between the kind of audit service provided by the auditor and the kind of audit service and standards expected by the public. Expectations of the public are very high from the auditors and there are serious gap on the delivery side. This is the reason the identified gaps are termed as Audit expectation gap. (The Audit-Expectation Gap, 2011)In case of TOY LOCAL there were some inherent problems which were also proposed by the court during the legal proceedings. These problems were:

1. Auditor of the company failed to report the problems with the internal control of the company at the board meeting in Sep-86, even though the same was reported earlier to the senior management of the company.

2. Auditor of the company again failed to report internal control problems in Sep-87, although this had been raised many a times with the CEO and management over the previous years.

3. Court rejected the auditors plea that they audited as per the auditing standard requirement.

This is the classical example where auditor knew that there were problems and was not able to report it. This is the example of audit expectation gap.

Some of the key public expectations from the auditor are:

1.      Auditor should take ownership of the report on which the firm puts his/her signature.

2.      Auditors should certify the financial statements on which the firm has signed as auditors.

3.      A clean certification by the auditor means that accuracy of the financial statements is guaranteed.

4.      It is expected that auditors perform 100% of the check on all activities in the firm.

5.      Auditors should be in a position to give early warnings about the possible failure in the conducted business.

6.      Auditors are the one who should detect fraud. (Yusuf MunirSidani, 2007)

The main problems with TOY LOCAL ltd were the accounting and recordings of foreign land transactions. The control system of the company was not good enough and hence there were accounting mistakes and frauds at that end. Auditor of the company was sure about the wrong doings and it has informed the management. Since tabling the information and possible future errors is not the part of auditor's job, Delloite failed to table it at board meetings. This was a point of concern and as we can see here it is a classic example of auditor expectation gap.(The AWA case). This highlights the fact that there was a problem which auditor knew about but didn't take a stern action and only informed to the management. This is because of the fact that they didn't take it as there part of the job to informed the investor. This is the concern which shows how the audit expectation gap was used by Delloite to stay Toy Localy from the case although knowing about the wrong doings. The problem could have been different if it was a regulatory policy to rotate auditors too often.

Audit process over the years have settled over a big framework and auditors need to increase there purview to detect accounting frauds by the companies. Whenever a fraud or misstatement is detected against a company, there are many lawsuits filed against the auditor of the company. This expectations gap from the investor and the people towards an auditor's responsibility is termed as Auditor's expectation gap. (Kimberly Gladden Burke, 2004)

Expectation gap has arisen from variety of reasons. Some of the reasons are:

The whole process of auditing is based on certain framework and methods which have huge factor of probability built in. This is the reason this nature of accounting can give rise to uncertainty in the final result and hence the expectation gap.

in understanding the findings of the auditor from the non auditor. There are certain extra expectations from the auditor and many of them are naïve or because of unrealistic expectation from the auditor. This can also give rise to expectation gap.

many a times is assessed on the data which was not available when the audit process was going on. This informational gap can give rise to huge audit expectation gap.

are constantly changing and hence there is increased gap between understanding of the same and the actual process.

One of the possible solutions for the TOY LOCAL ltd or for the accounting world is to rotate the auditors too often. This will make sure that the audit work is clear and best results are shown by the auditors. It is very important to understand that auditors all over the world have been using audit expectation gap as an excuse to run Toy Localy from better auditing methods. Big 4 audit firms have introduced forensic accounting to sell new form of professionalism rather than doing the same while auditing a firm. Recently we have seen the advent growth of Forensic accounting which is what exact requirement of the investor is. The auditors are not providing this service to the investor and will only do that when big money is spent by companies on forensic accounting.(Financial Fraud- AWA Ltd)

One more possible attribute to the conclusion is the fact that if the auditor were rotated many a times then the problem would have been highlighted easily. Think of a situation why a new auditor would take problems which were not highlighted by the previous auditor. Hence if the auditors are rotated enough there are high chances that the problems would come out in open in one form or the other.

The best form of audit will come out when the audit expectation gap is reduced. These have to happen from both the sides. Firms need to come forward and do better work at audit and public should also remove unrealistic expectations from them. If both the parties show approach towards reducing the gap then only the right method can be adopted. Public can't have unrealistic expectations from the audit firms and audit firms need not reduce their basic job and move towards forensic accounting just to earn more money. If audit firms keep doing this then regulators need to step in and make sure that audit expectation gap is reduced to acceptable levels. This will be the best solution for the whole problem. From this analysis we can clearly understand that the gap can actually be lowered and the best standards can actually be implemented, but this is not happening because auditors need extra money from the same. Big 4 of audit firms have actually shifted the best practices tools of auditing which were used 40 years from now from simple audit to forensic accounting. TOY LOCAL Ltd has given us the classic example of problems with audit expectation gap. Auditor Deloitte failed in making the right kind of reporting and hence was involved in corporate scandal. It is very important to understand that audit expectation gap has been of huge debate and TOY LOCAL ltd is a critical and important example of the same. TOY LOCAL had a inbuilt accounting system which was incapable of recording foreign transactions properly and foreign exchange transactions were conducted in an environment which had bad internal control problems.(Financial Fraud- AWA Ltd) 



Posted Date: 11/6/2012 2:22:11 AM | Location : United States

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