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Expectation Gap

The document discusses key concepts in auditing and corporate governance, including the expectation gap, stakeholder interests, stewardship, and the agency problem. It highlights the discrepancy between public expectations of auditors and their actual responsibilities, as well as conflicts of interest between shareholders and management. Additionally, it provides scenarios and multiple-choice questions to illustrate these concepts.

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4 views3 pages

Expectation Gap

The document discusses key concepts in auditing and corporate governance, including the expectation gap, stakeholder interests, stewardship, and the agency problem. It highlights the discrepancy between public expectations of auditors and their actual responsibilities, as well as conflicts of interest between shareholders and management. Additionally, it provides scenarios and multiple-choice questions to illustrate these concepts.

Uploaded by

fh2408429
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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1.

Expectation Gap

The expectation gap refers to the difference between what the public, particularly financial
statement users, believe auditors are responsible for, and what auditors are actually required to
do according to auditing standards. Many people believe auditors are responsible for detecting all
fraud and ensuring that financial statements are free of any misstatement. However, in reality,
auditors provide reasonable assurance, not absolute assurance, and their primary responsibility
is to express an opinion on whether financial statements are free from material misstatements.

2. Stakeholder

A stakeholder is any individual, group, or organization that has an interest or concern in an


organization. Stakeholders can affect or be affected by the organization's actions, objectives, and
policies. Key stakeholders include shareholders, employees, customers, suppliers, creditors, the
government, and the community.

3. Stewardship

Stewardship refers to the responsibility of management to manage a company’s resources on


behalf of its owners (shareholders). In the context of financial reporting, stewardship emphasizes
that management is accountable for safeguarding the company’s assets and ensuring their
efficient use. Financial statements are a key tool for management to communicate their
stewardship to stakeholders, particularly shareholders.

4. Agency Problem

The agency problem arises from conflicts of interest between the principal (e.g., shareholders)
and the agent (e.g., management). Since management operates the company on behalf of
shareholders, their interests might not always align. For example, management may pursue
personal goals, such as higher salaries or job security, which could conflict with the
shareholders’ objective of maximizing profits.

Scenario 1: Expectation Gap

An investor reviews the financial statements of a company and notices that the company went
bankrupt shortly after receiving an unqualified (clean) audit opinion. The investor is upset and
believes that the auditor should have warned the public about the company's financial problems.

MCQs for Scenario 1:

1. What is the expectation gap in auditing? A. The difference between what auditors do and
what stakeholders believe they should do
B. The gap between the auditor's knowledge and the company's financial performance
C. The difference between management’s responsibilities and the auditor’s role
D. The gap in communication between shareholders and management
2. Which of the following is a common cause of the expectation gap? A. Stakeholders
believe auditors guarantee the accuracy of financial statements
B. Auditors fail to detect minor errors in financial statements
C. Auditors perform insufficient audit work
D. Auditors are not independent of the company
3. The public often expects auditors to: A. Guarantee that financial statements are free from
all errors
B. Express an opinion on whether financial statements are free from material
misstatement
C. Ensure the company remains profitable
D. Approve all management decisions
4. Which of the following actions can help reduce the expectation gap? A. Auditors
providing absolute assurance in their reports
B. Educating the public about the auditor's actual responsibilities
C. Increasing the audit fee
D. Limiting the scope of the audit to financial transactions only
5. Why does the expectation gap exist? A. Because auditors fail to perform their duties
adequately
B. Due to misunderstandings between the audit profession and public expectations
C. Because auditors do not follow proper auditing standards
D. Due to auditors being part of the company management

Scenario 2: Agency Problem

In a large company, the shareholders notice that the CEO is frequently spending company funds
on expensive personal travel and bonuses, which do not align with maximizing company profits.
The shareholders are concerned that management is not acting in their best interests.

MCQs for Scenario 2:

1. What does the agency problem refer to? A. The conflict of interest between shareholders
and management
B. The inability of auditors to detect fraud
C. The miscommunication between auditors and stakeholders
D. The failure of the company to make a profit
2. Who are the main parties involved in the agency problem? A. The auditors and
management
B. The shareholders and management
C. The government and management
D. The auditors and shareholders
3. Which of the following could help reduce the agency problem? A. Offering higher
salaries to management
B. Aligning management's compensation with company performance
C. Allowing management to act without oversight
D. Reducing communication between management and shareholders
4. Why might management's interests conflict with those of shareholders? A. Management
is focused on short-term gains for personal benefit
B. Management wants to maximize shareholder profits
C. Shareholders are always informed about management’s decisions
D. There is no real conflict between management and shareholders
5. What is a common mechanism used to align management’s interests with shareholders'
interests? A. Offering management significant control over audit decisions
B. Providing stock options to management based on company performance
C. Increasing the company's dividend payouts
D. Replacing the management team regularly

Answers:

Scenario 1:

1. A
2. A
3. B
4. B
5. B

Scenario 2:

1. A
2. B
3. B
4. A
5. B

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