Closing the gap, or: what did you expect?

CPA Canada’s Pivot magazine recently asked whether auditors can “close the great expectation gap for good.”

The article takes the form of a moderated discussion between five experts.  As the lead-in puts it: “The expectation gap is a huge and thorny issue in the audit profession—so much so that even the definition is up for debate. Broadly speaking, it’s the difference between what the profession thinks an audit is—and does—and what everyone else thinks. But those gaps in perception can be different for every player—management, the audit committee, regulators, the investment community.”

One participant succinctly observes early on in the discussion that “the expectation gap is really the fault of people not reading the auditor’s report. The report is pretty clear about what auditors do and don’t do. “ But regardless of this: “Investors are looking at, and relying on, information beyond the audited financial statements. They may have some feeling that there’s been auditor involvement with it. So if there’s some sort of disaster, it leads to a real public concern about the role of auditors: “We thought you guys were involved in this reporting. How could you not be involved?” Further: “People think the MD&A is audited. Let’s be honest, MD&A is management’s story with numbers that are audited. And that just extends the expectation to an area that we’re not even really involved with to a great extent.”

We’ve looked before at some changes to the auditors’ report that might help with this. But again, if people don’t read an audit report in its current form, they may not be any more likely to read a longer one (at least not very carefully). The article sets out an interesting discussion, but at the end, I confess that I couldn’t determine whether that overriding question, of whether the expectation gap can be closed, had been even vaguely answered.

Well, if it were me, I wouldn’t worry that much about it – it’s just another example of how we often prefer willful ignorance and idealism to informed understanding. Here’s a famously egregious example:

  • The survey found that while most Canadians believe climate change is real, their faith in the ability of science to shine a light on the issue is not uniform across the population.
  • Only 28 per cent of those polled said the evidence for human-caused climate change is conclusive, with another 33 per cent describing the evidence as “solid.”
  • But from there the numbers start to slide — with 27 per cent saying there is some evidence, but it’s not conclusive. The last 11 per cent claimed there is little to no evidence to suggest human-caused climate change is real.

Plainly, very few of these opinions are based on extensively assessing the available evidence. And even for those 61% who believe the evidence to be either conclusive or solid, it doesn’t follow that they’ll support any particular policy response (the number that support a carbon tax appears to be lower than that, for instance). We’ve talked before about behavioural limitations on decision-making, on how people prioritize short-term risks over longer-term ones, and so forth. Obviously we could extend this indefinitely, to include how people decide how to vote, manage their personal finances and so on. The premise that people make decisions primarily on a rational risk-based weighting of all available evidence seems idealistic at best. And much as people may be skeptical of authorities and governments, they regularly overstate their powers: regulators, stock exchanges and the like hear on a daily basis from individuals carrying an inflated view of what should or could have been done to protect their interests.

So what might practically happen if an individual wrongly thinks that (say) an MD&A was audited? Presumably he or she might place too much reliance on that document, perhaps even to the extent of changing an investment decision. But putting such excess weight on a single MD&A is a bad idea regardless of how much assurance it carries. As with so many things, the real issue here is the idealistic belief in unfettered individual access to the capital markets, regardless that few people have the resources and capacity to make the most of such access.

The article refers to the expectation gap as the profession’s “existential problem,” as if implying that its very continuation may depend on solving it. But the problem has been with us for decades (the term was used at least as far back as 1974) and while the audit profession has plenty of challenges, it remains an enormously lucrative one for those who rise within it. One imagines the profession would have little enthusiasm for taking one obvious step to address the gap – that is, by voluntarily assuming greater liability for errors in issued financial information (one participant does slightly open that door, saying “we need to go there, because auditors need to extend the usefulness of an audit,” but the point isn’t pursued). So the hand-wringing isn’t altogether convincing (of course, it’s not unusual for the powerful to feel misunderstood and besieged …)

Naturally, I’m not advocating complacency or surrender. But like all other participants in capital markets, the audit profession would be best advised to stop chasing after unattainable vanishing points. The truest words spoken in the article may be these: “The thinking part of being an auditor is important to our future. Our young people entering the profession want challenging things to do.” That is: better to have an audit profession that keeps getting better and more relevant, even with an expectation gap that keeps widening, than one in which actuality and expectation eventually converge into tired stagnancy.

The opinions expressed are solely those of the author

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