Question

Provide two examples of items that “Do Not Fit the Auditor’s Expectation” per the risk analysis decision tree. One example should be an acceptable variation and the other an unacceptable variation.

Answer 1

What is a decision tree?

A decision tree is a map of the possible outcomes of a series of related choices. It allows an individual or organization to weigh possible actions against one another based on their costs, probabilities, and benefits. They can can be used either to drive informal discussion or to map out an algorithm that predicts the best choice mathematically.

A decision tree typically starts with a single node, which branches into possible outcomes. Each of those outcomes leads to additional nodes, which branch off into other possibilities. This gives it a treelike shape.

There are three different types of nodes: chance nodes, decision nodes, and end nodes. A chance node, represented by a circle, shows the probabilities of certain results. A decision node, represented by a square, shows a decision to be made, and an end node shows the final outcome of a decision path.

Expectations Gap

The expectations gap has been acknowledged since the 1970's and studied extensively by academics and the profession, which until relatively recently regulated itself.

But the scope, dimensions, and significance of this gap could receive more explicit attention in public policy debates and analyses.

At a high level, it is necessary to distinguish between two factors that contribute to this gap: (1) the information being provided to investors and market participants; and (2) the auditor's role in providing assurance over that information.

• First, there is the difference between the information investors want or need and the information required to be disclosed (or disclosed voluntarily) by participants in the capital markets. Some refer to this as an "information gap." Although this gap cannot necessarily be addressed by auditing standards or auditors, it is an important issue to be addressed. For example, good auditor assurance over required information that is irrelevant or inadequate may not meet investor needs and could even be diverting resources from material areas.

• Second, the opaque nature of the audit process and the audit results can cause a number of "gaps" between what investors and other market participants expect or need and what an audit is designed to provide.

Each facet or dimension of the audit expectations gap may inform regulatory oversight of auditors, as is it helpful to understand which gaps exist and which gaps are being addressed when trying to solve a problem through regulation or rulemaking.

Gaps Related to the Audit Process and Results

Gaps related to the audit process and results can be further broken down into a number of categories. There is a Normative Gap that encompasses both the role of the auditor (meaning the scope of the assurance or other services being engaged) and the responsibilities of the auditor to provide certain levels of assurance over information within that scope.

Some surveys and academic research demonstrate that there remains a gap between what market participants think an audit should be versus what an audit actually is required to be (by applicable standards and applicable laws and regulations). Part of this gap may exist because of a difference between the level of confidence that investors want or need in information versus what is required for the particular assurance service.

Another element of the audit expectations gap concerns the interpretation of what the existing auditing standards actually require auditors to do or to communicate to the user about the audit process or results. Stakeholders and market participants might have different interpretations about existing requirements and the assurance that is conveyed by the auditor's report (Interpretative Gap).

Another audit expectations gap relates to information about the audit (Information Gap). Stakeholders and market participants may need or want more information about the audit and the results of the audit, the nature and extent of the audit procedures performed, and the quality of the audit.

Economists refer to the audit as a "credence good," which is a good or service for which consumers find it difficult or impossible to ascertain its utility or quality, even after its use.^[1] Currently, the quality of an individual audit that investors are relying on is unknown to those investors. And although progress has been made among regulators and audit firms in exploring "Audit Quality Indicators," mechanisms for defining and measuring audit quality, and providing a level of transparency around audit quality remain elusive.

Finally, gaps can exist between actual auditor performance and what is required by the standards and related laws and regulations (Performance Gap). Regulatory inspection programs and enforcement actions are targeted toward this gap.