Accounting and Finance 46 (2006) 653– 676

P. ORIGINAL 4 46Schelluch, 0810-5391 ARTICLE Accounting G. Finance Association of Australia and New Zealand ACFI Oxford, UK and Gay Blackwell Publishing, Ltd.

Assurance provided by auditors’ reports on prospective financial information: implications for the expectation gap
Peter Schelluch, Grant Gay

Department of Accounting and Finance, Monash University, Melbourne, 3168, Australia

Abstract The results of this study indicate significant differences in beliefs between auditors, users and preparers of prospective financial information, concerning forecast reliability and the role and responsibilities of auditors and management. Contrary to the usual published studies on expectation gap, it was found that auditors believe that forecasts are more reliable than users or preparers. Auditors also believe that they have a higher level of responsibility and accountability than is attributed to them by users or preparers. Beliefs were affected by the type of report issued by the auditor and subjects were able to discriminate between the level of assurance provided by positive and negative assurance opinions. However, based on the responses of shareholders, it appears that the negative assurance opinion on assumptions for an audit might confuse users and might not meet the demands of the market. Key words: Assurance; Expectation gap; Prospective financial information JEL classification: M42 doi: 10.1111/j.1467-629x.2006.00187.x

1. Introduction Forecast disclosures are prepared extensively for the use of management, potential investors, shareholders, lenders, regulatory bodies and other interested parties. Such disclosures might be intended for general or limited distribution and use. The increasing reliance on such forecast disclosures has raised a number of concerns about the reliability of such prospective financial information and the ability of the auditor to enhance the credibility of such ex ante disclosures. The concerns have emerged as a consequence of differences in perceptions of different groups of financial report users concerning messages conveyed by audited financial information and a professional acknowledgement of this audit expectation gap.
Received 18 February 2005; accepted 2 September 2005 by Robert Faff (Editor).

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P. Schelluch, G. Gay/Accounting and Finance 46 (2006) 653–676

2. Expectation gap The audit expectation gap refers to differences between the public’s perceptions of the role and responsibilities of the auditor and the auditor’s perception of these roles and responsibilities. Humphrey et al. (1992, 1993) indicate that the gap relates directly to the uncertainty associated with the purpose, value, nature and effect of the audit. As a result, they indicate that the potential causes of the audit expectation gap are many and varied, including: unreasonable expectations of non-auditors; hindsight evaluation of audit performance; corporate crises that lead to new expectations and accountability requirements; and the profession attempting to control the direction and outcome of the expectation gap debate to maintain the status quo. Although a consensus as to the cause of the audit expectation gap has not been achieved, its persistence has been acknowledged.1 The Australian Society of Certified Practicing Accountants (now CPA Australia) and the Institute of Chartered Accountants in Australia (1993, 1996) in their Expectation Gap Reports made a number of recommendations to reduce the expectation gap in financial reporting and auditing. However, the Institute of Chartered Accountants in Australia (2003) acknowledged that attempts to reduce the gap by moving community expectations in line with the audit product have largely failed and consequently there is a need to expand the scope of audit and assurance services to meet market expectations. The audit expectation gap debate has consistently centred on a number of perennial issues,2 including: • The role and responsibilities of auditors • The quality of the audit function • The structure and regulation of the profession • The nature and meaning of audit report messages • The auditor’s ability to communicate different levels of assurance to users. 3. Prospective financial information Part of the motivation of this study is concern about the impact that the provision of prospective financial information might have on the audit expectation gap. This concern stems partly from the continuing existence of the expectation gap and the conflicting evidence concerning the utility and reliability of publicly available prospective financial information. According to Berlinger and Robbins (1986), the external use of prospective information was discouraged for a long time because of fears ‘that forecasts would fall far short in reliability’.
1

See, for example, Gay and Schelluch (1993) Gay et al. (1998), Humphrey et al. (1992, 1993), Monroe and Woodliff (1994) and Porter (1993). Ibid.

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Blair and Taylor (1989) also note that there might be disincentives to providing optimistic forecasts. Corless and Norgaard (1974) find that a report by an auditor on a profit forecast would only slightly increase the users’ confidence in the forecast data. the more confident management are of the outcome and so the more specific is the forecast. (2005) find that the revised funding regime and increased disclosure introduced by the Corporate Law Economic Reform Program (CLERP) Act 1999 was associated with a reduction in forecast frequency since 2000 and an increase in forecast value relevance. Conversely. Coulton and Taylor (2003) investigate 240 stand-alone earnings forecasts by Australian listed companies and find that good news forecasts are more specific than bad news forecasts. Blair and Taylor (1989) point out that for initial public offerings. Similarly. (1993) conduct a study of public offerings from 1976 to 1989 and find that the forecasts that were included were inaccurate and upwardly biased. p. Although theory suggests that managers might be motivated to bias their earnings forecasts. empirical studies have yielded conflicting results. but not with any change in forecast error or bias. concerns about the reliability of profit forecasts have been dealt with by legislation requiring independent checks of forecast information by an auditor to ensure their integrity and provide © The Authors Journal compilation © 2006 AFAANZ . 347) suggest that there has been an acceptance that ‘estimates of the future from those most knowledgeable about the business are as reliable as a historical accounting of what happened in the past’. G. However. Gay/Accounting and Finance 46 (2006) 653–676 655 Dev and Webb (1972) point out that it has often been argued that as forecasts are impossible to verify on an ex ante basis. Berlinger and Robbins (1986. Mak (1990) points out that in some cases. The ability of the auditor to enhance the credibility of forecast financial information has also been studied. Schelluch. Johnson and Pany (1984) find that both auditors and bank loan officers believe that auditor association would increase the likelihood that the forecast would be free of clerical errors and would be accurate. Lee et al. (2002) examine initial public offerings from 1991 to 1998 and find that the distribution of forecast errors was strongly suggestive of earnings management to avoid reporting earnings below the forecast figure. Chapple et al. Lee et al. equity issuers have an incentive to provide optimistic forecasts to make the investment opportunity appear more attractive. However. in Australia. in a later US study. They also find that the shorter the time before the release of the annual earnings statement. auditors have a higher expectation than loan officers as to the auditor’s effectiveness of detecting clerical errors on forecasts. they are of little value. because of the users’ overriding concern regarding the tentative nature of forecast data. Goodwin (1989) conducts a study of forecasts of newly listed companies between 1982 and 1986 and finds that the profit forecasting was inaccurate. although there was no obvious bias towards over-optimistic forecasting. McDonald (1973) finds an average overprediction in US profit forecasts of over 10 per cent. McNichols (1989) finds little support for the hypothesis that management forecasts are biased systematically.P. However. Imhoff (1978) finds actual earnings to be approximately 1 per cent below forecast earnings.

this study is also concerned with the level of assurance that an auditor can provide on forecast information and the impact of different types of audit reports on the assurance provided. 4. A reasonable level of assurance is provided through the auditor issuing a positive expression of opinion about an accountability matter. Schelluch. only a reasonable or limited level of assurance • The impact of the subject matter in determining the level of assurance (for example. Gay/Accounting and Finance 46 (2006) 653–676 assurance to users as to their reliability. 2004): 1 Reasonable level of assurance. Assurance In Australia. issued in June 2004. Auditing and Assurance Standard AUS 106. extent and results of audit procedures and the objectivity of the evidence obtained. They find that the majority of respondents believed that the auditor had reviewed the underlying assumptions of the forecast. G. which is a limited (previously defined as moderate) level of assurance provided by the auditor that the subject matter is plausible in the circumstance by stating that nothing has come to the auditor’s attention to indicate that the information is not presented fairly in accordance with identified criteria. Although the assurance services framework adopted in AUS 108 has received widespread general support. Auditing and Assurance Standard AUS 108. With a positive assurance report. Therefore. Corless and Norgaard (1974) examine whether the wording differences between a positive and negative assurance report made any difference to the user’s interpretation of the role that the auditor played in generating the forecast and the responsibility assumed by the auditor. 88 per cent of respondents indicated that the auditor had reviewed the assumptions. 2001). 2 Limited level of assurance. which is a reasonable (previously defined as high) but not absolute level of assurance. recognizes two types of assurance (Auditing and Assurance Standards Board. several aspects still remain unresolved and/or subject to debate.656 P. These include: • Whether the assurance framework should offer a continuous level of assurance or as is argued in the standard. Of those respondents indicating that the © The Authors Journal compilation © 2006 AFAANZ . An important issue is whether the user comprehends the level of assurance that is intended by the assurance provider. recognizing that it is not possible to achieve absolute assurance because of the inherent limitations of an audit and control systems.10 defines assurance as ‘the satisfaction as to the reliability of information provided’ (Auditing and Assurance Standards Board. whether a reasonable level of assurance can be provided on both historical and prospective information) • The best way to communicate the different levels of assurance particularly the limited level of assurance. and 82 per cent of respondents believed this to be the case with a negative assurance report. It points out that the level of satisfaction is determined by the nature.

rather than containing information for the reader from the description of work performed. the regulators encouraged the Canadian Institute of Chartered Accountants in 1989 to introduce revised auditing guidelines that increased the level of assurance required for earnings forecasts to audit-level or reasonable assurance. McConomy (1998) compares the accuracy and bias of earnings forecasts before and after this 1989 requirement that forecasts be audited rather than reviewed. Roebuck et al. With respect to the accuracy of computations. the Ontario Securities Commission has permitted the inclusion of an earnings forecast in prospectuses for initial public offerings since 1983. rather than only a cursory review for inconsistencies. As a result of dissatisfaction with the quality of the earnings forecasts. Although all groups recognized that an audit report with a positive assurance opinion provided greater assurance than a review report with a statement of negative assurance. (2000) manipulate first the subject matter of the work undertaken (historical (internal control) versus prospective (prospective information)). They examine the level of assurance conveyed by the assurance report and find that shareholders perceive a higher level of work for historical compared with prospective information. a greater proportion of positive assurance report respondents indicated that a thorough review was undertaken. Gay/Accounting and Finance 46 (2006) 653–676 657 auditor had reviewed the assumptions. Using subjects from different backgrounds. In Canada. shareholders did not change their perception of the level of assurance from the report as a result of the description of the work performed by the assurance provider (for which standard wording suggested for assurance reports and already used for audit and review reports was used). © The Authors Journal compilation © 2006 AFAANZ . Gay et al. However. (1998) find that users of financial information in Australia have different perceptions of the degree of reliability of financial information and the levels of assurance provided by review and audit reports.P. auditors were required to provide only review-level or limited assurance for these forecasts. a majority of report users believed that the auditor had verified the accuracy of computations inherent in the forecast and there was little difference between positive and negative assurance reports for this matter. he also finds an improvement in forecast accuracy as measured by average absolute forecast error associated with the shift from review to audit-level assurance. The findings also suggest that audit and review reports were used in the form of a ‘clean bill-of-health’ stamp or symbol. While Clarkson (2000) similarly finds a reduction in forecast bias. Results indicate that users found financial information to be less reliable compared to auditors. With respect to the accuracy of the forecast. He finds a significant reduction in optimistic bias. auditors had significantly stronger beliefs as to the extent of assurance being provided than user and preparer groups. a majority of report users did not believe that the auditor was attesting to the accuracy of the forecast. but relatively little improvement in accuracy resulting from the audit requirement. Before July 1989. G. and second the level of work undertaken (higher work level vs moderate work level). Schelluch.

In the light of previous research studies dealing with the expectation gap and messages conveyed by audit reports. speculative in nature. therefore. The requirements of AUS 804 are generally consistent with International Standard on Auditing ISA 810. Gay and Schelluch (1993). a limited level of assurance that the assumptions are free from material misstatement) (Auditing and Assurance Standards Board. Australian Auditing Standard AUS 804 advocates that the auditor provide a statement of negative assurance on the reasonableness of management’s best-estimate assumptions (i. Gay et al.3 This study tests the validity of these concerns. G. In addition. However. AUS 804 recognizes that it might be difficult. Hatherly et al. however. if not impossible. 2002). such evidence is itself generally future orientated and. for the auditor to obtain a level of satisfaction sufficient for the expression of a positive opinion because: • By their very nature. for example. the use of a statement of negative assurance in relation to the reasonableness of forecast assumptions raises concerns about users’ ability to distinguish between the levels of assurance communicated by negative assurance opinions when compared to positive assurance opinions. Schelluch. it would appear that there is uncertainty about the ability of positive and negative assurance reports to convey the desired level of assurance to users. Although audit evidence might be available to support these underlying assumptions. permit the auditor to express a positive assurance on the assumptions when the auditor has obtained an appropriate level of satisfaction that the assumptions are free from material misstatement.e. 3 See. (1991) and Monroe and Woodliff (1994). these previous expectation gap studies emphasize concerns about the ability of audit reports to clearly communicate the role and responsibilities of auditors and management in the reporting process. (1998). intentions and plans of management are reflected in a forecast and that the present expectations of management will not change in response to changing circumstances • The reasonableness of the assumptions cannot be compared to a reporting framework with the rigour necessary to allow for a positive assurance. 1992). Consequently. not all assumptions are capable of independent substantiation • The reasonableness of assumptions is assessed on presently available information • The auditor cannot be certain that all the expectations. AUS 804. Gay/Accounting and Finance 46 (2006) 653–676 Forecast disclosures are based on assumptions about future events that management expects to take place and actions that management expects to take.658 P. Such a positive opinion was originally proposed in exposure draft ED 49 and AUP 36. The use of a statement of negative assurance alleviates concerns that a positive assurance opinion on the reasonableness of the assumptions would result in a greater level of credibility (assurance) being attached to the underlying assumptions than that intended. while remaining neutral about the effectiveness of management and the future prospects of the reporting entity.34 does. In advocating the use of a negative assurance opinion. which were the predecessors to AUS 804 (Australian Accounting Research Foundation. © The Authors Journal compilation © 2006 AFAANZ .

a principal components analysis. although minor modifications to the wording of a number of statements were made as a consequence. together with varimax rotation. 1994) and Gay et al. This resulted in the identification of 45 unique statements. (1998). As a pilot study.P. Gay/Accounting and Finance 46 (2006) 653–676 659 The wording of the positive and negative assurance reports provided to participants in previous studies differ from the current wording. two pretest instruments were developed and mailed to 200 auditors. Useable responses were received from 76 of the 200 auditors participating in the pilot study (a response rate of 38 per cent). one audit partner and two audit managers. One instrument contained a negative assurance report and the other contained a positive assurance report on prospective financial information each followed by 47 bipolar adjectival statements separated by a 7 point Likert scale. The academic and professional literature was reviewed to identify messages that were intended to be conveyed by audit reports on prospective financial information. whereas Holt and Moizer (1990) use adjectival phrases. Research method 5. a semantic differential instrument was developed to measure the messages communicated through audit reports on prospective financial information. Monroe and Woodliff (1993.1. 1988). Research instrument Several studies have examined the measurement of meaning of audit report messages. To identify the underlying dimensions of the messages communicated. this study has used the wording suggested in AUS 804 and its predecessor exposure draft ED 49 to address: • The effect of positive and negative assurance reports on user/preparer beliefs concerning forecast reliability • The effect of positive and negative assurance reports on user/preparer beliefs about the auditor’s and management’s role and responsibilities • The effect of positive and negative assurance reports on user/preparer beliefs about the forecast entity’s prospects. Houghton and Messier (1990) examine the effect of wording changes on the meaning of audit reports using the general semantic differential scales of Osgood et al. G. 5. following the steps outlined by Malhotra (1981). This did not result in any additions to the existing bipolar adjectival statements. Schelluch. This resulted in two additional statements being included in the study. which were then reviewed for completeness by five audit academics. © The Authors Journal compilation © 2006 AFAANZ . Therefore.b. In the present study. 1973) and enhanced by Houghton (1987a. adapted for accounting by Haried (1972. Houghton and Messier (1990) use adjectives in their semantic differential scales. was performed. (1957). The auditors were asked to respond to the instrument and also to review it to ensure that their perceptions coincided with the views expressed in published reports.

The first phrase was treated as the ‘1’ end of the scale and the second phrase was treated as the ‘7’ end of the scale. The order and direction of the bipolar statements was randomly assigned and then fixed for all subjects.75 suggesting only slight information loss. 1998). 1994.91. In addition.’ and each of the selected bipolar adjectival statements separated by a 7 point scale. rather than exploring a number of diverse issues.98. 1993.50. demographic details of subjects were also sought in the final instrument. so that readers can easily identify the differences. if the factors are to be used as summary measures. was reduced to 11 statements with factor loadings greater than 0. 4 Houghton (1986) points out that a common benchmark for factor comparability is a correlation of factor scores of 0. G. Schelluch. The first factor. Similarly. Everett (1983) points out that it is important that the same procedures should provide stable factors when applied to different sets of respondents. although a valid.97 and 0. while the third factor. with coefficients of factor comparability of 0. Reliability analysis utilizing Cronbach coefficient alpha was used to reduce the statements with factor loadings greater than 0.9 or better.4 The split-halves technique involves splitting the respondent group into two. Each version of the research instrument contained one of the two audit reports.70. the second factor. was reduced to two statements with an alpha level of 0. .5 The data from each group of respondents are subjected to identical factor analyses.50 to 15 for the final instrument (Cronbach. followed by the words ‘This audit report indicates to me that . (ii) Responsibility. was reduced to two statements with an alpha level of 0.660 P. Reliability. while the second version contained the positive assurance audit report derived from its predecessor exposure draft ED49 (Appendix II). A cross-correlation of duplicate factor scores for each factor provides a measure of factor comparability and is referred to as the coefficient of factor comparability. The result is an in-depth analysis of the three factors selected. The differences in wording between the two reports are highlighted in bold for the purpose of this article. using a split halves technique (Everett. which resulted in three stable factors: (i) Reliability.74. Prospects. Two versions of the final research instrument were used. The two sets of factor score coefficients are used to calculate a duplicate set of factor scores for each respondent. 5 © The Authors Journal compilation © 2006 AFAANZ . This cut-off point is also used as an example in Everett (1983). objective and reliable method. It is acknowledged that the use of the split-halves factor analysis. The selected statements and their related factors are shown in Table 1. .. without any bolding. 1983. is mainly taxonomic and other methods could have been used to reduce the number of statements to a level where a reasonable response rate would be obtained. Responsibility. One version contained the statement of negative assurance report recommended by AUS 804 (Appendix I). Monroe and Woodliff. and (iii) Prospects. 1951). with an alpha of 0. Gay/Accounting and Finance 46 (2006) 653–676 This was supported by a factor comparability analysis. 0. Gay et al.

The forecast does not give a true and fair view. The auditor did not review the assumptions. The forecast complies with applicable accounting standards.P. The entity will continue operating next year. The auditor did review the assumptions. 13 Audit quality and accountability Prospects factor 14 Well managed 15 Continue operating The entity is not well managed. 10 True and fair 11 Auditor satisfaction Responsibility factor 12 Underlying assumptions Management is responsible for the assumptions underlying the forecast. Gay/Accounting and Finance 46 (2006) 653–676 Table 1 Belief statements Reliability factor 1 Extent of assurance 661 The extent of assurance provided by the auditor is clearly communicated. The auditor is not satisfied with the forecast. The entity will cease operating next year. © The Authors Journal compilation © 2006 AFAANZ . The shareholders (addressee) cannot hold the auditors accountable for the quality of their work. 6 7 8 9 Assumptions approved Accounting standards Significant errors Review assumptions The auditor did not approve the assumptions. Users can have no assurance that the forecast will be achieved in all material respects. The forecast gives a true and fair view. The auditor approved the assumptions. The entity is well managed. Users can have absolute assurance that there are no material misstatements in the forecast. The auditor is satisfied with the forecast. The forecast does not comply with applicable accounting standards. The auditor is responsible for the assumptions underlying the forecast. G. The forecast is not properly prepared on the basis of the assumptions. 5 Forecast achieved Users can have absolute assurance that the forecast will be achieved in all material respects. The forecast contains no significant errors. Users can have no assurance that there are no material misstatements in the forecast. The assumptions are not reasonable for the preparation of the forecast. The forecast contains significant errors. The assumptions are reasonable for the preparation of the forecast. Schelluch. The shareholders (addressee) can hold the auditors accountable for the quality of their work. The extent of assurance provided by the auditor is not clearly communicated. 2 3 4 Basis of assumptions Reasonable assumptions Material misstatements The forecast is properly prepared on the basis of the assumptions.

Non-responses were followed up.2. which provided a national list of its membership and foreshadowed the survey in its newsletter prior to the questionnaire being mailed out to a random selection of members. the auditing profession.e. Subject details Subjects were chosen from groups that would be associated with the preparation. © The Authors Journal compilation © 2006 AFAANZ . or have an interest in. company secretaries/ accountants. and a prepaid return envelope. In addition. some subjects could not be located or had died or retired. a covering letter. The ICAA provided a national list of members who are either engaged in. Company secretaries/chief accountants (CS) were randomly selected from the top 500 business entities. The subjects were mailed a copy of the questionnaire. G. The auditors (AUD) were randomly selected from members of the Institute of Chartered Accountants in Australia (ICAA). Shareholders (SH) were selected from members of the Australian Shareholders’ Association. the subjects chosen might not reflect the views held by similar subjects who might have been chosen from other professional/special interest organizations or other corporate mailing lists.662 P. company secretaries and chief accountants (CS) and shareholders (SH). use and audit of prospective financial information (i. 1993). The number of questionnaires distributed to each subject group and the subsequent responses for each report are shown in Table 2. Table 2 Subject distributions and response rates Group Distributeda Less unuseable responsesb and returned mail Useable responses Negative assurance Positive assurance Total Response rate (%) AUD 580 7/573 162 176 338 59 CS 301 5/296 42 63 105 36 SH 496 5/491 99 111 210 43 Respondent groups include auditors (AUD). Note: Mann–Whitney U-tests of differences between early and late subject responses revealed no significant differences in responses for each type of audit report for all subjects as well as for each class of subject for each report type. bUnuseable responses consisted of blank or partially completed returns. however. Schelluch. shareholders and auditors). been taken over or gone into liquidation at the time of mailing. the external validity of the study might be questioned if users do not read the audit reports in detail. Gay/Accounting and Finance 46 (2006) 653–676 5. or their firms had merged. but treat them as a symbol representing a clean bill of health (Gay and Schelluch. Although the response rates were good (36–59 per cent) and the Mann– Whitney U-tests of differences between early and late subject responses revealed no significant differences in responses for each type of audit report for all subjects as well as for each class of subject for each report type. the usual caveats about a potential non-response bias apply to the reported results. Also. aHalf of the subjects on the mailing lists were randomly assigned one of the two versions of the questionnaire in equal proportion.

8 per cent had a tertiary qualification. non-parametric statistics are used for analysis purposes.4 per cent were designated executive/managing directors. the responses by auditors indicate that they believe that the level of assurance provided by each form of audit report is clearly communicated to users (Question 1). rather than the order the questions were presented in the research instrument. The tables show the relevant statements and the mean responses for each of the subject groups.5 per cent were employed by the ‘Big Four’ public accounting firms.6 A review of the distribution of responses for each question was also undertaken and no unusual responses were found. Responses of subject groups to the two report types were analysed by demographic characteristics. no significant differences were found in responses within groups based on demographic characteristics that could not be attributed to chance at p ≤ 0. Reliability statements As would be expected. Gay/Accounting and Finance 46 (2006) 653–676 663 5. Also. The responses are not normally distributed and transformation of the data does not result in normality.8 years. Auditors were characterized by an average of 13 years of auditing experience and 5 years of other business experience.P.4 per cent were partners. 7. 20. However. Furthermore. Only 15 per cent indicated that they were unfamiliar. Schelluch. © The Authors Journal compilation © 2006 AFAANZ . their average business experience was 15. 97. the view of auditors about the clarity 6 The normality of the distribution of responses was tested by the Kolmogorov–Smirnov test. while 35.8 per cent had a tertiary qualification. 69.6 per cent were designated company secretaries. or very unfamiliar with financial reports. while 61 per cent stated they were familiar or very familiar (12 per cent) with financial reports. χ2-tests revealed no demographic differences between subject groups receiving the statement of negative assurance report and those receiving the positive assurance report. and the remaining 24. Demographic characteristics of subjects To obtain a profile of subject group characteristics. subjects were asked to respond to demographic questions as part of the questionnaire. Shareholder characteristics revealed that 68.6 per cent held a tertiary qualification.05.3 per cent invested in shares. 49.3. G. together with the results of Mann–Whitney U-tests of comparison between groups. The results are analysed under the appropriate factor headings.7 per cent were supervisors or below. and between negative and positive assurance reports for each subject group. Hence. Results The results for the 15 bipolar adjectival statements are presented in Tables 3–5. 39.9 per cent managers. 6. while 50 per cent were chief accountants. 29. Company secretaries revealed that 89. it is surprising that the extent of their belief is not stronger.

001 6.69 *4.05 3. of the communication is not shared by company secretaries and shareholders.27 0.83 *4. p< 6 Auditor did not approve assumptions.80 6.664 P. 0.18 3.29 *4.21 0.73 5.001 *6.83 *3. 2 Forecast is properly prepared on the basis of the assumptions.05 *6.33 *5.01 *3.28 6.55 *3. –ve +ve p< a a a c c a c c c a c c *5.99 1.62 0.59 6. Report type 2.07 6.001 *5.82 0. b.05 0.69 0.05. a.75 *4.53 *6. although this view is not strongly held as the mean response is close to the mid-point of the range. c: Mann–Whitney Z score significantly different between groups as indicated. –ve +ve p< 9 Auditors did not review assumptions. at p < 0.55 *3.94 0.67 *1.95 0.37 *3.44 *2.14 0.01 *3.58 *5. +ve 8 Forecast contains significant errors.03 0.40 *1.001 *3.05 *3.001 c c c Respondent groups include auditors (AUD).32 1.97 0. –ve +ve p< 11 Auditor is satisfied with forecast. 3 Assumptions are reasonable for the preparation of the forecast.05 *3.09 a 0.05 *2.01.00 *2.65 1.07 *1.001 0.001.01 *6.71 *3.41 *5. Gay/Accounting and Finance 46 (2006) 653–676 Table 3 Reliability statements mean responses and tests of differences Between group differences AUD AUD CS versus versus versus CS SH SH b c a c a c b c c a Group means AUD Statement 1 Extent of assurance provided by the auditor is clearly communicated. –ve +ve p< 10 Forecast gives a true and fair view.85 3.05 *6.34 *2.05 5.45 *6.97 *5.01 0. *Mann–Whitney Z score between negative and positive audit reports significantly different at levels indicated by p.79 a *2. p< 5 Users can have absolute assurance –ve that the forecast will be achieved in +ve all material respects.88 0. Report type is indicated by ‘–ve’ for the negative assurance opinion and ‘+ve’ for the positive assurance opinion.001 4.53 5. 0.81 0.13 4.05 *5.001 *4. For the positive assurance report non-audit © The Authors Journal compilation © 2006 AFAANZ .90 0.94 6.24 5. G.43 *5.91 *5.08 0.03 1.75 b 0.48 4.77 1.001 *4.05 3. company secretaries and chief accountants (CS) and shareholders (SH). For the negative form of assurance. –ve +ve p< 7 The forecast does not comply with –ve applicable accounting standards.97 *3.08 CS SH –ve +ve –ve +ve –ve +ve p< 4 Users can have absolute assurance –ve that there are no material +ve misstatements in the forecast. non-audit subject responses are significantly different to auditors and indicate that the level of assurance is not clearly communicated.35 3.60 1.58 0. Schelluch.001 6.

74 3.44 a 0. subject responses indicate that they believe that the extent of assurance is clearly communicated. 4.02 4. However.25 *1.58 4. Report type is indicated by ‘–ve’ for the negative assurance opinion and ‘+ve’ for the positive assurance opinion. Gay/Accounting and Finance 46 (2006) 653–676 Table 4 Responsibility statements mean responses and tests of differences Group means Report AUD type –ve +ve p< –ve +ve p< CS SH Between group differences 665 Statement 12 Management is responsible for the assumptions underlying the forecast. at p < 0. b.21 4.17 4. This suggests that there is some confusion in the minds of the non-audit subject groups as to the extent of assurance communicated by the positive and negative form of audit reports. 0.10 4. Report type is indicated by ‘–ve’ for the negative assurance opinion and ‘+ve’ for the positive assurance opinion. Schelluch. Therefore. G.45 4. their less-than-strong beliefs indicate that they are also uncertain about the relative levels of assurance communicated by each type of report.70 *4.01. 15 The entity will cease operating next year.05.39 1. c: Mann–Whitney Z score significantly different between groups as indicated.05 c b Respondent groups include auditors (AUD). 0.97 5. company secretaries and chief accountants (CS) and shareholders (SH). *Mann–Whitney Z score between negative and positive audit reports significantly different at levels indicated by p.01. at p < 0. c: Mann–Whitney Z score significantly different between groups as indicated.001. 0.65 0.21 4. 13 The shareholders (addressee) can hold the auditor accountable for the quality of their work. The responses from auditors might also indicate that.23 *3.01 *2.33 a Respondent groups include auditors (AUD). Table 5 Prospects statements mean responses and tests of differences Group means Report type –ve +ve –ve +ve AUD CS SH Between group differences AUD versus CS AUD versus SH CS versus SH Statement 14 The entity is not well managed. a.P. 0.001. a. b.42 *1. *Mann–Whitney Z score between negative and positive audit reports significantly different at levels indicated by p. there is a need to amend the wording of the reports to ensure that the level of assurance provided by the auditor in both reports is more clearly communicated.29 *2. particularly for the negative assurance report.05.26 1.38 1.05 0.39 4.98 5.74 4. company secretaries and chief accountants (CS) and shareholders (SH). © The Authors Journal compilation © 2006 AFAANZ .46 3. AUD AUD CS versus CS versus SH versus SH a 1. this belief is not strong and for shareholders is significantly less than for auditors. although they understand the forms of the two reports.

must be seen in the context of a particular framework identified within the financial report. This again might reflect subjects’ beliefs about the inability of the auditor to obtain the kind of evidence necessary to form a positive opinion (provide a reasonable level of assurance) in relation to management’s assumptions. whether expressed in terms of ‘truth and fairness’ or ‘presents fairly’. Schelluch. The non-audit subject groups’ beliefs about the reasonableness of the underlying assumptions are significantly less than that of the auditor for both report types. As the wording of the two audit reports is very different in relation to the reasonableness of the underlying assumptions. auditors have a significantly higher belief than shareholders. © The Authors Journal compilation © 2006 AFAANZ . which is explicitly outlined in the last paragraph of the scope section of the negative assurance report. significant differences in responses between auditors and the other subject groups indicate that the wording of the negative opinion on the reasonableness of the assumptions has tempered the beliefs of all subject groups. As both reports provide a positive opinion for this question.7 In the case of prospective financial information. The profession has been attempting to educate users that the audit opinion. All groups had significantly stronger beliefs about the reasonableness of assumptions for the positive assurance report than for the negative assurance report. G. The responses to this question indicate that all groups perceive that the audit opinion must be related to a defined reporting framework. The difference may be explained by a lower familiarity with the role of the underlying assumptions in forecasts held by shareholders or their greater scepticism. however. one would expect the extent of beliefs of subject groups to differ between the two reports as to whether the assumptions are reasonable for the preparation of the forecast (Question 3). It might also reflect difficulties experienced by company secretaries and shareholders in interpreting the wording of the negative assurance report. For the positive assurance report. However. it is not surprising that there were no significant differences between reports. the closeness of responses to the endpoint. Gay/Accounting and Finance 46 (2006) 653–676 Although all subject groups believe that both reports communicate the message that the forecast is properly prepared on the basis of the assumptions (Question 2). This appears to reflect an understanding of the differing levels of assurance provided by the two reports in relation to the reasonableness of underlying assumptions by the respective user/preparer groups. indicates that subject groups believe in the reasonableness of the underlying assumptions. The level of responses to both reports indicates that all subject groups are aware that an audit cannot provide absolute assurance that there are no material 7 Refer to AUS 702.21–22.17 (g) and AUS 702.666 P. it is information prepared on the basis of a set of identified assumptions. the strength of beliefs differed significantly between auditors and the other subject groups for both audit report types. For the negative assurance report. which require reference to the identified reporting framework in both the scope and opinion sections of the audit report.

but does not actually approve them. Although for both reports subjects in general believe that the forecast did not contain significant errors (Question 8). both non-audit subject groups are significantly less confident than auditors that the forecasts are free of significant errors for the positive assurance report. This is particularly the case for auditors. These subject groups associate the positive assurance report with auditor approval of the assumptions. as it might be argued that the auditor only forms an opinion on the reasonableness or otherwise of the assumptions. However. For the negative assurance report. While company secretaries’ and auditors’ beliefs are similar. all users clearly distinguished between the level of assurance that can be obtained from the negative and positive assurance reports.P. For the positive assurance report. Both audit report types make explicit reference in the audit opinion sections to fair presentation in accordance with applicable accounting standards (Question 7). Subjects’ beliefs about approval levels vary significantly between report type for both auditors and shareholders. if any. one would expect to find a consensus in beliefs between subject groups and also within groups between the two report types. The responses indicate that all subject groups are aware that little. shareholders’ beliefs are significantly stronger than those of auditors. again showing an ability to discriminate between the assurance levels provided by the respective reports. indicating the possible existence of an expectation gap. The level of responses further indicates that all subject groups believe that the negative assurance report provides a lower level of assurance than the positive assurance report. As a result. The contrary beliefs held by company secretaries might be due to the use of the term ‘approve’. while both forms of audit report also make explicit reference to the fact that the forecast may not be achieved and that the auditor does not express any opinion as to whether the forecast will be achieved. As with the previous question. believing that the negative assurance report provides less assurance than the positive assurance report that the forecast will be achieved. shareholders are significantly more sceptical about the level of assurance than the other subject groups. highlights a degree of uncertainty about the auditor’s role in relation to the assumptions. All subject groups believe that the auditor does not approve the assumptions (Question 6) for the negative assurance report. although again such beliefs are not strong. The level of responses of subjects. particularly auditors in relation to the negative assurance report. whereas the negative assurance report is viewed as not leading to auditor approval. the responses of subject groups in general are consistent and are approaching the end-point of the scale. although these beliefs are not strong. all subjects other than company secretaries believe that the auditor does approve the assumptions. assurance can be provided by the auditor that the forecast will be achieved (Question 5). Gay/Accounting and Finance 46 (2006) 653–676 667 misstatements (Question 4). This was the case. © The Authors Journal compilation © 2006 AFAANZ . although company secretaries’ beliefs are significantly weaker than those of the auditors for the negative assurance report. G. However. This may be expected as the wording of the positive assurance opinion makes explicit reference to the reasonableness of the underlying assumptions. Schelluch.

The direction of subject responses indicates that all subject groups believe that both audit reports communicate that the forecasts give a true and fair view (Question 10). Responsibility The level of responses towards the strongly agree end-point indicate that all subject groups believe that management is responsible for the underlying © The Authors Journal compilation © 2006 AFAANZ . The responses to this statement indicate that subjects are able to discriminate between the two forms of audit report with respect to the level of assurance. as well as the last paragraph of the scope section of the audit report that details the inherent nature and limitations of prospective financial information. Gay/Accounting and Finance 46 (2006) 653–676 shareholders are significantly less convinced than auditors that the forecast contained no significant errors. As expected. might not be able to achieve the degree of truth and fairness that might be expected for historical cost financial information. This belief might stem from the wording of the negative assurance opinion in relation to the underlying assumptions. shareholders believe that the auditor is not satisfied with the forecast with respect to the negative assurance report. Although all subjects for both audit reports (with the exception of shareholders for negative assurance reports) believe that the auditor is satisfied with the forecast (Question 11). All subject groups hold significantly stronger beliefs about auditor satisfaction with the forecast for the positive assurance report than the negative assurance report. the underlying assumptions and the type of audit evidence available to assess these assumptions. Schelluch. However. However. The level of subject responses suggests that all subjects believe that the auditor reviewed the assumptions (Question 9) for both report types. all subjects’ beliefs that the assumptions are reviewed are stronger for the positive assurance report than for the negative assurance report. The fact that subject responses in general are not strong might be because of subjects’ beliefs that forecasts. particularly in the case of auditors where the difference is significant. the degree of satisfaction is significantly less for all nonaudit subject groups when compared to that of the auditors. particularly in the case of auditors and shareholders. Subjects’ beliefs are influenced by report type as subjects hold stronger beliefs that no significant errors existed in relation to the positive assurance report than the negative assurance report. because of their inherent nature. Alternatively. non-audit subjects’ beliefs were significantly lower than auditor’s beliefs (with the exception of company secretaries for the negative assurance report). The level of responses of non-audit groups and the fact that they differ significantly from the beliefs of the auditors in all but one case indicate that they have less faith in the ability of the auditor to detect and require management to correct significant errors than do the auditors themselves. it might reflect uncertainty about the meaning of ‘truth and fairness’. 8. G. Subject groups’ beliefs as to the truth and fairness of the forecast are significantly stronger for the positive assurance report than for the negative assurance audit report.668 P.

This is consistent with professional pronouncements. All subjects believe that the entity will continue operating next year (Question 15) for both audit report types. Only shareholders perceive a difference in responsibility between the two different audit reports by attributing a lower level of responsibility to management for the positive assurance report than for the negative assurance report. which could imply that a detailed audit and evaluation process is undertaken by the auditor rather than merely a review of the assumptions.P. The beliefs held by shareholders are consistent with previous shareholder responses indicating confusion about the nature and level of assurance provided by the negative assurance report. although the level of responses indicates that these beliefs are not very strong. as well as the scepticism expressed towards the profession and reporting process. However. it could be implied from a negative assurance opinion that only a review has taken place. There were no significant differences between responses for the positive and negative assurance reports. Prospects The mean responses of all subject groups around the mid-point on the scale indicates uncertainty among subjects concerning whether any message is communicated about the entity being well managed (Question 14). even though non-audit subject groups held a significantly lower level of beliefs about accountability than the auditors did. Gay/Accounting and Finance 46 (2006) 653–676 669 assumptions of the forecast (Question 12). all groups believe the auditor to be accountable. as respondents did not believe that either of the reports told them much about the way the entity was managed. Schelluch. even though an audit is conducted in each case. whereas the auditors and company secretaries believe there is a degree of accountability. believing that the auditor is significantly more accountable in respect of the positive assurance report than the negative assurance report. For the positive assurance report. This difference might be a result of the fact that the auditor expresses a positive opinion on the reasonableness of the assumptions in the positive assurance report. 9. which indicate that the auditor’s opinion is on the financial information and not the efficiency of management. indicating that an expectation gap might exist between shareholders and the other subject groups. Auditors and shareholders believe that there is a significant difference in accountability for audit quality between the two report types. G. For the negative assurance report. there appears to be no expectation gap between auditors © The Authors Journal compilation © 2006 AFAANZ . Given the level and direction of responses of subjects. Management’s responsibility for the assumptions should not be affected by the type of audit report. Shareholders have significantly stronger beliefs about management’s responsibility for the underlying assumptions than auditors do for the negative assurance report. The results indicate that an expectation gap may exist between auditors and other subject groups with respect to beliefs about accountability of the auditor for the quality of their work. the shareholders believe that the auditor is not accountable to the addressee of the report for the quality of their work (Question 13).

shareholders). In general. the profession’s fears about the existence of an expectation gap with respect to audit opinions on prospective financial information appear to be justified. responses indicated some doubt about the appropriateness of the wording of the negative assurance report. With respect to the responsibility statements. there is little difference in beliefs between subjects or reports. although company secretaries’ beliefs are significantly weaker than those of shareholders that the entity will continue operating next year. Where a significant difference is found between report types for the subject groups. With respect to the reliability statements. Of particular © The Authors Journal compilation © 2006 AFAANZ . although the extent of the gap is not as pronounced as might have been expected given the results of previous studies and the extensive public discussion of the audit expectation gap. it is generally found that greater reliability is placed on the positive assurance report than the negative assurance report by subject groups. with auditors deriving a greater degree of assurance about the reasonableness of the assumptions and that the forecast has been properly prepared. With respect to the future prospect statements.e. Summary and conclusion This study investigated beliefs about messages communicated by both negative and positive assurance audit reports on prospective financial information. 10. the expectation gap appears to be greater between auditors and shareholders than between auditors and company secretaries. auditors have a significantly stronger view that auditors are accountable for the quality of their work on the forecast. Beliefs were assessed with respect to the reliability of prospective financial information. there appear to be significant differences in responses for both reports between auditors and shareholders and between auditors and company secretaries. Nevertheless. First. the expectation gap appears to be greatest between auditors and user subjects (i. the responsibilities of auditors and management. where there are significant differences in the beliefs of subject groups about responsibilities between report types. subject groups tended to attach greater responsibility to the auditor with respect to the positive assurance report than the negative assurance report. Gay/Accounting and Finance 46 (2006) 653–676 and other subject groups. G.670 P. which is consistent with expectations and highlights the ability of subjects to distinguish between the levels of assurance provided by each report. In general. the results also indicate that significant differences in beliefs exist between auditors and shareholders and between auditors and company secretaries. Schelluch. In particular. In general. Although all groups recognize that management is responsible for the assumptions used in the forecast. There are several implications of this study. the results relating to the reliability statements indicate that there is considerable room for improvement by modifying the wording of the two reports and/or further educating users. in relation to the positive assurance report. and the future prospects of the entity.

Auditors also believe that they have a higher level of responsibility and accountability than is attributed to them by users or preparers. in particular. The wording of audit reports needs to be simplified and enhanced so that they become more understandable to users and preparers and the level of assurance is more clearly communicated. Third. Auditing Standard AUS 106: Explanatory Framework for Standards on Audit and Audit Related Services. when he called for plain English audit reports. 2001. they all attach greater forecast reliability to the positive assurance report than to the negative assurance report. is probably a result of the recent corporate scandals and audit failures of the late 1990s and early 2000s. This study also indicates that there is scope for further research on the wording used for different types of audit reports and that this should be considered by the Australian Auditing and Assurance Standards Board in any revisions they make to auditing standards. In general. in general. preparers and auditors are uncertain about applying the term ‘true and fair’ to prospective financial information. auditors. an area of future research will be to see if the changes to auditors’ responsibilities and independence requirements under the CLERP 9 amendments to the Corporations Act 2001 have done anything to redress this perception and restore user and preparer confidence in the audit function. Where subject group beliefs about auditor/management responsibilities differed significantly between reports this was in general consistent with professional expectations. G. which supports the continued use of the current wording ‘presents fairly’ in the audit report. Auditors believe that forecasts are more reliable than user or preparer groups do. users and preparers can differentiate between positive and negative forms of audit reports. users. References Auditing and Assurance Standards Board. The sceptical attitude of shareholders. Gay/Accounting and Finance 46 (2006) 653–676 671 significance is that the results indicate that the current expectation gap in respect of prospective financial information is in the opposite direction to that indicated in published reports on expectation gap. subject groups are able to distinguish between management and auditor responsibilities for both report types in a manner that is consistent with professional expectations. Fourth. Even auditors showed some uncertainty as to the messages being communicated. Therefore.P. it could be argued that based on the responses of shareholders. Finally. as the underlying assumptions of forecasts are crucial to the fairness of prospective financial information. In addition. the profession should re-examine the wording used in the audit report. Second. Schelluch. © The Authors Journal compilation © 2006 AFAANZ . These results support the view put by Justice Owen in the HIH Royal Commission Report (2003). Auditing and Assurance Standards Board. 2002. the current negative assurance opinion on such assumptions for an audit might confuse users and might not meet the demands of the market. Auditing Standard AUS 804: The Audit of Prospective Financial Information.

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such evidence is generally future orientated and therefore speculative in nature. . do not provide a reasonable basis for the preparation of the forecast. Our procedures included examination. . on a test basis. . Audit Opinion Based on our examination of the evidence supporting the assumptions. The [members of the governing body] are responsible for the preparation and presentation of the forecast and the information contained therein. amounts and other disclosures in the forecast and the evaluation of accounting policies. to . . current and future operations. . Gay/Accounting and Finance 46 (2006) 653–676 INDEPENDENT AUDIT REPORT To [addressee] Scope We have audited the forecast of [entity] for the [period] as set out on pages . We have conducted an independent audit of the forecast in order to express an opinion on it to [addressee]. of evidence supporting the assumptions. Our audit has been conducted in accordance with Australian Auditing Standards. we are not in a position to obtain the level of assurance necessary to express a positive opinion on those assumptions. Prospective financial information relates to events and actions that have not yet occurred and may not occur. While evidence may be available to support the assumptions on which prospective financial information is based. and is presented fairly in accordance with . These procedures have been undertaken to form an opinion as to whether anything has come to our attention which causes us to believe that management’s assumptions as set out in note . We disclaim any assumption of responsibility for any reliance on this report or on the forecast to which it relates to any person other than to [addressee] or for any purpose other than that for which it was prepared. The audit opinion expressed in this report has been formed on the above basis. . . and whether. © The Authors Journal compilation © 2006 AFAANZ . including the assumptions as set out in note .674 P. . in all material respects. on which the forecast is based. the forecast is properly prepared on the basis of the assumptions as set out in note . . . do not provide a reasonable basis for the preparation of the forecast. . we provide a lesser level of assurance on the reasonableness of management’s assumptions. Schelluch. G. Given the nature of the evidence available in assessing the reasonableness of management’s assumptions. . . . The forecast has been prepared for distribution to [addressee] for the purpose . . . (and on a basis consistent with the accounting policies adopted and disclosed by the entity in its audited financial report for the [period] ended [date]) so as to present a view of the entity which is consistent with our understanding of the [entity’s] past. nothing has come to our attention which causes us to believe that the assumptions as set out in note . Accordingly.

. on a test basis. . . and (b) the forecast is presented fairly in accordance with (i) . . G. . including the assumptions as set out in note . we express no opinion as to whether the forecast will be achieved. The forecast has been prepared for distribution to [addressee] for the purpose . on which the forecast is based. Our audit has been conducted in accordance with Australian Auditing Standards. to . . applicable accounting standards. . The [members of the governing body] are responsible for the preparation and presentation of the forecast and the information contained therein. . We have conducted an independent audit of the forecast in order to express an opinion on it to [addressee]. and (ii) on a basis consistent with the accounting policies adopted and disclosed by the entity in its audited financial report for the [period] ended [date] Actual results are likely to be different from the forecast since anticipated events frequently do not occur as expected and the variation may be material. are reasonable for the © The Authors Journal compilation © 2006 AFAANZ . (a) the forecast is properly prepared on the basis of the assumptions as set out in note . Our procedures included examination. . We disclaim any assumption of responsibility for any reliance on this report or on the forecast to which it relates to any person other than to [addressee] and for any purpose other than that for which it was prepared. . . . . Schelluch. Date Firm Address Partner Appendix II Positive assurance report (Bold type has been used to highlight differences between reports in Appendix I and Appendix II) INDEPENDENT AUDIT REPORT To [addressee] Scope We have audited the forecast of [entity] for the [period] as set out on pages . of evidence supporting the assumptions. . amounts and other disclosures in the forecast and the evaluation of accounting policies.P. These procedures have been undertaken to form an opinion as to whether the assumptions as set out in note . . Gay/Accounting and Finance 46 (2006) 653–676 675 In our opinion. Accordingly.

. . . and (ii) on a basis consistent with the accounting policies adopted and disclosed by the entity in its audited financial report for the [period] ended [date] Actual results are likely to be different from the forecast since anticipated events frequently do not occur as expected and the variation may be material. . Accordingly. . the forecast is properly prepared on the basis of the assumptions as set out in note . and is presented fairly in accordance with . and whether. and (c) the forecast is presented fairly in accordance with: (i) applicable accounting standards. (a) the assumptions as set out in note . we express no opinion as to whether the forecast will be achieved. current and future operations. (and on a basis consistent with the accounting policies adopted and disclosed by the entity in its audited financial report for the [period] ended [date] so as to present a view of the [entity] which is consistent with our understanding of the [entity’s] past. Schelluch. Audit Opinion In our opinion. Gay/Accounting and Finance 46 (2006) 653–676 preparation of the forecast. . . in all material respects. (b) the forecast is properly prepared on the basis of the assumptions as set out in note .676 P. G. . are reasonable for the preparation of the forecast. Date Firm Address Partner © The Authors Journal compilation © 2006 AFAANZ . .

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