University College of Technology Sarawak

MBC3453 AUDIT AND ASSURANCE II

Year 4, Semester 1 2020-2021

Miss Ivy Kiew

Name Student ID
Eric Wong JiunJie BAC17070004

Submission Date : 09/11/2020

Table Content :

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 Content Pages
Introduction 3
Contents
Three Types of Expectation Gaps 4
TYCO's Financial Scandal 4-5
Auditor's Failure 6-7
Conclusion of Scandal 7
Closing the Expectation Gaps 8
Conclusion 9
References 10

Introduction

Nowadays, the level of audit attention by the public is getting higher as

most of them have realized the importance of audit in evaluating the
performance of the company. However, their expectations of audit

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performance are different from the actual audit performance level, which
creates gaps, also known as audit expectations gaps. Therefore, it is widely
used to measure the audit concern by the public. Not only the high level of
audit concern, the auditors' achievement and requirement increased will also
increase the audit expectation, and the gap will be wider. If there has any
debate between the public and the audit, this kind of discuss will directly shift
to expectation gap, therefore this will lead to the public to have an impression
that the expectation gap is a new issue, but actually it had been appeared
since 50 years ago.

Back to year 1974, the expectation gap had been defined as 'the
difference between the independent accountant and the intended user of
financial statements expect level for the audit performance' (Liggio, 1974,p.7).
After that, it also had came out another definition, which was 'the difference
between the expectation of the public from the auditing profession and the
actual profession provided by the auditor' (Jennings et al.,1993,p.7). Today,
ACCA has combined all the definitions and created a new and broader
definition for the expectation gap as 'the different between the public's
expectation of the role of auditor and their requirement for the role of the
auditor'(Maggie McGhee,2019,p7). Normally, the range of the expectation gap
will be affected by the corporate failure. Even though the expectation gap has
been tried to be lightened, but once there has any corporate failure occurs,
everything will be backed to the original position again.

Therefore, ACCA has conducted the survey around the world in order
to investigate and identify the reason of gap and find the ways to lighten the
gap between the public and the auditor. Based on their research, they have a
new way to explain the expectation gaps. They conclude all the research and
divide the expectation gaps into three components, which are the knowledge
gap, the performance gap and the evolution gap.

Content

The knowledge gap is the different between the public's expectation of

the role of the auditors and the actual role of the auditor (Maggie
McGhee,2019,p.9). This can indicate that sometime the public will confuse the

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actual role of the auditor. For example, they will believe that the main
responsible of the auditors is to prevent the company bankruptcy. Not only
that, they may also not clear about the limitation of non-audit services
provided by the audit firm to the entity. Before that, some audit professions
might use the knowledge gap as the reason to refuse change as they
described this 'problem' as the public does not have better understanding
rather than reasonable concern. But ACCA had rejected this kind of reason as
the knowledge gaps exists is not to ask the auditor to do more and it also
cannot be used as the reason for the performance gap. The performance gap
concentrates on whether the auditor has applied the audit standard or
regulations requirement in his performance (Maggie McGhee,2019,p.10). The
quality of the audit engagement will be affected by the complication of audit
standard, different understanding of audit standard and regulatory
requirements. The evolution gap exists in the audit field that needs to be
developed by considering the needs of the public, technological progress and
the way of the entire audit process which will help to increase the value
(Maggie McGhee,2019,p.10).

Financial Scandal of TYCO

Background

In 1960, Arthur J. Rosenberg had founded TYCO. It was originally an

investment and holding company focused on solid-state science and energy
conversion. The first sustainable laser beam had been produced by the
company for the medical procedures. Later, the commercial sector had drew
an attention of Rosenberg. Therefore, TYCO had changed to listed company
in 1964, and until 1968, the company had acquired around sixteen
companies. In order to close the gap between its distribution network and
development, the company was continued to expand the acquisition until
1982. In the result, the consolidate sales of the company had increased from
$34 million to $500 million. The company was restructured into three business
segments, which are fire protection, electronics and packaging. TYCO had
resume its growth model through acquisitions in 1986. After that, it was
restructured into four core segments, which are electrical and electronic

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components, healthcare and special products, fire and security services, flow
control services, and flow control. Then, it had maintained these until 1990s.
During this period, the company had changed its name to Tyco International.
More than 30 major companies had been purchased by the company by the
early 2000s.

Discovery of Financial Scandal

Actually TYCO had been pointed out that the financial account
recorded by TYCO was irregular in 1999 but the leader of TYCO was rejected
this rumour. In 2002, due to the incorrect behaviour of the members, the
board of director started an investigation for them and discovered the financial
scandal in the company. The former CEO and CFO of the company, Dennis
Kozlowski and Mark C. Swartz were arrested and accused of embezzling
more than 170 million US dollars. Not only that, they were also reported that
they had stole more than $430 million through deceptively sold TYCO's stock
and hide the information from shareholders. They were charged of 30
misbehaviour, including serious theft, corporate corruption and falsified
business records. Moreover, the former general counsel of the company,
Mark A. Belnick was charged with concealing a personal loan of $14 million.
Although months have passed since the initial arrest, but the charges and
lawsuits were still being filed which had made the Tyco scandal be one of the
most famous scandals of the early 2000s.

Auditor's Failure

The accounting fraud is one of the main issue. In this case, due to the
weak trust between the Tyco International’s auditors, accountants, and

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executives, this will create the conflicts of interest. As the interest of the
shareholders and stakeholders is different with their personal interests,
therefore they tend to endure the quality of financial report information for
personal gain.

As the executives of Tyco had know that they were unable to provide
transparency financial status , therefore they used forged business records in
order to hide the large number of unapproved loans. In addition, it was
discovered that the income of the company had been manipulated. Jerry
Boggess had committed bookkeeping fraud and affected Tyco's earnings per
share reported incorrectly. Besides that, Dennis Kozlowski also committed tax
evasion and had been charged to pay an additional $1 million in New York
State and local sales tax (Andrew and Alex, 2002).

The former external auditor of TYCO, PricewaterhouseCoopers (PwC)

had been found that the engagement partner, Scalzo had created fraudulent
audit report and involved in improper professional conduct. Scalzo had been
found out that he was failed to take proper audit steps in audit procedure. By
the end of Tyco’s annual fiscal year audit, which ended on 30 September
1998, these facts were sufficient to enable Scalzo to reassess Tyco’s audit
risk assessment in accordance with the Generally Accepted Auditing
Standards (GAAS) and perform other audit procedures, including the high-risk
items, such as the benefits and compensation of the executives and
transaction of related party. But, Scalzo failed in taking enough steps in these
areas. So, Scalzo reluctantly failed to conduct an audit in accordance with
GAAS. In addition, PwC had issued an audit report from TYCO fiscal year end
30 September 1998 to 2001 and stated in audited financial statements that
the audit standards were generally accepted in the United States. Hence,
Scalzo was responsible for these statements as he was an engagement
partner for financial statement audit team. When these statements were
released, Scalzo was incautious that Tyco's audit was not conducted in
accordance with GAAS. In the result,, due to the violation of the anti-fraud
provisions of the Federal Securities Act, Scalzo had been ordered by
Commision Order to quite from violating these rules. Not only that, he also

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had been prohibited from appearing or practicing before the Commission as
an accountant permanently (Washington, D.C., 2003).

Conclusion of TYCO's Scandal

In short, it is reasonable for the public to be frustrated that PWC should

do more and detect fraud early. PricewaterhouseCoopers should prevent the
unethical corporate governance used when auditing and should complete
more capable tests around high-risk elements to ensure that such a large-
scale scandal does not happen. Maybe the auditors were trying to satisfy the
client, so they did not pay too much attention to the affairs of Kozlowski and
his directors to avoid conflict between client and themselves. Therefore, the
public hopes that the large companies like Tyco can hire independent auditors
that can report the activities of authorities like Kozlowski who has the power
and opportunity to deceive the company. Not only that, the low
communication efficiency can also expand the scandal to its ultimate extent
as PwC had failed to clearly disclose the facts to shareholder . In addition, as
the expectation gaps between public and the auditor has already existed, so
PwC should understand and maintain their role as the auditors to explain the
service content and the depth level of auditing company activities but not to
mislead customers. Therefore, the behaviour of internal audit should be
observed deeply as it is the part which will involve the abnormal performance
easily.

Closing the Expectation Gap

As the expectation gaps have been mentioned before, it has three

types of gaps, which are knowledge gap, performance gap and evaluation

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gap. If these gaps are keeping on expanding, these will bring negative
impacts for both public and the auditors. Therefore, it is necessary to reduce
these gaps.

It is significant to narrow the knowledge gap so that the public can

focus on existing problems rather than non-existent problems. The audit
profession has responsible in explaining the audit process clearly. Therefore,
it is important to introduce the key audit matters for listed companies by the
International Auditing and Assurance Standards Board (IAASB). However, it is
hard for the audit profession to achieve this alone as the UK Competition and
Markets Authority has stated that 'most people will never pay attention on the
auditor’s opinion on company's financial report' (Competition and Markets
Authority, 2018). Therefore, the stakeholders and others who have connection
with the audit process are required to participate in reducing the knowledge
gaps by providing the audit regulations and auditing standard in fair and
understandable to the public.

Next, for the performance gaps, most of this gaps can be solved by
responding to the results of audit inspections. However, sometime the way
standards are written may heighten deviations (ACCA,2017). For example,
the discussion of the risk of material misstatements will be easily lead to
collective thinking during the engagement team meeting. Therefore, it is
significant that the standards can be created as clear as possible. Not only
that, the requirements that may cause judgment bias or not objectively
should be avoided.

Lastly, if both of the knowledge and performance gaps can be closed,

this can lead the public able to pay more attention on the way of evolution of
the audit that they want. Therefore, the discussion between the stakeholders
and others who have closely connected with them is necessary in order to
ensure that the information provided is relevant and can meet the expectation
of the public.

Conclusion

In short, from the TYCO case, we can learn that the importance of
being an independence and objective auditor. As these are the basic

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requirements for the auditor to reduce the expectation gaps. If the auditor fails
to fulfil these requirements, he will not able to provide true and fair opinion in
the audit report which will cause the gaps become wider. Therefore,
independence and objectively is the first step for them to reduce the
expectation gaps.

Reference

1. McGhee, M. (2019, May). Closing the expectation gap in audit. (p.6 -

10)Retrieved November 1, 2020, from

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 file:///C:/Users/User/Downloads/pi-closing-expectation-gap-audit
%20(1).pdf

2. Unethical Issues or Legal Issues in Tyco International. (n.d.). (Para.19 -

24) Retrieved November 08, 2020, from
https://www.lawteacher.net/free-law-essays/company-law/unethical-
issues-or-legal-issues-in-tyco-international-company-law-essay.php

3. (n.d.). (Para.1 - 4) Retrieved November 08, 2020, from

https://www.sec.gov/news/press/2003-95.htm

4. Remedies & Resolution - Tyco Case Study. (n.d.). (Para. 4) Retrieved

November 08, 2020, from
https://sites.google.com/site/infosystemsacc2015group18/analysis-of-
the-case/remedies

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