Hayley is the majority shareholder and managing director of a medium sized company. An annual audit is performed at the insistence of the bank, which bases decisions on the lending facilities extended to the company each year, on the audited financial statements. Hayley is happy to have the audit performed. She tells you that:

We all get some value out of the audit reports you provide:

1. The bank is reassured about the quality of information we provide in our financial statements;

2. My fellow shareholders are reassured that I am not advantaging myself at their expense in my role as managing director; and

3. Both the bank and the shareholders have someone to sue if our accountant is perpetrating a fraud or if the company collapses, as the auditor should be preventing such problems from happening or at least detecting them and providing early warnings.

Required:

a. Researchers seeking to explain the demand for audits have developed a number of theories, three of which are relevant to this scenario. Each of Hayleys statements (1) (3) above can be associated with a different one of these three theories.

State which theory best explains each of Hayleys statement (1) (3) above. (3 marks)

b. Hayley has misunderstood the responsibilities of auditors. The term expectation gap is used to describe such misperceptions:

i. Briefly explain the term expectation gap and the components which make up this gap. (3 marks)

ii. Hayleys statement (3) above demonstrates one particular component of the expectation gap identify which component and explain why this is so, relating your explanation to what Hayley has said. (2 marks)