Non-Audit Services (NAS) Effect on Auditor Quality

The provision of Non-Audit Services (NAS) by auditors with their audit clients reduces total costs, increases specialized competence and motivates more powerful competition. However, the recent corporate and business collapses in the US, Australia and anywhere else, was shocking our attention. The problem of Enron arouses great concerns on commercial governance revealing the audit freedom problem when CPAs provide audit and NAS for the same clients. Inside the view of the fact, now a days because of NAS, the audit practice is questionable, whereas third people think that without independence, there is no value for accounting and auditing procedures (Salehi, M. , 2009). Therefore, regulatory has been drawn to the issues of auditor provided NAS and audit quality. In fact, these services do not necessarily damage auditor freedom or the quality of NAS. Due to that, this newspaper plays a part in seen the impact of NAS on auditor quality.

INTRODUCTION OF NON-AUDIT SERVICES

Traditionally, audits have provided Authorized Open public Accountant (CPA) companies with a large percentage of the overall profits. However, for many years consulting services constituted a relatively minor part of the companies' revenues. Lately, firms have widened the range of services they give to audit and other clients such as NAS. Today NAS provided more than 50 percent (%) or even more of the full total revenues attained by the CPA organizations. As Accounting Today in USA (2001, Apr) state governments, the income of accounting organizations in 2000 confirmed that the percentage of international and countrywide confidence service was 35%, whereas that of duty advisory service and management advisory service accounted for 21% and 44% respectively. It demonstrates management advisory service has become the way to obtain total income of accounting businesses.

NAS generally make reference to the assistance above or beyond the related audit services or services other than traditional CPA work. Many scholars in their studies use different conditions for a few relevant issues, particularly 'Management Advisory Services' (MAS) and 'Management Consulting Service' (MCS). Regarding to Purcell and Lifison (2003), NAS as traditional CPA works including confidence, investment assurance, business enrollment and accounting affairs, duty advisory service, management advisory service, finance and investment advisory service, public offering, mergers and acquisitions services, information technology advisory service among others. However, there are three basics of the prohibition of particular NAS is predicated:

  • An auditor cannot function in the role of management;
  • An auditor cannot audit its work; and
  • An auditor cannot serve within an advocacy role because of its client.

Most of the firm's expansion originates from NAS that CPAs provide for their clients when interacting with auditing affairs (Purcell and Lifison, 2003). So, the particular motivation and interest in provision of NAS to companies? Firth (1997a) contends that companies usually entrust external consultants/organizations for service in the next situation:

  • One-off assignments
  • Urgent problems
  • Expert techniques
  • Arbitrating initial disputes
  • Seeking advise
  • Decrease the risk overall management

The economic causes for offering NAS include;

  • Growth opportunities
  • Personnel fascination and retention
  • Meeting client's needs
  • Risk diversification opportunities

The Sarbanes-Oxley Work 2002 state governments that NAS provided to a client shouldn't be more than 5% of the total auditor's remuneration; usually, your client must obtain pre-approval from its audit committee, as non-audit fees paid more than this ratio would consider the auditor as not being 3rd party. In Malaysia, under Malaysian Institute of Accountant (MIA) suggests that audit firms should not accept any appointment if they're also providing NAS to a client; whereby the provision of NAS would create a significant threat with their professional freedom, integrity and objectivity. Effective June 1, 2001, Bursa Malaysia (previously known as Kuala Lumpur STOCK MARKET or KLSE) requires all listed companies to reveal non-audit fees in their twelve-monthly reports. That is to protect shareholders' interests also to increase commercial transparency. Consistent with the procedures in other Commonwealth countries such as Australia and the uk (UK), which likewise have managed to get a requirement that non-audit fees of posted companies to be disclosed in the gross annual report.

THE ISSUES OF NON-AUDIT SERVICES

The main question/issue that develops when auditors provide or could provide both audit and NAS is if the auditors are able to perform their audits impartially, without having to be concerned about getting rid of or failing woefully to gain additional services, and the subsequent monetary implications for the audit company (Lee, 1993). Auditors seek to provide NAS due to appreciable economies of opportunity that ensue, i. e. cost savings that occur when both types of service are given by the same company. However, the result from several researchers show that the joint provision of audit and non-audit services gives rise to monetary rents, which create bonuses for audit organizations to compromise their objectivity, e. g. , waive audit adjustments, to hold on to audit clients (Palmrose 1986; Simunic 1984).

For disclosure of NAS, shareholders must have enough information to enable them to judge the independence of a company's auditors. The suggested guidelines would bring the benefits of sunlight to the auditor freedom area by necessitating companies to disclose in their total annual proxy statements certain information about, among other activities, the NAS provided by their auditors and the participation of leased staff in performing the business's total annual audit. Generally a firm required to disclose the charge paid for each and every NAS performed by its auditor and the charge recharged for the total annual audit. An exception to these basic disclosure requirements is the fact that issuers wouldn't normally have to describe a NAS, nor disclose the charge to the service. In NAS and its independence, England and Australia have asked companies to publish audit and NAS cost in their total annual financial report. Corresponding to Dopuch et al (2003) discovered that disclosure of NAS reduced the correctness of buyers' beliefs of auditors' self-reliance in truth when independence to look at was inconsistent with independence in reality.

THE AFTEREFFECT OF NON-AUDIT SERVICES

The dramatic upsurge in the nature, quantity, and monetary value of NAS that accounting businesses provide to audit clients seen may influence their independence. Accordingly, the proposals specify certain NAS that, if provided by an accounting firm with an audit customer, impair an auditor's self-reliance. Sami and Zhang (2003) investigated the effect of non-audit services on the background of SEC's modified rule that pressured perceived audit independence. They recommended that investors perceive that NAS impair auditors' independence.

According to Defond et. al. (2000) regulators are concerned about two ramifications of NAS. Some may be a dread that NAS fees make auditors fiscally reliant on their clients, and therefore less prepared to stand up to management pressure for fear of burning off their business. The other is that the consulting nature of several NAS put auditors in managerial role. From the SEC polices mandating cost disclosures (SEC, 2000), Auditor's services romantic relationship boosts two types of freedom concerns. First, more the auditor has at stake in its dealing with the audit client, particularly if the NAS marriage has the potential to generate significant revenues on top of the audit marriage. Second, certain types of NAS, when provided by the auditor, create natural issues that are incompatible with objectivity. While, matching to Firth (1997b), synergy would happen between auditor and auditee when an accounting organization provides audit and NAS all together and consequently it could influence freedom of auditor.

Simunic (1984) reveals that CPA providing NAS would decrease the possibility for presenting the real financial claims and would influence the users of the assertions on the recognition of CPA freedom. It would further influence audit quality, the stability of financial assertions and the common sense of decision-making.

How NAS MAKE A DIFFERENCE Auditor Independence?

The dramatic enlargement of NAS may fundamentally modify the relationships between auditors and their audit clients in two principal ways. First, as auditing becomes an ever-smaller portion of a firm's business using its audit clients, auditors become progressively more vulnerable to economical stresses from audit clients. Large non-audit engagements could make it harder for auditors to be objective when evaluating their client's financial assertions. Under any circumstances, it can be difficult for an auditor to make a view that works contrary to the audit client's interest. Where making that judgment may imperil a range of service engagements of the firm, which the audit is a reasonably small part, it can be unrealistic to anticipate an auditor can ignore completely the actual firm stands to reduce by the auditor's action. Second, certain NAS, by their very character, raise freedom issues. Providing certain NAS to the audit client may lead an audit organization to have a common or conflicting interest with the client, audit its work, advocate a position for your client, or function as an employee or management of the client.

However, not absolutely all NAS pose the same risk to self-reliance. Only these specific NAS that impair self-reliance, namely:

Bookkeeping or other services related to the audit client's accounting files or financial statements of the company. The prohibited services are:

(a) Maintaining or planning the company's accounting details;

(b) Organizing the financial statements or the info that forms the basis of the financial assertions that are essential by the company and;

(c) Preparing or originating source data root the company's financial assertions.

Design and execution of financial information systems that aggregate source data or generate information that is significant to the financial statements as a whole, unless it is acceptable to summarize that the results of these services will not be at the mercy of audit procedures during the audit of the company's financial statements. This rule will not preclude the external auditors from working on hardware or software systems that are unrelated to the company's financial statements or accounting files.

Appraisal or valuation services, fairness ideas or contribution-in-kind reviews or other opinions or reports where the external auditors offer an opinion on the adequacy of account in a transfer, unless it is sensible to summarize that the results of these services will not be at the mercy of audit procedures during the audit of the company's financial statements. This rule does not prohibit the external auditors organization from providing such services for non-financial reporting purposes (e. g. , copy prices studies, cost segregation studies and other tax-only valuations).

Actuarial services regarding amounts documented in the financial assertions and related makes up about the company where it is fairly likely that the results of the services will be at the mercy of audit methods during an audit of the business's financial claims. This prohibition extends to providing the business with any actuarially-oriented advisory service involving the determination of sums registered in the financial claims and related makes up about the company apart from assisting the company in understanding the methods, models, assumptions and inputs found in computing an amount.

Internal audit outsourcing services relating to the inner accounting controls, financial systems or financial statements of the business. This prohibition on outsourcing will not preclude the external auditors from providing attest services related to internal controls, evaluating the business's internal controls through the audit or making recommendations for improvements to the control buttons, or management from engaging the external auditors to perform "agreed-upon strategies" engagements related to the company's internal settings.

Management functions. This rule prohibits the external auditors from acting, temporarily or forever, as a director, official or staff of the business or doing any decision making, supervisory or monitoring function for the company. However, the external auditors may determine the potency of the company's inner handles and recommend advancements in the look and execution of internal adjustments and risk management controls.

Human resources functions. The exterior auditors might not seek out potential individuals for managerial, executive or director positions, become negotiator on the company's behalf such as identifying position, reimbursement or fringe benefits or other conditions of occupation or undertake reference checks of potential candidates. The external auditors may also not take part in psychological testing or other formal screening or analysis or recommend or guide the company to hire a specific prospect for a specific job.

Broker or supplier, investment adviser, or investment bank services. The external auditors are prohibited from providing as promoter or underwriter, making investment decisions with respect to the company or elsewhere having discretionary power over the company's investments, or performing a exchange to buy or sell an investment of the business, or having guardianship of investments of the company.

Legal services that could be provided only by someone qualified, admitted or elsewhere qualified to practice regulation in the jurisdiction in which the service is provided.

Expert services within an advocacy capacity unrelated to the audit. This precludes engagements that are designed to cause the exterior audit firm's special knowledge, experience and experience being used to support the audit client's positions in adversarial proceedings. This prohibits the exterior auditors from providing expert opinions or other services to the business or a legal rep of the company for the purpose of advocating the business's passions in litigation, or regulatory or administrative investigations or proceedings. This guideline does not however preclude the company from engaging the exterior auditors to perform inside investigations or fact-finding engagements including forensic work and using the results of this work in subsequently initiated proceedings or investigations.

Any other service that the Audit Committee decides is impermissible.

According to Zulkarnain (2006), in Malaysia, scholars reported that only a tiny number of the shareholders and auditors that participated in their review assumed that NAS provision increased their confidence in auditor independence. Alternatively, Teoh and Lim (1996) discovered that the provision of NAS was positioned as the second most important factor that undermines auditor freedom.

Arrunada (1999) pointed out that joint provision of audit and NAS would reduce overall costs, increases the complex quality of auditing, enhance competition and need not prejudice auditor freedom or the quality of NAS, which would finally increase auditor independence (Goldman and Barlev, 1974). Predicated on the standard group evaluation, Arrunada (1999) showed that cost savings gained from the joint provision of audit and NAS will be transferred to customers as a decrease in price in both marketplaces, and also that the provision of NAS would 'direct result in an upsurge in customer- and firm-specific possessions', where firm-specific resources would 'always have an optimistic effect on freedom'. This discussion is reinforced by Grout et al. (1994), who argued that permitting auditors to execute joint services would reduce auditors' dependence on a single customer and encourage them to diversify as a result.

Opponents to the joint provision of audit and NAS claimed that auditors would not perform their audit services objectively and this joint provision would impair identified independence because ultimately they would be auditing their own work or behaving as management (SEC, 2001), and management's vitality over the auditor could be increased anticipated to auditors' reliance on fees received (Canning and Gwilliam, 1999). Thus, it may impact their mental frame of mind, impartiality and objectivity, and self-reliance of thought and action (Flint, 1988).

The time 2002 acquired seen the largest corporate collapses in the United States history that contain raised plenty of questions regarding auditor's self-reliance. For example, Arthur Andersen, being the auditor of the three biggest bankruptcies, Enron, WorldCom and Global Crossing, was greatly criticized for the collapses. It is stated that Andersen was purportedly stressing more on non-audit services (NAS) than the audit itself. Auditing vocation as a whole has been badly blamed for the collapses and changes were being proposed to ensure that audit firms reduce their over-reliance on NAS (The Star, 2002).

As an outcome, to ensure the self-reliance of auditors also to protect the eye of traders, the accounting vocation generally in most countries has come up with a code of ethics as a guidelines for auditors competency and freedom. In Malaysia, under MIA guidelines that become effective January 15, 2002, professional freedom is considered impaired if total fees arising from provision of NAS to a client is 20% or even more of the audit firm's total gross annual fees received for just two or even more consecutive years. Before 2001, the regulators in Malaysia emphasized only on the disclosure of audit fees in the companies' gross annual information, as required by the firms Work 1965.

Several studies have analyzed if the provision of non-audit services impairs audit quality. However, the previous studies article seems issue in the results depending on proxy of audit quality used. Teoh and Lim (1996) discovered that the disclosure on non-audit fees would effect and impair audit self-reliance. A study done by Gul and Teoh (1986) in Malaysia, shows that the provision of NAS reduces open public self-assurance in auditors independence. The auditor can be interpreted to bargain its self-reliance if the provision of NAS is significantly linked with the issuance of clean audit judgment. Wines (1994) discovered that the auditors of these companies that received clean information over the period produced a significantly higher percentage of these remuneration from NAS fees than the auditors of companies that received at least one audit qualification. This finding shows that auditors are less inclined to give qualified reports to clients' financial statements when high levels of NAS fees are involved. Firth (2002) discovered that companies that have relatively high consultancy fees are more likely to get a clean audit opinion because of the non-audit work unscrambling problem areas at the client company; or it might be scheduled to high consultancy fees, thus impairing auditor independence.

Ayoib, Rohami and Nor (2006) shows that non-Big Five auditors are less indie when issuing audit reports for NAS purchased companies. This is also consistent with the preposition that large auditors are usually more indie than smaller auditors (DeAngelo, 1981). The results imply audit opinion is dependent on the quantity of NAS fee. Maybe it's argued that small auditors cannot withstand against management pressure when issuing certified opinion.

Frankel, Johnson and Nelson (2002) suggest that their results provide facts that auditor freedom is affected when clients pay high nonaudit fees relative to total fees. Securities and Exchange Commission's (SEC) concern about the growth of nonaudit fees in accordance with audit fees during the 1990s (e. g. , see Levitt 2000). The SEC's matter that the development in the provision of nonaudit services compromises audit company independence is based on the idea that the provision of nonaudit services increases the fees paid to the audit organization in so doing increasing the economical dependence of the audit company on the client.

Based on the utilization of discretionary accruals and earnings benchmarks as proxies for biased financial reporting, Hollis, Ryan and Brian (2003) find evidence supporting the claim that auditors violate their independence as the consequence of clients paying high fees or having high fee ratios. DeAngelo (1981) models that as the monetary bond between your audit organization and client increases the audit firm's dependence on the client boosts. Nonaudit fees further increase the client auditor connection by increasing the portion of audit firm wealth derived from a customer (Simunic 1984; Beck et al. 1988). Nonaudit fees can also threaten self-reliance when clients utilize them as contingent fees. Magee and Tseng (1990) note that while contingent fees are explicitly prohibited by audit criteria, clients can create contingent fees by withholding profitable nonaudit services when the auditor will not allow the client to report its preferred financial condition.

Costs and Benefits of Restricting Certain Non-Audit Services (proposals by SEC)

There is increasing matter that the expansion of NAS provided to audit clients impacts the independence of auditors. If shareholders lose confidence in auditors' potential or determination to provide an unbiased and impartial study of companies' financial claims, then investors' trust in the reliability of publicly available financial information, and in the integrity of the securities marketplaces, may be harmed. Currently, accounting companies may well not provide certain services to their audit clients without impairing their independence. The Securities Exchange and Commission rate (SEC) proposals expand and clarify those restrictions that needs to be used to judge the effect of NAS by using an auditor's freedom and by designating certain NAS that if performed by an auditor for an SEC registrant that is an audit customer, impair the auditor's freedom. The SEC's proposals on the provision of NAS may influence to:

1. Benefits

(a) Investors. For the reason why described above, the SEC is convinced that the proposals will improve auditor self-reliance and thereby improve the reliability and reliability of financial assertions of general public companies. SEC expect these benefits to inure mainly to shareholders who, if the proposals are used, can review public companies' financial assertions with greater assurance that reliance on the assertions will lead to more knowledgeable investment decisions.

(b) Community Accounting Organizations. SEC anticipates that the proposals will confer two primary benefits on public accounting companies:

The proposals should clarify what NAS may be provided with an audit customer without jeopardizing auditor independence.

The proposals could improve competition in the market for the provision of NAS by open public accounting firms. Because the limitations on providing NAS to the audit consumer would apply similarly to all or any accounting firms, the overall impact of the suggested constraints may be to re-distribute the limited NAS among the general public accounting companies.

2. Costs

SEC proposals on NAS may impose costs on issuers and open public accounting firms.

(a) Issuers. The proposed amendments have the result of restricting issuers from purchasing certain NAS of their auditors.

(b) Community Accounting Organizations. Some open public accounting firms give you a wide variety of services both to audit and non-audit clients. Our opportunity of services proposals will probably affect these organizations in several ways. The primary cost for these firms is that they singularly may lose one source of revenue because they'll no longer have the ability to sell certain NAS to their audit clients.

CONCLUSION

In conclusion, facts shows that although auditors have market founded incentives to remain independent, auditor independence may be threaten when an auditor provide NAS with their clients and is sensible that the NAS actually impair self-reliance and quality of auditor. Hillison and Kennelley (1988) experienced suggested three additional alternatives to a total prohibition of NAS provision to audit clients:

  • Offer NAS to non-audit clients only,
  • Prohibit certain types of NAS, or
  • Permit all types of NAS with full disclosure requirements.

However, some professional and academic seen it looked like not much enough to safeguard auditor self-reliance and It would further impact auditor quality. Thus, national and international occupations should be redefined accounting and auditing legislation as well as scanted new regulation regarding to NAS and presenting clear picture about that services to auditors as well as buyers and heavy penalties, to whom overriding these rules.

  • More than 7,000 students prefer us to work on their projects
  • 90% of customers trust us with more than 5 assignments
Special
price
£5
/page
submit a project

Latest posts

Read more informative topics on our blog
Shiseido Company Limited Is A Japanese Makeup Company Marketing Essay
Marketing Strength: Among the main talents of Shiseido is its high quality products. To be able to satisfy customers, the company invested a great deal...
Fail To Plan You Plan To Fail Management Essay
Management This report will concentrate on two aspects of project management, their importance within the overall project management process. The report...
Role of High-protein Diet in Weight Management
Nursing Structured Representation: Probably one of the most wide-spread and popular problems on earth is the weight problems that people is suffering...
Waste To Prosperity Program Environmental Sciences Essay
Environmental Sciences Urban and rural regions of India produce very much garbage daily and hurting by various kinds of pollutions which are increasing...
Water POLLUTING OF THE ENVIRONMENT | Analysis
Environmental Studies Pollution Introduction Many people across the world can remember having walked on the street and seen smoke cigars in the air or...
Soft System Methodology
Information Technology Andrzej Werner Soft System Methodology can be described as a 7-step process aimed to help provide a solution to true to life...
Strategic and Coherent methods to Recruiting management
Business Traditionally HRM has been regarded as the tactical and coherent method of the management of the organizations most appreciated assets - the...
Religious Healthcare Organisation
Health Religious Health Care Introduction I help the firm of consulting. Spiritual HEALTHCARE of Middleville community have appointed us to identify and...
Enterprise Rent AN AUTOMOBILE Case Analysis Business Essay
Commerce With a massive network of over 6,000 local rental locations and 850,000 automobiles, Organization Rent-A-Car is the greatest rental car company...
Check the price
for your project
we accept
Money back
guarantee
100% quality