Non-Audit Services (NAS) Impact on Auditor Quality

Non-Audit Services (NAS) contact on Auditor QualityThe prep of Non-Audit Services (NAS) by scrutinizeors to their take stock thickenings reduces be costs, increases technical competence and motivates much than intense competition. However, the recent corporeal collapses in the US, Australia and elsewhere, was surprising our attention. The growth of Enron aro functions great concerns on incorporate organisation revealing the take stocked account freedom problem when certified familiar accountants pop the question analyze and NAS for the akin clients. In the view of the fact, now a days because of NAS, the scrutinise utilization is question adequate to(p), whereas third parties believe that without emancipation, at that place is no value for invoice and canvasing employs (Salehi, M., 2009). on that pointfore, regulative has been drawn to the issues of listener provided NAS and canvass timberland. In fact, these servicings do non necessarily damage list ener independence or the quality of NAS. Because of that, this root contributes to seen the impact of NAS on take stockor quality.INTRODUCTION OF NON-AUDIT SERVICESTraditionally, audits experience provided aw ar Public Accountant (certified public accountant) firms with a large percentage of their overall revenues. However, for numerous years consulting serve constituted a relation backly minor spate of the firms revenues. In recent years, firms commit expanded the scope of service they head to audit and other clients such as NAS. Today NAS provided to a greater extent than 50 percent (%) or more of the total revenues earned by the certified public accountant firms. As Accounting Today in USA (2001, April) states, the in bring of bill firms in 2000 showed that the symmetricalness of inter subject area and national sanction service was 35%, whereas that of tax advisory service and focus advisory service accounted for 21% and 44% respectively. It shows that management advisory service has become the kickoff of total income of accounting firms.NAS generally refer to the service above or beyond the cerebrate audit serve or services other than traditional CPA train. Many scholars in their studies use different terms for some germane(predicate) issues, namely Management Advisory Services (MAS) and Management Consulting Service (MCS). concord to Purcell and Lifison (2003), NAS as traditional CPA solves including assurance, investiture assurance, commerce allowance and accounting affairs, tax advisory service, management advisory service, finance and enthronization advisory service, public offering, mergers and acquisitions services, information technology advisory service and others. However, there atomic number 18 three basic principles of the breastwork of specified NAS is predicatedAn auditor can non form in the role of managementAn auditor can non audit its own work andAn auditor cannot serve in an advocacy role for its client.Most o f the firms emersion comes from NAS that CPAs provide for their clients when relations with auditing affairs (Purcell and Lifison, 2003). So, what the motivation and attraction in supply of NAS to companies? Firth (1997a) contends that companies usually entrust outside consultants/firms for service in the following mooringOne-off assignmentsUrgent problemsExpert techniquesArbitrating initial dis directesSeeking adviseDecrease the luck overall managementThe scotch causes for offering NAS includeGrowth opportunities force out attraction and retentionMeeting clients needsRisk diversification opportunitiesThe Sarbanes-Oxley prompt 2002 states that NAS provided to a client should not be more than 5% of the total auditors remuneration otherwise, the client must obtain pre-approval from its audit committee, as non-audit fees promoteful in excess of this percentage would deem the auditor as not being independent. In Malaysia, under Malaysian Institute of Accountant (MIA) projects that audit firms should not accept any appointment if they argon besides providing NAS to a client whereby the grooming of NAS would create a significant threat to their sea captain independence, integrity and objectivity. Effective June 1, 2001, Bursa Malaysia (previously known as Kuala Lumpur Stock Exchange or KLSE) requires all listed companies to disclose non-audit fees in their annual scores. This is to protect shareholders interests and to increase corporate transparency. Consistent with the practices in other Commonwealth countries such as Australia and the joined Kingdom (UK), which to a fault have made it a requirement that non-audit fees of listed companies to be disclosed in the annual report.THE ISSUES OF NON-AUDIT SERVICESThe main question/issue that arises when auditors provide or could provide both audit and NAS is whether the auditors are able to conduct their audits impartially, without being concerned to the broad(prenominal)est degree losing or failing to g ain additional services, and the subsequent economic implications for the audit firm (Lee, 1993). Auditors seek to provide NAS because of the considerable economies of scope that ensue, i.e. cost nest egg that arise when both types of service are provided by the same firm. However, the subject from several(prenominal) researchers show that the marijuana cigarette readiness of audit and non-audit services gives rise to economic rents, which create incentives for audit firms to compromise their objectivity, e.g., waive audit adjustments, to retain audit clients (Palmrose 1986 Simunic 1984).For divine revelation of NAS, investors should have passable information to enable them to evaluate the independence of a smart sets auditors. The proposed die hards would subscribe to the benefits of sunlight to the auditor independence area by requiring companies to disclose in their annual proxy statements certain information about, among other things, the NAS provided by their auditors a nd the conflict of leased personnel in performing the companys annual audit. Generally a company required to disclose the fee paid for each NAS performed by its auditor and the fee charged for the annual audit. An exception to these general apocalypse requirements is that issuers would not have to describe a NAS, nor disclose the fee for that service. In NAS and its independence, England and Australia have asked companies to publish audit and NAS fee in their annual pecuniary report. According to Dopuch et al (2003) gear up that disclosure of NAS reduced the accuracy of investors beliefs of auditors independence in fact when independence in appearance was inconsistent with independence in fact.THE EFFECT OF NON-AUDIT SERVICESThe dramatic increase in the nature, number, and fiscal value of NAS that accounting firms provide to audit clients seen whitethorn affect their independence. Accordingly, the proposals swear certain NAS that, if provided by an accounting firm to an audit client, impair an auditors independence. Sami and Zhang (2003) investigated the resultant of non-audit services on the backdrop of SECs revised rule that stressed comprehend audit independence. They suggested that investors perceive that NAS impair auditors independence.According to Defond et.al. (2000) regulators are concerned about both results of NAS. One is a fear that NAS fees make auditors financially dependent on their clients, and hence less giveing to stand up to management pressure for fear of losing their business. The other is that the consulting nature of many NAS put auditors in managerial role. From the SEC regulations mandating fee disclosures (SEC, 2000), Auditors services relationship raises two types of independence concerns. First, more the auditor has at stake in its dealing with the audit client, particularly when the NAS relationship has the potential to generate significant revenues on top of the audit relationship. Second, certain types of NAS, when pro vided by the auditor, create inherent conflicts that are incompatible with objectivity. While, according to Firth (1997b), synergy would occur between auditor and auditee when an accounting firm provides audit and NAS simultaneously and consequently it would influence independence of auditor.Simunic (1984) indicates that CPA providing NAS would decrease the possibility for presenting the true financial statements and would influence the users of the statements on the perception of CPA independence. It would further affect audit quality, the reliability of financial statements and the purpose of decision- make.How NAS Can Affect Auditor Independence?The dramatic expansion of NAS whitethorn fundamentally alter the relationships between auditors and their audit clients in two bargainer ways. First, as auditing becomes an ever- milder portion of a firms business with its audit clients, auditors become progressively vulnerable to economic pressures from audit clients. Large non-audit engagements may make it harder for auditors to be objective when examining their clients financial statements. Under any circumstances, it can be catchy for an auditor to make a judgment that works against the audit clients interest. Where do that judgment may imperil a range of service engagements of the firm, of which the audit is a fairly small part, it may be unrealistic to channel that an auditor can ignore completely what the firm stands to lose by the auditors action. Second, certain NAS, by their very nature, raise independence issues. Providing certain NAS to an audit client can lead an audit firm to have a mutual or conflicting interest with the client, audit its own work, promote a position for the client, or thing as an employee or management of the client.However, not all NAS pose the same risk to independence. Only these circumstantial NAS that impair independence, namelyBookkeeping or other services related to to the audit clients accounting records or financ ial statements of the company. The prohibited services are(a) Maintaining or preparing the companys accounting records(b) Preparing the financial statements or the information that forms the basis of the financial statements that are required by the company and(c) Preparing or originating source entropy underlying the companys financial statements.Design and implementation of financial information systems that meat source data or generate information that is significant to the financial statements taken as a whole, unless it is reasonable to conclude that the results of these services go forth not be subject to audit procedures during the audit of the companys financial statements. This rule does not preclude the extraneous auditors from working on hardware or software systems that are unrelated to the companys financial statements or accounting records. estimation or valuation services, fairness opinions or contribution-in-kind reports or other opinions or reports in which the external auditors provide an opinion on the adequacy of status in a transaction, unless it is reasonable to conclude that the results of these services will not be subject to audit procedures during the audit of the companys financial statements. This rule does not prohibit the external auditors firm from providing such services for non-financial reporting purposes (e.g., lurch pricing studies, cost segregation studies and other tax-only valuations). cropuarial services involving amounts save in the financial statements and related accounts for the company where it is reasonably likely that the results of these services will be subject to audit procedures during an audit of the companys financial statements. This prohibition extends to providing the company with any actuarially-oriented advisory service involving the determination of amounts recorded in the financial statements and related accounts for the company other than assisting the company in discretion the methods, mode ls, assumptions and inputs used in computing an amount.Internal audit outsourcing services relating to the innate accounting controls, financial systems or financial statements of the company. This prohibition on outsourcing does not preclude the external auditors from providing attest services related to native controls, evaluating the companys internal controls during the audit or making recommendations for improvements to the controls, or management from winsome the external auditors to perform agreed-upon procedures engagements related to the companys internal controls.Management functions. This rule prohibits the external auditors from acting, temporarily or permanently, as a director, officer or employee of the company or performing any decision making, supervisory or monitoring function for the company. However, the external auditors may assess the effectiveness of the companys internal controls and recommend improvements in the design and implementation of internal contro ls and risk management controls.Human resources functions. The external auditors may not seek out prospective candidates for managerial, executive or director positions, act as negotiator on the companys behalf such as determining position, compensation or fringe benefits or other conditions of example or undertake reference checks of prospective candidates. The external auditors may also not engage in psychological testing or other formal testing or evaluation or recommend or advise the company to hire a specific candidate for a specific job.Broker or dealer, investment adviser, or investment banking services. The external auditors are prohibited from serving as promoter or underwriter, making investment decisions on behalf of the company or otherwise having discretionary ascendency over the companys investments, or executing a transaction to buy or mete out an investment of the company, or having custody of assets of the company.Legal services that could be provided only by som eone licensed, admitted or otherwise qualified to practice law in the jurisdiction in which the service is provided.Expert services in an advocacy capacity unrelated to the audit. This precludes engagements that are intended to result in the external audit firms specialized knowledge, experience and expertise being used to support the audit clients positions in adversarial proceedings. This prohibits the external auditors from providing expert opinions or other services to the company or a legal exemplification of the company for the purpose of advocating the companys interests in litigation, or regulatory or administrative investigations or proceedings. This rule does not however preclude the company from engaging the external auditors to perform internal investigations or fact-decision engagements including forensic work and using the results of this work in subsequently initiated proceedings or investigations. whatsoever other service that the Audit Committee determines is imper missible.According to Zulkarnain (2006), in Malaysia, scholars report that only a small number of the shareholders and auditors that participated in their study believed that NAS planning increased their trust in auditor independence. On the other hand, Teoh and Lim (1996) piece that the provision of NAS was ranked as the second most important promoter that undermines auditor independence.Arrunada (1999) pointed out that joystick provision of audit and NAS would reduce overall costs, raises the technical quality of auditing, enhance competition and need not prepossession auditor independence or the quality of NAS, which would ultimately increase auditor independence (Goldman and Barlev, 1974). Based on the standard organization analysis, 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 commercializes, and also that the provision of NAS would result in an increase in client - and firm-specific assets, where firm-specific assets would always have a positive effect on independence. This argument is supported by secure et al. (1994), who argued that permitting auditors to perform joint services would reduce auditors dependence on a single client and encourage them to diversify as a consequence.Opponents to the joint provision of audit and NAS claimed that auditors would not perform their audit services objectively and that joint provision would impair perceived independence because ultimately they would be auditing their own work or acting as management (SEC, 2001), and managements condition over the auditor could be increased due(p) to auditors reliance on fees real (Canning and Gwilliam, 1999). Thus, it may influence their mental attitude, impartiality and objectivity, and independence of apprehension and action (Flint, 1988).The year 2002 had seen the biggest corporate collapses in the United States history that have raised lots of questions regar ding auditors independence. For example, Arthur Andersen, being the auditor of the three biggest bankruptcies, Enron, WorldCom and Global Crossing, was to a great extent criticized for the collapses. It is said that Andersen was purportedly stressing more on non-audit services (NAS) than the audit itself. Auditing trade as a whole has been badly blamed for the collapses and changes were being proposed to get word that audit firms reduce their over-reliance on NAS (The Star, 2002).As a result, to ensure the independence of auditors and to protect the interest of investors, the accounting profession in most countries has come up with a code of ethics as a guidelines for auditors faculty and independence. In Malaysia, under MIA rules that become effective January 15, 2002, professional independence is considered impaired if total fees arising from provision of NAS to a client is 20% or more of the audit firms total annual fees received for two or more consecutive years. Before 200 1, the regulators in Malaysia emphasized only on the disclosure of audit fees in the companies annual reports, as required by the Companies Act 1965.Several studies have examined whether the provision of non-audit services impairs audit quality. However, the previous studies report seems conflict in the results depending on the proxy of audit quality used. Teoh and Lim (1996) found that the disclosure on non-audit fees would influence and impair audit independence. A stick to done by Gul and Teoh (1986) in Malaysia, suggests that the provision of NAS reduces public confidence in auditors independence. The auditor can be interpreted to compromise its independence if the provision of NAS is significantly tied to the issuance of clean audit opinion. Wines (1994) found that the auditors of those companies that received clean reports over the period derived a significantly higher proportion of their remuneration from NAS fees than the auditors of companies that received at least one aud it qualification. This finding suggests that auditors are less likely to give qualified reports to clients financial statements when high levels of NAS fees are involved. Firth (2002) found that companies that have relatively high consultancy fees are more likely to receive a clean audit opinion due to the non-audit work clearing up problem areas at the client company or it might be due to high consultancy fees, thus impairing auditor independence.Ayoib, Rohami and Nor (2006) suggests that non-Big Five auditors are less independent when issuing audit reports for NAS purchased companies. This is also consistent with the preposition that large auditors are more independent than smaller auditors (DeAngelo, 1981). The results suggest that audit opinion is dependent on the amount of NAS fee. It could be argued that small auditors could not resist against management pressure when issuing qualified opinion.Frankel, Johnson and Nelson (2002) suggest that their results provide conclusion t hat auditor independence is compromised when clients pay high nonaudit fees relative to total fees. Securities and Exchange committees (SEC) concern about the growth of nonaudit fees relative to audit fees during the 1990s (e.g., see Levitt 2000). The SECs concern that the growth in the provision of nonaudit services compromises audit firm independence is based on the premise that the provision of nonaudit services increases the fees paid to the audit firm thereby increasing the economic dependence of the audit firm on the client.Based on the use 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 result of clients compensable high fees or having high fee ratios. DeAngelo (1981) models that as the economic alignment between the audit firm and client increases the audit firms dependence on the client increases. Nonaudit fees furt her increase the client auditor bond by increasing the portion of audit firm wealth derived from a client (Simunic 1984 Beck et al. 1988). Nonaudit fees can also menace independence when clients use them as dependent upon(p) fees. Magee and Tseng (1990) note that while contingent fees are explicitly prohibited by audit standards, clients can create contingent fees by withholding fat nonaudit services when the auditor does not allow the client to report its pet financial condition.Costs and Benefits of Restricting Certain Non-Audit Services (proposals by SEC)There is increasing concern that the growth of NAS provided to audit clients affects the independence of auditors. If investors lose confidence in auditors ability or willingness to provide an unbiased and impartial psychometric test of companies financial statements, then investors trust in the reliability of publicly visible(prenominal) financial information, and in the integrity of the securities markets, may be damaged. Currently, accounting firms may not provide certain services to their audit clients without impairing their independence. The Securities Exchange and Commission (SEC) proposals extend and clarify those restrictions that should be used to evaluate the effect of NAS on an auditors independence and by designating certain NAS that if performed by an auditor for an SEC registrant that is an audit client, impair the auditors independence. The SECs proposals on the provision of NAS may affect to1. Benefits(a) Investors. For the reasons explained above, the SEC believes that the proposals will enhance auditor independence and thereby enhance the reliability and credibility of financial statements of public companies. SEC expect these benefits to inure primarily to investors who, if the proposals are adopted, should be able to review public companies financial statements with greater assurance that reliance on the statements will lead to more informed investment decisions.(b) Public Accoun ting Firms. SEC anticipates that the proposals will confer two special benefits on public accounting firmsThe proposals should clarify what NAS may be provided to an audit client without jeopardizing auditor independence.The proposals could improve competition in the market for the provision of NAS by public accounting firms. Because the restrictions on providing NAS to an audit client would devote equally to all accounting firms, the overall impact of the proposed restrictions may be to re-distribute the restricted NAS among the public accounting firms.2. CostsSEC proposals on NAS may impose costs on issuers and public accounting firms.(a) Issuers. The proposed amendments have the effect of restricting issuers from purchasing certain NAS from their auditors.(b) Public Accounting Firms. Some public accounting firms provide a wide variety of services both to audit and non-audit clients. Our scope of services proposals is likely to affect these firms in several ways. The primary cos t for these firms is that they individually may lose one source of revenue because they will no longer be able to sell certain NAS to their audit clients.CONCLUSIONIn conclusion, evidence suggests that although auditors have market based incentives to remain independent, auditor independence may be threaten when an auditor provide NAS to their clients and is reasonable that the NAS actually impair independence and quality of auditor. Hillison and Kennelley (1988) had recommended three additional alternatives to a total prohibition of NAS provision to audit clientsOffer NAS to non-audit clients only,Prohibit certain types of NAS, orPermit all types of NAS with undecomposed disclosure requirements.However, some professional and academic seen it seemed not much enough to protect auditor independence and It would further affect auditor quality. Thus, national and international professions should be redefined accounting and auditing regulation as well as scanted new regulation regarding to NAS and giving clear picture about that services to auditors as well as investors and heavy penalties, to whom overriding these regulation.