Do Auditor‐Provided Nonaudit Services Improve Audit Effectiveness?*

Abstract

JENNIFER R. JOE, Georgia State UniversitySCOTT D. VANDERVELDE, University of South Carolina1. IntroductionIn recent years, there has been a heated debate over whether auditors should beallowed to provide any nonaudit services to their audit clients.' Public accountingfirms and other proponents of auditor-provided nonaudit services argue that perform-ing both audit and nonaudit services for the same client increases audit effectivenessand audit efficiency because it promotes a more comprehensive understanding ofthe client. For example, Terry Strange, global managing partner of KPMG, arguesthat services enhance audit effectiveness (cf. Norris 2000). However,opponents of auditor-provided nonaudit services, many of whom advocate a com-plete ban on such services, argue that acting in a dual capacity as auditor andconsultant/adviser compromises auditor independence and objectivity. Bazerman,Loewenstein, and Moore (2002) argue that the structural aspects of accounting andcharacteristics of human nature can cause unconscious bias in an auditor's judge-ments in the direction of the client's preferences. Bazerman et al. point out thatperforming nonaudit services for audit clients increases the auditor's attachment tothat client, leading to bias in judgement. Former Securities and Exchange Com-mission (SEC) chairman Arthur Levitt expresses a similar sentiment: I think thatany kind of consulting in this environment makes the audit look at least in ques-tion (cf. Revell and Burke 2003). Many users of audit reports also share this view.According to a survey of financial analysts, 83 percent of analysts believe thatobjectivity is threatened even when the non-audit fee is less than the audit fee(emphasis added) (SEC 2001).In this paper, we use an experiment to investigate (a) whether knowledgegained from working on a nonaudit task can be transferred to enhance the perfor-mance of audit tasks, and (b) whether any knowledge transfer can be achieved ifthe auditor only reviews the nonaudit workpapers prepared by nonaudit staff in thesame audit firm or a different audit firm. Thus, this study focuses on the cognitive