Auditor-provided Non-audit Services Research Articles

The impact of auditor-provided non-audit services on audit quality: A review of the archival literature

The paper gives an overview of the results of a structured literature review. It covers archival studies on the relationship between non-audit services (NAS) fees and factual as well as perceived audit quality published in journals included in the accounting subject category of the SCImago Journal Ranking. It also includes a critical evaluation of the research methods applied in prior research and offers avenues for future research. The provision of NAS to audit clients creates threats to auditor independence. Consequently, regulators have focused on the simultaneous provision of audit and NAS for many years and restricted it over time. This paper aims to assess which regulatory actions are justified in light of related archival research findings. Overall, prior research does not clearly prove a negative impact of non-audit services on factual audit quality. However, it demonstrates a negative relationship between non-audit fees and audit quality perceptions. Moreover, it also reveals that tax consulting fees are less problematic

The audit market for listed Australian companies from 2012 to 2018: A state of play

Motivated by recent regulatory scrutiny of auditing in Australia, we provide an overview of the audit market for Australian listed companies from 2012 to 2018. Using descriptive analyses, we explore audit market competition, the provision of non-audit services (NAS), and audit firm tenure. We find that the Australian audit market is highly segmented. Big 4 firms increasingly dominate the larger client segment, while Non-Big 4 firms focus on medium and smaller clients. Auditor-provided NAS fees represent a relatively small fraction of audit fees for smaller clients, but a relatively high fraction for larger clients. We further observe that the share of total revenue from NAS of Big 4 firms increases over time. Finally, a relatively small percentage of clients has long audit firm tenure, and that long tenure is more common in the larger client segments. We discuss the implications of these findings and research opportunities that emerge. JEL Classification: D40, L11, M42, L84

Investments in Auditor-Provided Non-Audit Services and Future Operating Performance

SUMMARY The “organization capital” of a firm consists of its internal investments in its business units, processes, know-how, employee skills, and information systems. We investigate whether a firm's investments in auditor-provided non-audit services (NAS) can supplement its own internal investment in organization capital, resulting in improved operating performance. We find that investments in NAS are positively related to a firm's subsequent operating performance consistent with NAS augmenting a firm's organization capital. Firms with low organization capital in general, high complexity, or disruption due to acquisitions benefit the most from purchasing NAS from their auditor. We also show that firms engaging auditors with a high level of expertise manifest higher levels of future operating performance. We find no evidence that the improvement in operating performance subsequent to NAS investment is due to earnings management or lower audit quality. JEL Classifications: M41; M49; L84.

외부감사인의 비감사서비스 동시 제공이 감사품질에 미치는 영향에 대한 문헌검토와 미래 연구방향의 제안

외부감사인의 비감사서비스 동시 제공이 감사품질에 미치는 영향에 대한 문헌검토와 미래 연구방향의 제안

Evidence of a Nonlinear Association between Auditor-Provided Non-Audit Services and Audit Quality

This study examines the possibility of a nonlinear association between auditor-provided non-audit services (NAS) and audit quality. The effect of NAS on audit quality has been a long-standing debate among academics and regulators. One view is that NAS can potentially create economic bonding between the auditor and client, lowering audit quality. Another view is that NAS creates knowledge spillover, improving audit quality. Our unique approach provides evidence of a nonlinear association between NAS and audit quality, where client misstatement rates are higher for audit offices with both high and low levels of NAS. We also find a nonlinear association between NAS provision and both missed material weaknesses and meeting or beating analysts’ consensus forecast by a small amount. This study should be of interest to audit firms, audit committees, and regulators because it advances our understanding of the effects of NAS on audit quality.

Core Earnings Management: How Do Audit Firms Interact with the Balance Between Classification Shifting and Accruals Management?

This study examines the interaction of audit firm characteristics with two core earnings management tools: classification shifting (CS) and core accruals management (CACM). CS occurs when management intentionally misclassifies recurring operational expenses as special items to inflate perceptions of core earnings. A Norwegian sample of companies, with forthcoming equity issues and acquisitions, reveals that CS substitutes for CACM for clients of Big 4 and industry-specialized audit firms. By contrast, CS complements CACM for clients of non-Big 4 and non-specialized audit firms. The level of auditor-provided non-audit services during a forthcoming equity issue, a measure of economic bond potential, also interacts with CS and CACM, though this interaction is different for clients of Big 4 and non-Big 4 audit firms. The overall results suggest that auditor incentives may support tolerating CS, which raises a question about the effectiveness of current accounting and auditing standards.

Auditor-Provided Tax Services: The Effect of PCAOB Identification of Income Tax Related Deficiencies in the Part II Inspection Report

We examine whether quality control deficiencies in auditing income tax accounts publicly released in Deloitte’s 2007 PCAOB Part II report impose costs on the accounting firm’s auditor-provided tax services (ATS). We document that audit clients reduce reliance on ATS upon the public disclosure of Deloitte’s income tax-related audit deficiencies. This suggests that publicly disclosed audit deficiencies in the Part II report have a spillover effect on the inspected firm’s non-audit services. We also find that the decision of terminating ATS is predominantly evident in clients who rely more on Deloitte’s non-audit, non-tax services, and in those who excessively increase deferred tax valuation allowance and reserve for uncertain tax benefits. This is consistent with our expectation that reduced demand for Deloitte’s ATS is driven by stakeholders’ concern about independence impairment and by clients’ concern about ATS quality. In additional analyses, we find that Deloitte’s audit clients are less likely to retain ATS when the auditors lack sufficient tax expertise. We also find that PCAOB-identified income tax-related audit deficiencies are associated with reduced tax fees for clients that choose to retain ATS. Additionally, we document that reported earnings and income tax expenses are more value relevant for Deloitte’s audit clients that drop ATS in response to PCAOB-disclosed deficiencies in auditing income tax accounts. Collectively, our results are consistent with audit clients responding to the PCAOB Part II reports after they are publicly disclosed, suggesting that the PCAOB inspection on overall audit quality control has informational value. Specifically, this inspection report incentivizes audit clients to reconsider the benefits/costs of auditor-provided non-audit services and influences investor perception of financial reporting quality.

Audit committees, non-audit services, and auditor reporting decisions prior to failure

This study investigates the associations between audit committee characteristics and the likelihood of auditors' going-concern decisions among UK failed firms. Specifically, we examine whether the threat posed by auditor-provided non-audit services (NAS) to auditors' reporting decisions is mediated by audit committee characteristics. We find that failed firms with higher proportions of independent non-executive directors (NEDs) and financial experts on the audit committee are more likely to receive auditor going-concern modifications prior to failure, but that there is no significant relationship between NAS fees and the likelihood of receiving a going-concern modification. The evidence further suggests that the association between NAS and auditors' reporting decisions is subject to audit committee characteristics. Where the audit committee is more independent and includes a greater proportion of financial experts, auditors providing the client with NAS are less likely to issue a standard unmodified going-concern report prior to failure. Overall, the findings provide support for corporate governance regulators' concerns about the monitoring benefits of audit committee independence and the presence of financial expertise on the audit committee for auditors' reporting decisions.

Restricting Non-Audit Services in Europe – The Potential (Lack of) Impact of a Blacklist and a Fee Cap on Auditor Independence and Audit Quality

The European audit reform aims to stabilize financial markets by enhancing trust in the statutory audit. To strengthen auditor independence and to increase audit quality, the provision of non-audit services to audit clients is further restricted. The supranational introduction of a blacklist, including prohibited non-audit services, and of a cap on the volume of non-audit fees is a novelty on the European level. The purpose of this paper is threefold. First, we analyze these measures in light of both current national restrictions of non-audit services and auditor fee disclosure requirements in France, Germany and the UK. Second, we assess the potential impact of the cap on the volume of non-audit services by providing descriptive evidence on current fee levels in these three countries. Third, we critically assess the impact of the audit reform regarding non-audit services in light of audit research by analyzing the state of the art. On this basis, we doubt whether the European reform of auditor-provided non-audit services is effective and efficient. The main goal of enhancing perceived auditor independence and, thus, public trust in audited financial statements of public-interest entities may be hardly achieved and the blacklist might present a tradeoff between auditor independence and audit quality.

The Demand for Auditor Provided Non-Audit Services: A Panel Data Analysis

In this paper, we analyze which characteristics of the firm determine the demand for auditor provided non-audit services (APNAS). Using a panel data sample of 195 Australian companies between 1999 and 2002, we found that board characteristics and audit characteristics matter little for APNAS purchase. Instead, consistent results across models suggest the importance of other firm characteristics such as whether there is a leadership change, the auditor's share of APNAS and whether the auditor's firm is a Big 5 auditing firm. Additionally, historical APNAS purchases also have an impact on current APNAS purchase.

Auditor-provided non-audit services in listed and private family firms

Purpose – The aim of this paper is to provide evidence on the extent and the consequences of the provision of non-audit services (NAS) by statutory auditors to German family firms. Design/methodology/approach – The study analyzes hand collected fee data of 368 listed and private family firms in Germany. It employs univariate tests, ordinary least squares and two-stage least squares regressions to investigate potential threats to perceived auditor independence and knowledge spillovers between jointly provided NAS and audit services. Findings – Incumbent auditors are shown to be a significant source of various types of NAS to family firms. There is weak evidence on threats to perceived auditor independence and support for reciprocal knowledge spillovers between the services. While listed and private family firms do not differ in regard to the proportion of NAS fees, comparative findings suggest that key threats and benefits of jointly provided services are more prevalent among private than among listed family firms. Research limitations/implications – The study suffers from limited data availability and is restricted to the initial year of mandatory audit fee disclosure of private firms in Germany. Particularities of family firms and the German setting, as well as differential results for listed and private family firms, suggest fruitful avenues for future research. Practical implications – The study addresses the current issues in audit regulation. Regulatory bodies should consider that key threats and benefits of auditor-provided NAS decrease with stronger exogenous restrictions. Attempts to restrict jointly provided services in the EU suggest family firms to reconsider their reliance on auditors as a trusted source of NAS. Originality/value – This study is the first to provide evidence on the extent and consequences of auditor-provided NAS in family firms based on fee disclosure. It is also among the few studies that investigate private firms in a code law country and complements prior evidence from Germany that is restricted to listed firms. More generally, it contributes to limited evidence at the intersection of audit and family business research.

DISCUSSION OF Do Auditor-Provided Tax Services Enhance or Impair the Value Relevance of Earnings?

K rishnan, Visvanathan, and Yu (2013) (hereafter, KVY) fill a relevant gap in the burgeoning auditor-provided tax services (ATS) literature by examining investor perception of the costs and benefits of ATS. Prior and contemporaneous studies have investigated the influence of ATS on tax avoidance, financial statement quality, and creditor perception, but a study of the influence of ATS on value relevance was missing from the literature until now. KVY provide evidence that the value relevance of earnings is positively associated with the ratio of tax fees to total fees paid to auditors.

Earnings Management around Large Equity Increases: Do Audit Firm Size and Non-Audit Services Matter?

We investigate how audit firm size and large auditor-provided non-audit services (NAS) affect accruals quality around large equity issues and acquisitions for Norwegian public companies from 1999-2013. We find poorer accruals quality around large equity increases. Big 4 audit firms mitigate adverse accruals quality but only if the provision of NAS is moderate or low. In contrast, non-Big 4 audit firms are associated with lower accruals quality around large equity increases, but this effect is moderated if the provision of NAS is high. The findings are consistent with joint provision of audit and NAS as an effective learning mechanism to mitigate earnings management for smaller audit firms and a lesser willingness of larger audit firms to protect earnings when the provision of NAS is high. The evidence contrasts with the notion of large audit firms as universally superior audit quality suppliers and establishes new evidence on how knowledge spillovers from NAS may improve audit quality.

Auditor-Provided Nonaudit Services and Audit Effectiveness and Efficiency: Evidence from Pre- and Post-SOX Audit Report Lags

SUMMARY The Sarbanes-Oxley Act of 2002 (SOX) effectively bars an auditor from providing nonaudit services to an audit client based on the belief that the resulting economic bonding undermines the auditor's independence and quality of the audit (U.S. House of Representatives 2002). The accounting profession has strongly debated this view and counter-argues that auditor-provided nonaudit services benefit the client. We contribute to this debate by examining the effect of auditor-provided nonaudit services on the effectiveness and efficiency of the audit. We find that higher nonaudit service fees are associated with shorter audit report lags—a potential indicator of audit efficiency—prior to the passage of SOX, but such effects dissipate after SOX. We find that discretionary accruals and financial restatements—potential indicators of audit effectiveness—do not increase when shorter audit lags occur in conjunction with high nonaudit service fees. We also find that the firms with the highest levels of nonaudit service fees prior to SOX have the largest increase in audit lags after SOX. These results suggest that there is some merit to the profession's argument that auditor-provided nonaudit services benefit clients without leading to a loss of audit effectiveness. Data Availability: All data are publicly available from sources identified in the text.

Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees

ABSTRACTThis study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001–2007 as an indicator for audit failure, I find that the amount of NAS fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.Data Availability: All data are publicly available from sources identified in the study.

Is There an Association between Earnings Management and Auditor-Provided Tax Services?

ABSTRACTThe issue of whether auditor-provided nonaudit services enhance or exacerbate financial reporting quality has been intensely debated among regulators, auditors, investors, academic researchers, and the media. In 2006, the SEC approved the rules proposed by the PCAOB limiting the tax services that incumbent auditors can offer to their clients. We contribute to this debate by examining whether auditor-provided tax services mitigate earnings management. We find a negative and significant relation between earnings management (loss avoidance) and tax fee paid to the incumbent auditor. Our results are consistent with knowledge spillover, i.e., when the same audit firm provides both audit and tax services, insight learned from providing tax services can contribute to audit quality.

Nonaudit Services and Earnings Management in the Pre-SOX and Post-SOX Eras

SUMMARY Concerns about the impact of auditor-provided nonaudit services (NAS) on auditor independence arise because of (1) auditors' economic dependence on their clients, and (2) some specific types of NAS which the Securities and Exchange Commission (SEC) argues can harm auditor objectivity. The SEC's prohibition in 2003 of specific kinds of NAS led to a significant decline in NAS between 2000–2001 and 2004–2005. We argue that this decline in observed NAS fees can be used to identify firms that had a greater likelihood of impaired auditor independence in the pre-SOX period. Using discretionary accruals to proxy for earnings management, we find a positive association between discretionary accruals in the pre-SOX era and the subsequent reduction in NAS, but this was confined to income-decreasing accruals. Further, the association between downward earnings management and the decline in NAS was reduced in the post-SOX era.

Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees

This study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001 – 2007 as an indicator for audit failure, I find that the amount of nonaudit (NAS) fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.

Non-Audit Services and Earnings Management in the Pre-SOX and Post-SOX Eras

Concerns about the impact of auditor-provided non-audit services (NAS) on auditor independence arise because of (1) auditors’ economic dependence on their clients and (2) some specific types of NAS which the SEC argues can harm auditor objectivity. The SEC’s prohibition in 2003 of specific kinds of NAS led to a significant decline in NAS between 2000-2001 and 2004-2005. We argue that this decline in observed NAS fees can be used to identify firms that had a greater likelihood of impaired auditor independence in the pre-SOX period. Using discretionary accruals to proxy for earnings management, we find a positive association between discretionary accruals in the pre-SOX era and the subsequent reduction in NAS, but this was confined to income-decreasing accruals. Further, the association between downwards earnings management and the decline in NAS was reduced in the post-SOX era.

Do Auditor‐Provided Nonaudit Services Improve Audit Effectiveness?*

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