Non-audit Service Fees Research Articles

Non-audit services, audit quality and enforcement - evidence from German enforcement examinations

In this paper, I use privileged data on German enforcement examinations to analyse the association between non-audit service (NAS) fees paid to the statutory auditor and audit quality or auditor independence, respectively. The results show that in the German setting for the years from 2005 to 2012, a period with already tightened regulation on NAS, there is neither a positive nor a negative significant association between NAS fees and enforcement examinations resulting in an error finding. The results do not change when controlling for the specific type of NAS as well as for abnormal NAS fees. Thus, the findings do neither provide support for the occurrence of knowledge spillovers nor do I find evidence indicating that NAS impair auditor independence. However, I find some evidence that the level of audit fees (and total fees) is positively associated with the likelihood of enforcement examinations resulting without a finding of material misstatements. In light of the observable pressure on audit fees in the German market, this is consistent with the notion that higher audit fees may signal higher audit effort.

Non-audit services provided to audit clients, independence of mind and independence in appearance: latest evidence from large UK listed companies

This paper investigates whether the provision of non-audit services (NAS) to audit clients impairs auditor independence of mind and independence in appearance. The main contributions of this paper are in terms of its timeliness with respect to regulatory changes, the simultaneous examination of both forms of auditor independence and the methodological innovation whereby it uses a variable derived from the level of abnormal audit fees as a moderating variable in order to capture the direct impact of the NAS fee level on auditor independence as well as how its influence is moderated by the level of unexpected audit fees. Our results indicate that auditor independence of mind is compromised by the size of NAS fees, particularly for clients who pay below the level of expected audit fee. The stock market perceives that auditor independence is compromised by NAS fees but, at the same time, additional tests indicate that there are benefits that accrue from NAS and, in particular, the relation between return and non-discretionary net income is increasing in NAS fees. The balance of evidence suggests that the European Union is correct in undertaking some reform of the auditing market.

The pricing of audit and non-audit services in a regulated environment: a longitudinal study of the UK life insurance industry

This paper studies the relationship between audit and non-audit service fees paid to the statutory auditor by UK life insurance firms, utilising an extensive panel-data sample set for the period 1999–2009. Consistent with a knowledge spillover (impairment of independence) hypothesis, we predict and find that audit fees are positively (negatively) associated with actuarial (tax service) fees. Additionally, our results indicate that regulatory changes enforced after 2004 deterred UK life insurance firms from purchasing non-audit services that are perceived to impair auditor independence. Finally, we find evidence concerning the inter-temporal determination of audit fees.

Audit Firm Tenure, Non‐Audit Services, and Internal Assessments of Audit Quality

ABSTRACTWe use data from internal assessments of audit quality in a Big 4 firm to investigate the impact of audit firm tenure and auditor‐provided non‐audit services (NAS) on audit quality. We find that first‐year audits receive lower assessments of audit quality and that quality improves shortly thereafter and then declines as tenure becomes very long. Partitioning our sample between SEC registrants and private clients, we find that the decline in audit quality in the long tenure range is attributable to audits of private clients. For audits of SEC registrants, the probability of a high quality audit reaches its maximum with very long tenure. We also find that audit fees are discounted for first‐year audits but auditor effort is higher than in subsequent years. We find no association, on average, between total NAS fees and audit quality in the full sample but observe that total NAS fees are positively associated with quality for SEC registrants and negatively associated with quality for privately held clients. Our findings are important for regulatory policies related to audit firm tenure and auditor‐provided NAS.

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.

Auditor independence and accounting conservatism

Purpose – The purpose of this paper is to examine the efficacy of the current legislative provisions that protect auditor independence in Australia. The collapses of several high-profile companies (Enron and WorldCom in the USA, HIH insurance and OneTel in Australia) in the early 2000s has raised questions about audit quality and independence. In response, regulators have introduced new regulations and guidance to improve audit quality. In Australia, the Corporations Act 2001 (2001) was amended via the Corporate Law Economic Reform Program Act 2004. This study poses the question: do non-audit service fees influence the level of accounting conservatism? Design/methodology/approach – The sample used in this analysis consists of all available Australian listed companies from the years 2006 till 2010. Findings – Using multiple measures of accounting conservatism and the auditor-client economic bond, our results suggest that the level of the economic bond between the auditor and the client does not significantly influence the level of accounting conservatism. Originality/value – Our results demonstrate that the combination of intrinsic market mechanisms and regulation in Australia sufficiently protect auditor independence.

Auditor Fees and Going-Concern Reporting Decisions on Bankrupt Companies: Additional Evidence

SUMMARYThe recent growth in non-audit services (NAS) at the major audit firms has the attention of auditing regulators. On several occasions recently, board members of the Public Company Accounting Oversight Board (PCAOB) have indicated that the rise in NAS may place auditor independence at risk (Harris 2014; Tysiac 2014). Impaired independence can result in audit failure, which includes situations when auditors fail to issue going-concern (GC) audit opinions to soon-to-be bankrupt companies. In this paper, I examine the association between the propensity of auditors to issue GC opinions and NAS fees (and audit fees) to 203 bankrupt companies during 2002–2013. In analysis, I find no significant relation between GC decisions and NAS fees and audit fees. My results may interest U.S. regulators, who recently expressed concerns about the threat to auditor independence from the spike in NAS at the major firms.Data Availability: Publicly available from sources identified in the paper.

Do nonaudit service fees associate with accrual earnings management during the IPO?

The objectives of this paper it to examine the association between nonaudit service fees and accrual earnings management that take place during the IPO year. While nonaudit service fees and accrual earnings management has been examined in a number of settings, to date, there has been no work that analyses this association for IPO firm. The findings of this paper find evidence for clients of low quality audit firms that nonaudit service fees are positively associated with accrual earnings management during the IPO year, suggesting that nonaudit service fees compromise auditor independence.

Do Non-Audit Fees Impair Auditor Independence? Using Goodwill Accounting to Help Reconcile the Debate

Prior literature’s inability to document an empirical relation between non-audit service fees and compromised auditor independence contradicts the significant and long-standing concerns expressed by regulators and the investing community. In this paper, we examine whether currently permissible non-audit services pose a threat to auditor independence using a measure – goodwill impairments – that reduces many of the potential limitations that could have prevented prior research from documenting evidence to support the proposed negative association. Our results indicate that the non-audit fees a client pays are inversely related to the likelihood of impairment in settings where goodwill is likely to be impaired. Additional examinations suggest that higher levels of non-audit fees are also associated with lower impairment amounts and a longer time lag until impairment occurs. Taken together, our findings suggest that the understanding of how non-audit services impact auditor independence may not be as complete as many believe.

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.

Future Nonaudit Service Fees and Audit Quality

Prior to the Sarbanes–Oxley Act of 2002, audit partners experienced economic pressure to grow revenue from the sale of nonaudit services to their audit clients. To an auditor who is highly rewarded for revenue generation and growth, nonaudit services may represent a particularly strengthened economic bond with the client. Prior research shows that, in general, nonaudit service fees received in the current period do not impair audit quality. We examine a different setting. We propose that auditor independence can become impaired, and audit quality compromised, when clients that currently purchase relatively low amounts of nonaudit services, increase their purchases of nonaudit services from the auditor in the subsequent period. We test our prediction in the context of earnings management as a proxy for audit quality, measured by (a) performance‐adjusted discretionary accruals and (b) classification shifting of core expenses. Our results indicate that prior to the Sarbanes‐Oxley Act, rewards to the auditor in the form offutureadditional nonaudit service fees from current‐year high fee‐growth‐opportunity clients adversely affects audit quality. This effect is particularly strong among companies with powerful incentives to manage earnings. Our findings indicate that regulators should consider the multiperiod nature of the client–auditor relationship when contemplating policies that restrict nonaudit services, as well as the overall environment in which audit partners operate. This might include partner compensation arrangements that put pressure on audit partners to focus on increasing revenue at the expense of audit quality.

The effects of board and auditor independence on earnings quality: evidence from Italy

Most regulations and corporate governance codes emphasize the adjective independent next to the words auditor and director because auditor and director independence is expected to result in better protection for shareholders and other stakeholders. In this study we use (1) the extent to which the auditor provides non-audit services (NAS) to clients as a possible factor influencing auditor independence and (2) the proportion of outside independent directors to the total number of directors as a proxy of board of directors’ independence (BODI). The two fundamental questions are the following: (1) Does the provision of NAS by auditors to audit clients impair auditor independence, thus reducing the quality of earnings? (2) Does BODI play a role in improving earnings quality? An empirical analysis is conducted on a sample of Italian listed companies during the period 2007–2010. Our evidence does not show an influence of BODI on our proxies of earnings management. Regarding the issue of auditor independence, the provision of NAS appears to be positively associated with the absolute abnormal working capital accruals, which is an indicator of a lower quality of earnings. We also show that board characteristics are not determinants in the choice of purchasing NAS and that the new Italian regulation on mandatory disclosure of audit and NAS fees appears to have had some influence on the behavior of companies in the 2007–2010 period in the form of a reduction in the relative magnitude of NAS compared to audit fees.

The pricing of initial audit engagements by big 4 and leading mid-tier auditors

The recent investigation of the UK audit market by the Competition Commission testifies to perennial regulatory concerns regarding increasing supplier concentration, big 4 dominance of large company audits and the capacity of mid-tier auditors to compete. Against this backdrop, this paper presents new evidence on whether there is competitive pricing for initial audit engagements by big 4 auditors relative to their next four largest mid-tier (mid 4) counterparts for the UK quoted and private corporate sectors. Based on data from FAME for 2007 and 2010, the evidence indicates that larger quoted companies switching between the big 4 benefit from substantial discounts, with smaller discounts attracted by clients switching to the mid 4. Coupled with evidence that fees for both audit and non-audit services recover in subsequent periods, and consistent with the theoretical framework, the paper concludes that big 4 discounting is a competitive outcome aimed at securing future economic rents. New evidence demonstrates that smaller clients switching to big 4 or mid 4 auditors do not benefit from low-balling.

Do Big-Four affiliates earn audit fee premiums in emerging markets?

The paper investigates whether Big-Four affiliated (B4A) firms earn audit premiums in an emerging economy context, using Bangladesh as a case. The joint determination of audit and non-audit service fees is also examined using a sample of 122 companies listed in the Dhaka Stock Exchange. Our findings reveal that although the B4A firms do not generally earn a fee premium in Bangladesh, they charge higher audit fees for clients not purchasing non-audit services. This suggests that the B4A firms may actually lower audit fees to attract non-audit services, and cross subsidizes audit fees through non-audit-services fees. The lack of a B4A premium implies that there is lack of quality audit in emerging markets. We also document that audit and non-audit service fees are jointly determined in Bangladesh. Thus, we provide evidence of joint determination of audit and non-audit service fees in an emerging economy context.

Corporate Governance Effectiveness and the Pricing of Audit Services: A Longitudinal Study of the UK Life Insurance Industry

This paper studies the relationship between audit and non-audit service fees in the UK life insurance industry in the period 1999-2009. Moreover, we examine the impact of ownership structure and internal governance on the level of direct audit fees. Utilizing panel data econometric techniques, we find that audit fees are positively (negatively) affected by actuarial (legal service) fees. We conclude that actuarial services generate knowledge spillover, while legal services impair auditor's independence. Our results indicate that the improved corporate governance environment after the Revised Code of 2003 filtered the fundamental nature of different non-audit services. Furthermore, mutual ownership and independent board of directors increase the level of audit fees. Finally, we find evidence for the inter-temporal determination of audit fees.

Auditor Fees and Fraud Firms

The issue of whether auditor fees affect auditor independence has been extensively debated by regulators, investors, investment professionals, auditors, and researchers. The revised Securities and Exchange Commission (SEC) requirements that resulted from the implementation of the Sarbanes‐Oxley Act (2002) limit nonaudit services (NAS) and mandate NAS fee disclosure. The SEC's requirements are based on the argument that auditor independence could be impaired—and hence audit quality may be reduced—when auditors become economically dependent on their clients or audit their own work. Economic bonding leads to reduced independence, which can lead to reduced audit quality. We study a sample of firms sanctioned by the SEC for fraudulent financial reporting in Accounting and Auditing Enforcement Releases (SEC‐sanctioned fraud firms) and examine whether there is a relationship between auditor fee variables and the likelihood of being sanctioned by the SEC for fraud. We use SEC sanction as a measure of audit quality that has not previously been used in the auditor fee literature and is more precise than some of the other proxies used for flawed financial/auditor reporting. We find, in univariate tests, that fraud firms paid significantly higher (total, audit, and NAS) fees. However, in multivariate tests, when controlling for other fraud determinants and endogeneity among the fraud, NAS, and audit fee variables, we find that while NAS fees and total fees are positively and significantly related to the likelihood of being sanctioned by the SEC for fraud, audit fees are not. These findings suggest that higher NAS fees may cause economic bonding, thereby leading to reduced audit quality. Our findings of significantly higher NAS fees and total fees in fraud firms hold after controlling for latent size effects and other rigorous testing. These results contribute to the literature that examines the SEC's concerns regarding NAS and can be used by policy makers for additional consideration.

The Impact of Non-audit Services on Going Concern Opinions Revisited: The Case of Triennially Inspected Audit Firms

The validity of information contained in financial statements is an important concern for users of these statements. Validity can only be achieved through independent attestation of financial statements by auditors. Hence, auditor independence has been a concern of regulators for a long time. Specifically, the provision of non-audit services by auditors is assumed to create economic dependence of auditors on clients and therefore impairs auditor independence. This paper examines whether the provision of non-audit services by triennially inspected audit firms impairs audit quality, measured as the propensity to issue a going concern opinion (GCO) for the time period 2004 - 2006. In addition, it is examined whether the association between non-audit service fees and the propensity to issue a GCO is stronger for triennially inspected audit firms that receive a deficient inspection report from the PCAOB than for triennially inspected audit firms that receive a clean inspection report from the PCAOB. This study does not find support for either of these hypotheses. The relationship between non-audit service fees and the likelihood of issuing a GCO is insignificant for the sample of triennially inspected firms. In addition, the going concern decision by triennially inspected auditors is not influenced by the outcome of their inspection report and the association between NAS and GCO is not stronger for firms with a deficient inspection report compared to those with a clean inspection report. The study does, however, find a significantly positive relationship between the magnitude of audit fees and total fees and the likelihood of a GCO.

Effect of Regulatory Changes on Auditor Independence and Audit Quality

This study investigates the impact of CLERP 9 on auditor independence and audit quality. Audit quality is measured by performance‐adjusted discretionary accruals and the auditor's propensity to issue a going‐concern opinion for a financially distressed company. The results show a significant and positive association between auditor‐provided non‐audit services (NAS) fees and the propensity to issue a going‐concern opinion for a financially distressed company post‐CLERP 9, but an insignificant association pre‐CLERP 9. The results show a significant and positive association between NAS fees and the performance‐adjusted absolute value of discretionary accruals pre‐CLERP 9, but this significant association was mitigated by the introduction of CLERP 9. To address the potential impact of the level of abnormal NAS fees on auditor independence, the analysis is extended by incorporating predictions of abnormal NAS fees. Abnormal NAS fees are significantly and negatively associated with the propensity to issue a going‐concern opinion for a financially distressed company and positively associated with discretionary accruals pre‐CLERP 9, but they are not significant post‐CLERP 9. The results provide evidence of improved audit quality after the implementation of CLERP 9. The results will be useful to regulators for the justification of regulatory changes. The findings provide evidence of the effectiveness of regulatory changes, specifically the CLERP 9, on the improvement of auditor independence and audit quality.

The Influence of the Audit Committee on Auditor Provided Tax Planning Services

Motivated by the continued allowance of tax non-audit services (NAS), recent studies (e.g., Cook and Omer 2012) document a positive effect of tax NAS fees on tax avoidance. Based on an extensive hand-collected sample of firms voluntarily disclosing the tax planning and compliance components of tax NAS fees, we show that the positive relationship between tax NAS fees and tax avoidance is driven by tax planning NAS fees. However, the impact of tax planning NAS fees on tax avoidance is more pronounced if the auditor provides tax planning services in conjunction with tax compliance services. Such findings are consistent with knowledge spillover effects as the auditor’s tax team most likely provides both tax planning and tax compliance services to an audit client. We also document a positive association between tax planning NAS fees and firm valuation. Finally, our documented effects of tax planning NAS fees on tax avoidance and firm valuation are more pronounced when there is effective audit committee oversight over tax NAS, in the form of accounting experts serving on the audit committee. This study creates new knowledge and provides a more complete view of the roles auditors and audit committees play in an important focal area of interest to regulators, investors and the accounting profession.

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.