Auditor independence and non-audit services - ICAEW

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PART 4OVERALL SUMMARY AND CONCLUSIONS11.1 Overall summaryCHAPTER 11OVERALL SUMMARY AND CONCLUSIONS11.1.1 Models of auditor independenceFormal modelling studies generally show that the joint provision of audit and NAS byincumbent auditors does not adversely affect auditor independence. This is asignificant finding, in that it allows us to see that economic incentives generally act toproduce independent behaviour on the part of auditors.Other studies recognise behavioural factors, drawing upon concepts in moralpsychology. Experimental studies have found that the individual auditor’s level ofethical cognition has a significant impact on audit decisions. These studies are basedon hypothetical audit conflict scenarios and conducted in artificial settings. Themediating influence of the audit firm’s culture is just beginning to be explored in suchstudies.There also exist broader-based frameworks of auditor decision making that sacrificethe rigour of formal modelling in order to encompass a comprehensive set of factors(economic, behavioural, regulatory and contextual). One of these frameworks hasbeen developed from recent UK case studies of real-life audit conflict situations.11.1.2 Current regulatory frameworksFive auditor independence regulatory frameworks are reviewed in detail, those for theUK, the US, Australia, EC and IFAC. There is recognition that independence is amatter of degree, rather than an absolute concept. The frameworks all distinguishbetween independence in fact (referred to as independence of mind) and independencein appearance, both being important. In considering the appearance of independence,it is the views of a reasonable and informed third party that are to be taken intoaccount. Apart from the US framework, a principles-based approach is taken. The USframework is a predominantly rule-based approach comprising a series ofprohibitions, although several principles are stated outside the framework.The other frameworks identify five threats – self-interest, self-review, advocacy,familiarity or trust, and intimidation. There are four main sources of safeguards –regulatory, audit firm, client company and refusal to act. The discussion of threats andsafeguards does not distinguish between independence in fact and in appearance. Inrelation to the joint provision of services, only intimidation does not appear a relevantthreat. The practical application of independence frameworks to small companies israised in the frameworks.The guidelines (rules in the case of the US) in relation to a range of NAS areexplicitly compared. There is less convergence among the frameworks about the levelof threat which arises from internal audit and the installation of financial informationsystems than there is for the other threats. With the exception of the UK framework,where the recommended upper level of economic dependence for a firm is defined,59
the frameworks are generally imprecise about an acceptable level of economicdependence for a firm, a specific office of a firm or an individual partner.The Independence Standards Board (ISB) (now defunct) suggests that the regulationof independence should involve considering the costs and benefits of actions to reduceindependence risk and the views of investors and other interested parties.11.1.3 Empirical studies of NASThese studies are divided into six categories: descriptive studies of the amount andtype of NAS, studies of the determinants of the purchase decision and four types ofstudy into the consequences of joint provision. This latter set covers the impact ofjoint provision on independence in appearance (by looking at the perception ofindependence) and the impact on independence in fact (by looking at the associationbetween joint provision and (i) audit pricing; (ii) audit opinion and litigation; andearnings quality).In some jurisdictions and time periods, there has been no requirement for companiesto disclose the total amount of NAS purchased from their auditor. Even where this is arequirement, there is generally no breakdown of the total by service type. In thesecircumstances, evidence is collected via company surveys. This method generates lessreliable data, due to the risk of response bias. In the UK, the ratio of non-audit to auditfees paid to the incumbent auditor has risen to 300% for the FTSE 100 companies (upfrom 98% in 1996). There is some evidence that taxation services predominate andthat the overall ratio is higher in the UK than in the US.Researchers have investigated three aspects of the NAS purchase decision: the choicebetween the incumbent auditor or another provider; the types of service purchased;and the absolute and relative amounts of NAS. A major argument is that thosecompanies with higher agency costs have greater need of the audit as a monitoringdevice. The value of the audit is reduced if there are independence concerns and socompanies with high agency costs are predicted to purchase less NAS from theirauditor.Studies show that, in general, and consistent with expectations, companies with higheragency costs, more effective audit committees and a lower proportion of performancebasedmanagement compensation have lower NAS fee ratios. The overall explanatorypower of these models is, however, low, the amount of variation being explained is inthe region of 10-20%. It may be that factors that are systematically related to thepurchase decision have been omitted and/or the decision has inherently randomelements.Most perception studies either focus exclusively on actual or proposed ethical rules oneby-oneor investigate a very limited number of key generic threat factors combined inexperimental ‘case studies’. While the majority indicate that NAS provision impairsindependence perceptions for at least a significant proportion of respondents, otherssuggest that independence perceptions are either unaffected or enhanced and yet otherstudies show that decisions can be unaffected even if independence perceptions arenegatively affected. These studies suffer from the risks of non-response bias anddemand effects. In related strands of literature it is found that (i) actual auditorindependence in settings where joint provision occurs tends to increase as they60
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LIST OF TABLESPage3.1 Definitions a
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LIST OF ABBREVIATIONSACCAAICPAAPBAR
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Auditor Independence and Non-audit
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2.2 Current regulatory frameworks:
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There is limited evidence that, in
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firms have, over the last 10 years,
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CHAPTER 2AUDITOR INDEPENDENCE2.1 In
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low cost strategies to protect and/
Page 21 and 22: • the costs of auditor switching
Page 23 and 24: Johnstone, Sutton and Warfield (200
Page 25 and 26: estrictive. Nevertheless, these stu
Page 27 and 28: 3.3 Independence in professional an
Page 29 and 30: Table 3.1 (cont.): Definitions and
Page 31 and 32: followed by a detailed set of rules
Page 33 and 34: Provision of some of these services
Page 35 and 36: There is a significant self-review
Page 37 and 38: of taking management decisions, sel
Page 39 and 40: pieces. While a few research-relate
Page 41 and 42: CHAPTER 5DESCRIPTIVE STUDIES OF NAT
Page 43 and 44: Ezzamel, Gwilliam and Holland (2002
Page 45 and 46: Parkash and Venable’s (1993) stud
Page 47 and 48: CHAPTER 7IMPACT OF JOINT PROVISION
Page 49 and 50: affirmative to five type of service
Page 51 and 52: McKinley, Pany and Reckers (1985) u
Page 53 and 54: NAS and audit fees regardless of th
Page 55 and 56: 7.3.5 New Zealand studiesGul (1989)
Page 57 and 58: support those of Corless and Parker
Page 59 and 60: CHAPTER 8ASSOCIATIONS BETWEEN JOINT
Page 61 and 62: an independent variable in the audi
Page 63 and 64: Ezzamel, Gwilliam and Holland (2002
Page 65 and 66: 8.7 Auditor tenure and auditor chan
Page 67 and 68: CHAPTER 9EVIDENCE OF ASSOCIATION BE
Page 69 and 70: CHAPTER 10EVIDENCE OF ASSOCIATION B
Page 71: 10.3.3 Australian studiesGul and Ts
Page 75 and 76: publicly available data of relevanc
Page 77 and 78: Antle, R. and Demski, J.S. (1991),
Page 79 and 80: Craswell, A.T., Stokes, D.J. and La
Page 81 and 82: Frankel, R.M., Johnson, M.F. and Ne
Page 83 and 84: Jeppesen, K.K. (1998), ‘Reinventi
Page 85 and 86: O’Sullivan, N. and Diacon, S.R. (
Page 87 and 88: Schuetze, W.P. (1994), ‘A Mountai
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