provision of non audit services to audit clients – impact on auditors’ independence and quality...

8/13/2019 Provision of Non Audit services to audit clients Impact on Auditors Independence and Quality of Work

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CHAPTER ONE

1.1 Introduction

This chapter introduces the research study on the issue of whether the provision of non auditservices by external auditors compromises their independence or enhances their quality of

work. To begin with, the background of the study is presented, giving details of historical and

economic information related to the study. Secondly, the problem statement contextualizes

the problem and takes a critical view of the questions that need to be answered concerning

whether the provision of non audit services by external auditors is beneficial or detrimental to

independence. The third component of the introduction is the objective of the study. This

section gives detail on the overall aim and targets that have been set for this study. ourthly,

the significance of the study will inform about the importance or relevance of doing the

research. The fact that not many studies of its kind have been conducted in !amibia is one of

the issues presented in this section. "t is followed by the research questions, which are a

number of questions, related to the topic that the study is intended to answer# for example,$%o non audit services affect investor judgement&'. The thesis statement comes next and it

mainly gives the central idea of this study, it is followed by the key terms and definitions,

assumptions and limitations.

1.2 Background of the study

(uditor)s independence is an essential characteristic of the audit process and lack of it can

extremely affect the quality of the audit. "ndependence provides the users of financial

information with reasonable level of assurance that the audit was conducted with the utmostobjectivity and thus eliminating any bias. The "ndependent *egulatory +oard of (uditors)

"*+(- ode lists independence as one of its fundamental principles and it explains that,

$/ractitioners, when undertaking a reporting assignment, should be independent in fact and in

appearance. "ndependence is an essential quality, concomitant with integrity and objectivity,

in a practitioner undertaking a reporting assignment.' /uttick et al, 0112-, explains further

that, $"ndependence is a quality that enables a practitioner to apply unbiased judgment and

objective consideration, to establish facts and arrive at an opinion or decision. To be

recognized as independent, the practitioner must be free from any obligation to, or interest in

the client, its management or owners.' /uttick et al, 0112-. 3napp, 4256- also defines

auditor independence as the ability to resist client pressure. Similarly, "ndependence

Standards +oard "S+- 0111-defined auditor independence as the7$8 reedom from those pressures and other factors that compromise, or can reasonably be

expected to compromise an auditors9 ability to realize unbiased audit decisions' (lleyne,

011:-.

(uditors are professionals who are trained to understand the dynamics of businesses from an

external perspective and their independent viewpoint can assist clients in solving many

business problems that are often beyond their competencies www.icaew.com-. lients

therefore find it appropriate to solicit for help and engage the services of their auditors in

areas beyond auditing of their books.

;iven the auditors role in improving organizational performance and serving as surety to

users of accounting information, auditing should be the auditor)s primary service, but theyhave been providing non audit services !(S- in the recent past. The !(S often provided by

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auditors include accounting and bookkeeping services, internal audit services, management

consultancy, taxation services, etc.

The current debate regarding the extension of audit activities beyond audit is that it has

become a growing concern that the provision of !(S by auditors may impact negatively on

auditor)s independence. ;hosh and 3allapur 011


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1.% O!&ecti'es of the $tudy

The study is intended to address the following interrelated objectives7

To educate users of financial information and auditors about the impact of !(S on audit

work.

To inform audit related policies and regulations on the potential threats to auditor

independence by !(S.

To ascertain the impact of the provision of !(S on auditors independence

To examine whether there is a relationship between audit fees and auditor)s independence.

To identify the different types of !(S and the extent which audit firms in !amibia provide

these services to their clients.

To ascertain whether !(S provided by audit firms have positive or negative effect on the

independence of auditors.

1.( $ignificance of the $tudy

This study is worth the investigation because there has been no work in this field of study in

!amibia and this is intended to fill in that gap. The study will increase knowledge and

understanding of !(S provision and its effect on auditor)s independence and it will stimulate

further research on threats to auditor)s independence and potential benefits of !(S provision

in !amibia. The findings of this investigation could hopefully improve better independence

environment, so that investors can once more fully rely on audited financial statements.

1.) Research *uestion

The controversy surrounding the provision of !(S by auditors is not new. The debate has

been going on for several years and this study is intended to provide answers to the following

questions7

C Bhat are the types of non audit services provided by audit firms&

C %o audit firms in !amibia take part in providing non audit services to their clients&

C %oes the industry believe that the provision of non audit services to audit clients

impairs independence&

C Should non audit services be provided to clients by staff from a different department

in the same audit firm or should the non audit services be provided by a separate firm

altogether&

C Should auditors only be allowed to provide non audit services to non audit clients&

C Should audit firms and clients disclose audit fees and non audit fees separately in their

financial statements&

C "f audit firms do indeed engage in non audit services, then what are their reasons for

engagement in such practices&

C (re the recent cases of fraud in large companies around the world a result of auditors

failing to be independent&

C Bhat does the word $independent' mean to the auditor or accountant on a

professional level&

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1.+ ,ey ter#s and definitions

!on (udit Services !(S-7 Services provided by auditors to clients besides auditing their

books.

(uditors "ndependence7 The ability of the auditor to operate independently without influence

by clients or any other party interested in the services auditors provide.

SarbanesCDxley (ct7 (n (ct enacted by the GS Supreme ourt in 0110 after the collapse of

the ?!*D! orporation and demise of (nderson (udit irm. The act is meant to regulate

the operations of (uditors and businesses in general.

?!*D!7 The name of the ompany that collapsed necessitating the enactment of the

SarbanesCDxley (ct of 0110.

"*+( ode7 "ndependent *egulatory +oard of (uditors.

1.- e"ineations and /i#itations

(s is the case with all research, this investigation is subject to certain limitations. Dwing to

the relatively small sample size the interpretation and use of the findings must be done with

caution. (gain due to the limited time at my disposal, my study will be limited to Bindhoek

municipal area.

1.0 Conc"usion

The chapter flowed from the historical works done on this topic to explaining the problem

statement, presenting the research objectives and questions and providing some definitions of

key terms referred to in the study. Iastly, the limitations that the study is subject to were also

explained. hapter two, will focus on the various literary works conducted on topics that are

similar or relate to the topic.

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CHAPTER TO

/iterature Re'ie

2.1 Introduction

This section is intended to briefly review the literature on the impact of !(S on auditor

independence, as well as ideas and arguments by previous researchers.

Dne relevant theoretical framework that will be used to guide this research paper is $*ole

onflict Theory' used by (lleyne 0110-. *ole conflict theory is based on the following

assumptions7 the auditor is required to monitor the client9s financial statements and the public

expects the auditor to faithfully carry out that role 3oo and Sim, 4222-. The auditor has to

serve two opposing interests, client companies and the general public *izzo et al, 42F1- and

identified several role conflicts.

irstly, there exists conflict between a particular role and the individual9s values J personCrole

conflict. Secondly, there exists intraCsender role conflict, which concerns multiple roles being

allocated to an individual. Thirdly, roleCoverload conflict is where many roles are imposed on

the individual, considering his or her capacity to fulfill them in the light of availableresources. ourthly, 3oo and Sim 4222, p. 01F- further state that $8 interCsender role

conflict appears through mutually opposing expectation of roles, conflicting policies and

needs of others, and incompatible criteria.'

The most important conflict for the auditor is the interCsender role conflict. This is where the

auditor is expected to satisfy both the needs of the client management and the third party

users. Third party users expect the auditor to find and report all problems with the financial

statements while management wants the auditor to ignore financial statements manipulation

3oo and Sim, 4222-. Thus, at times, the auditor needs to choose from these conflicting

needs. The auditor9s role conflict may negatively impact the auditor9s independence and the

ability to conduct a just audit Schultz, 42F>-. "f the auditor tries to be adamantly ethical in a

situation of conflict, management may seek to replace himKher. (s a result, the auditor may

buckle under management9s pressure, resulting in a compromise of auditor independence.

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Three major conflicts of interest, which worked against auditor independence, were advanced

by ;oldman and +arlev 42F>-.These include conflicts between auditors and firms, owners

and managers, as well as conflict between the auditor9s economic motives and audit criteria.

Thus, auditor independence may be compromised when conflicting interests arise as to what

is the auditor9s role.

"ndependence is critically important to an auditor as it is regarded as being one of the

fundamental principles underlying the auditor9s work. The financial markets must have

confidence in the integrity and objectivity of auditors. Bithout definite independence, audits

have little value to the numerous consumers of audit information. *ecently, researchers,

regulators and the public have been concerned about auditor independence in the current

audit environment where severe audit failures like ?nron and Borldom, have emerged.

The SarbanesCDxley (ct has implemented measures to ensure that a company)s auditors

remain skeptical of their client)s financial reporting. Title "" of the SarbanesCDxley (ct

(uditor "ndependence- lists services that auditors may no longer provide to clients. The

reason for this prohibition is that maintaining independence is critical during the process of

auditing financial statements. "nvestors would not have the confidence to invest large

amounts of money in the stock market without the honest opinions of independent auditors

3leckner et al, 011>-. The rules of the (ct, issued on Aanuary 05, 011: make it very clear on

areas of nonCaudit services that affect the auditors) independence if made available to an audit

client7

C Bookkee3ing or other ser'ices re"ating to the accounting records or financia"

state#ents of the audit c"ient.

C 4inancia" infor#ation syste#s design and i#3"e#entation.

C A33raisa" or 'a"uation ser'ices5 fairness o3inions5 or contri!ution6in6kind

re3orts.C Actuaria" ser'ices.

C Interna" audit outsourcing ser'ices.

C 7anage#ent functions.

C Hu#an resource ser'ices.

C Broker8dea"er5 in'est#ent ad'isor5 or in'est#ent !anking ser'ices.

C /ega" ser'ices.

C E93ert ser'ices unre"ated to the audit.

C Any other ser'ice that the Pu!"ic Co#3any Accounting O'ersight Board

:PCAOB; deter#ines !y regu"ation to !e i#3er#issi!"e


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The (ct further requires that the following activities be adhered to7

1. Partner rotation. Audit 3artners are 3rohi!ited fro# 3ro'iding ser'ice to

the sa#e audit c"ient for fi'e to se'en consecuti'e years5 de3ending on the

3artner=s ro"e in the engage#ent.

2. Conf"icts of interest. An accounting fir# is 3rohi!ited fro# auditing the

financia" state#ents of a c"ient if key #e#!ers of #anage#ent ere on the

audit engage#ent tea# ithin a one year 3eriod.

. Prea33ro'a" re>uire#ents. Audit co##ittees #ust 3re6a33ro'e a"" ser'ices

3ro'ided !y their auditors.

%. Enhanced financia" disc"osure. The act re>uires #ore co#3rehensi'e

disc"osure in the financia" state#ents5 inc"uding off6!a"ance6sheet

transactions.

(. Partner co#3ensation. $ar!anes6O9"ey indicates that inde3endence sha""

!eco#e i#3aired if the audit 3artner=s co#3ensation is !ased on se""ing non6

audit engage#ents to the audit c"ient.

). Auditor re3orts to audit co##ittees. Auditors no #ust co##unicate

certain #atters to audit co##ittees5 inc"uding accounting 3o"icies of the

co#3any.

( concern expressed by 3leckner and Aackson 011>- on the above requirements is that small

companies may not have the resources to abide by many of the SarbanesCDxley requirements,

especially those under section >1>, which requires public companies to include an internal

control report to their annual filings indicating the following7

C An ackno"edge#ent that it is the res3onsi!i"ity of #anage#ent to 3ut together

and #aintain suita!"e interna" contro"s.

C A re'ie of the efficiency of interna" contro" structure and techni>ues for

financia" re3orting.

C An attestation !y an e9terna" auditor on the assertions #ade !y #anage#ent in

its e'a"uation of interna" contro"s.

2.2 Ty3es of NA$ Pro'ided !y Auditors to c"ients

(ccording to the "nstitute of hartered (ccountants of ?ngland and Bales "(?B-, there

are three categories of !(S. The first category is, services required by legislation or contract

to be undertaken by the auditors of the business. These include, regulatory returns, for

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example returns to the inancial Services (uthority. They also include legal requirements to

report on matters such as share issues for nonCcash consideration, expenditure for grant

application purposes, etc. "n addition to that, they include contractual requirements, for

example to report to lenders or vendors on net assets, covenant requirements, etc. The second

category is services that it is most efficient for the auditors to provide because of their

existing knowledge of the business, or because the information required is a result of the

audit process. They include tax compliance, where most of the information derives from the

financial records# and reports in acquisition or reorganisation situations where completion is

necessary in a very short time. The third category deals with services that could be provided

by numerous firms such as management consultancy, tax advice and human resources

consultancy, etc. www.icaew.com-

=owever, while provision of nonCaudit services is on its foremost progress, ?nron, the

biggest bankruptcy in (merican business in 0114, has exposed the problem of audit

independence. The auditor providing both audit and nonCaudit services have been likened to

the role of the coach and the referee at the same time. That led the promulgation of the wellC

known SarbanesCDxley (ct of 0110, also called the L+usiness *evolution (ctL. The (ct

focuses on the independence and prohibits (uditor from providing both audit and nonCaudit

services to the same client as stipulated by the /ublic ompany (ccounting Dversight +oard

(D+-. hien et al, 0116-.

2. Argu#ents to 'eto the 3ro'ision of NA$ !y auditors

The study takes a look at inCdepth literature of other scholars concerning the prohibition of

provision of !(S by auditors. Bhen a company is unsuccessful, the quality of the audit

comes under scrutiny. Typically, the accusation is that the practitioners have allowed

inappropriate accounting treatments because their independence has been compromised. The

loss of independence by an auditor is normally the result of the $familiarity threat', where the

auditor becomes too close to the client# or because their neutrality is challenged by overC

dependency on revenue from a single source. or those who believe this view, the only

solution is to prevent auditors from providing any !(S and solely performing audit services

www.icaew.com-.

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(s mentioned earlier, the collapse of large companies such as ?!*D! and BD*I%D@

caused the implementation of the SarbanesCDxley (ct, whose aim is, to protect investors by

improving the accuracy and reliability of corporate disclosures. The SarbanesCDxley (ct

pioneered the imposing of legislative reporting requirements of the Securities ?xchange (ct

in the Gnited States, of issuers whose securities are registered with the Securities and

?xchange ommission and listed on national securities associations and to subsidiaries or

affiliated entities of such companies wherever they may, operate, anywhere in the world

/uttick et al, 011F-.

Section >1> of the act significantly impacts the responsibilities of South (frican auditors of

qualifying S? registrants. This is inclusive of any auditors of those South (frican

companies listed on any of the GS Securities ?xchanges or subsidiaries, branches or affiliates

of such companies and GS companies with South (frican branches, affiliates or subsidiaries.

The SarbanesCDxley (ct is significant because of the large number of South (frican firms

currently in !amibia which are at the same time listed on the stock exchanges in the GS as

well as the large number of GS subsidiaries situated in South (frica /uttick et al, 011F-.

The code of conduct forbids auditors from providing !(S to audit clients where there is a

threat to independence and there are no safeguards put in place to deal with those threats. "n

such circumstances, the firm must resign as auditor or refuse to supply the !(S. (n example

of a situation that is prohibited is the promotion of shares of audit clients www.icaew.com-.

Secondly, under the auspices of the G3 ombined ode of corporate governance, the audit

committee as representative of the shareholders is required to oversee the relationship with

the auditors and keep the nature and extent of audit services under review. The audit

committee must be satisfied that the independence and objectivity of the auditor are not

compromised. (s a result, audit engagement partners who are responsible for a company)s

audit must# disclose in writing to the audit committee, all relationships between the audit firm

and the client that may be thought to bear on the firms independence and the objectivity of

the audit engagement partner and staff and the related safeguards that are in place# and

confirm that, in their professional judgment, the firm is independent and the objectivity of the

audit engagement partner and audit staff is not impaired www.icaew.com-.

Thirdly, the ethical code specifies that an audit appointment should not be accepted if the

client provides, for whatever work, an unduly large proportion of a firm)s gross practice

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income. That approach limits the undue financial dependency on any client without

unimportant restrictions on the balance between different types of income www.icaew.com-.

The code also requests that shareholders themselves are able to assess the extent of nonCaudit

services provided by auditors. The ompanies (cts have for some years required the total

amount on nonCaudit fees paid to auditors to be disclosed www.icaew.com-.

The bond between the auditor and the client may impair both the actual and perceived

auditor independence because the audit firm is unwilling to criticize the work done by its

consultancy division for example, and the audit firm does not want to lose lucrative !(S and

is, therefore, more reluctant to disagree with management)s interpretations of accounting

matters. "n respect of the personal relationship, the greatest threat to auditor independence is a

slow, gradual, almost casual erosion of their honest disinterestedness He, 011-. @oreover, %avis)

findings also suggest that financial markets are less efficient when greater levels of nonCaudit

service fees are disclosed and that the relative level of nonCaudit service fees does impair

auditors) objectivity in the investors) mind %avis, et al 011>-. The extant literature has

explored issues related to nonCaudit services fees and market reactions. /rior research

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examining the effects of nonCaudit service fees generally find that although there are marketC

based incentives for the auditors to remain independent, providing such services may actually

impair auditor independence in appearance. @aterial levels of consulting fees, representing

approximately 40M of the audit firm)s office revenues and client revenues, significantly

affected financial statement users) perceptions and decisions %avis, et al 011>-. Specifically,

loan officers perceived greater auditor independence and higher financial statement reliability

to exist when the auditor received an immaterial level of fees i.e., less than 4M of revenues-

from an audit client. SixtyCseven percent of the loan officers in the immaterial condition

approved the loan as compared to only >6 percent of loan officers in the material condition.

"n a subsequent study, %avis, et al 011> 011>- also find similar results for financial analysts.

Their results indicate that immaterial levels of consulting fees did not decrease investors)

perceptions when compared to a control group in which the auditor received no consulting

fees.

!ew S? proxy disclosure requirements reveal an average !(S fee to audit fee ratio of 011

percent laming, 0110-. The significance of these !(S fees and advocacy issues they bring

up, increase concerns about auditor independence and the investors) perceptions of the

auditor and the financial statements themselves. Bhen graduate business students acting as

investors, viewed financial information and audit fee disclosures about a firm, the perceptions

of auditor independence, audit quality and attractiveness of the entity as an investment were

negatively affected laming, 0110-

"n reference to !(S, the S? now requests that all public companies disclose, in their proxy

statement, all fees paid to the external auditor, split into : sections7 audit fees, information

technology service fees, and fees for other !(S. These new disclosures indicate an average

!(S to audit fee ratio well above 011 percent Beil and Tannenbaum 0114# rankel et al.

0110# laming 0110-. @embers of the public accounting community have debated that these

!(S fees do not affect independence Beil and Tannenbaum, 0114# laming 0110-, while

earlier academic research investigating the effect that various !(S have on perceptions of

auditor independence has reported varying results.

*esults from prior experimentation and investigation reveal that by providing !(S there is a

downturn in investors) judgements of auditor independence, audit quality, and the

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attractiveness of the firm as an investment, but not their auditor knowledge or financial

statement reliability judgments. laming, 0110-

rankel et al 0114- show that !(S fees average over 0>-. Some archival research suggests that !(S impairs

independence by finding that higher amount of !(S are in line with higher levels of

discretionary accruals rankel et al. 0114-, lower informativeness of income ;ul and Tsui,

0114- and fewer qualified opinions Bines 422>-. +eeler and =unton 0111- found

experimentally that audit partners exhibited more subjective ways of making decisions in the

presence of potential nonCaudit revenue.

The S? believes perceptions of the auditor)s independence have an effect on the confidence

of investors in financial statements, and affect financial statement user)s decisions based on

those statements S? 0111-. The S? considers that $an auditor is not independent if a

reasonable investor, with knowledge of all relevant facts and circumstances, would conclude

that the auditor is not capable of exercising objective and impartial judgment'. laming found

that the fees received by auditors from their audit clients, especially large amounts revealed

in new proxy disclosures, seem to create an economic bond between client and auditor that

could tend to bias an auditor in favour of a client. (lso, the client advocacy role that the

auditor assumes by providing !(S might reduce the auditor)s objectivity during the audit.

This client advocacy role is in conflict with the public advocacy role the auditor is supposed

to hold as an external auditor.

urther findings from laming 0110- indicate that perceptions of auditor independence were

statistically significantly lower for the cases where the audit firm performed !(S in addition

to audit services, compared to cases where only audit services were provided. This decrease

in independence perception occurred even when the audit fees themselves were high,

suggesting that it is the nature of !(S and not the fee amount that affects investors. (udit

quality and investment attractiveness perceptions were also lower when the client)s auditors

performed !(S.

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%avis et al. 011>-, using the magnitude of discretionary accruals and the likelihood of

meeting earnings benchmarks as evidence of biased financial statements, find that high fees

for nonCaudit services significantly impair auditor independence and reduce the quality of

earnings. They also find evidence of a negative association between the disclosure of nonC

audit fees and share values.

@any recent studies examine the association between !(S and auditor independence using

different proxies for audit quality. /roxies include allegations of audit failure in litigation,

propensity to issue going concern opinions, earnings quality or restatements.

2.% Argu#ents against the 3rohi!ition of NA$

(t a more fundamental level, an examination of past cases of audit failure which have led to

the enforcing of regulatory or disciplinary penalties have shown that the provision of nonC

audit services was not the cause of the audit failure, nor did it arise from undue dependency

on audit fees. The problem as stated is not supported by evidence and appears to be based on

biased impressions of challenges that may arise rather than fact www.icaew.com-. @ost

studies fail to find that !(S or lengthy audit firm tenure leads to a reduced propensity of

issuing a qualified audit report arcello and !agy, 011>-, a higher level of discretionary

accruals (shbaugh et al., 011:# hung and 3allapur, 011:# @yers et al., 011:- and a higher

frequency of annual report restatement 3inney et al., 011:# *aghunandan, et al., 011:#

@yers et al., 011>-.

irst of all, unnecessarily restricting the provision of !(S would have an unintended, adverse

effect on the underlying quality of the audit through restrictions in knowledge and skills

www.icaew.com-. @any studies have dismissed the idea of prohibition of !(S as unsound.

/rovision of !(S reduces audit costs to the client if such services can usually be provided by

the same firm benefitting from cumulative audit knowledge.

"t has become apparent that investors base their predictions on their belief of the level of

auditor independence. @ore recent evidence by %opuch, et al. 011:- reveals that disclosures

of nonCaudit services reduced the precision of investors) beliefs of auditors) independence in

fact when independence in appearance was inconsistent with independence in fact. This

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caused prices of assets to diverge more from their economic predictions in the inconsistent

settings relative to the noCdisclosure and consistent settings, therefore causing low market

efficiency. Thus, disclosure of fees for !(S could reduce the efficiency of capital markets if

such disclosures result in investors forming incorrect assumptions of auditor independence in

fact.

urthermore, hurch and Nhang 011:- find that auditor lawsuits are more frequent when the

auditor provides !(S, regardless of the fees generated from such services. (ccording to

/almrose 4222-, less than one percent of auditor related litigation disputes has !(S as part

of the basis on which the lawsuits are founded.

+onner and Iewis 4221- discovered that experience and taskCspecific knowledge affected

auditor performance more than general business knowledge or years of experience, indicating

that the auditor may gain valuable knowledge by performing !(S. The S? considered the

issue of the auditor gaining knowledge and its effect. "f investors believe this knowledge

spillover occurs, the auditor who performs the !(S might be perceived to be more

knowledgeable and competent regarding their client, and more likely to detect an error in the

system or in the financial information laming, 0110-.

laming 0110-, conducted experiments about the types of !(S and arrived at conclusions

which suggest that the disclosure or presence of information technology services reduce the

severity some of the perceived audit quality, investment attractiveness rating, and financial

statement reliability impairments created by !(S in general.

urther investigation by laming 0110-, interestingly suggested that when information

technology "T- was identified as part of the !(S, the decline in perceived audit quality and

investment attractiveness did not occur. (lso, the drop in independence perceptions was

smaller for !(S including "T than when all !(S were listed under an $other fees' heading.

This unexpected finding, can possibly be explained by the fact that knowing the specific !(S

performed mitigated the ambivalence of the $other' designation, which might have been

believed to include suspicious services. +oth legislators and firms might find that interesting,

when deciding on the extent of auditor fee information to require or provide voluntarily.

These prior research results of the implications of nonCaudit service fees disclosures on users)

Page | 14


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perceptions of auditor independence and market outcomes are somewhat inconclusive,

pointing towards the need for further research in this area.

2.( Conc"usionThe debate of the effect of provision of !(S to clients is still ongoing with pros and cons

advanced by accounting scholars. "t is hoped that this study will come up with a solution to

untangle the current impasse.

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CHAPTER THREE

Research 7ethodo"ogy

.1 Introduction

This chapter is intended to show the exact research methods and the data collection

techniques that were used in this study. The structure of methodology consists of the research

design type of research, sampling, research instruments-, research population, sample

population, and data collection and analyses.( breakdown of the primary and secondary data

used is also indicated.

.2 Research design

To achieve the research objectives# and provide tangible answers to the research questions,

the qualitative study approach that uses a descriptive strategic approach described by %avid

and Sutton, 011>- is used. This approach involves gathering a large amount of informationabout a small number of people or organizations Ticehurst and Oeal, 0111-. "t is based on

the theory that a complete and rounded comprehension of the organizational experiences and

situations of a few individuals, however unrepresentative they may be, is of more substance

than a limited understanding of a numerically greater representative group. "n addition to that,

the quantitative approach is also used. This approach involves statistical analysis and depends

on numerical evidence to draw conclusions. Dne of the best and most effective ways of

analyzing the data collected from the quantitative approach is by using the computer

Ticehurst and Oeal, 0111-.

or the qualitative approach, the data can be derived from observation, informal and inCdepth

interviewing and participant observation. Dn the other hand, methods of collecting data for

the quantitative approach involve questionnaire surveys, observation and secondary sources.

(s a result, face to face interviews supported by questionnaires were used to gather the

primary data.

There are a considerable number of advantages of using qualitative methods as compared to

quantitative methods. These advantages arise mainly from the basic beliefs and theories of

knowledge underlying qualitative research ?asterbyCSmith, Thorpe and Iowe 4224#

;ummeson 4224# 3elly 4251-. Some of these advantages are7

C Pualitative methods can be used for very limited studies as well as holistic studiesthat examine the entire situation

C Pualitative methods are useful in investigating personal changes over time

C Pualitative methods focus on people)s comprehension and translations rather than

finding external causes or Qrules) for behaviour

C Pualitative methods aid the researcher in understanding and divulging the personal

experiences of individuals which may be internal or external experiences

C Pualitative researchers can use a mixture of methods of execution and performance or

even establish methods to provide a wide understanding of a social situation

C Pualitative research reports are normally presented in a narrative format rather than in

a statistical manner, making it easier for readers not trained in statistics to

comprehend and maintain interest in the topic

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C Pualitative research allows the researcher to experience issues from a respondents

perspective

The use of questionnaires is beneficial because it provides a standardized dataCgathering

procedure and eliminates any form of bias. The interviews are also appropriate because

obtaining a personal account from interviewees on the issues at hand improves the quality ofthe information gathered. The secondary data was gathered from books, journal articles, and

internet search websites-.

. Research 3o3u"ation

The research population includes all the auditors from major audit firms in Bindhoek,

namely /rice Baterhouse oopers, ;rant and Thornton and 3/@;KS;(. Dther (uditors

and (ccountants employed at various entities and who are not necessarily performing

external auditing functions were included to broaden the views of the respondents. (uditors

and (ccountants constituted the main population as information from the $horse)s own

mouth' is more credible.

.% $a#3"e Po3u"ation

%ue to the confidential nature of the research topic, " was granted permission to engage with

senior management at the three audit firms mentioned above, as well as senior management

at +ank Bindhoek and atholic (ids (ction. (s a result, there were eleven respondents.

.(. The research 3rocess

.(.1 Ad#inistration of >uestionnaires

Some questionnaires were distributed to the research participants by hand delivery and the

rest were eCmailed. or those respondents who were working against time, the use of eCmail

ensured that they could answer the questions at a time when they were not under work

pressure and therefore they could answer the questions clearly and honestly. This was also

the benefit of delivering the questionnaire by personally and allowing the respondent a

number of days within which they could complete the questionnaire. /articipants where

informed to complete the questionnaire and then hand them to the personal assistant in their

respective departments. The others were kindly requested to forward their responses at the

earliest time possible. (s expected, some participants forgot to timely complete and submit

their questionnaires. =owever, three of the respondents granted me an audience and

completed the questionnaire in the format of an interview# this was helpful as it resulted in

less time delay in terms of collecting the questionnaires. This process was also beneficial as

they shared some relevant knowledge and contributed to the research by suggesting other

ways of clarifying some questions which may have seemed ambiguous.

.(.2 Co""ection of >uestionnaire

Puestionnaires were distributed to the respondents who were willing to participate in the

study and were collected by the researcher. The researcher collected the completedquestionnaires from the respondents and at the time of collection, verification of unclear

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information in the questionnaire was done. The respondents who had problems understanding

how to answer specific questions were also assisted in order to complete their questionnaires.

.(. ata ana"ysis

The data collected through questionnaires will be analysed statistically and the results will beexpressed with the aid of tables, graphs and charts for clarity. The questionnaire consisted of

mainly closedCended questions, but there were some few openCended questions. The

utilisation of openCended questions allowed for a free response in the respondent)s own

words. The data obtained was gathered from people in the industry such as senior

management at three audit firms, one bank and nonCgovernmental organization. This data

reflects directly on the variables J provision of !(S and impact on auditor independence.

The strength of such kind of data is that it reflects the beliefs of professionals and what they

perceive to be the main issue behind alleged compromise of auditor independence.

.) Conc"usion

This chapter presented the research methodology and the research design of the study. The

chapter discussed where the data was gathered from, the methods that were used for data

collection and how the data of the study was obtained, presented and treated. The following

chapter presents the findings and data analysis of the study.

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CHAPTER %

4ININ?$ AN ANA/@$I$

%.1 Introduction

This chapter analyses the data collected from the information provided in the questionnaires.

The data was collected from senior audit and accounting staff in /rice Baterhouse oopers,

3/@;KS;(, ;rant and Thornton, +ank Bindhoek and atholic (ids (ction. The data is

presented in tabular format as well as graphs, and interpretations will be given beneath the

numerical data.

%.2 4indings Re"ated to the Research *uestion

The following research questions have been addressed7

*uestion 1

1.1 hich of the fo""oing Non Audit $er'ices :NA$; is 3erfor#ed !y your fir# to

c"ients

The findings on the !(S performed by firms are presented in Table >.4 and figure >.4

respectively.

Ta!"e %.1 Res3onses on NA$ 3erfor#ed !y fir#s

Ty3e of Non Audit $er'ice Percentage:@E$;

Percentage:NO;

Tota"Percentage

4 (ccounting 5:.::M 4


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4igure %.1Res3onses on NA$ 3erfor#ed !y fir#s

The Table and graph indicate that 411M of the respondents do not perform actuarial services,

internal audits, forensic services, legal services, information technology systems services or

management authority services as part of non audit services. 5:.::M, a clear majority,

perform accounting, advisory and bookkeeping services. (s for tax services,


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41 Iegal :F.6M


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(s indicated above, six of the respondents participated in this question and they all admitted

that they provide non audit services to clients. Therefore representing 411M.

*uestion

o you think 3ro'ision of non audit ser'ices to audit c"ients i#3airs inde3endence

The findings on whether the respondents think the provision of !(S to audit clients impairs

independence are presented in Table >.> and igure >.>.

Ta!"e %.% Res3onses on hether NA$ to audit c"ients i#3airs inde3endence

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;

44 > F :M .6 and igure >.6.

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Ta!"e %.( Res3onses on hether NA$ shou"d !e 3ro'ided !y a se3arate de3art#ent in

the audit fir#

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;

44 2 0 54.5M 45.0M

4igure %.( Res3onses on hether NA$ shou"d !e 3ro'ided !y a se3arate de3art#ent in

the audit fir#

( significant majority of 54.5M feel that non audit services should be provided to clients by

staff from a different department in the audit firm. Dnly 45.0M disagreed with that notion.

*uestion (

o you agree ith the 'ie that5 Auditor=s inde3endence ou"d !e threatened if the

3ro'ision of non audit ser'ices to audit c"ients ere undertaken !y staff fro# different

de3art#ents ithin the sa#e fir#

indings on whether respondents agree that auditor)s independence would be threatened if

!(S were provided by a separate department are presented in Table >.< and igure >.


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This Table as well as the graph confirm the response in question >, by stating that F0.FM,

representing a significant majority, do not think that non audit services provided by a separate

department in the audit firm will compromise auditor independence.

*uestion )

o you think auditor inde3endence ou"d !e "ess threatened if 3ro'ision of non audit

ser'ices to an audit c"ient is done !y a different audit fir#5 than if they are done !y a

se3arate de3art#ent

indings on whether auditor independence is less threatened if !(S is provided by a different

audit firm as compared to a separate department# are presented in Table >.F and igure >.F.

Ta!"e %.+ Res3onses on hether auditor inde3endence is "ess threatened if NA$ is

3ro'ided !y a different audit fir# as co#3ared to a se3arate de3art#ent

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;

44 41 4 21.2M 2.4M

4igure %.+ Res3onses on hether auditor inde3endence is "ess threatened if NA$ is

3ro'ided !y a different audit fir# as co#3ared to a se3arate de3art#ent

21.2M of the respondents agree that it is better for non audit services to be performed by a

different firm than a separate department in the same audit firm. 2.4M disagreed with this

view.

*uestion +

o you agree ith the 'ie that5 auditors shou"d on"y !e a""oed to 3ro'ide non audit

ser'ices to non audit c"ients

indings on whether auditors should only be allowed to provide !(S to non audit clients are

presented in Table >.5 and igure >.5.

Ta!"e %.- Res3onses on hether auditors shou"d on"y !e a""oed to 3ro'ide NA$ to non

audit c"ients

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;44 > F :M


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4igure %.- Res3onses on hether auditors shou"d on"y !e a""oed to 3ro'ide NA$ to

non audit c"ients

:M of the respondents believe that auditors should only be allowed to provide nonCaudit

services to nonCaudit clients, whereas .2 and igure >.2.

Ta!"e %.0 Res3onses on hether audit fir#s shou"d disc"ose audit fees se3arate fro#

non6audit fees

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;

44 41 4 21.2M 2.4M

4igure %.0 Res3onses on hether audit fir#s shou"d disc"ose audit fees se3arate fro#non6audit fees

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Dnly 2.4M of the respondents felt that audit firms should not disclose audit fees and non audit

fees separately in the firm)s financial statements. The remaining 21.2M majority agreed that

that is the way audit firms should disclose their fees.

*uestion 0

o you think se3arate disc"osure of audit and non audit ser'ice fees in the c"ient=s

financia" state#ents can reduce threats to auditor inde3endence

indings on whether separate disclosure of audit and nonCaudit fees in the client)s financial

statements can reduce threats to auditor independence are presented in Table >.41 and igure

>.41.

Ta!"e %.1 Res3onses on hether se3arate disc"osure of audit and non6audit fees in the

c"ient=s financia" state#ents can reduce threats to auditor inde3endence

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;

44 2 0 54.5M 45.0M

4igure %.1 Res3onses on hether se3arate disc"osure of audit and non6audit fees in

the c"ient=s financia" state#ents can reduce threats to auditor inde3endence

The Table and graph indicate that 54.5M of the respondents agree that separate disclosure of

audit and non audit fees in the client)s financial statements can reduce auditor independence.

45.0M disagreed with that view.

*uestion 1

o you agree ith the 'ie that5 auditor inde3endence can !e i#3aired if auditors areon"y a""oed to 3ro'ide non audit ser'ices to non audit c"ients

indings on whether auditor independence can be impaired if auditors are only allowed to

provide nonCaudit services to nonCaudit clients are presented in Table >.44 and igure >.44.

Ta!"e %.11 Res3onses on hether auditor inde3endence can !e i#3aired if auditors are

on"y a""oed to 3ro'ide non6audit ser'ices to non6audit c"ients

Nu#!er of

Res3ondents

@E$ NO PERCENTA?E

:@E$;

PERCENTA?E

:NO;

44 : 5 0F.:M F0.FM

Page | 26


27/42

4igure %.11 Res3onses on hether auditor inde3endence can !e i#3aired if auditors

are on"y a""oed to 3ro'ide non6audit ser'ices to non6audit c"ients

rom Table >.44 and igure >.44 above it is evident that F0.FM of the participants felt that if

auditors are only allowed to provide non audit services to non audit clients, their

independence will not be impaired. ( minority of 0F.:M agreed that the auditor)s

independence can be impaired.

*uestion 11

hy do audit fir#s engage in non audit ser'ices

indings on the reasons why audit firms engage in !(S are presented in Table >.40 and

igure >.40.

Ta!"e %.12 Res3onses on the reasons hy audit fir#s engage in NA$

Reason Nu#!er of

Res3ondents ho

agreed

Tota" Res3ondents Percentage

i. !on audit

services

are part of

normal

audit

business

6 5


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There were eight respondents for this question and


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41 Iegal < 0 ::.:M- >


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44 5 : F0.FM 0F.:M

4igure %.1% Res3onses on hether recent cases of fraud !eing unco'ered in the or"d

:Enron5 or"dCo#5 etc.; are due to auditors fai"ing to !e inde3endent.

( majority of F0.FM of the respondents agreed that, recent cases of fraud being uncovered in

major companies were as a result of auditors compromising their independence. Bith a

0F.:M minority disagreeing with this view, it is generally believed that impairment of

auditor)s independence was a huge contributing factor to the demise of those major firms.

*uestion 1%

Bhat does the word independent mean to you on a professional level&

E93"anation Nu#!er of 3eo3"eho agreed

Tota" nu#!er ofres3ondents

Percentage

The auditor should

be objective.

< 44 6>.6M

The auditor should

have no fear of being

threatened in anyway

after expressing his

or her opinion.

: 44 0F.:M

The auditor should

not only be

independent in mind

but independent in

(//?(*(!? as

well.

0 44 45.0M

The respondents were requested to explain what the word $independence' means to them on

a professional level. ( 6>.6M majority explained that it means that the auditor should

maintain objectivity when performing his or her duties. 0F.:M believe that independence

means, the auditor should be able to perform his or her work without being threatened in such

Page | 30


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a way that the validity of the audit work is questioned. Iastly 45.0M of the respondents felt

that apart from the auditor being independent in mind, he or she should also be independent

in appearance. "n other words he or she should be seen as independent and free from bias.

%. Conc"usion

The chapter related the findings of the questionnaire to the research question. The data was

presented in tabular format and also with the aid of graphs. The opinions of auditors and

accountants differ but they do not believe there is clear justification that non audit services

are detrimental to auditor independence. They explained that with the right controls and risk

management procedures in place, auditors should be allowed to perform non audit services

without compromising their independence. The next chapter provides conclusions and

summaries of each of the chapters that were presented in this study. "n addition to that, the

researcher provides some recommendations that may be helpful in finding solutions for this

study.

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CHAPTER (

CONC/D$ION$ AN RECO77ENATION$

(.1 Introduction

This study investigated the provision of non audit services to audit clients by auditors, the

impact on auditor)s independence and quality of work.

(.2 iscussion of findings in re"ation to the research o!&ecti'es.

(.2.1 Educating users of financia" infor#ation and auditors a!out the i#3act of non

audit ser'ices on audit ork.

@ajority of the participants agreed that non audit services have an impact on audit work.

=owever, most of them argued that non audit services do not have a negative impact onauditors work. There was a general consensus that auditors have the necessary expertise to

perform the non audit services appropriately and with proper controls and risk management

procedures implemented, the quality of work should not be negatively affected. "n a small

country like !amibia, the audit firms cannot survive on solely providing audit services.

(.2.2 Identifying the different ty3es of non audit ser'ices and the e9tent to hich audit

fir#s in Na#i!ia 3ro'ide these ser'ices to c"ients.

(s evident from the findings, some non audit services are provided by audit firms in !amibia

and some are not provided at all. "n terms of actuarial services, internal audit, forensic, legal,

information technology systems and management authority# firms in !amibia do not providethose services to clients that they audit. =owever, when the auditors were asked about

accounting, taxation, advisory and bookkeeping, majority of them said that those services are

provided. Bhen they were asked about risk compliance, their responses were split and so the

findings displayed that 61M of the auditors provide non risk compliance and the other 61M

do not. The range of respondents who felt that the non audit services provided do not impair

auditor)s independence was from 5F.6M to


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C @anagement (uthority

(.2. Infor#ing hether there is a re"ationshi3 !eteen audit fees and auditor=s

inde3endence.

21.2M of the respondents believe that audit firms should disclose audit fees and non auditservice fees separately in their financial statements. "n addition to that 54.5M of the

respondents believed that the client should also disclose audit fees separately from non audit

service fees in order to reduce the threat to independence. These figures clearly indicate that

there is a relationship between audit fees and auditor)s independence and therefore firms

disclose the non audit service fees and audit fees separately in order to enhance independence

by exercising transparency. (ccording to laming 0110-, the perceptions of independence

did not drop as much when non audit services were disclosed separately, as compared to

when they were simply disclosed as part of other fees. The simple explanation is that the

level of suspicion rises because the user of the financial statements may think that intricate

details are being hidden.

(.2.% Ascertaining hether non audit ser'ices 3ro'ided !y audit fir#s ha'e a 3ositi'e or

negati'e effect on the inde3endence of auditors.

@ajority


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inCdepth information about the various arguments presented by scholars from around the

globe and to observe whether the findings in chapter four relate to them.

(.. Cha3ter three

This is the research methodology chapter and the chapter explains how both qualitative and

quantitative methods were used to conduct this research. They represented the primary data

and entailed conducting interviews, distributing questionnaires and analysing the results. The

secondary data were books, journals and the internet.

(..% Cha3ter four

This chapter displays all the information obtained in tabular format as well as graphically. "t

is clear that from the findings, most auditors and accountants in !amibia believe that the

provision of non audit services by auditors does not impair their independence. =owever,

there should be proper implementation of controls and risk management procedures to ensurethat in the event of the auditor)s independence being compromised, necessary steps can be

taken to prevent that from happening. The findings also indicated that the level of threat of a

non audit service depends on the nature of the non audit service. Therefore in terms of the

research question, $%oes !(S affect investor judgements&' or $Bhat is the impact of !(S

on audit quality&', the findings indicate that the type of non audit service performed does

indeed affect investor judgements but not merely the fact that a non audit service has been

performed. (dditionally, majority of the auditors feel that non audit service has a positive

impact on audit quality.

(.% Conc"usion

This study was aimed at uncovering the detail about the extent of non audit services provided

by audit firms in the country. (fter studying the relevant literature and conducting

experimental surveys on the industry in !amibia, the conclusion is that non audit services do

not negatively affect auditor)s independence. (uditors clearly view certain non audit services

as part and parcel of their audit work and therefore they do not consider them as threats to

their independence. Dn the other hand, there are a number of non audit services that auditors

do not provide to clients at all, although most of the auditors do not perceive those non audit

services as impairments to their independence. "t is possible that there is another reason why

they do not provide such services to clients# for instance, the auditors may lack the necessary

expertise in the field in which the client requests aid. "n general, independence simply meansthat the auditor should be objective when performing his or her duties. "n conclusion, non

audit services evidently have an impact on auditor)s independence and quality of work but

with the right controls and risk management procedures in place, non audit services will not

negatively affect the quality of audit work or the independence of the auditor.

(.( Reco##endations

(s a result of the findings discovered in this study, the following recommendations are made7

C (udit firms should ensure that a different department to the audit department providesthe non audit services

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C (ll audit firms should have proper controls in place and regular evaluations of

whether the controls are still effective

C This study is limited to Bindhoek, therefore a nationwide study on the topic should

be conducted as there will be a larger sample, which is more likely to lead to more

accurate results

C The regulatory boards in the country should be stricter when it comes to clarifyingwhich non audit services an audit firm is allowed to provide

C Smaller audit firms that may not have many departments should not provide nonC

audit services to the clients that they audit

C @ore studies should be conducted on this topic from a !amibian point of view in

order to clarify whether, all audit firms and their clients clearly disclose audit fees and

non audit service fees separately in their financial statements

Page | 35


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References

(lleyne, /. 0110-. "ndependence of auditors7 in the deep end& ( +arbadian analysis,Journal

of Eastern Caribbean Studies, Ool. 0F !o.0, pp.66CF2.

(ntle, *. 425>-.Auditor Independence. Aournal of (ccounting *esearch spring-7 4C01

(shbaugh, =., Iaond, *., E @ayhew, +.B. 011:-. %o !onCaudit Service ompromise

(uditor "ndependence& urther ?vidence. The Accounting Review. Ool. F5, "ss. :, pp. 0

+eeler, A.%. E =unton, A.?. 0111-. Contingent econo$ic rents% Insidious Threats to Auditor

Independence&Borking paper. @illsaps ollege and Gniversity of South lorida.

+onner, S. E Iewis, +. 4221-.'eter$inants of Auditor E"pertise& Aournal of (ccounting

*esearch

arcello, A.O., E !agy, (.I. 011>-.Audit fir$ tenure and fraudulent financial reporting.

Borking /aper, Gniversity of Tennessee.

hung, =. E 3allapur, S. 011:-. Client i$portance, non(audit services, and abnor$al

accruals. The (ccounting *eview, F5, >, 2:4C266

hurch, +.3. E Nhang, /. 011:-. "ndependence in (ppearance, !onC(uditing Services, and

(uditor ee %isclosures. Borking /aper. ;eorgia "nstitute of Technology, (tlanta, ;eorgia

and Gniversity of Toronto, Toronto, D!.

%avis, S. @. E =ollie, %. H. 011>-& An E"peri$ental Investigation of )on(Audit Service

*ees and Investors+ erceptions of Auditor Independence% ost(Enron Era. /h% Thesis.

;eorgia State Gniversity.

%opuch, !., 3ing, *. E Schwartz, *. 011:-. "ndependence in appearance and in fact7 (n

experimental investigation. Conte$porar Accounting Research. Ool. 01, "ss. 4# pp.F2C446.

0114-. (n ?xperimental "nvestigation of *etention and *otation *equirements. Journal of

Accounting Research. Aune-, Ool. :2, !o. 4# pp. 2:C44F.

%eond, @., *aghunandan, 3., E Subramanyam, 3.*. 0110-. %o nonCaudit fees impair

auditor independence& ?vidence from going concern and auditor opinions. Journal of

Accounting Research September-# pp.40>FC40F>.

?asterbyCSmith, @., Thorpe, *. E Iowe, (. 422:-.-anage$ent Research% An Introduction&

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argher, !., Iee, =.H. E @ande, O. 0116-. The effect of audit partner tenure on client

$anagers+ accounting discretion. Borking paper. Gniversity of !ebraska

erguson, @. A., Seow, ;. E Houng, %. 011>-. )onaudit services and earnings

$anage$ent% ./ evidence& ontemporary (ccounting *esearch. 04, >, 54:C5>4

laming, I. 0110-.'o )on(Audit Services Affect Investor Judge$ents#

rankel, *., Aohnson, @. E !elson, 3. 0110-. The relation between auditors+ fees for non

audit services and earnings $anage$ent. The (ccounting *eview FF, > supplement-7 F4C

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;eiger, @., E *aghunandan, 3. 0110-. Auditor Tenure and Audit 0ualit. (uditing7 (

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provision of non audit services to audit clients – impact on auditors’ independence and quality...

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