Auditing independence: should an equivalent law to the Sarbanes-Oxley Act be introduced in the UK? Raghavan Iyengara and Judy Land think it's worth considering.
When an auditor auditor n. an accountant who conducts an audit to verify the accuracy of the financial records and accounting practices of a business or government. A proper audit will point out deficiencies in accounting and other financial operations. supplements its income by performing a variety of non-audit functions for an audit client, there is a risk that the relationship will become too cozy See COSE. . The auditor might lose sight of its duty to cast a critical eye over the client's accounts for fear of losing a lucrative revenue source. There is also an inherent conflict of interest whenever the auditor provides management consulting Noun 1. management consulting - a service industry that provides advice to those in charge of running a business
service industry - an industry that provides services rather than tangible objects services, because its client is the firm's management team and not the shareholders.
A substantial increase in the proportion of non-audit fees charged relative to audit fees has led to a perceived (and real, according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. some studies) (1) impairment Impairment
1. A reduction in a company's stated capital.
2. The total capital that is less than the par value of the company's capital stock.
1. This is usually reduced because of poorly estimated losses or gains.
2. of external auditors' objectivity and independence in the assurance function. Corporate scandals A corporate scandal is a scandal involving allegations of unethical behavior by people acting within or on behalf of a corporation. A corporate scandal sometimes involves accounting fraud of some sort. in large companies such as Enron Enron
A U.S. energy-trading and utilities company that housed one of the biggest accounting frauds in history. Enron's executives employed accounting practices that falsely inflated the company's revenues, which, at the height of the scandal, made the firm become the seventh (2001) and Tyco (2002) caused investors to lose confidence in audited financial statements. Although the Sarbanes-Oxley Act See SOX. 2002 (Sox) now prohibits auditors AUDITORS, practice. Persons lawfully appointed to examine and digest accounts referred to them, take down the evidence in writing, which may be lawfully offered in relation to such accounts, and prepare materials on which a decree or judgment may be made; and to report the whole, together from performing eight specific non-auditing functions for clients listed in the US, no similar legislation has been enacted in the UK. The main aim of Sox was to restore investor confidence by correcting weaknesses in corporate governance Corporate Governance
The relationship between all the stakeholders in a company. This includes the shareholders, directors, and management of a company, as defined by the corporate charter, bylaws, formal policy, and rule of law. and improving internal control mechanisms over financial reporting. But critics have questioned the efficacy of the changes required by Sox and the extra compliance costs the law has introduced.
From 2001 (the year before Sox was enacted) to 2006, legal compliance costs for audit clients in the US rose by 171 per cent while auditors' fees increased by 271 per cent over the same period, according to a 2007 survey by law firm Foley fo·ley
1. A technical process by which sounds are created or altered for use in a film, video, or other electronically produced work.
2. A person who creates or alters sounds using this process. & Lardne (www.snipurl.com/dg7jg). These numbers contrasted sharply with audit fees in the UK: audit fees paid by FTSE-100 companies increased by less than one per cent between 2003 and 2006. Clearly, the costs of auditing in the US have increased much more quickly because of the compliance demands of Sox--so much so that it's it's
1. Contraction of it is.
2. Contraction of it has. See Usage Note at its.
it's it is or it has
it's be ~have obvious that audit costs in the US are significantly higher in absolute terms (Alg.) such as are known, or which do not contain the unknown quantity.
See also: Absolute today than they are in the UK.
The increasing number of audit failures and accounting restatements in the US has highlighted issues relating to relating to relate prep → concernant
relating to relate prep → bezüglich +gen, mit Bezug auf +acc audit and non-audit fees. These same issues may also be pertinent PERTINENT, evidence. Those facts which tend to prove the allegations of the party offering them, are called pertinent; those which have no such tendency are called impertinent, 8 Toull. n. 22. By pertinent is also meant that which belongs. Willes, 319. to UK firms. We wanted to address whether the audit and non-audit costs in large companies were significantly different in the US relative to the UK before Sox was enacted. To this end, our research aimed to:
* Document the relative differences in audit and non-audit fees in US and UK in both absolute and relative terms (ie, before and after controlling for client size).
* Determine whether audit and non-audit costs reveal a trend over time.
* Explore the potential policy implications of the results.
First we analysed audit and non-audit costs for 2000-01--the last year before Sox's enactment--on both sides of the Atlantic. Our sample comprised 188 organisations: 91 companies in the FTSE FTSE
A company that specializes in index calculation. Although not part of a stock exchange, co-owners include the London Stock Exchange and the Financial Times.
The FTSE is similar to Standard & Poor's in the United States. 100 and 97 companies in the S&P 100. Table 1 presents the distribution of the sample by industry and the mean values of main audit and non-audit variables in our study. The industry distribution of our sample is similar to that of prior studies using comparable sample evidence, including those of Frankel Frankel is the surname of:
In terms of absolute magnitude absolute magnitude: see magnitude. , we found audit fees, non-audit fees and total fees to be highest among extractive extractive /ex·trac·tive/ (-tiv) any substance present in an organized tissue, or in a mixture in a small quantity, and requiring extraction by a special method.
1. industries in the case of both UK and US companies. They were lowest in computing computing - computer for UK firms and in retail for US companies. When we scaled these fees by total assets, they were highest in textiles (UK) and food (US), and lowest in chemicals (UK) and the financial industry (US).
Table 2 summarises the differences in the size of client and the amount of fees paid in the UK and the US. We used a Wilcoxon rank-sum test to test for significant differences in the audit and non-audit fees and other variables between UK and US companies. On average, US businesses were almost twice the size of their UK counterparts in terms of sales Terms of sale
Conditions under which a firm proposes to sell its goods or services for cash or credit. and total assets. Accordingly, US companies paid substantially higher fees to their auditors. But, once we controlled for client size by scaling the fees by sales and total assets, we discovered that UK companies paid their auditors proportionately pro·por·tion·ate
Being in due proportion; proportional.
tr.v. pro·por·tion·at·ed, pro·por·tion·at·ing, pro·por·tion·ates
To make proportionate. larger audit and non-audit fees.
Next we partitioned par·ti·tion
a. The act or process of dividing something into parts.
b. The state of being so divided.
a. the data into fees paid by firms to the corresponding big five auditors (see table 3, previous page) and scaled the audit and non-audit fees by client size. In the cases of Deloitte & Touche and KPMG KPMG Klynveld Peat Marwick Goerdeler (accounting firm)
KPMG Kaiser Permanente Medical Group
KPMG Keiner Prüft Mehr Genau (German)
KPMG Kommen Prüfen Meckern Gehen we found no significant transatlantic differences, on average, in audit or non-audit fees when adjusted for client size. For the other three firms--Arthur Andersen, Ernst & Young, and PwC--when audit and non-audit fees were scaled by sales, their UK clients paid them significantly more than their US clients. When audit and non-audit fees were scaled by total assets, only Ernst & Young showed a significant transatlantic difference in both, while PwC showed a significant difference only in audit fees. Table 4 shows non-audit fees charged by each of the big five in 2000-01 as a proportion of total fees.
Another important issue we considered was whether the level of US audit and nonaudit fees after Sox differed significantly from the situation before the law was enacted. Since Sex prohibited pro·hib·it
tr.v. pro·hib·it·ed, pro·hib·it·ing, pro·hib·its
1. To forbid by authority: Smoking is prohibited in most theaters. See Synonyms at forbid.
2. certain types of nonaudit services, we determined whether permitted non-audit fees after Sox were significantly larger or smaller relative to the same non-audit fees before Sox. For the sake of completeness, we also compared audit fees pre- pre- word element [L.], before (in time or space).
1. Earlier; before; prior to: prenatal.
2. and post-Sox. Table 5 shows the absolute magnitude of the audit and nonaudit fees respectively.
Overall, it is safe to conclude that, while non-audit fees have declined, audit fees have soared in the US since the enactment of Sox.
We believe that our findings are interesting and revealing. For example, sweeping regulatory changes in corporate governance and corporate audits were enacted via Sox as a direct result of fraud, mismanagement mis·man·age
tr.v. mis·man·aged, mis·man·ag·ing, mis·man·ag·es
To manage badly or carelessly.
mis·manage·ment n. and accounting shenanigans shenanigans
1. mischief or nonsense
2. trickery or deception [origin unknown] . But no similar steps were taken in the UK, despite the fact that both audit and non-audit fees were substantially larger, in terms of client size, in the UK relative to the US. Based on the evidence provided about the relative size of audit and non-audit fees, British regulators may want to reconsider re·con·sid·er
v. re·con·sid·ered, re·con·sid·er·ing, re·con·sid·ers
1. To consider again, especially with intent to alter or modify a previous decision.
2. the consequences of non-enactment of a statute similar to Sox.
Our analysis provides a telling insight into comparative costs of audit and non-audit services in the UK and the US. Concerns about the excessive amount of non-audit work performed by external auditors--and the concomitant concomitant /con·com·i·tant/ (kon-kom´i-tant) accompanying; accessory; joined with another.
concomitant adjective Accompanying, accessory, joined with another impairment of auditor objectivity and auditor independence--should be high on the regulators' agendas.
(1) F Gul gul
A stylized octagonal motif in Oriental rugs.
[Persian, rose; see julep.] , B Jaggi and G Krishnan, "Auditor independence: evidence on the joint effects of auditor tenure and non-audit fees", Auditing: A Journal of Practice & Theory, Vol 26, No 2, 2007.
(2) R Frankel, M Johnson and K Nelson, "The relation between auditors' fees for non-audit services and earnings management", The Accounting Review, Vol 71, 2002.
(3) S Whisenant, K Raghunandan and S Sankaraguruswamy, "Evidence on the joint determination of audit and non-audit fees", Journal of Accounting Research, Vol 41, No 4, 2003.
Raghavan Iyengara is professor of accounting at North Carolina Central University History
NCCU was chartered in 1909 and opened in 1910 as the National Religious Training School and Chautauqua under the leadership of President James E. Shepard. , where Judy Land is an assistant professor of accounting. They thank Julius Bradshaw, Augustine Duru, Samuel Kotz, Robert Moffie
1 Audit and non-audit fees paid by FTSE 100 and S&P 100 companies in 2000-01 by industry Non-audit Number of Audit fees fees Industry companies paid $0 paid $0 UK US UK US UK US Food 9 7 4,297 5,963 12,023 17,574 Textiles/printing 4 3 2,400 3,857 9,300 7,635 Chemicals 4 5 2,888 7,117 4,425 11,718 Pharmaceuticals 4 6 3,762 4,243 15,150 21,121 Extractive 3 3 5,897 10,402 24,672 32,347 Durables 7 16 3,970 6,551 8,725 22,244 Computers 3 14 690 4,430 904 13,364 Transport 7 11 2,805 3,023 16,829 13,834 Retail 12 7 1,305 1,723 5,197 4,094 Services 7 3 3,092 5,403 6,359 16,116 Financial 20 13 4,065 10,914 10,412 24,003 Utilities 9 7 1,300 3,729 6,979 5,685 Other 2 2 7,025 18,350 4,400 29,400 Total 91 97 3,147 5,965 9,517 16,609 Audit fees Non-audit Ratio of per $m fees per non-audit of client $m of client fees to Industry assets assets total fees UK US UK US UK US Food 346 295 772 1,187 0.649 0.757 Textiles/printing 423 191 1957 262 0.664 0.514 Chemicals 410 499 620 758 0.604 0.567 Pharmaceuticals 416 151 754 721 0.639 0.727 Extractive 131 354 461 877 0.706 0.701 Durables 595 327 1,104 1,054 0.615 0.675 Computers 613 215 754 506 0.545 0.673 Transport 222 79 1,174 406 0.806 0.723 Retail 224 164 648 388 0.652 0.642 Services 644 190 1,159 233 0.556 0.595 Financial 575 31 633 64 0.632 0.635 Utilities 107 98 589 146 0.714 0.598 Other 231 83 171 135 0.414 0.617 Total 397 1981 8141 5551 0.646 0.662 2 Descriptive statistics and tests on sample companies for 2000-01 UK companies: US companies: Variable mean (median) mean (median) Sales ($m) 12,364 (6,243) 31,180 (17,953) Assets ($m) 54,669 (10,430) 90,453 (27,812) Audit fees paid ($000) 3,147 (2,250) 5,965 (4,300) Non-audit fees paid ($000) 9,517 (4,050) 16,609 (8,000) Total fees paid ($000) 12,676 (6,900) 22,495 (13,829) Audit fee per $m of client sales 576 (364) 268 (237) Audit fee per $m of client assets 397 (198) 198 (150) Non-audit fee per $m of sales 2,047 (1,192) 1,033 (769) Non-audit fee per $m of assets 1,190 (807) 753 (497) Ratio of non-audit fees to total fees 0.646 (0.662) 0.662 (0.657) Wilcoxon Z (median test: Pearson Variable [chi.sup.2] Sales ($m) -6.278* (24.621 *) Assets ($m) -4.836* (21.809 *) Audit fees paid ($000) -4.741 * (21.809 *) Non-audit fees paid ($000) -3.568 * (10.308 *) Total fees paid ($000) -3.936 * (6.901 *) Audit fee per $m of client sales 3.673 * (12.268 *) Audit fee per $m of client assets 1.954 ([dagger])(2.130) Non-audit fee per $m of sales 3.881 *(12.268 *) Non-audit fee per $m of assets 2.201 ([section]) (5.4522 ([section])) Ratio of non-audit fees to total fees -0.243 (0.000) ([dagger]), ([section]) and * indicate two-tailed significance at the ten percent, five per cent and one per cent levels respectively. 3 Average audit and non-audit fees paid by the sample companies to the big five auditors in 2000-01 Mean audit Mean non-audit Auditor fee ($000s) fee ($000s) UK US UK US Arthur Andersen 1,958 3,517 5,706 8,837 Deloitte & Touche 3,762 8,319 6,928 18,156 Ernst & Young 3,020 3,681 8,281 9,094 KPMG 3,726 9,370 9,553 15,534 PwC 2,960 6,325 11,109 22,907 Mean audit Mean non-audit fee per $m of fee per $m of Auditor client sales client sales UK US UK US Arthur Andersen 1,413 263 4,473 852 Deloitte & Touche 280 317 784 1,200 Ernst & Young 943 248 2,147 714 KPMG 380 320 1,763 821 PwC 482 250 2,023 1,246 Mean audit fee Mean non-audit Auditor per $m of fee per $m of client assets client assets UK US UK US Arthur Andersen Deloitte & Touche 884 267 2,178 935 Ernst & Young 183 192 565 701 KPMG 797 160 1,810 437 PwC 202 208 727 538 335 193 11,981 918 4 Non-audit fee ratios for the big five auditors in 2000-01 Ratio of non- Auditor audit fees to total fees UK US Arthur Andersen 0.643 0.623 Deloitte & Touche 0.615 0.603 Ernst & Young 0.586 0.642 KPMG 0.631 0.636 PwC 0.680 0.716 5 Pre- and post-Sox audit fees and permitted non-audit fees in the US Mean audit Mean permitted fees ($000) non-audit Year Wilcoxon Z fees ($000) Wilcoxon Z 2001 6,727 -- 13,383 -- 2002 8,718 -7.42 * 11,296 3.76 * 2003 10,760 -7.59 * 8,815 4.90 * 2004 16,455 -7.96 * 7,413 6.17 * 2005 17,251 -7.79 * 5,624 7.34 * 2006 18,450 -7.78 * 5,717 6.88 * * indicates two-tailed significance at the one per cent level.