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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.

 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.

 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 ( 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 prepconcernant

relating to relate prepbezüglich +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:
  • Benjamin Frankel (1906 – 1973), a British composer.
  • Robert "Bobby" J. Frankel (born 1941), an American thoroughbred race horse trainer
  • Charles Frankel (1917–1975), an American philosopher, known for
 et al (2) in 2002 and Whisenant et al (3) in 2003.

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.

 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.

 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.

 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.

 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
Noun, pl


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.

 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
  • Moffie - one of the cats mentioned in The Diary of Anne Frank
  • Moffie is a derogatory word for homosexual used in South Africa. It literally means 'glove' in Afrikaans, and possibily originated from the idea that men who wore gloves were homosexual.
, Ibrahim Salama and North Carolina Central University for their assistance.
1 Audit and non-audit fees paid by FTSE 100 and S&P 100
companies in 2000-01 by industry

                     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

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.
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Title Annotation:technical matters
Author:Iyengara, Raghavan; Land, Judy
Publication:Financial Management (UK)
Date:Apr 1, 2009
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