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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 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. 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 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 some studies) (1) impairment of external auditors' objectivity and independence in the assurance function. Corporate scandals in large companies such as Enron (2001) and Tyco (2002) caused investors to lose confidence in audited financial statements. Although the Sarbanes-Oxley Act 2002 (Sox) now prohibits auditors 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 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 & 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 obvious that audit costs in the US are significantly higher in absolute terms today than they are in the UK.

The increasing number of audit failures and accounting restatements in the US has highlighted issues relating to audit and non-audit fees. These same issues may also be pertinent 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 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 et al (2) in 2002 and Whisenant et al (3) in 2003.

In terms of absolute magnitude, we found audit fees, non-audit fees and total fees to be highest among extractive industries in the case of both UK and US companies. They were lowest in computing 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 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 larger audit and non-audit fees.

Next we partitioned 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 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 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- 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 and accounting shenanigans. 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 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 impairment of auditor objectivity and auditor independence--should be high on the regulators' agendas.


(1) F Gul, 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, where Judy Land is an assistant professor of accounting. They thank Julius Bradshaw, Augustine Duru, Samuel Kotz, Robert Moffie, 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


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


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)


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


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

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


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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