Audit and Non Audit Services

Question: Describe about audit and non audit services? Answer: Introduction Non-Audit Services (NAS) provided by an auditor has remained a long standing debate. The services other than audit that is provided by an audit firm to their audit client have always been a hotly debated auditor independence issue. It has been reported that providing NAS results in creating an economic bond between the audit firm and their audit client which can lead to impairment of the auditors independence, thus, leading to poor audit quality. Various research reports had in the past shown that NAS does not leads to lower audit quality and found no evidence that providing NAS by the audit firm to their audit client can result in lower financial reporting quality. But recent study and research reports have shown that NAS does results in lowering the audit quality by impairing the independence of the auditor. Auditor independence can suffer due to the fact that potential NAS revenue can lead to leniency by the auditor in conducting the audit, thus, impairing the independence of the auditor (Houghton et al., 2010). The topic has been in debate for many decades with arguments been made from allowing the auditor to provide NAS to calling for a ban on NAS provided by the auditor to their clients. With the businesses growing the demand for NAS has been growing substantially with many audit firms providing more NAS than Audit Services, thus, complete ban or removal of the NAS would have a very negative impact on the pricing and cost structures of both NAS and Audit Services for both Audit Firm and its Audit Client. As it is a very sensitive and hotly debated issue at a same time, many institutes around the world who govern the provisions of audit and issue audit frameworks and standards in their respective countries have issued various guidelines on this issue. But still many problems are cropping up as these guidelines dont seem enough (Abou-Seada, and Hussey, 1996). Audit Independence Independence means that the judgement of a person is not subordinate to wishes of another person. It requires that he should not act under the influence of some other person or body and his opinion is not biased. Thus, he can work in a completely unbiased manner. Thus, it is required for the auditor to be independent in his opinions and judgements so that the quality of financial reporting is high so as to bring out a true and fair view of the financial statements reported as on a particular date. If auditor maintains a high degree of independence, credibility of financial statements is enhanced (Keane, 2014). Independent audit report will be accepted and respected by all stakeholders of the business. Thus, independence of the auditor is the key to achieving satisfactory financial reporting. Advantages of independent audit for various stakeholders are as follows: For management They can control and judge reasons of losses and ensure the general reliability of accounting systems. For employee it discourages them from committing frauds as it acts as a moral check on them. They can also judge the reasonableness of payments w.r.t salary, bonus etc. For lenders Bankers can rely on the audited financial statements while assessing the creditworthiness of loan applicants. For computing taxes Audited financial statements help in determining income tax. Also helpful to compute excise duty, sales tax etc. For owners They get a real picture of profit and losses earned. The share in profits and share valuations can also be known. For investors The prospective investors use these statements to assess the dividend, growth possibilities to make decisions whether they should invest or not. For insurer In the case of losses or damages to property, it helps the insurer to settle the claims. For arbitration In the case of disputes, these audited financial statements help in settling claims (Hae-Young, 2014). Prohibited Relations Audit regulatory bodies around the world have prohibited certain relations between the audit firms and the companies in which audit is conducted by them. These include the following relationships: Employment Relations - Companies cannot hire their auditors as employees when they are working as their Even when these auditors resign and discontinue as their auditor, the companies cannot legally hire them as employees until a certain cooling off period ceases. The same requirement is in place even for the employees of the auditor of the company, the person cannot be employed in the company until the cooling off period ceases. Contingent Fees Auditors cannot be hired on a commission basis or a system where the auditors remuneration would be on a basis of contingent fees. Business Relations Auditors cannot have a business relation with the company, its employees, its officers, significant shareholders or the directors. The relation cannot be direct or even indirect. Thus, the audit committee must check and identify such prohibited relationships. Certain Financial Relations There are certain types of financial relationships that are prohibited between the audit firm and the client company. These types of relations are debtor and creditor, broker and dealer, banking, lender, etc. These relations specify the importance of the auditor to be independent, thus, specifying the importance of the independence of the auditor (Krauy, 2003). Non-Audit Services Growth in businesses and emergence of larger professional firms has led to growing demands for specialist and technical advice by these business houses to achieve their business objectives and to achieve an advantage over the rivals in an increasingly competitive marketplace. Much of this advice is sought from these audit firms because auditors can better understand the dynamic business environment from an external perspective and individual views often shed light on important areas of the conduct of business which an insider sometimes cannot observe. These services provided by the auditor to his audit client are called Non-Audit Services (Doyle, 2012). The auditor provides NAS to its clients falls into three main categories: Services that an Auditor can provide efficiently because of his existing knowledge in that field as these are based on information that is a by-product of the audit Examples are Tax Compliance Services, Reports in acquisitions and mergers, Due Diligence reports, etc. Services that are required by legislation. Example are Regulatory Reports, report on expenditure for grant application purposes, etc. Services which can be provided by many types of professional firms and its incidental that the audit firm has been chosen. Examples are Tax Advisory services, Consultancy services like Human Resource Consultancy, Portfolio Management Consultancy, etc. These services result in the audit firm providing specialist services along with conducting the audit of the client's business. It can happen that the revenue derived by the firm from NAS is more than the revenue derived by conducting an audit. Thus, sometimes auditors independence can be impaired and the auditor may become lenient due to the fact that future NAS work will be given to the audit firm. The expectation of future NAS revenue which might be more than the audit fee itself leads to poor quality of audit and financial reporting quality is damaged. The audit firm and the client can develop an economic bond when a lot of NAS revenue is derived from the client in proportion to the audit revenue. Research has found evidence that high level of NAS revenue resulted in the low quality of the audit. Over the last few years, the proportion of NAS fees paid by the business houses against the Audit fees has been steadily rising which has resulted in turning the audit firms into multidi sciplinary professional services firm. Thus, NAS has resulted in concerns over the auditors independence (Chai, and Jubb, 2000). Whenever a company fails question marks are raised about the quality of audit conducted of its financial statements reported, the auditors independence is also put into question. The Enron scandal showcased how the auditor must be independent enough. Enrons auditor had received total audit fees amounting to 25 million dollars while the fees for NAS provided were 27 million dollars. The audit firm should maintain a level till which it can accept NAS and stricter guidelines over these NAS revenues must be implemented. The NAS revenue has boomed which has resulted in an increased ties between the auditor and the client. The audit firms should, therefore, be more cautious in conducting an audit. Some NAS which involves expressing an opinion like Internal Audit, maintaining the books of accounts should be avoided as it may involve direct conflict interest leadi ng to impairing the independence of auditor (Malek, and Saidin, 2013). Relations between NAS Revenue and Total Earnings There were almost no studies related to NAS Fees and Earnings of the firm to depict any relation between qualities of an audit conducted by the firms to the NAS performed for the business houses. But recently studies have been conducted to show the NAS impacts upon the attributes of total earnings. NAS fees disclosures by the firms have resulted in studies that link NAS fee to client importance. Client Importance is measured as the fees received from a client divided by the total revenue of the firm and the ratio of clients NAS fees to the total revenue of the firm. These findings have shown that when huge revenue is received from NAS then the audit firm may become a little impaired towards the audit client. The proportion of the NAS fees paid by companies in U.K. was more than the Audit fees than the USA based companies (Antle, et al., 2014). The ethical code specifies that a firm should not accept an audit appointment from a client company which provides an unduly large proportion of NAS fees. It has also been advised that a firm should not conduct an audit if a single company provides audit fees that are unduly large in the proportion of the firms gross revenue so that ethical practices are maintained. Shareholders of the company should also be able to assess the ratio of NAS provided by the companys auditor to the audit work conducted by the firm. The net impact resulted from an increase of the NAS fees is that auditor may neglect his duties towards performing the audit and becomes more inclined to perform NAS (Son and Chen, 2005). Joint Provision of Audit Fees and Pricing of Non-Audit Services It has been often noticed that the companies generally engage their auditors to perform related services in finance, tax compliance, advisory and other services even though many other professional firms do exist to provide these services. The reason for the same is that both the auditor and the client company are interested in providing for services related to audit due to economies of scope (Adelopo, 2012). Economies of scope are referred to the cost savings achieved when the same firm or person provides more than one services. The cost of these joint services is lesser when compared with the total cost of audit and NAS from different firms. Joint provision reduces the cost of both ensuring contractual performance and cost of locating a quality consultant. Many companies, thus, nowadays increasingly engage a multi-disciplinary firm to conduct its audit and perform other services as well. The increased competition between audit firms has also led to firms charging their clients lesse r if its services are taken on the basis of bundles and both audit as well as NAS is conducted by the audit firm (Abou-Seada, and Hussey, 1996). But when audit firms conduct both the audit work and NAS then the effort towards the audit may reduce and the firm may become lenient in conducting the audit of the client. The expectation of future NAS work also makes the auditor impaired resulting in poor quality of the audit. Joint Service Provision and Audit Opinion The studies have been conducted to judge whether the audit conducted, audit opinion made by the audit firm and NAS provided by the audit firm are interrelated. Though the studies have not found any significant data to show that level of NAS performed and the audit opinion made by the auditor are interrelated but the auditors can give an incorrect opinion when the expectation of future NAS work received and future NAS fees received is also taken into consideration. The expectation of future NAS work might impair an auditor and an Unqualified Opinion may be granted by the auditor even though the company deserved a Qualified Opinion. Thus, auditors might grant the best opinion to the clients from whom the NAS fees is high and from whom future NAS engagement is also expected resulting in a disparity and poor quality reporting of financial statements. When the fees received by the firm for conducting an audit is lesser in proportion to fees received from the same client for conducting rel ated works and providing NAS then also the auditor may make an opinion better than the opinion deserved by the client (Arrunada, 1999). The auditor should, thus, not accept NAS work from a client if the NAS work increases than audit work to be conducted or he/she should not accept the audit work from the client which provides a substantially large amount of fees for the NAS performed. Conclusion It has proved to be very difficult to provide for evidence related to the impairment of audit when Non-Audit Services are also provided to the client company by the audit firm. This is because of the fact that this evidence is deeply embedded in the organisation and the system as a whole is such that both the audit firm and client company are too happy to complain about it. Even if the auditor becomes lenient in conducting the audit, the client company wont complain as it gains by cost saving and the auditor wont complain because it can gain a considerable amount of revenue from the same company. The system also helps in developing a very trusted relation between the auditor and the company officials, thus, both dont complain about this system. It has been seen that there is an increase in a NAS work performed when a considerable time has elapsed between the engagement of the audit firm and the client company. Thus, it is advisable to make laws strict enough that control the conduct of an audit and the NAS performed for the same client by the auditor. The audit governing bodies around the world are trying to make sure that no impairment occurs due to NAS work assigned to the audit firm. Thus, the institutes should either put a complete ban on these NAS or should make guidelines bring down the NAS to be performed below a certain level. To control the audit failures some hard step should be taken by the governing bodies so that the proper audit is conducted according to all guidelines issued by these governing bodies and the correct opinion is made by the audit firms on which all stakeholders can be proud off (Steinhoff, 2002). Thus, even the expectation of future Non-Audit services to be performed for the company cannot cause the quality of audit to be conducted to be poor. Auditors have a lot of responsibility when conducting an audit, preparing reports and making an opinion which should be respected by them as on the basis of their audited statements many impo rtant financial decisions are made. References Abou-Seada, M. and Hussey, R. (1996). The use of evidence in establishing audit opinion. Bristol: Bristol Business School, the University of the West of England. Adelopo, I. (2012). Auditor independence. Burlington, VT: Gower Pub. Antle, R., Gordon, E., Narayanamoorthy, G. and Zhou, L. (2014). 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