The issue of hearer independency is a important component and really of import for the audit profession. This construct has been discussed widely and many definitions have been presented in literature. Independence refers to the hearer ‘s ability to show his sentiment about the dependability of fiscal statements candidly and impartially off from his involvement or the force per unit area of clients[ 1 ]( Ahmad, 2009 ; 1985 ) . Accountants[ 2 ]hold long recognized that independency is critical to the viability of scrutinizing as a profession. Few among hearers, preparers, fiscal statement users, or their legal advisers would earnestly challenge the value of independent confidence on a company ‘s fiscal statements. Therefore hearers should show his decisions candidly and impartial.
Literature has contemplated two criterions for measuring hearer independency. Mautz & A ; sharaf ( 1961 ) , who are among the innovators in the survey on hearers independency have developed a construct of independency with two constituents: practitioner-independence ( independency in fact ) and profession- independency ( independency in visual aspect ) . The Public Oversight Board emphasized that the members that the members of Certified Public Accountant houses should protect the profession by being independency both ‘in fact ‘ and in ‘appearance ‘ ( Lowe et al, 1999 ) . Independence in fact refers to the mental attitude of the hearer characterized by the unity and the nonsubjective attack to the audit procedure. Besides, the practician independency requires the hearer to be free from personal involvement, susceptibleness to inordinate force per unit area[ 3 ]( Moizer & A ; Sutton, 1997 ) . However, since this mental procedure is unobservable and hearers besides have inducements to go against their independency through fulfilling their clients so as to keep the economic bonding to the client[ 4 ]( DeAngelo, 1981 ) , there is a demand for the hearers to be perceived as independent ( named independency in visual aspect ) from the direction squad who prepares the fiscal statements. Orren ( 1997 ) states that independency in fact refers to the existent, nonsubjective relationship between scrutinizing houses and their clients whereas independency in visual aspect is the subjective stated of that relationship as perceived by the clients and the 3rd parties. Church and Zhang, ( 2002 ) argue that independency in fact is necessary to heighten the dependability of fiscal statements. On other manus, independency in visual aspect is necessary to advance public assurance such that users will trust on audited fiscal statements.
Securities and Exchange Commission, 1979 asserts:
“ The [ hearer independency ] issue is both one of visual aspect and of fact ; if public assurance in the unity of fiscal coverage is to be maintained, it is of the extreme importance that public assurance in the objectiveness of independent hearers be likewise maintained ” .
American Institute of Certified Public Accountants ( Public Oversight Board, 1979 ) :
“ While it is, of class, indispensable that an hearer preserve his objectiveness and unity from his ain point of view, normally called “ independency in fact, ” it is besides of import that the hearer appear independent to all users of the fiscal information he provides. This latter construct is a cardinal ingredient to the value of the audit map, since users of audit studies must be able to trust on the independent hearer. If they perceive that there is a deficiency of independency, whether or non such a lack exists, much of that value is lost ” .
The demand for Auditor ‘s independency
Independence is an of import scrutinizing criterion because the hearer adds justification and credibleness to fiscal statement even when there are no material misstatements or skips in the fiscal statements prepared by direction ( okolie 2007 ) . Teoh ( 1992 ) states “ the audit of fiscal information adds important confidence that the information is dependable and thereby enhances its credibleness. ” The writer Gupta ( 1999 ) is of sentiment that is hearer is non independent of direction ; his sentiment would intend nil to stockholders, prospective investors, bankers, authorities bureaus, and others who are concerned with the fiscal statements of a company.
The writer Ezeipe ( 2004 ) describes the construct of hearer ‘s independency in three dimensions[ 5 ]:
Programme independency: Sometimes client director have the purpose to curtail or modify the processs that the hearer want to execute. Thus hearers should ever stay free from intervention of client directors.
Reporting Independence: The hearer should ne’er allow any feelings of trueness towards the client to impact his work. He must to the full and reasonably unwrap his duties. Management are ne’er allowed to supercharge the hearer.
Fact-finding Independence: The hearer should hold entree to all necessary stuffs required on the content of an audit. For illustration, the hearer must hold entree to books and records ; besides active co-operation from direction forces during audit scrutiny is required ( salehi 2009 ) .
In theory, there are many factors that affect independency of an hearer and these factors which have been studied can be:
The effects of gifts ( pany and Reckers, 1980 )
The purchase of price reductions agreement ( pany and Reckers, 1980 )
The audit house size ( Shockley, 1981 )
The proviso of direction advisory services by the audit house ( Knapp, 1985 )
The client fiscal status ( ( Knapp, 1985 )
The nature of struggle issue ( )
The audit house ‘s term of office
The grade of completion in the audit services market
The size of the audit fees
The audit commission
Rehearsing non-audit services by hearers
In this survey, merely factors such as the proviso of non audit services, the audit house size, the audit house ‘s term of office, the grade of competition in the audit services market, the size of audit fees and the audit commission will be analysed and whether these factors will impair or heighten hearer ‘s independency.
The proviso of non audit services by hearers
Audited account failures reported in the yesteryear have affected the profession of hearer worldwide because the involvements of stockholders and shareholders have non been safeguarded. This job has arisen as a consequence of the proviso of non-audit services ( Salehi and Moradi 2010 ) .
Non- audit services can be any services other than audit that an hearer provides to an audit client. Over the late twentieth century, demand for concern expert services has increased, wattington and Pany ( 2001 ) identified the different scope of services which are offered by hearers to private and public sectors and these non-audit services include: preparation, services for paysheet, hazard direction advice, amalgamations and acquisition, revenue enhancement, public offering, portfolio monitoring, enlisting and human resources and corporate administration. Prior research suggests that the impact of non-audit services on hearer ‘s independency is unsure. An hearer needs to pay much attending when both audit and non-audit services are provided to the same client, because these non-audit services may endanger the independency of hearer.
Equally far as globalisation in accounting profession is concerned, confidence service has created the multidisciplinary nature of big audit houses ( Brierley and Gwilliam, 2003 ) . These multidisciplinary houses offer audit and non-audit services to scrutinize clients and this have become one of the major concerns sing the possible hearer independency quandary ( Quick and Rasmussen, 2005 )
Although there are market-based inducements for hearers to stay independent, there are besides forces that potentially threaten auditor independency. Specifically, regulators are concerned about two effects of non-audit services. One is a fright that non-audit service fees make hearers financially dependent on their clients, and therefore less willing to stand up to direction force per unit area for fright of losing their concern
The other is that the confer withing nature of many non-audit services put hearers in managerial function ( Defond et al 2002 ) . These concerns are summarized in the undermentioned quotation mark from the SEC ordinances mandating fee revelations ( SEC, 2000 ) . Auditor ‘s services relationship raises two types ofindependence concerns. First, the more the hearer has at interest in its dealing with the audit client, peculiarly when the non-audit services relationship has the possible to bring forth important grosss on top of the audit relationship. Second, certain types of non-audit services, when provided by the hearer, create built-in struggles that are incompatible with objectiveness.
In the United States, the Sarbanes Oxley Act of 2002 implemented a prohibition on nine non-audit services which include:
1. Bookkeeping and other services related to the audit client ‘s accounting records or fiscal statements
2. Fiscal information systems design and execution
3. Appraisal or rating services and fairness sentiments
4. Actuarial services
5. Internal audit services
6. Management maps
7. Human resources
8. Broker-dealer services
9. Legal services
Harmonizing to Ojo ( 2009 ) , the proviso of non- audit services by audit houses does non needfully impact hearer independency. However, where the fees generated from such non-audit services are well high ( in proportion to the audit fees earned by such accounting houses ) and deficient precautions operates to protect the hearer ‘s independency, this creates a state of affairs whereby the hearers independency is likely to be compromised since the hearer may be denied profitable contracts[ 6 ]where he decides to give a qualified sentiment on the fiscal statement being audited.
Advocates of the proviso of audit services argue that synergisms of cognition spillover and audit efficiency arise from supplying both audit and non- audit services. While the oppositions contend that supplying non-audit services increases the hearer ‘s fiscal trust on the client and therefore may impair hearer ‘s independency.
An audit commission consists of a selected figure of members of a company ‘s board of managers whose chief responsibilities are to assist hearers remain independent of direction ( Arens at Al, 1999 ) , that is, commission should back up the hearer alternatively of direction in different audit differences. The members who participate in the audit commission can be corporate directors, academicians and retired spouses of CPA houses ( Knapp, 1987 ) . Beattie et Al. ( 1999 ) reported that audit spouses, finance managers and fiscal journalists believed that audit commission helps to heighten hearer independency[ 7 ]( Beattie et al 1999 ) .
SEC requires Audit Committees to measure the independency of the company ‘s external hearer when make up one’s minding whether or non to engage the hearer for supplying non-audit services. In so making, Audit Committees besides are encouraged to see how the hearer provided non-audit services may better audit quality and affect hearer independency
Size of audit house[ 8 ]
The size of audit house is an indispensable feature that reflects auditor independency. A figure of surveies have proven that hearer repute is straight associated with audit quality. Large audit houses will do certain to supply an independent quality audit service as the larger audit houses tend to hold better research installations and efficient fiscal resources, more advanced engineering and more skilled employees who will be able to set about big company audits comparison to smaller audit houses. Large audit houses have larger client portfolios which enable them to defy direction force per unit areas whereas little houses provide individualized services as their client portfolios are limited and they have to yield to direction demands ( Lys and Watts, 1994 ) .
The issue of keeping hearer independency is more important for smaller houses than larger houses. Pearson ( 1980 ) found the larger size of audit houses will heighten hearer ‘s independency, because, smaller houses would see more trouble in defying client force per unit areas in state of affairss of struggle. As a consequence, the information content of audit studies certified by big houses are considered to be more and dependable than those of smaller audit houses[ 9 ]( Titman and Trueman, 1986 ) .
However, as pointed out by Goldman & A ; Barlev ( 1974 ) , it can non be concluded that big CPA houses are more immune to force per unit areas from their clients. This is so because the few tribunal instances which challenge the premise that CPA houses acted independently indicate that there is no warrant that big CPA house has the ability to defy force per unit areas from clients, as happened with Arthur Andersen and Enron[ 10 ].
Degree of competition in audit service industry
Competition[ 11 ]has been identified as an external factor impacting hearer independency ( Shockley 1981 ) . Many houses which operate in an intensely competitory environment may hold trouble staying independent as the client can easy get services of another hearer. The[ 12 ]AICP Cohen Commission ( 1978 ) in its study affirms that there are inordinate competitions among public accounting houses. This inordinate competition among different houses has become a job to the scrutinizing profession today.
Therefore, extended competition within the audit market has been systematically identified as a factor endangering hearer independency[ 13 ]( Farmer et al. , 1987 ) . The audit houses which operate in an environment characterized by a high degree of competition for audit clients normally have a greater hazard of diminishing their audit independency comparison to those audit houses which operate in a low-competition environment.
Shockley ( 1981 ) had found that audit houses runing in an environment characterized by a high degree of competition for audit clients would hold a greater hazard of diminishing their audit independency than where audit houses operated in a low-competition environment.
Auditor term of office
An audit house ‘s term of office refers to the length of clip required to make full the audit demands of a given client. A long association between a company and an accounting house is likely to ensue a close designation of the house with the involvements of its clients, therefore an independent action by the accounting house ( U.S. Senate, 1976 ) . The writer Mautz & A ; Sharaf ( 1961 ) added that after a long association, less strict audit processs, complacence and a erudite assurance in the client may originate. However, long hearer term of office may take to a cosy relationship between the client and the hearer ad this may impair hearer independency due to a lessening in the hearer ‘s due-diligence and besides becomes more prepared to “ turn a blind oculus ” to inappropriate managerial actions. On the other manus, long hearer term of office is good as hearers gain expertness in the field they audit and may may cut down the hearer ‘s ability to observe abnormalities or material misstatements ( Gul et al. , 2009 )
Size of audit and non audit fees
The IFAC ‘s Code of Ethics for Professional Accountants ( 1996, para 8.7 ) propose that client size which is measured from size of fees could raise uncertainties as to independence. The EFAA ( October, 1998, p.4 ) clearly states that, ” the ( entire ) fee from one client should non transcend a certain per centum of the entire turnover of the audit house ” . In instances of accounting dirts ( for illustration Enron and WorldCom ) , the audit house appeared to be in collusion with the direction in concealing deceitful activities. The major factor behind such reserve was the sum that the hearers received as non-audit fees from these clients. Anderson, the hearer for Enron, received US dollar 27 million as non audit fees in add-on to US dollar 23 million as audit fees. The fact that the accounting house received more than half of its Enron gross from NAS gives an visual aspect of a deficiency of independency in the audit ( Flaring 2002 ) .
In add-on, the fees for non-audit services has besides increased well and are more profitable than fees from audit services, therefore beef uping the economic bond and well take to impairment of AI. The regulative organic structures in the U.S. like the SEC, the POB and the AICPA emphasized that important high non audit fees can negatively impact hearer independency and besides impair hearer decision-making, when those determinations involve a significant sum of professional judgement.
In Malaysia the MIA By-Law ( Section B-1.98 on Professional Independence ) has emphasized that “ if the sum fees ( originating from confidence and non-assurance services ) generated by one confidence client or its related entities exceed 15 % of the house ‘s entire fees in each twelvemonth over two back-to-back fiscal periods, fiscal dependence shall be considered to be, in which instance, a self-interest menace to independency is created. In such event, the lone class of action is to decline to execute or retreat from the confidence battle ” . This 15 % standard has besides been the degree by and large used by the ICAEW and Australia at which hearers have to see their independent place.
There have been a big figure of surveies on perceptual experiences of hearer ‘s independency. Some illustrations can be Dykxhoorn & A ; Sinning ( 1981 ) in German, Gul ( 1989 ) in New Zealand, Gul & A ; Tsui ( 1992 ) and Lau & A ; Ng ; ( 1994 ) in Hong Kong, and Alleyne et Al. ( 2006 ) in Barbados to call a few. There are merely some published surveies concentrating chiefly on the factors impacting hearer ‘s independency ( i.e Gul & A ; Teoh, 1984 ; Teoh & A ; Lim 1996 ; Abu Bakar et Al. 2005, 2009 ) .The survey Gul and Teoh ( 1984 ) analyses the chief effects of combined audit and direction consulting services provided by public accounting houses and the population sample taken comprised of bankers, public comptrollers, troughs and stockholders. The consequence obtained was that the enlargement by audit houses into non audit services reduced their assurance in the hearer ‘s independency.
The survey Teoh & A ; Lim ( 1996 ) look into the effects of five selected factors of AI of Malaysian populace and nonpublic comptrollers. They make usage of a perennial steps experimental design. The consequences conclude that a big audit fee received from a individual client is the most indispensable factor taking to the hazard of losing AI, followed by the proviso of direction consultancy services. The non-rotation of audit houses is non considered to be a dominant factor but the formation of audit commissions is found to hold a strong positive impact on bettering hearer independency, while the positive impact of revelation of non-audit fees is well less.
Some surveies can be those of Abu Bakar ( 2005 ) who analyses the factors act uponing hearer ‘s independency from the perceptual experiences of Malayan loan officers. The survey examines the sentiments of commercial loan officers who were comparatively fiscal statement users who would understand the importance of audit study and the issues related to auditor independency. A sum of 86 officers responded to the ego administered questionnaire. The consequences indicate that audit houses runing in a higher degree of competitory environment, larger size of audit fees, audit house functioning a client over longer continuance, audit house supplying managerial consultative services and non-existence of an audit commission are perceived as holding the hazard of losing hearer ‘s independency. The most of import factor impacting AI is given by Audit house size, followed by term of office, competition, audit commission, MAS and size of audit fee. Another survey by Abu Bakar ( 2009 ) , attempts to research the chief determiners of hearer independency as perceived by Malayan comptrollers. A ego administered mail study was used and a sum of 72 completed questionnaires were received bring forthing useable answers of 14.4 % . From the study, it is evidenced that, larger size of audit fees is the most of import factor that is perceived as holding hazard of losing hearer independency followed by other factors[ 14 ]. Additionally, the survey besides provides a footing for the profession to set up policies associating to auditor independency.
Reappraisal of literature in footings of the different factors
In world there are many factors which impair hearer independency and some surveies concentrated on merely one factor. For illustration, Salehi ( 2009 ) examined non audit services and audit independency. The consequence of this survey strongly agrees that supplying NAS to external hearers to the same client impair hearer independency. Several anterior surveies concluded that NAS has negative effects on hearer patterns and hearer independency. A Survey carried out by Wines ( 1994 ) suggests that hearers having NAS fees are less likely to measure up their sentiment than hearers that do n’t have such fees, based on his empirical analysis of audit study issued between 1980 and 1989 by 76 companies promotion listed on Australian stock exchange. He found that hearers of companies with clean sentiments received higher proportion of non audit fees than did hearers of companies with at least one making.
Harmonizing to Beeler and Hunton ( 2002 ) contingent economic rents such as possible non-audit gross, increase unwilled prejudice in the judgements of hearers. They found by experimentation that audit spouse participants searched more supportively, weighted collateral grounds more to a great extent, and made more luxuriant statements in the presence of low balling and possible non-audit gross than proviso of audit, and NAS claimed that hearers would non execute their audit service objectively and that joint proviso would impair sensed independency ( Glezen and Miller, 1985[ 15 ]; ) . Mitchel et Al. ( 1993 ) believed that the joint proviso of audit and NAS to scrutinize clients would do unjust competition due to the usage of audit services to the same client and therefore would impair AI.
Several anterior surveies besides suggest that NAS has positive effects on hearer patterns and hearer independency. Gul ( 1989 ) who studied the perceptual experiences of bankers in New Zealand found that the consequence of proviso of NAS was significantly and positively associated with hearer independency. Hussey ( 1999 ) reported that the bulk of the UK finance managers that participated in his survey suggested that joint proviso of audit and NAS to scrutinize clients should go on to be allowed. In Malaysia Gul and Yap ( 1984 ) reported that NAS proviso increased their assurance in hearer independency. Arruanda ( 1999, p. 165 ) pointed out that joint proviso of audit and NAS would cut down overall cost, raises the proficient quality of scrutinizing, enhance competition. This would finally increase hearer independency. Kinney et Al ( 2004 ) denoted cognition of a client ‘s information system and revenue enhancement accounting could slop over to the audit, better the information available to the hearer and therefore better audit quality which in bend would increase the chance that jobs are discovered.
The writer Sori ( 2009 ) made the survey of audit Committee and Auditor Independence through the Bankers ‘ Perception. The questionnaire and the interview study reveal that the bulk of the respondents agreed that hearer independency would be safeguarded by the presence of an active and independent audit commission. The audit commission is responsible for O.K.ing and reexamining audit fees as the bulk of audit commission members are independent and non-executive managers. Teoh & A ; Lim ( 1996 ) in their survey happen that the formation of audit commissions has a strong positive impact on heightening hearer independency. Similarly, Patten & A ; Nuckols ( 1970 ) , Knapp ( 1985 ) and Lau & A ; Ng ( 1994 ) find that the being of an audit commission increases the likeliness of bankers ‘ O.K.ing a loan, which is a contemplation of an increased assurance in the hearer. On the contrary, Gul ( 1989 ) suggests that audit commissions did non significantly impact the perceptual experiences of hearer independency.
Many empirical surveies have proven that the high degree of competition in the audit house has resulted in less hearer independency ( e.g. Shockley, 1981[ 16 ]; ) . However, Gul ( 1989 )[ 17 ]who obtains the opposite, in explicating this, he argued that the being of competition caused hearers to be more independent and make a favorable image in order to keep their patronage. In a UK survey ( Beattie et al 1999 ) competition was the factor act uponing hearer AI. The sample comprised of audit spouses and the writer argued that the factors impacting the perceptual experiences of AI are likely to alter over clip owing to alterations in the local economic, political, cultural and regulative environment.
Size of audit house and hearer term of office
About all empirical surveies that attempted to happen relationship between larger audit house size and AI concluded that there is a positive relation between them[ 18 ]( De Angelo 1981 ) . The writer DR Zulkarnain ( 2006 ) analyses the size of audit house and perceived hearer independency in his survey. Questionnaires and interview study were used to seek the perceptual experiences of senior directors of audit houses, Bankss and public listed companies. The consequence concluded that the Big Four houses were perceived to be superior and more efficient compared to the non-big four houses in all facets associating to independence from their clients. The respondents indicated that large four hearers are better able to defy direction force per unit area in state of affairss of struggles and are more effectual at observing activities that will impact clients ‘ company continuity. The non-big four houses are more risk averse with respect to judicial proceeding originating from fraud and abnormalities compare to non-big four houses.
Most authors[ 19 ], who discuss the relationship between term of office and AI, support that audit houses functioning a given client over a longer continuance has the hazard of losing an hearer ‘s independency. However, in surveies conducted by Shockley ( 1981 ) and Teoh & A ; Lim ( 1996 ) term of office was non found to hold a important impact on perceptual experiences of AI.
Audited account and non audit fees
Most empirical surveies conducted on size of audit fees do non look at that factor itself ; alternatively the surveies are inter-related with other factors. For illustration, Shockley ( 1982 ) in his survey suggests that the negative effects of MAS, the size of the audit house and competition on a 3rd party ‘s PAI really arise because of the linkage of these variables to scrutinize fees.
However, there is a survey that proves otherwise. For illustration, Gul ( 1991 ) who analyses banker ‘s perceptual experiences of AI proves that each independence-related variable such as the audit house size, affects bankers ‘ PAI in its ain right. He besides found size of audit fees to be indispensable factor of bankers ‘ PAI. Another survey related to the size of audit fees was by Pany & A ; Reckers ( 1983 ) .They noted that the big size of the client ‘s audit fee ( measured as a per centum of office grosss to the audit house ) , though do non demo any important impacts on PAI, have influenced respondents to experience less assurance in the hearer ‘s independency.
Additionally, where non-audit fees are concerned, several anterior documents have studied the involvements and importance of non-audit fees in footings of hearer independency. Unfortunately, the research watercourse which evaluates the association between non-audit services and hearer independency, by analyzing the consequence of non-audit fees on the hearer ‘s leaning to publish a traveling concern modified sentiment ( hereafter GC ) , has produced instead assorted consequences[ 20 ]. Research workers in the U.S. suggest that there is no relationship ( DeFond et al. , 2002 ; Geiger and Rama, 2003 ) 1. Therefore, despite the concerns of the regulators and the fiscal imperativeness, there is no clear grounds that higher non-audit fees negatively affect hearer independency.
Research on audit fees has besides documented that client size is an of import determiner of audit fees ( Simunic, 1980 ; Francis, 1984 ) , while other research indicates that the comparative magnitude of non-audit fees is besides higher for larger clients ( Abbott et al. , 2002 ) . Further, the proviso of non-audit services by the incumbent hearer leads to better apprehension of the client and cognition spillovers ( Simunic, 1984 ; Francis, 1984 ) , and therefore to a better informed audit coverage determinations. Together, these consequences suggest that audit sentiments may be influenced by the magnitude of non-audit ( and audit ) fees received from clients. Some anterior research base on the consequence of non-audit fees on hearer independency is besides inconclusive[ 21 ]( for illustration, Wines 1994 )
In most empirical surveies audit independency is proxied by the comparative magnitude of the audit fee as against the NAF received from a peculiar audit client. Hoitash ( 2007 ) hypothesise that the fees paid to hearers can impact audit quality in two chief ways. First, big fees paid to hearers may increase the attempt exerted by hearers and thereby increase audit quality. Alternatively, big fees paid to hearers, peculiarly those that are related to NAS, make hearers more economically dependent on their clients.