Non-audit Services and External
Auditor’s Perception of Audit
Independence in the Netherlands
Stephany JML Girigori 10422110
UNIVERSITY OF AMSTERDAM
14 August 2014
Master’s of science in Accountancy and Control Control track
University of Amsterdam
Master thesis supervisor: Ph.D. Bo Qin (University of Amsterdam)
Table of contents
Abstract ... 4
1. Introduction ... 5
1.2 Research question ... 7
1.3 Motivation ... 8
1.4 Structure of the thesis... 8
2. Literature review and hypotheses ... 10
2.1 Defining audit independence ... 10
2.1.2 Importance of audit independence ... 11
2.1.3 Principal agent theory... 12
2.2 Defining perception ... 12
2.2.1 Importance of external auditors’ perceptions of audit independence ... 13
2.3 Non-audit service definition and Dutch regulation ... 13
2.4 Defining professionalism ... 16
2.4.1 Importance of professionalism ... 19
2.4.2 Hypothesis: non-audit services on auditor’s perception ... 20
2.4.3 Hypothesis : moderating effect of professionalism ... 21
3. Research methodology ... 22
3.1 Design ... 22
3.2 Participants ... 22
3.3 Variables and measurement ... 23
3.3.1 Dependent variable ... 23
3.3.2 Independent variables ... 23
4. Findings... 26
4.1 Descriptive statistics analysis ... 26
4.3 Relation between non-audit services and perception of audit independence ... 28
4.4 Professionalism effect on non-audit services and perception of audit independence ... 29
4.5 Conclusions ... 31
5. Discussions and implications ... 33
5.2 Academic and managerial contribution ... 34
5.3 Limitations and future recommendation ... 34
References ... 36
Abstract
External auditors have expanded their services by providing audit services and non-audit services to their audit clients, such as bookkeeping; actuarial services; management functions, human recourses, legal and expert services. The additional non-audit services have brought various questions and concerns regarding the ability of external auditors to act as a
professional by being independent and function in an objective manner. The purpose of this study is to investigate whether there is a relationship between non-audit services and the perception of external audit independence by conducting a survey under the external auditors in the Netherlands. To be more specific, this study examines whether professionalism affects non-audit services and the external auditor’s perception of audit independence. The analysis was performed based on six types of organization s that received non audit services in the past two years. These organizational types were namely; Trade organizations, Production organizations, Service organizations with limited flow of goods, Service organizations that put space and electronic capacity at customer disposal, Service organizations that put knowledge and skill at customer disposal and Governmental and Other not-for-profit organizations.
As a result this study concludes that there is a main effect between non-audit services and perception of audit independence and this main effect is positively strengthened by the types of organizations. The study showed as well that there is no significant statistic evidence that the previous mentioned relationship will strengthen the relationship between non-audit services and perception of audit independence. As such this study contributes to the ongoing existing debate in the accounting field concerning non-audit services and audit independence in the Netherlands.
1. Introduction
The increase of development of professional services in the past years has resulted in a large demand from firms for professional advice to help them achieve a competitive advantage within the market that they operate. In addition to the increase of development of professional services, external auditors have been performing non-audit services for their clients and this has raised concerns about the external auditor’s role of being independent (Salehi,
2009).Watts and Zimmerman (1980) have argued that it is implausible for an external auditor to be perfectly independent from their clients. In this line of thinking DeAngelo (1981a) defines audit independence as “the conditional probability given that when a breach has been discovered, the auditor will report the breach” (pp.115-116). These findings suggest that essentially, external auditors are always dependent on their clients in one way or another and, external auditor (in) dependence relates to the auditors’ freedom or willingness to report a breach when encountered.
The external auditor has an important role in the financial reporting process because the external auditor is responsible for the correctness and completeness of the financial
statements which are management responsibilities, which in turn acts on behalf of the
shareholders and also to other management entities. Shareholders need to have the confidence that the firm is being well managed and will continue to be profitable. They will be able to rely on the published annual report and accounts of the firm in order to have the assurance. As such the auditor has become the intermediary between the shareholders and other
organizational entities who relies on the financial statements (Salehi, 2009).The shareholders expect that the annual report and accounts will represent the current financial position of the firm. Therefore an independent external auditor is expected to act professional and to give a true and fair view of financial statement in order to improve and also to add value to the organizational operations.
Providing non-audit services to audit clients might lead the audit firm to be economically dependent on the company. This could initially reduce the probability of the auditor to report a misstatement on a client’s financial statement which, could also result in an unqualified audit opinion (Lin and Tepalagul 2009; DeAngelo, 1981b and Wines, 1994).On the contrary, Glezen and Millar (1985) and Corless and Parker (1987) argue that non-audit services have no negative effect on external auditor independency. The relationship between non-audit services and external auditor independence has been the topic of numerous research studies however; there is a lot of ambiguity and contradictions between the findings. The impact of
non-audit services has been and remains a heavily debated subject within the accounting field. This is mainly due to the fact that external auditors must provide an assurance that the management of a corresponding firm presented a true and fair view of the performance and financial position of their organization.
A lot of concerns have been raised upon the fact that external auditors provide non-audit services such as Bookkeeping; Actuarial services; Management functions and Human recourses, Legal and expert services unrelated to the audit of their clients. These concerns have led to a worldwide public policy debate of whether an audit firm should be allowed to perform audit services and non-audit services to the same company. The Securities and Exchange Commission (SEC), which is a government commission created by the U.S. Congress to regulate the securities market and protect investors, argues that these
relationships might impair investor confidence in auditor independency and lead to a decrease of confidentiality in the public capital market. As a reaction to these concerns, the SEC has revised the rules on auditor independence in November of 2000 (SEC, 2000). The revised rule prohibits U.S. external auditors from providing non-audit services to their clients. In addition the revised rule limits the external auditor from providing certain services by requiring a pre-approval of the audit committee. Finally the revised rule also requires businesses to disclose all fees paid to their audit firm. Furthermore the Sarbanes Oxley Act (SOX) passed in 2002 in response to fraudulent accounting events that had occurred, also prohibited auditors in the U.S. to perform financial information system design and
implementation services to their clients. Now the general belief in the U.S.is that external auditor independence might be affected when providing non-auditor services to their clients and a regulation has been introduced that will minimize these types of services.
On the other hand, the European Union and the Dutch Government have also introduced new regulations and amendments related to the auditing profession. On 11 December 2012, the Dutch Senate has adopted the new Accountancy Profession Act (Wet op het
accountantsberoep, or ‘Wab’) and it became active on January 1, 2013. The Act introduces two new amendments in the Audit Firms Supervision Act (Wet toezicht
accountantsorganisaties, or ‘Wta’) that will affect the services carried out by audit firms. Both amendments were developed to increase the external auditor independency by
prohibiting audit firms from providing services other than audit services and by introducing mandatory audit firm rotation (NBA, 2012). This study investigates if there is a relationship
between non-audit services and the perception of audit independency and how professionalism may affect the possible relationship.
1.2 Research question
Based on the aforementioned problem background the research question is formulated as follows:
Q1. Is there a relationship between non-audit service on the perception of audit independence?
Q2. How does auditor professionalism influence the relationship between non-audit services and the perception of audit independence?
The expected relationships of this study are illustrated in the following framework:
Non-audit Audit + Services Perception of audit + independence Professionalism
The expected relationship amongst the variables is that primarily, “Non-audit services” will increase the degree of “Perception of audit independence” of the external auditors, which implicates a positive effect. Prior researches, namely Swanger and Chewning (2001), Low et al., (1999) and Thorthon et al. (2003) have investigated this subject from the third party (users) perspectives and found that non-audit services does impair the external auditor independence. However there is little research performed from the point of view of the external auditor and especially in the Netherlands. A study in the state of Nigeria has showed that external auditors do significantly comply with the codes of professional ethics in the conduct of their professional engagements as prescribed by the Institute that regulates the principles and rules of the external auditor profession in Nigeria (Isu, 2007). This means that external auditors will not undertake a professional activity that might create a threat to their
objectivity and to the other fundamental principles of their profession. Based on these facts, this study expects a positive effect between non-audit services and the perception of
independent audit. This means that the respondents (external auditors) will perceive themselves as independent when providing non-audit services.
External auditors are required to comply with the rules, principles and code of ethics of the external auditors’ profession, otherwise it may have severe negative effects on the quality and validity of the audit services they provide. In order to be able to increase the audit quality and validity, this study expects that the relationship between non-audit services and perception of audit independence is increased by the presence of professionalism. This means that the respondents (external auditors) have perceive themselves as being more independent when providing non-audit services.
1.3 Motivation
The purpose of this study is to investigate the external auditors’ perception of audit
independence by examining whether there is a relationships between non-audit services and audit independence and investigate whether professionalism of external auditors can
influence the relationship between non-audit services perception of independence. The external auditor’s perception of audit independence refers to the ‘mental image’ that they have on non-audit services with regards to audit independence. Thorthon et al. (2003) have investigated whether stakeholders perceive that non-audit services impair auditor
independence, and if recent high-profile accounting scandals changed their perceptions. This study can be related to the study of Thorton et al. (2003) however the focus of this study will be on the external auditor within the country of Netherlands.
The external auditors’ perception is important because each person tends to view things in different ways and with their own perspective. In addition, perception might influence the external auditor’s choice, and this aspect will provide information that might help understand the relation between non-audit service and audit independence.
1.4 Structure of the thesis
Table 1: Structure of the study
Block 1 Title page Abstract
Table of contents
Block 2 Chapter 1: Background - Research questions
- Motivation, Academic and Managerial contribution Chapter 2: Literature review and hypotheses
Chapter 3: Research Methodology Chapter 4: Findings and conclusions
Chapter 5: Discussions, Limitations and future recommendations Block 3 Literature list
2. Literature review and hypotheses
This section discusses relevant literature, which is needed to answer the research questions: Q1. Is there a relationship between non-audit service on the perception of audit
independence?
Q2. How does auditor professionalism influence the relationship between non-audit services and the perception of audit independence?
This section includes a literature review of the terms audit independence, non-audit services and professionalism. The hypotheses are made by using this literature review and the research questions.
2.1 Defining audit independence
As mentioned before, DeAngelo (1981a) defines audit independence as the conditional probability given when a breach has been discovered, the external auditor will report the breach. But, there are numerous other definitions provided by other researchers. For example, Knapp (1985, p. 203) defines audit independence as the extent to which a client can exert pressure on the audit firm to alert the type and/or form of the audit opinion will influence the information that opinions conveys to financial statement users. Magee and Tseng (1990, p.317) define audit independence in a different point of view. They define it as an external auditor making reporting decisions consistent with his or her beliefs as to whether the reporting decision may be regarded as an audit failure. Furthermore Penno and Watts (1991, p.195) define audit independence if the external auditor's preferences over disclosures depend neither directly on management's wishes nor indirectly on management's preferences.
Although these findings and definitions have diverse formulations, they all seem to point that integrity and an objective approach to the audit process are the main issues regarding external auditor independence.
The International Federation of Accountants (hereafter IFAC) Code of ethics makes a distinction between independence of mind and independence in appearance. Despite a clear definition of audit independence the NBA which is the Netherlands Institute of Chartered Accountants (hereafter NBA),and the American Institute of Certified Public Accountants (hereafter AICPA) which is the world's largest member association representing the accounting profession, requires external auditors to be independence of mind and in
appearance. These aspects were developed in order to reduce and manage threats that might occur to the external auditor and are described as follows (IFAC, 2013):
(a) Independence of mind includes the state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity and exercise objectivity and professional skepticism.
(b) Independence in appearance includes the avoidance of facts and circumstances that are so significant and reasonable. It informs third parties, of all relevant information, including any safeguards applied, that would reasonably conclude if a firm’s or a member of the assurance team’s integrity, objectivity or professional skepticism has been compromised.
This study will focus on both, independence of mind and independence in appearance as the elements of external auditor independence. As shown by the previously indicated findings, both elements are required and equally important in the external auditors’ role of being independent during the financial reporting process.
2.1.2 Importance of audit independence
The board of directors is responsible for the financial statement of a firm. The financial statement is mainly prepared by the board of directors or by others that act on their behalf, for shareholders and for other third parties (e.g. bankers, taxation and regulatory authorities). The financial statement is for a listed firm on the capital market an important source of information. As such, independence is a very important factor in the auditor’s role when providing audit services since the internal and external users of the financial statements are depending upon the reliability, correctness and completeness of the information within the report.
Audit independence is a crucial aspect of the credibility of the external audit because, the assessment of the audit adds credibility to the financial statements. The users can rely on the information presented reason why the entire system of financial reporting is enhanced (Sucher and Kosmala-MacLullich, 2004). Moreover, McGrath et al.(2001, pp.39-40) stated that audit independence helps to ensure quality audits and supports the financial statement users’ reliance on the financial reporting process, thus increasing capital market efficiency.
Dupoch et al. (1991, pp.84) states that independence of mind refers to the external auditor that possesses an independent mindset when planning and executing an audit, and that the audit report is unbiased whereas independence in appearance indicates whether the
subjective view as perceived by the clients and other third parties. Thus, independence in appearance is needed to develop and promote public confidence in the users of the audited financial statements. As mentioned before, the AICPA and the NBA recognize the
importancy of the perceptions of the external auditor independence and require auditors to be independent in fact but also deceived situation that may lead others to be dubiousness about their independence.
However there are factors mentioned in the literature that might impair external auditor’s independence, such as gifts, provision of management advisory services, non-audit services, size of the audit firm, audit committee and client’s financial condition. The focus of this study is to clarify the effects of non-audit services on the auditor’s perception of audit independency from external auditors in the Netherlands.
2.1.3 Principal agent theory
According to the above descriptions and aspects of external auditor independence, it can be easily linked to the principal agent theory. The principal agent theory concerns to resolve two problems that might occur in an agency relationship. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principal to verify what the agent is actually doing (Eisenhardt, 1989). These problems will arise when the principal (e.g. shareholders) engages another person as their agent (e.g. managers) to act on their behalf. Therefore the principal delegates decision-making authorities to the agents and agency problem might arise due to inefficiency and incompleteness of information.
As mentioned previously, the external auditor has an important role in the financial reporting process because he/she will become the intermediary between the principal and the agent. In addition, the external auditor needs to give assurance to the shareholders and other stakeholders that the provided financial information of the firm is correct and complete. Additionally the external auditor must also assist them in assessing the leadership exercised by the managers over the business that has been entrusted to them. Hence the auditor should not put him-/ herself in a situation that may lead others doubt in his/her independence, because this might decrease the confidence of the shareholders and other stakeholders.
2.2 Defining perception
Perception is closely related to attitudes. Perception is the process by which organisms interpret and organize sensation to produce a meaningful experience of the world (Lindsay
and Norman, 1977).In other words, a person is confronted with a situation or stimuli. The person interprets the stimuli into something meaningful to him or her based on prior experiences. However, what an individual interprets or perceives may be substantially different from reality. Perception can also be defined as the set of processes by which an individual becomes aware of and interprets information about the environment (Management consulting courses, 2014).Perception can vary across economic, cultural and regulatory settings and could be influenced by numerous factors. Beattie et al. (1999, pp.84-87)
identifies 45 factors that might affect the independence perception positively and negatively of financial directors, audit partners and financial journalists. The authors conclude that several factors have a significant impact upon the perception of audit independence for those groups and non-audit service provision is one of the factors that are likely to have an impact among the groups. As previously mentioned IFAC makes a distinction between independence of mind and independence in appearance. Independence in appearance refers to the
perception of a third party, namely that the external auditor has no relationship with or is influenced by the client.
2.2.1 Importance of external auditors’ perceptions of audit independence
According to Pearson (1985) external auditors hold themselves out to be professionals in every sense of the word. Pearson further states that auditors have a code of ethics that they should comply with in order to provide guidance and maintaining a professional attitude and stature. In addition external auditors should also act in a correct manner and provide a qualified opinion regarding the financial statements.
Accounting research literature provides numerous findings regarding the perceptions of financial statement user however; there has been no study that focused on the perceptions of the auditors. Since the auditors have a crucial role in the financial reporting process and they provide assurance services, it is imperative to determine their perception about independence. Their views about audit independence are important because the external auditors play a key role in the financial reporting process and this might give insight into their view of independence.
2.3 Non-audit service definition and Dutch regulation
Non-audit service refers to all non-audit services provided by the incumbent auditor, this means that it includes services that are provided by the external audit firm conducting the auditing tasks. These services have grown by the mid-1950s and have increased by means of
the growth in computing technology (Koh et al., 2011). These services raised questions relate to the concerns that non-audit services fees may impair investor perceptions of external auditor independence. These concerns have led to public policy debates and revision in regulation (in the U.S. and in the Netherlands) in order to safeguard and increase the audit independency.
As previously mentioned the Dutch senate has introduced new amendments that prohibit audit firms to provide both audit services and other services to public interest entities (NBA, 2012). Public interest entities refers to firms whose transferable securities are admitted to trading on an EU-regulated market, such as listed companies, banks, life and non-life insurers and reinsurers. The new amendment has been added to the Wta (section 24b) and states: An audit firm conducting statutory audits of a public interest entity shall not provide other services to this entity in addition to audit services. There is a transitional provision with reference to the prohibition which states that the new amendment (section 24b) is not applied to services for which the auditor or the audit firm was engaged prior to the Accountancy Profession Act became active until two years after the date on which the Accountancy Profession Act becomes active(NBA,2012). The transitional provision of two years can be applied however, the amendment is active immediately, and therefore from then on forth other activities are no longer permitted other than the completion of existing advisory
engagements. Thus external auditors are still able to provide non-audit services if the external audit firm was engaged prior to when the Accountancy Profession Act became active, namely January 1, 2013.
The non-audit services that are prohibited in the Netherlands are services that are focused on providing assurance for the information provided by the audited client, which is to be used for external users and on behalf of the Supervisory Board. Because of the wide range of services provided by the audit firms, it is important to clarify the meaning of services described above. Hence the NBA has publicized a guidance on which services can still be provided by the auditor in combination with the statutory audit. The key factor is whether or not the external auditor’s report is intended for external users or for the Supervisory Board. The Supervisory board has a role in overseeing the management of a public interest entity and is therefore important to have access to reliable audited information. BDO, which is one of the big four firms here in the Netherlands, has publicized the services that are still allowed to be provided by the external auditors along with the statutory audit of a public entity interest and, services that are prohibited (BDO, 2013). These are as follows:
Services that are still allowed;
1) (additional) statutory and non-statutory audit, review and assurance services for third parties;
2) assurance on management reports and corporate governance, risk management and sustainability reports
3) assurance and fact-finding for external users (e.g. external regulators and the tax authorities) or the supervisory board (including on internal controls, fraud, and mergers and acquisitions).
Services that are no longer allowed;
1) fact-finding where the results are for ‘for internal use’ only; 2) compilation of financial statements and accounting services;
3) tax compliance services, including corporate tax returns, calculating the tax position, transfer pricing and tax planning; and
4) consultancy services, including tax advisory services, strategic and management consulting, services relating to internal controls and mergers and acquisitions (including due diligence reviews), legal services, Human Resource services and Information and Telecommunication services.
2.3.1 The effects of non-audit service according to prior researches
Several prior researches have studied the effects of non-audit services. Arruanda (1999) examined the provision of non-audit services by external auditors and stated that non-audit services do not damage external auditor independence or the quality of non-audit services. Furthermore the author stated that non-audit service will reduce cost, raise the overall technical quality of auditing and enhance competition (p.165). Also Gul (1989) has
investigated the effects of audit committees, client financial condition, management advisory services, competition and audit firm size of bankers' perceptions of auditor independence in New Zealand. The author found that audit committees, client financial condition,
management advisory services and competition had positive effects on external auditors’ independence although; firm size had a negative effect on external auditors’ independence.
On the contrary to the previous mentioned studies, there are some researches that argue that non-audit services have a negative impact on external auditor’s independency. For example, Wines (1994) used cross-sectional pooled data for the period 1980–1989 for
opinions of the external auditors. Furthermore the author established that there is an
independence problem when external auditors are providing such services. Also Swanger and Chewning (2001) studied the effect of internal audit outsourcing, and they found that external auditors are perceived by financial analysts to be less independent when they performed internal audit functions for audit clients. Although the external auditors are perceived to be more independent if the staff providing the services are in a separate division than the ones who perform the audit. Dopuch and King (1991) did an experimental market study about the adverse impact of management advisory service on external auditor's independence, as well as the possible influence of external auditors' provision of both management advisory service and audit services. These authors found that limiting an external auditor from
providing non-audit services and audit services to their client may result in external auditors choosing for non-audit services over audit services. However providing non-audit services might have an adverse impact on loan officers’ perception of auditor independence and financial statement reliability (Low et al., 1999).
There are other research studies that did not find a positive or a negative relationship between non-audit services and auditor’s independence. Defond et al. (2002) investigated the effect of non-audit services on external auditors’ independence and found no significant association between non-audit service fees and impaired external auditor independence. They also found no association between ongoing concern opinions and either total fees or audit fees. Reynolds et al. (2004) findings are consistent with Defond et al. (2002). The authors investigated whether external auditor’s objectivity is impaired by non-audit services or by the level of economic dependence on a client using data of 2507 U.S. companies and found no evidence that the relative level of non-audit fees impairs the external auditors’ objectivity. The authors concluded that their findings do not support the notion that non-audit services jeopardize external auditor independence.
2.4 Defining professionalism
Beaton (2010) defines professionalism as a combination of knowledge, skills, trustworthiness and altruism found in those who commit themselves to a life of service to others and stated that professionalism is more relevant today as it was when the concept first emerged centuries ago (p. 2). The author advocates that professionalism is not only a skill set in a given
occupation, but it is how the person acts in manner, dress, speech and standards of practice such as honesty, due diligence, perseverance, willingness to listen and learn, creative thinking
within a training framework. Davis (1988) defines professionalism when an individual put their profession first. The author than defines profession as an occupational group organized to use the characteristic skill of its members for the public good and advocate that he believes profession that the professional should be put first is the standard of skill and conduct the individual professes by being a member of a profession (p. 342). In this study professionalism refers to the rules, standards and principles of the external auditor profession.
All professions, no matter which field they represent is regulate by rules, standards and principles applied to control their conduct of the related activities within the field they represent. In this study professionalism represent the rules, standards and principles of the external auditor profession. The International Financial Reporting Standards (hereafter IFRS) contains a set of accounting standards developed by the International Accounting Standards Board (IASB) that is becoming the global standard for the preparation of public company annual reports (IFRS, 2014). Therefore all publicly traded firms in the Netherlands are
obligate to report under the IFRS since 2005. On the contrary, private firms can still apply the national system, which is the Generally Accepted Accounting Principles and are not obligate to report under the IFRS.
Besides the reporting standards, external auditors must follow the code of ethics developed by IFAC (2013), mentioned earlier in this study, in order to act adequate according to the external auditor profession. The code of ethics contains three parts, namely;
a. This part establishes the fundamental principles of professional ethics for professional external auditor and provides a conceptual framework that professional external auditors shall apply to:
1. Identify threats to compliance with the fundamental principles; 2. Evaluate the significance of the threats identified; and
3. Apply safeguards, when necessary, to eliminate the threats or reduce them to an acceptable level.
b. This part describes how the conceptual framework applies in to professional accountants in public practice.
c. This part describes how the conceptual framework applies to professional accountants in business.
According to the first part of the code of ethics, a professional external auditor shall comply with the following fundamental principles; integrity, objectivity, professional competence and due care, confidentiality and professional behavior. This study considers the fundamental
principles key factors that reflect the appropriate professional ethical behavior of an external auditor. Table 2 describes these fundamental principles;
Table 2: Fundamental principles
Integrity refers to be straightforward and honest in all professional and business relationships.
Objectivity refers to not allow bias, conflict of interest or undue influence of others to override professional or business judgments.
Professional competence and due care refers to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional
services based on current developments in practice, legislation and techniques and act diligently and in accordance with applicable technical and professional standards. Confidentiality refers to respect the confidentiality of information acquired as a result of professional and business relationships and, therefore, not disclose any such information to third parties without proper and specific authority.
Professional behavior refers to comply with relevant laws and regulations and avoid any action that discredits the profession.
Also the American board of internal Medicine (1994) has created a method consisting of six factors that measures professionalism applied in different industry. These six factors include altruism, accountability, excellence, duty, honor and integrity, and respect for others. These six factors were developed for the medical profession, but are also suitable for the external auditor profession since both professions serve the interest of the clients above their self-interest. The 6 factors are described in Table 3 as per below;
Table 3: Six factors of professionalism
Altruism refers to the essence of professionalism. The best interest of patients, not self-interest, is the rule.
Accountability refers to being accountable at many levels (individual clients, society and the profession).
Excellence refers to entails a conscientious effort to exceed ordinary expectations and to make a commitment to life-long learning.
Duty refers to the free acceptance of a commitment to service.
Honor and integrity refers to the consistent regard for the highest standards of behavior and the refusal to violate one’s personal and professional codes.
Respect for others refers to the essence of humanism, and humanism is both central to professionalism, and fundamental to enhancing collegiality among each other.
Some of the fundamental principles mentioned in the code of ethics for the external auditor corresponds to the factors of the model developed for the medical profession, such as being objective by acting in the best interest of the client, being honest and having strong moral principles and to maintain professional knowledge and skill in order to provide the client with an excellent services. This strengthen suitability of the factors within the external auditor profession, and this study will also take the factors created by the American board of internal Medicine into consideration when measuring the professionalism of external auditors.
2.4.1 Importance of professionalism
Professionalism is important because it shows that an individual is committed to his/her job for the organization they are associated with. Jui and Wong (2013) wrote a paper regarding professional accountants in business and the authors describe in the importance of the role of professional external auditors in business because of their responsibility in ensuring the quality of the annual report. The authors stated that external auditors have a crucial role in the financial reporting process by safeguarding the integrity of financial reporting. The authors further stated that competent professional external auditor is a key asset to the company.
In addition Baotham (2007) did a study regarding professionalism, audit quality and self- image by using Certified Public Accountants in Thailand. The focus point of the author was describing the relationship between professionalism, audit quality and self- image by studying the external auditor’s ability and auditor’s professional conduct, which relates to the rules, standards and principles of the external auditor profession. The author discovered that professionalism has a direct positive influence on both items. This means that external auditor professionalism has a positive effect on the audit quality, which implies that external
auditor’s professional conducts has positive effects on audit quality. Furthermore other researchers (Robkob et al., 2012) have investigatedthe influence of audit independence, audit professionalism, and audit quality, on audit value creation of Tax Auditors in Thailand and the authors found that audit independence has a positive influence on audit quality. In
additions the authors also found that audit independence has a strongly positive effect on audit professionalism.
The standards within the IFRS and the code of ethics are key factors for the external auditor profession, because these two elements provide guidance in accounting, system, process and guidance in appropriate ethical behavior within the financial reporting process. In addition, the principle of professional behavior is an important principle within the external auditor profession, because it requires an obligation on all professional external auditor to comply with relevant laws and regulations and avoid any action that the professional external auditor knows (based on their professional judgments) or should know and that may damage the reputation of the external auditor profession (IFAC, 2013, p.22). According to Davis (1992) professional judgment refers to good judgment, good enough at least to make others want it instead of lay judgment. The author further states that any professionals must provide responsible decision and judgments. In addition the author argues that a professional without a particular form of judgment distinguishing his profession from all others would be an incompetent individual that would not be able to honestly practice his profession in adequate way. Since the external auditor is exposed to different threats such as interest, self-review, advocacy, familiarity and intimidation threats, their professional judgment becomes very important for an external auditor profession.
2.4.2 Hypothesis: non-audit services on auditor’s perception
This study is primarily centered on determining the relationships non-audit services on the manner of which an external auditor is perceived as to being independent using external auditors as target group. It is known that non-audit services might have a negative impact on the external audit partners regarding audit independence, because external auditors might become economically dependent (Beattie et al., 1999). It is also known that third parties will find external auditors not being independent when they are providing non-audit services to their audit clients (Swanger and Chewning 2001; Low et al., 1999). Now the traditional believe is that non-audit services might impaired audit independence, which means that external auditor might go against the principles, codes and ethical behavior of the auditing profession and implicate his/her objectivity that could lead to unqualified audit. This might negatively affect users’ reliance on the audit work, which means that it could impair the trust of the users. However as indicated before, Isu (2007) finds that external auditors do
professional engagements as prescribed. From the perspective of my study this means that external auditor will perceive themselves as being independent when providing non-audit services. For that reason this study expects that non-audit services will increase the external auditor’s perception of audit independence.
Hypothesis 1: Non-audit services increases the external auditors’ perception of audit independence
2.4.3 Hypothesis: moderating effect of professionalism
This study also seeks to investigate whether professionalism influence the relationship between non-audit services and perception of audit independence. As mentioned before, this study expects a positive relation between non-audit services and the perception of audit independence by external auditors. First of all the International Standards of Supreme Audit Institutions (n.d.) indicated that the conduct of external auditors should be beyond reproach at all times and in all circumstances. Any deficiency in their professional conduct or any
improper conduct in their personal life places may have severe negative effects on the quality and validity of the audit services they provide. This result primarily emphasizes the
importance of external auditor professionalism for quality of provided (non) audit services. Furthermore in this same line of thinking the study of Baotham (2007) indicated a positive relationship between professionalism and audit quality and he also found evidence of a positive effect of audit quality on audit independence. This implies that a lack of
professionalism might result in poor audit quality which could implicates a poor level of audit independence. Hereby the existence of a relationship between audit professionalism, (non) audit services and audit independence is apparent. Moreover this study assumed that external auditors do comply with rules, principles and codes of professional ethics in the conduct of their professional engagements, and will have a greater level of professionalism in which could positively affect the relationship between non-audit services and perception of audit independence. Based on the previously mentioned result this study expects that
professionalism strengthen the positive effect of non-audit services on the perception of audit independence.
Hypothesis 2: The presence of professionalism within external auditors will increase the relationship between non-audit services and perception of audit independence.
3. Research methodology
3.1 Design
In order to collect as much of information possible regarding this subject, an online
questionnaire was developed and conducted on 129 randomly chosen external auditors in the Netherlands of whom 100 completed the questionnaire. The questionnaire of this study included questions of Thorthon et al. (2003) in order to evaluate the perceptions of non-audit services and independence regarding the external auditors alongside with formulated
statements regarding the professionalism of the external auditor. A within subject design was chosen predominantly considering the fact that this study wants to describe the relationship of non-audit services and professionalism on the perception of audit independence. A within subject design enabled a comparison of the respondents to describe the independent variables considered in this study.
3.2 Participants
Regarding the respondents of this study a convenience sampling method was utilized on male and female external auditors in the Netherlands. The respondents were individually (or via referrals) contacted via e-mail and telephone and were asked to participate in the study. After agreement each respondent received a hyperlink via e-mail which directed them to the online questionnaire formulated for this study. After clicking on the questionnaire’s hyperlink each respondent was automatically assigned to the questionnaires that were constructed in the online program Qualtrics. The questionnaire was divided into 2 parts, namely part A and part B. Part A was containing data of “non-audit services” and “perceived audit independence” variables based on industry level. The industry level refers to types of organizations based on the classification of the typology of organizations developed by Vaassen et al. (2009, pp. 216-218). The authors divided organizations into Trade organizations, Production
organizations, Service organizations with limited flow of goods, Service organizations that put space and electronic capacity at customer disposal, Service organizations that put knowledge and skill at customer disposal and Governmental and other not-for-profit organizations. The research questions will be answered for each type of organization described above in order to illustrate the differences of the types of organization. Subsequently part B contains data of “professionalism” variable and demographics
information of the respondent based on external auditor level, which refers each individual external auditor that completed the survey.
3.3 Variables and measurement
3.3.1 Dependent variable
Self-constructed questions were used during this study in order to identify the level of independence of mind and appearance. The external auditors were asked to respond 2 questions related to audit independence. The first question covered the extent to which the respondents (external auditors) perceived their degree of independence in performing the auditing tasks and subsequently how third parties perceived their independence in performing auditing tasks. The answers regarding audit independence within the questionnaire were organized as “a” to “e”, where “a” indicated “Not at all independent” and “e” indicated “Very much independent”. Subsequently these survey answers were transformed into numerical measures based on a 5-point Likert-scale, where “1”indicated“Not at all independent” and “5” indicated “Very much independent”. As stated in the independent variable section, the questions corresponding to the dependent variable were answered for each type of
organization mentioned earlier in this study.
3.3.2 Independent variables
The utilized questionnaire was developed by means of the online program Qualtrics consisted of a brief introduction followed by a total of 52 questions which related to the independent (and dependent) variables of this study and is presented in appendix section A. The
respondents were instructed to answer 4 questions about the test (control) condition “non-audit services” of the independent variable “services”. These were self constructed questions in order to identify whether non-audit services have been provided and the types of non-audit services that have been provided by the external auditors and to identify the importance of those non-audit services for the corresponding organization. The answers regarding importance of non-audit services within the questionnaire were organized as “a” to “e”, where “a” indicated “1%-20%” and “e” indicated “81%-100%”. Subsequently these survey answers were transformed into numerical measures based on a 5-point Likert-scale, where “1” indicated “1%-20%” and “5” indicated “81%-100%”. In addition the independent variable illustrated the fee ratio percentage for non-audit services in comparison to audit services. The answers regarding fee ratio percentage within the questionnaire were organized
as “a” to “f”, where “a” indicated “1%-20%” and “f” indicated “higher than 100%”. Again, these survey answers were transformed into numerical measures based on a 6-point Likert scale, where “1” indicated “1%-20%” and “6” indicated “higher than 100%”. The questions corresponding to the independent variable were answered for each type of organization mentioned earlier in this study.
3.3.3 Independent (moderator) variable
Subsequently the independent variable “professionalism” consisted of 7 items that
represented the rules, standards and principles of the external auditor profession. These items are integrity, objectivity/altruism, professional competence and due care/excellence,
confidentiality/respect to others, professional behavior, accountability and duty. Contrary to the dependent variable and the independent variable “services” that were measured on an industrial level, the questions corresponding to the moderator variable were based on external auditor level. The answers corresponding to the items of the variable professionalism were organized as “a” to “e”, where “a” indicated “Strongly disagree” and “e” indicated “Strongly agree”. These survey answers were transformed into numerical measures based on a 5-point Likert-scale, where “1” indicated “Strongly disagree” and “5” indicated “Strongly agree”. This study used statements of Dart (2011) which investigated how investors perceived the external auditors independence after a series of high-profile corporate collapses. A different and more appropriate style of presentation was used for these questions which were more suitable for the sample group of this study and also in order to encompass statements regarding auditor professionalism.
After answering the questions related to independent and dependent variables, the respondents were asked to fill a series of 3 demographical questions regarding their gender, highest obtained or currently attending education level and experience. After the
demographical questions, the respondents were instructed to provide their opinions about 6 statements regarding non-audit services organized as “a” to “e” and these were subsequently transformed into numerical values based on a 5-point Likert-scale, where “1” indicated “Strongly disagree” and “5” “Strongly agree”. The first 5 statements were taken out of Thorthon et al. (2003) study in which the author investigated whether stakeholders perceive that non-audit services impair auditor independence and whether (recent) high-profile accounting scandals would change their perceptions. The last statement was self constructed
in order to determine the respondents’ view of whether professionalism would help safeguard audit independence in the presence of non-audit services.
Furthermore, this study created industry (organizational type) dummy variables and these were set as control variables. Dummy variables were included within the regression model in order to investigate the effect of the independent variables on the dependent variables within the different type of organizations. These dummies variables were created based on the survey question related to whether the respondent (external auditor) had provided non-audit services to corresponding type of organization indicated in the survey. The respondents could answer either “yes” or “no” to indicate whether they (not) provide non-audit services to the corresponding organizational type. In other words this implicates that respondents that answered “yes” indicated that there were presence of non-audit services within the corresponding type of organization. The dummy variables were coded as “1” and respondents who have answered “no” meaning that there were no presences of non-audit services within the corresponding type of organization were coded as “0”.
4. Findings
This section provides an overview of the research questions and examines the results of the analysis performed in the completion of this study. First of all, the main focus of this study was to investigate whether there is a relationship between non-audit services and audit independence. Therefore a multiple regression test was performed in order to examine the relationship of the variables. Secondly this study investigated whether professionalism has any influence on the relationship between non-audit services and perception of audit
independence. Again, a multiple regression analysis was performed in order to investigate the influence of professionalism on the dependent and independent variables. These concepts were measured based on the multiple items within the survey questions. A decision was made to transform the survey data into standardize values (i.e. z scores) in order to produce proper regression analysis data. After transforming these data into standardize values (i.e. z scores), an average value was calculated per concept, in order to produce a singular variable per concept.
Furthermore the previously mentioned dummy variables were included within the regression model for investigating the effect of the independent variables on the dependent variables within the different type of organizations. Hence, a multiple regression analysis allows a more sophisticated exploration of the interrelationship among a set of variables. These all makes multiple regression analysis ideal in order to answer the research questions of this study.
4.1 Descriptive statistics analysis
First of all the descriptive statistics analysis were used to summarize the survey results, and the tables of the descriptive statistics can be found in the appendix section B. The survey results show that 44.0% of the respondents were male and 56.0% of the respondents were female. Furthermore 36.0% had 1-5 years experience in accounting, 48.0% had 6-10 years of experience, 12.0% had 11-15 years experience and the remaining 4.0% had more than 15 years of experience. It can therefore be clearly construed that the majority of the respondents had a high educational degree and a considerable experience in accounting. In addition it is also clear that accountancy outsourcing, legal services and tax compliance and planning are the most provided non-audit services according to the result of my survey. Additional descriptive table including statistically function ofeach survey questions can be found in appendix section B.
The respondents were instructed to provide their opinions about 6 statements
regarding non-audit services and audit independence. The result indicates that almost 50% of the respondents were in favor for abandoning the "independence in appearance” test. This could be explain due the subjective character of the independence in appearance test, which means that it refers to the perception of a third party. On the contrary 40% of the respondents did not believe that non-audit service hinder audit independence, whilst 60% believe that non-audit services help auditors to better understand their client and above 40% of the respondents believes non-audit services help auditors perform better audit work and helps auditors make “better” recommendations that improve their clients’ operational. In addition, the respondents 47% of the respondents indicate that professionalism will help to safeguard audit independence in the presence of non-audit service, whilst 30% disagree and the remaining 24% were undecided. These results show that the majority of the respondents (external auditors), disagree that non-audit services does influence the audit independence, and agree that such type of services might positively affect the audit work (see appendix section B, table 5).
4.2 Reliability analysis
Subsequently to the data analysis, a reliability analysis was carried out on the items that correspond to the dependent and independent variables that were utilized in the questionnaire of this study. This was done in order to assess the internal consistency of the items
corresponding to the dependent and independent variables. The independent variable “services” was subjected to a Reliability analysis which resulted in Cronbach Alpha coefficient scores ranging from 0.871corresponding to organizations with limited flow of goods to 0.912 corresponding to trade organizations (see appendix section B, table 7) which is considerably higher than the threshold value of 0.7 (Nunnaly, 1978). Cronbach’s Alpha coefficient examines the internal consistency of scaled items by examining the average inter-item correlation (Le et al., 2008). This meant that 87.1% of the variance in the test scores can be attributed to true score variance, which indicated a high reliability for the test results.
The remaining additional independent variables (integrity, objectivity, professional competence and due care/excellence, confidentiality and respect to others, professional behavior, accountability and duty) were also subjected to a reliability analysis and these revealed Cronbach Alpha coefficient scores of 0.605 (see appendix section B, table 8). This Cronbach alpha coefficient of α=0.605 is lower than threshold value of 0.7 Nunnaly (1978)
however it is considered to be an acceptable reliability coefficient. In addition the low Cronbach alpha can be explained due the size of the sample used in this study.
As follows the dependent variable “Perception of audit independence” was also subjected to a Reliability analysis which resulted inCronbach alpha coefficient scores ranging from 0.942 corresponding to trade organizations to 0.987 corresponding to Governmental and other not-for-profit organizations (see appendix B, table 9).
4.3 Relation between non-audit services and perception of audit independence
First of all a multiple regression analysis was conducted with a degree of 95% confidence level to examine the relationship between the test (control) conditions “non-audit services” and the dependent variable “perception of audit independence”, using industry
(organizational type) dummy variables as control variables. Subsequently, a multiple regression analysis showed that non-audit services explained 84.2% of the variances, F(7,92)= 70.088, p <0.01. This means that the importance of non-audit services and the fee ratio (in percentages) for non-audit services in comparison to audit services collectively account for a statistically significant proportion of the variances explained.
In order to examine the relationship between non-audit services and perception of audit independence, this study obtained unstandardized regression weights of all variables. The unstandardized regression weights give the (beta) weights corresponding to each
independent variable to the dependent variable. Table 5 provides the regression beta weights for the independent variable, along with the control variables of this study.
Table 5: Regression results
Summary of multiple regression for perception of audit independence (N=100)
Model 1
Independent variable unstandardized beta
Non-audit services -0.350**
Control variables (organizational type)
Trade organizations 5.967**
Production organizations 5.213**
Service organizations with limited 5.254** flow of goods
Service organizations that put space 5.352** and electronic capacity at customer disposal
Service organizations that put knowledge 6.339** and skill at customer disposal
Governmental and other not-for-profit 2.912** organizations
R-squared 0.842
F- statistics 70.088**
**p<0.01
As can be seen in table 5, non-audit services was statistically significant recording a negative unstandardized beta weight to the perception of audit independence,. This indicates that external auditor with higher scores on these scales were expected to have lower effect on the perception of audit independence. However this relationship is positively affected by the presence of an organizational type by a maximum of 6.339 for Service organizations that put knowledge and space at customer disposal and a minimum of 2.912 for Governmental and other not-for-profit organizations. This means that the perception of audit independence is positively influenced by the type of organizations considered in this study. This influence is depicted by the indicated amount of the unstandardized beta weight corresponding to the organizational type (table 5). In addition this implicates that if there was no presence of a type of organization, the perception of audit independence will increase by zero (i.e. neither increase nor decrease). The significant values of the independent and control variables are shown in the appendix (see table 10).
4.4 Professionalism effect on non-audit services and perception of audit independence
After determined the relation between non-audit services and perception of audit independence a multiple regression analysis at a degree of 95% confidence level was performed in order to determine the interaction between the independent variables and the dependent variable (perception of independence) per type organization. The presence of a significant interaction illustrate that the effect of one independent variable on the dependent variable is different at different values of the other independent variable. In line with this study, this means that if there is a statistically significant interaction between the variables, the effect on non-audit services on the perception of audit independent will be different at any other levels of professionalism.
First of all a new variable was created for all type of organizations by multiplying the standardized (i.e. z-score) values of non-audit services and professionalism with each other. This new variable was created in order to test the interaction between the independent variables within the regression analysis. Subsequently a multiple regression was run including the dependent variable “perception of audit independence” and the independent
variable “non-audit service”, the moderator (independent) variable “professionalism” and a
multiplied value of the two independent variables “professionalism and non-audit services. Again industry (organizational type) dummy variables were used as control variables within the multiple regression model in order to investigate the effect of the independent variables on the dependent variables within the different type of organizations.
A multiple regression analysis was conducted and showed that 85.1% of the total variance was explained by the model F(9,90)=56.913, p< 0.01. The independent variable “non-audit services” and the control variables remains significant. Which means that these variables have a relationship with the dependent variable “perception of audit independence”. However there was no statistically significant interaction effect between non-audit services and professionalism, p=0.597. Although the interaction effect between non-audit services and perception of audit independence was not statistically significant, professionalism did have a positive main effect on the perception of audit independence (p<0.05). This means that professionalism did not have a statistically significant affect on the relationship between “non-audit service” and “perception of audit independence” but on the “perception of audit independence”. Table 6 illustrates the coefficient beta weights.
Table 6: Regression results
Summary of multiple regression for perception of audit independence (N=100)
Model 2 Independent variable unstandardized beta
Non-audit services -0.347**
Professionalism 0.115*
Non-audit x Professionalism -0.006 Control variables (organizational type)
Trade organizations 6.036**
Production organizations 5.122**
Service organizations with limited 5.158** flow of goods
Service organizations that put space 5.426** and electronic capacity at customer disposal
Service organizations that put knowledge 6.279** and skill at customer disposal
Governmental and other not-for-profit 2.803** organizations
R-squared 0.851
F- statistics 56.913**
Furthermore it can be seen that all coefficients beta weights of the independent and industry (organizational type) dummy variables (with the exception of Trade organizations and Service organizations that put space and electronic at customer disposal) has slightly decreased which means that these variables were negatively affected by the moderator variable “professionalism”. Moreover the significant values of the independent and control variables are shown in the appendix (see table 10).
4.5 Conclusions
The purpose of this study was to discover whether there is a relationship between the test (control) condition “non-audit services” and the dependent variable “perception of audit independence” per type of organizations. Therefore a multiple regression was run using standardized values (i.e. z scores) of the items “importance of the non-audit services provided” and “ratio of non-audit fee to audit fee” along with “independence of mind” and “independence in appearance”. Furthermore this study primarily treated external auditor’s perception of audit independence as a ‘mental conceptualization’ on non-audit services with regard to audit independence, and industry (organizational type) dummy variables were used as control variables. The findings revealed that non-audit services have a main effect over perception of audit independence. Therefore it can be concluded that non-audit service has a relationship with the perception of audit independence within Trade organizations,
Production organizations, Service organizations with limited flow of goods, Service organizations that put space and electronic capacity at customer disposal, Service
organizations that put knowledge and skill at customer disposal and Governmental and other not-for-profit organizations. Furthermore the relation between non-audit services and
perception of audit independence is apparent within the multiple regression analysis. Non-audit services showed a negative effect upon the relation between non-Non-audit services and perception of audit independence. However all type of organizations showed a positive and significant unstandardized beta weight. This illustrates that the previous negative effect is positively affected by the presence of one or more type of organizations.
As previously mentioned all the beta’s that corresponded to the different industry types were positive, which means that there is a positive relationship between the variables non-audit services and perception of audit independence in all type of organization. A higher beta weight indicates a stronger relationship between the variables. As a result, these findings
demonstrate that a low importance of non-audit services provided and low fee ratio (in percentages) for non-audit services in comparison to the audit services comes along with a high level of audit independence. However this effect was shown to be positively affected by the type of organization that the non-audit service was provided to. This also implicates that a high importance of and a high fee ratio (in percentage) for non-audit services can probably lower the auditor’s perception of audit independence, although this is also positively affected by the type of organization that the non-audit service was provided in. Finally these results are consistent with the expectation of this study that non-audit services has a positive effect on the perception of audit independence
Furthermore it was predicted that the presence of professionalism within external auditors will increase the relationship between non-audit services and perception of audit independence. The results revealed that professionalism did have no statistical significant combine effect on the relationship between non-audit services and perception of audit independence. Contrary to that results professionalism showed a statistical significant main effect for professionalism on perception of audit independence, however there was no statistical significant interaction between non-audit services and the perception of audit independence. These results imply that the presence of professionalism thus complying with the rules, standards and principles of the external auditor profession does influence on the perception of audit independence. This influence is positively affected by the type of
organization that the non-audit service was provided in. The effect is observable through the positive unstandardized beta weight value, which correspond to a positive effect of the variables. However there are no combine effects between non-audit services and
professionalism, which means that there is no interaction between the variables. This result is not consistent with the expectation of this study. As a result this study concludes that
professionalism does not strengthen the relation between non-audit services and perception of audit independence, although it has a direct effect on the relationship with perception of audit independence.
