Academic journal article Indian Journal of Economics and Business

Audit and Nonaudit Fees from Different Reporting Regimes and Perceived Audit Quality

Academic journal article Indian Journal of Economics and Business

Audit and Nonaudit Fees from Different Reporting Regimes and Perceived Audit Quality

Article excerpt

Abstract

Auditor independence in fact as well as in appearance has been one of the concerns of the Securities and Exchange Commission. The debate on perceived audit quality is concentrated on short reporting periods. In this paper we study the issue of auditor independence by analyzing how investors and financial analysts perceive audit quality in the presence of auditor provided nonaudit services under different reporting regimes. We analyze the issue by focusing on three distinct disclosure periods. The first period of our analysis covers the relatively noncontroversial accounting disclosures made between 1978 and 1980. The second period of our analysis includes accounting scandals and perceived audit failures over February 2001 and July 2002. Our third period of analysis includes restrictions on provisions of certain nonaudit services and other audit related radical reforms with the enactment of the Sarbanes-Oxley Act in July 2002.

I. INTRODUCTION

The Securities and Exchange Commission (SEC) has been concerned about auditor provided nonaudit services and its impact on auditor independence for last four. decades. SEC's concern pertains to auditor's independence in fact as well as in appearance (Levitt 2000). The debate on perceived audit quality has focused on how auditor provided nonaudit services are viewed by financial information users affecting their perception of auditor independence and objectivity. Concentrating on short reporting periods, several recent studies have provided insights into this debate. Data used from short disclosure periods do not address an important issue of whether perception of audit quality with auditor provided nonaudit services remains unchanged across different disclosure periods. In this study, we focus on how investors and financial analysts perceive audit quality in the presence of auditor provided nonaudit services under different reporting regimes.

Under ASR No. 250, the SEC required registrants to disclose information about nonaudit fees in relation to audit fees. The disclosure requirement was rescinded with ASR No. 304. This resulted in disclosure of the ratio of nonaudit to audit fees for 1978-1980, which was a period without any controversial accounting issues. Subsequently, in November 2000, the SEC issued Final Rule S7-13-00, which mandated disclosure of nonaudit and audit fees paid to auditors in proxy statements filed after February 5, 2001. This period involved accounting scandals and perceived audit failure resulting in criticism of accounting profession and independence of auditors. Following these controversies, the Sarbanes-Oxley Act of 2002 (SOX) was enacted to impose restrictions on provisions of certain nonaudit services along with other audit related radical reforms. On February 6, 2003 the SEC issued Final Rule S7-49-02, requiring companies listed on U.S. exchanges to disclose audit fees, audit-related fees, tax fees and all other fees for each of the two most recent fiscal years. Given the history of required nonaudit fees disclosures, we identify three distinct periods for our analysis: (i) non-controversial period of 1978-80 under ASR No. 250, (ii) controversial period which extends from pre-SOX time period of February 2001 through July 2002, and (iii) SOX period after enactment of SOX in July 2002.

In requiring these disclosures in different time periods, the SEC's focus has been to provide information to users of financial statements and disclosures to assess impartiality and objectivity of auditors. Under varying time periods and circumstances, the SEC emphasized independence in appearance to justify the mandated disclosure of nonaudit and audit fees to enable the users of financial information to conclude if auditor is exercising objectivity and independence. In forming their assessment about auditor independence and audit quality, users of financial information judge the benefits and sacrifices of joint provision of audit and nonaudit services. …

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