Conclusion

This chapter presents the motivations behind the current study. The chapter begins with an analysis of the concepts of auditor independence, in fact, and in appearance, and their significance in ensuring the credibility of the auditing profession. It is acknowledged that for the sheer survival of the profession, it is not only important that the auditors are independent in their minds while conducting an audit, but they must also make efforts to appear independent in the minds of the public. The chapter identifies that the auditing profession has some inherent characteristics that makes it appear non-independent, the joint provision of audit and NAS and longer auditor association with same clients being two of such traits. The fact that the auditors are economically dependent on their clients may create serious perception problem for auditor independence.

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Having established the importance of auditor independence, the chapter then moves on to identify specific threats to independence in mind and in appearance that might arise from provision of NAS and longer audit firm tenure. It has identified that the joint provision of audit and NAS gives rise to a number of self-interest, self-review, management, advocacy, and familiarity threats that may create serious problems for auditor independence. However, it is acknowledged that despite the presence of such threats, clients still continue to purchase significant amounts of NAS from incumbent auditors.

In pursuit of finding answer for the above anomaly, the chapter then presents a number of possible explanations for such preference. It is found that prior literature provides two major explanations for the joint provision of audit and NAS and longer auditor tenure. First, it is argued that joint provision and long association with clients create an economic dependence between the auditor and the client. For the auditors, such joint provision leads to knowledge spill-over, which eventually provides them with higher profits. The clients also achieve economic benefits from engaging their auditors as suppliers of NAS rather than outsourcing such services from other suppliers at a higher price and by avoiding the tendering of audit contract to another provider more frequently. Therefore, both the auditors and the clients have incentives to maintain this relationship. Second, it is also argued that awarding the NAS contract to the incumbent auditors may be used by the clients as a tool for controlling the behaviour of the auditors.

Having established the rationale for joint supply of audit and NAS and longer association with clients, the chapter then moves on to provide a brief review of prior literature addressing the issue of such joint provision and longer association and their potential effects on auditor independence. Approaches taken in prior research in this area include formulation of analytical models of relationship between audit fees and NAS fees; models for determinants of NAS fees; and studies investigating in fact auditor independence and FRQ. It is found that though prior research is inconclusive regarding the effect of joint provision of audit and NAS on independence in fact, the perceptions of auditor independence have always been found to have negatively

affected by such relationship. This is consistent with Mautz and Sharaf‟s (1961)

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doubts in the minds of the users regarding the credibility of the audited financial statements, and the auditing profession.

The review of literature suggests that the joint provision of audit and NAS and long association of auditors with the same clients were already a very well researched area. The accounting scandals in the early 2000s‟ and the recent financial crisis of 2007-09 and their subsequent effects on perceptions of auditor independence, discussed in the later sections of the chapter, set the context for this study. The fact that the companies involved in the accounting scandals were purchasing high amount of NAS from their incumbent auditors, that the financial services companies were in serious trouble even after getting clean bill of health from their auditors, and that the audit process failed to highlight developing problems in the banking sector which led to the doubt about the current audit process to be deficient, raised serious concerns regarding auditor independence. This concern was reflected in the share prices of companies purchasing above average NAS (Eduardo and Zhang 2011) and heavy-handed bailout plans for the banking sector by UK and other Western governments. Also, the audit firms expected significant spill-over effects of the scandals (Krishnamurty et al. 2006).

The final sections the chapter provide a review of the regulations restricting purchase of NAS from incumbent auditors and their long association with the clients in the UK and discuss the contexts at which specific regulations were produced. The review indicates that a number of international developments, such as, the accounting scandals, and subsequent regulatory developments in the USA and the EC, led to introduction of changes in the UK regulatory environment for joint provision of audit and NAS and long audit firm tenure. In addition to reviewing the current legal environment for joint provision of audit and NAS and auditor rotation requirements, these sections have also presented evidence regarding the process of development of regulations for these two

major issues in the UK auditing arena. Using Whittington‟s (1993) classification of

different stages of financial reporting regulation, three stages of development of NAS and long auditor tenure regulations have been identified. The chronology of regulatory initiatives presented in Table 2.3 above indicates that, consistent with other regulations in auditing and financial reporting, regulations regarding purchase of NAS and long association of auditors also tended to switch from voluntary self-regulations to mandatory private regulations or public sector interventions primarily due to market reaction after the accounting scandals of early 21st century, the recent banking crisis and

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the apparent failure of self-regulations to protect broader public interest. Whereas in earlier years, the relationship between joint provision of audit and NAS was primarily addressed through a number of reports, and codes of best practice, the regulators eventually had to produce standards (such as APB 2004, 2010a), and amend the Companies Act (2006) to make disclosure of NAS fees in a number of different categories mandatory.

Prior to the accounting scandals, the environment for joint supply of audit and NAS was already characterised by economic dependence between the auditors and the clients, and a scepticism regarding such relationship in the minds of the users. The accounting scandals and banking crisis converted this scepticism into a concern. Regulatory and professional bodies in different parts of the world responded to such concerns by enacting a number of legislations, some of which specifically addressed the joint provision of audit and NAS and long audit firm tenure. The accounting scandals, recent financial crisis and the consequent regulatory environment, therefore, provides a new window of opportunity to study the impact of those regulatory initiatives on the auditor independence reflected in the FRQ of UK companies. This sets the context for this study. The first chapter introduces the research while this chapter provides an analysis of how NAS and auditor tenure related regulations evolved with a review of related literature to set the context for the study. The next chapter will now discuss the hypotheses to be tested while chapter 4 discusses the methodology and research design for the empirical analyses to be carried out in chapter 5.

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