Corporate Governance And Auditing Accounting Essay


Audit fees and corporate governance are relations and many researchers provide this issue in their research. The study is explaining the relation between corporate governance and audit fees paid by companies for auditing. Simunic (1980) was started the determinant audit fees and published his study on the US audit service market. The studies also carried out to examine the relationship between the audit fees and corporate governance in developed economies (O'Sullivan and Diacon, 1994; Peel and Clatworthy, 2006; Yatim at al.,2006). Good corporate governance will reduce the auditor risk assessment and results with lower audit fees (Yatim at al,2006). Auditor will assume that their service reflects benefits of better governance especially auditing. The study is particular view to researchers because the ease to get the information of audit fees and corporate governance issues which disclose in companies' annual reports. The disclosure of information auditors' remuneration provides us the opportunity to provide additional evidence on the determinations of audit fees. From the literature review, the relations to audit fees amongst are the director remuneration, size of the companies, complexity and risk, board composition and size, the number of board meeting and audit committee meeting during the financial year and status of audit firm.

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The public accounting profession has been widely criticized during the past decade for failing to protect investor interests. While much of the audit profession performed admirably during this time period, the failures monumental: Enron, WolrdCom, and Global Crossing. The new legislation, the Sarbanes-Oxley Act of 2002, fundamentally changed the auditor-client relationship and moved the process of setting audit standards from the private sector to the public sector. However, the failures that occurred were not solely attributable to failures in the audit profession. They also represented the heart of organizations- failures of the corporate governance structure.

Corporate Governance and Auditing

The failures of the past decades represented failures across all parts of the corporate governance structure. They were just not audit failures or just management failures. Every part the system failed - at least to some extent in some organizations - from management, to auditors, board of directors, self-regulatory organizations such as AICPA and FASB, regulatory agencies such as the SEC, lending institutions, security analysts and stock exchanges. The researcher will look further on changes affecting the audit profession and understand how the audit profession fits into the overall corporate governance [1] structure.

The Malaysian Corporate Governance (MCG) Index 2009 has highlighted the need for corporate to boards to improve corporate governance practices in the organizations. [2] The domestic policy weaknesses, poor risk management and limited investment risk management technology are highlighted as a contribution to the economy falls (IMF, 1999; World Bank 1998). After the Asian Financial Crisis, 1997, the quality of corporate governance becomes a concerned to attract investors' confidence. In Malaysia, the main sources of corporate governance reform agenda are from the Malaysia Code on Corporate Government by Finance Committee on Corporate Governance, Capital Market Plan by Securities Commission and Financial Sector Master Plan by Bank Negara Malaysia on the financial sector. It serves the guideline on the best practice of corporate governance and provides the direction for the implementations. The role of external auditor is part of the reform activities that can facilitate good governance.

The audit activity serves as a monitoring device and thus is part of the corporate governance mechanism. According to N. O'Sullivan (1994), an integral part of the financial reporting process is a statutory audit which provides independent verification of corporate disclosures. He further cited that auditors are uniquely placed to assess the quality of corporate governance since the auditor's liability exposure suggests that its view of a company's governance quality is reflected in the price charged for the audit. Therefore, external audit has an important role in reviewing and contributing to the agency's control structure (Barrett, 2007) [3] . Malaysian Code on Corporate Governance (Revised 2007) stated that external auditor should independently report to the shareholders in accordance with the statutory and professional requirement and independently assure the board on the discharge of its responsibilities. It also regards auditor as the external force responsible for good corporate governance. On the other hand, the principles of corporate governance by Organization for Economic Co-operation and Development (OECD) define external auditor should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the audit conduct.

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The listing requirement of Bursa Malaysia issued in January, 2001, for example provides greater obligation of public listed companies to enhance Malaysia's corporate governance regime. It also outlines the requirement for financial reporting disclosure on corporate governance matters. Therefore, this study will provide the general ideas of corporate governance structure and explore whether the various best practices and recommendation on corporate governance have influenced external audit fees.

Problem Statement

In a recent year, the auditors' role in corporate governance has been widely discussed. The quality of corporate governance affected auditors' decision making whether to associate with particular client. Corporate governance is about how an organization is manage, its corporate and other structures, its cultures, its policies and the way it deals with various stakeholders (Barrett,1997)companies with stronger internal governance structures also seem to produce more reliable financial statement and resulting in reduction in the problem of auditors. The use of audit services is to provide confidence and credibility of the information receive (especially financial statement) by the user such as shareholders, bankers, creditors, government authorities, investors, financial analysts and public. User confidence in the financial statement can be described into independence in fact and independence in appearance. The auditors have to maintain an unbiased attitude in performing their work (independence in fact) and to be perceived by users as being independent (independence in appearance). Generally, the more independent auditor perceived by the public, the greater is the probability that user will have confidence in his works and opinions.

Meeting with the key stakeholders may help the auditor in understanding their concern and key compliance issues that will affect the conduct of the audit. Both auditors and client have to negotiate audit fees that are mutually agree by themselves before perform the audit work. Price negotiation is not an easy task because auditor often fined the fees inadequate to cover the cost incurred while client wish to pay as little as possible. The understanding process stimulated clients to make effort to minimize controllable risks and thereby reduce audit cost. It also helps auditors to apprehend their position and therefore be able to negotiate a fair compensation for services rendered. On the other hand, there are cases were audit fees are manipulated by top management to influence auditors' objective opinions and report (Sandra and Patrick, 1996). Since the audit fees are negotiated between auditor and the board of directors, it may arouse the publics' doubt on the independence of auditors. There may be a compromise between the management and auditor for the latter to report on the contrary to the fact in the return for higher audit fees.

This paper provides the audit fees structure which relates to the governance practices by listed companies. The recommendation and mandatory governance practices may influence the negotiation of external audit fees. Corporate size is one of the traditional determinants of audit fees and has been considered as the most significant and consistent explanatory variable across all previous studies (Jie Low, 2008). The total assets of the company which is shown in the balance sheet can be used as a measurement and indicator of the company wealth and size. It is part of the essential factors in determining the external audit fees. In general, auditor remuneration is based on time cost basis where auditors are paid based on the time they spent to do the field works. The auditor need to spend longer tome to verify huge transaction of large companies and therefore leads to higher audit fees.

In dealing with day-to-day operation, the business widely exposed to the risk which is natural part of the business activities. Audit risk is emphases as one of the fundamental concept in the process of audit and audit fees determination. For instance, auditors are engage with engagement risk that may lose their reputation, inability of the client to pay the audit fees, litigation and financial loss. In determining the corporate risk, external auditor need to have a better and sufficient understanding of the client business such as client's operating environment, regulation, management objectives, strategies and internal control. A corporation which is considered risky was expected to run the risk of audit failure. However, it is widely accepted that audit risk is difficult and subjective to measure directly and accurately. Therefore, different proxies have been used to measure the risk associated with the client such as acid test ratio, liquidity ratio, quick ratio, gearing ratio, loss sustained in the previous year, loss sustained in the current year and corporate age.

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Sizeable studies have attempted to identify the relationship between auditor size and audit fees. The study is to clarify whether there is a higher audit fee is charged by Big-4 audit firms compared with Non Big-4 audit firms. Auditor's report especially produced by the Big-4 audit firm [4] , plays as an effective mechanism in corporate governance because they have a dominant power in many audit markets. Their reputation influence the quality of the service provided. Therefore, large companies prefer to deal with the big international audit firm to ensure the public of audit quality minimize agency cost (Zulkarnain, 2008). However, there is no conclusive evidence to state the relationship between the status of the audit firm and the price of external auditors.

The complexity of the business (either financial or non-financial measure) may lead to ahiher audit fees. Many prior studies on audit pricing model have indicated that complexity variable has been used extensively (Cameran, 2005; Chan et al.; 1993; Clatworthy and Peel, 2006; Simunic, 1980; O'Keefe et al., 1994; Joshi & Al-Bastaki, 2000; Zulkarnain et. al., 2008). From the non-financial point of views, number of total subsidiaries and foreign subsidiaries, locations, and number of industries the business operates are often cited as the proxies of complexity.

The company is led by the board of directors who is elected by the shareholders and has a fiduciary duty obligation to protect shareholders interests. Coles et al., 2001 stated that the board has the duty to make sure that the top management is behaving in a way that will provide the optimal value for shareholder. In Malaysia, the laws governing the composition of board of directors are Companies Act 1965, the listing requirement of Bursa Malaysia (formerly known as Kuala Lumpur Stock Exchange) amended release January 2001 and the Malaysia Code on Corporate Governance (revised 2007). The code outlined that the effective board balance should made up of at least one third of independent non-executive directors. The term independent as prescribed by the listing requirement and the Malaysian Governance Code refers to independence from management and significant shareholders. The board should meet regularly and the numbers of meeting in a year together with director's attendance should be disclosed. The more diligent boards measured by the numbers of meeting in a year are likely to be negative associated with external audit fees.

The Malaysian Code on Corporate Governance also requires the Director's remuneration should be appreciable and should reflect the responsibility and commitment of the directors. The incentives of top management have been characterized as an important mechanism of corporate governance as it assures the alignment of the management and the shareholders interest. It also serves as a mechanism for resolving the conflict of interest among the managers and shareholders. Director remuneration is very much related to the agency theory which provides the suitable remuneration to the director as incentives to promote corporate objectives and ensure long term corporate performance. Where remuneration is based on performance, the external auditor is expected to undergo intensive testing of corporate account to verify performance measures and therefore the audit fees will be increased.

Research Objectives

The general purpose of this study is to explore and identify whether the various best practices and recommendations on corporate governance have influenced external audit fees in Malaysia listed companies in Bursa Malaysia for the financial year 2011. This study will be more descriptive to identify specific objective as follows:

To ascertain the relationship between external audit fees (dependent variable) and corporate governance structure (independent variable) among the companies listed on the main board of the Bursa Malaysia.

To understand the differences in audit pricing strategies of companies with different size, listing requirement and internal governance structure.

To provide some preliminary evidence that external audit fees is determined by the factor of corporate size, corporate risk, audit firm status, complexity of the firm, board diligence, director remuneration and board composition.

Significant of the Study

A sizeable number of studies have examined the relationship between audit price model and corporate governance characteristics in developed economies. The approach of the study will allows us to understand the differences in audit pricing strategies of Malaysian listed companies with the different corporate size and risk, complexity of the corporation, audit firm size, and internal governance variables (i.e. board size, number of board meeting and director's remuneration). The evidence provided from this study will contribute to guide other future research related to the study of audit price model. This will further extend the body of literature form different perspectives. Finally, the evidence presented in this study will assist the audit firm, listed companies and also private companies to negotiate audit fees that are mutually agree to them.

Organization of the Study

This study is divided into five chapters. Chapter one provides the research background, problem statement, research objectives and the significant of the study. Chapter two outlines the background to auditing and accounting in Malaysia, Malaysia business environment and Malaysian corporate governance environment. This chapter also presents the relevant literature review of prior researchers which highlights the issue of corporate governance structure and its relationship with the external audit fees. Chapter three discusses on the research methodology that is employed in obtaining the data from the sample of public listed companies and the statistical used to analyze the data. Chapter four reports the empirical result and discusses the finding of the study. Finally, chapter five provides the conclusions, limitations to the study and some suggestions for future research.


Since most of the previous studies only focus on the audit price model which was introduced by Simunic in 1980, this study will provide the relationship between the external audit fees and the variable that represent the governance structure in Malaysian public listed companies such as director's composition, director's remuneration, board composition, board diligence and other variable such as status of the audit firm, complexity of the corporation, corporate size and corporate risk.