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This chapter will discuss the previous literature review on quality control, quality service, satisfaction level and level of non-audit fees being charged. It will overview the relationship between quality control, quality service, satisfaction level and level of non-audit fees, theoretical framework and development of hypothesis.
Services offered by Audit Firms
Basically, audit firm provides assurance services to organization (Messier, 2000) The purpose of this assurance service is to tackle the asymmetry information that occurred in principal-agent relationship. By this assurance service, the report that made by agent can be reliable and trusted for principal.
However, Audit firm can also provide non-audit services. Messier (2000) addresses three non assurance service categories that can be also provided by Audit Firm, which are: Tax Service, Management Advisory Services, and Accounting and Review Services. The detail will be described in the section
2.1.1 Audit Service
Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria (Arens,Elder & Beasley, 2003). Financial statement audit is the determination by the auditors whether the financial statements of a company shows a true and fair view.
Messier (2000) states that there are 4 types of audit services, which are:
Financial Audit Services. It determines whether the financial statement present fairly in accordance to the Generally Accepted Accounting Principle
Compliance Audit. It determines the extent to which rules, policies, laws, covenants, or governmental regulations are followed by the entity being audited.
Operational Audit. It involves a systematic review of an organization activities in regards of efficiency and effectiveness
Forensic Audit. It investigates the detection or deterrence of a wide of fraudulent activities such as: Business Fraud, Employee Fraud, Criminal Investigation, Shareholder disputes, Business Economic Losses, and Matrimonial Disputes.
The output and outcome of an audit is an auditor opinion on the work under investigation. For financial statement audit, it would be whether they will issue a qualified or an unqualified opinion. Audit Services consist of financial, operational, and information technology audits in accordance with approved plans and its established policies and procedures. Further, Audit Service complies with the Code of Ethics and the Standards for the Professional Practice of Internal Auditing. It is promulgated by The Institute of Internal Auditors, as well as other professional auditing standards which may be applicable to the performance of work assignments.
In conducting assurance service such as auditing, the audit firm has to follow the regulation body such as Institute of Certified Public Accounting (ICPA) (Arens,Elder & Beasley, 2003). This ICPA has several rules and standards that must be followed by audit firm. Messier (2000) categorizes the rule and standards as:
Bylaw. It establishes the rules and regulation that govern the activities of ICPA such as admission, retention, and termination of membership.
Code of Professional Conduct. It establishes the guide for all audit firms in the performance of their professional responsibilities. It consists of Principle Code and Rules of Conduct.
Statements on Auditing Standards. It is established by the Board of Auditing Standard for establishing generally accepted auditing standards and issuing the pronouncements on auditing matters.
Statements on Standards for Accounting and Review Services. It is established by the Accounting and Review Services Committee for establishing the conduct of compilation and reviews.
Standards for Performing and Reporting on Peer Reviews. ICPA issues Statements on Standards for Attestation Engagement. This statement covers the examining financial forecast, internal control reporting, and other attestation. The purpose is to ensure the reliability of the attestation service that deliver by audit firm.
Statements on Standards for Consulting Services. ICPA in every country usually establishes one body called Management Advisory Service Executive Committee. The purpose is to monitor the consultation activities that delivered by audit firm. The name of the standard is Statements on Standards for Consulting Services.
Statements on Responsibilities in Tax Services. ICPA also establishes the Statements on Responsibilities in Tax Practice. It emphasizes on the audit firm responsibilities when involved with tax engagement.
Statements on Quality Control Standards. It is a rule of conduct that made to maintain the quality control of audit firm. It is established to ensure that a firm's practice meets the professional standards.
As this research wants to investigate the Quality Control, this research emphasizes on the quality control. The details of this issue will be described in other section.
2.1.2 Non-Audit Services
Non-audit services generally refer to the services above and beyond the related audit services or services other than traditional CPA work. Some scholar in their studies use different terms for the same relevant issues namely, "Management Advisory Service" (MAS) and "Management Consulting Service" (MCS). Schemer and Kiger, 1982; Pany and Reckers, 1983 suggested there is no particular restriction for the scope or classification on non-audit services but diverse classification methods have been employed by the researchers. Non-audit service is defined as service rendered by the accounting firm that do not result in the expression of an opinion, negative assurance, a summary of findings or other form of assurance (Gill & Cosserat, 1996). The types of non-assurance services rendered are taxation, secretarial practice, consultation and internal audit review. Purcell and Lifison (2003) described non-assurance services as traditional job for accountant (including assurance, investment assurance, commerce registration and accounting affairs, and so on.) Taxation involves among others to assist clients to prepare the tax returns and to assist them in planning their tax. Secretarial is to assist clients to prepare the submission of documents to the Companies Commission and consultation involves giving their views on whether a certain exercise by the client would be detrimental to the company and also offering various alternatives of how a problem can be solved.
Messier (2000) categorized the non-audit services into three types, which are:
Tax Services. Audit firm deliver service of preparing and filing tax returns, providing advice on tax and estate planning, providing representation on tax issue.
Management Advisory Services. It covers the consulting activities that may involve providing advice and assistance concerning an entity's organization, personnel, finance, operations, systems, or other activities.
Accounting and Review Services. Audit firm provides a number of accounting services such as book keeping, payroll processing, and preparing the financial statement.
The audit services and non-audit services provided by audit firms to its clients are required to be separated. Johnson and Nelson (2002), found in their studies, non-audit services were used as tolls to increased audit firm's income. Arrunada (1999) states that providing the non-audit service is a bonus for the firms because not much work had to be done because they are already familiarized with the client's accounts. The provision of non-audit services by auditors to their audit clients has been regarded by the regulators in the UK, the US, Australia and various countries as a threat to auditor independence. In 2000, The Investor Responsibility Research Center (IRRC) reported that Enron paid $25 million to Anderson for consulting services and $27 million for audit-related services. It show clearly that the fees paid for non-audit services are significant and comparable to the fees paid for auditing services and thus give rise to the possibility of conflict of interest.
According to Sarbanes-Oxley Act Title II, Section 201 Point G and H, a registered public accounting firm may engage in any non-audit service, including tax services, that is not described in any of paragraphs (1) through (9) of subsection (g) for an audit client, only if the activity is approved in advance by the audit committee of the issuer, in accordance with subsection (i).It means that an audit firm can give audit service and non-audit service as long the audit committee approve it on the audit engagement. The Non audit services that can be provided are:
(1) bookkeeping or other services related to the accounting records or financial statements of the audit client;
(2) financial information systems design and implementation;H.R.3763-28
(3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports;
(4) actuarial services;
(5) internal audit outsourcing services;
(6) management functions or human resources;
(7) broker or dealer, investment adviser, or investment banking services;
(8) legal services and expert services unrelated to the audit; and
(9) any other service that the Board determines, by regulation.
Hay, Knechel, and Wong (2006) found the audit fee has been shown to depend on auditee size, on various measures of auditee risk and complexity and other characteristics, on auditor attributes, and on characteristics of the audit engagement.
Review of the Literature Review
This section review the literature of quality theory, quality control, Level of Fee, the relationship between non-audit service and level of fee, the relationship between quality control and level of fee, and the relationship between quality service and level of fee. This literature is important as it will be used to analysis the results.
De Angelo (1981) introduced the quality theory model as shown in figure 1, where the control on the audit firm is divided into four factors: one controlling on the firm factors such as human resource, control process, and industry experience. The second factor refer to controlling on audit team factors such as supervision, planning, and performance the service, client experience and professionalism.
Furthermore, studies by De Angelo, 1981 and Palmrose, 1988 suggested that detecting the material misstatements is influenced by how well the quality control system on the audit firm influence the audit team in performing their services
Simunic (1984) developed a model in which audit fees are cross-subsidised by non-audit work: competitive pressures in the audit market might then compel auditors to discount their audit fees, so that higher non-audit profits would be associated with lower audit fees. He suggested that as an outcome to high service quality, auditor able to charge higher fees.
Several studies have several definitions of service quality. Lewis and Booms (1983) as cited by Bungsu (2004) defined service quality as a measure of how well the service level delivered matches customer expectations. Delivering quality service means conforming to customers' expectations on a consistent basis. However, Parasuraman, Zeithaml & Berry (1985) argue that most researchers and managers of service firms agree that service quality involves a comparison of expectations with performance.
Gronroos (1984) as cited by Bungsu (2004) proposed that there are two types of service quality, technical and functional quality. Technical quality involves what the customer is actually receiving from the service. The customer can often measure the service outcome in an objective manner. Functional quality is the manner in which the service is delivered which refers to the interaction between service provider and recipient of a service. The conceptual model of service quality developed by Gronroos is the first one which the purpose is to increase understanding of customers' service quality perceptions and the factors that influence those perceptions.
Parasuraman et al (1985) developed another model for service quality known as SERVQUAL. This model provides a technology for measuring and managing service quality which attempts to prove the salient activities of the service organization that influence the perception of quality.
Ziethaml, Parasuraman, and Berry (1990a) has defined service quality as a multidimensional concept and they identified there are five key dimensions of service quality. The first concept is reliability. Reliability is defined as the ability to deliver the promised service dependably and accurately. It is a situation where keeping promises of delivery, price and complaint handling. Secondly is responsiveness which described as willingness to help customers and provide prompt service. It measures stresses service personnel's attitude to be attentive to customer requests questions and complaints. Thirdly, assurance is the service quality dimension that focuses on the ability to inspire trust and confidence. Fourthly, empathy is the service aspect that stresses the treatment of customers as individuals. Lastly, tangibles are the service dimension that focuses on the elements that represent the service physically.
Studies by Haron, Ismail, Ibrahim and Isa 2006 using the SERVQUAL model in auditing sector found that public listed companies in Malaysia were only satisfied with tangible dimensions and customer loyalty partially mediates the relationship between reliability dimensions and customer satisfaction. Bungsu (2004) states that there was a positive relationships between customer loyalty and service quality but she found that SMEs were not satisfied with all the SERVQUAL dimensions especially on reliability dimensions. Che Din (2008) used partial SERVQUAL model to examine the relationship between SMEs perceptions on service quality and level of fees.
Level of the fees
Wynne (2008) defines level of fees as an average price at which product of service being charged. In modern economic, level of fees were defined as an exercise to setup a specific standard in terms of weight of the work given, distance and value the work carried (Hall, 2002). Malaysian Institute of Accountant (MIA) By-law B1-6 has defined the level of audit fees as any amount of fees charged to client as long as it does not jeopardized auditor's professionalism (By-Law, pp 30-39).The level of fees in this study is defined as customer satisfaction on the service received from their auditor.
B-6.1 Professional fees charged by members in public practice shall be a fair reflection of the value of the work performed for the client, and shall take into account inter alia -
(a) the skill and knowledge required for the type of work involved;
(b) the level of training and experience of the persons necessarily engaged on the work;
(c) the time necessarily occupied by each person engaged on the work; and
(d) the degree of responsibility and urgency that the work entails
B-6.2 (1) No member shall charge an unrealistically low professional fee.
Fees were charged at different level based on the size of the client's company (Palmrose, 1986), companies' business sector (Besacier & Schatt, 2007) and type of risk to be handle (Simunic, 1980). In Malaysian audit market, MIA By-Law has stated a benchmark of fees to be charged as a guideline auditor on the level of audit fees to be charged. However there is no specific guideline given for non-audit service. As a conclusion, we know that measuring the right level of fees to be charged is very subjective especially in non-audit service where there is no specific guideline to be followed. Based on the previous research done by Ismail, Haron, Ibrahim and Mohd. Isa (2006) on public listed companies in Malaysia found that 98% of the respondents feel that paying high taxation fees is reasonable with the current service provided to them.
Non-audit service and Audit Fee
Simunic (1984) as cited by Chien, Chen (2005) states that the effect of the provision of non-audit by accounting firms on audit fee is determined by "demand elastic that the client requests to audit service. In addition, Abdel-khalik (1990) found in his study that audit fee and non-audit fee are positively related. Furthermore, Barkess & Simnett (1994), and Firth (1997a) show a significant correlation between audit fee and non-audit services fee.
2.2.6 Quality Control and Services Quality
Many studies have proven that the success of quality control was driven by high service quality (DeAngelo, 1981; Ridley, 1994; Bij & Ekert, 1999). Low control on production process or service will cause low service quality which means the detection of misstatement or product defect increased (Lian, 2001). Lian (2001) again in his report stated that the success of service quality and its impact is largely within the control of leadership. According to Ridley (1994) quality control and quality service interact with each other. The success of quality control on product or service in the market was driven by the high quality of service.
According to above literature, quality control can deliver goo services quality as it ensures the services provided to be added value. Hence, the quality control has effects on service quality.
Quality service and level of the fees
Zeithaml and Bitner, (2000) defined that satisfied customer would remain loyal, required service more often, fewer price sensitive and shall talk favorable things about the company. Moreover, De Angelo (1981) and Palmrose (1986) have stated that client willingness to pay high amount of fees in order to receive a high quality of service.
Quality Service and Satisfaction
Service quality is produced at the same time as the service supply and consumption. Bolton and Drew (1991), and Boulding et al (1993), and Sohail (2003) stated that service quality has a significant relationship to customer satisfaction. Formell et al,(1996) states the satisfaction of customer is depended to the way of customer valued the quality delivery. De Angelo (1981) and Palmrose (1986) have stated that client willingness to pay high amount of fees in order to receive a high quality of service.
In other contexts, by using SERVQUAL model, Sewell (1997) found that patients emphasize greater importance on reliability dimension. Angelopoulou et al (1998) found that quality perception in services has significant influence on customer satisfaction. It is confirmed by Manaf (2006) who concluded service quality perception has effect on customer satisfaction.
In accounting context, Behn et al (1997) investigated the relationship between audit service quality and client satisfaction. They found that responsiveness, effectiveness, on-going interaction and the appropriate conduct of audit field influence the clients' satisfaction significantly. This confirmed by Gao (2003) who found that audit service quality has positive and significant relationship to clients' satisfaction.
Satisfaction and Level of Fee
The issue of relationship between satisfaction and level of fee extensively investigated in service marketing field. Kotler and Keller (2006) also found that if client is satisfied with the service received, they would not mind to pay at any price for the services.
For instance, Anthanassopoulos (1999) found the direct link between satisfaction and level of price/fee. It is confirmed by several studies such as Fornell et al (1996), Hallowell (1996), and Ennew and Binks (1999). It clearly describes how satisfaction level has significant association with the level of fee.
In exploring the opportunity to enhance the support provided by the SMPs to the SMEs, it is important to understand the business needs of the SMEs and identify areas where accountants in public practice could focus on in addition to the areas currently serviced. At the same time, the barriers preventing the SMPs in meeting the needs of the SMEs need to be understood.
One of the barriers could be the lack of quality in delivery services. Although SMPs could value can and audit bring to SMEs. This is because SMEs' internal control systems are usually not that strong, and they are often led persons who lack in management and technical skills. Internal controls of the SMEs are not as extensive as those of large companies, where auditors cannot rely on the system to make their audits more efficient. The lack of formal internal control systems and the application of universal auditing standards have given rise to the use of a special "small company audit qualification " in the UK (Keasey et al., 1988)
In addition to that, SMEs lack in resources. In Malaysia, although there is no decision made to date, nevertheless there is an inclination to give an "audit exemption" to SME. What it means is that SMEs should not be subjected to compulsory audit as there are too many weaknesses in opinion there is a probability that he will no long be appointed as an auditor for next year. In summary, audit of SME would be most likely to impair auditor's independence. For that matter even if the auditor was to give a qualified opinion, SMEs would not be able to rectify the matter due to lack of resources.
An interview with several small practitioners indicated that the non-assurance services that they usually supply or offer to SMEs are the internal audit review, preparing accounts, setting up of an accounting system, advise to go for listing, applying for financing, applying for manufacturing license, preparing for customs declaration, preparing tax returns, tax planning, secretarial practices. These services can be broadly categorixed into four areas: (1) secretarial practice, (2) consultation - applying for financing, doing accounting work, (3) tax-preparing tax return and tax planning, (4) internal audit review.According to Carcello (2002) the firms that demand s higher quality audit willing to pay a higher fees.
As stated in MIA By-Law 240.1, auditors may quote whatever fee that they feel appropriate to them even though the fee is lower then other auditors. But at the same time will create a threat to their professional competence even though the law agrees that the auditor may charge whatever amount to their client but they must protect their lower the audit fee received, the lower will be the quality of audit given.
This section describes the hypotheses of the research that strengthen by previous empirical results. As can be seen in conceptual framework, there are 5 major hypotheses that tested in this research. To make it more robust, we add 2 more hypotheses in regards of testing the mediating effect. The first mediating effect is the effect of quality delivery services in the relationship between quality control and satisfaction level. The second and last mediating effect is the effect of satisfaction level in the relationship between quality delivery services and level of non-audit fee. The details are described below:
2.4.2 Quality Deliver Services and Satisfaction Level
Formell et al (1996) states that customer satisfaction is actually a perceived of quality. It means that the satisfaction of customer is depended to the way of customer valued the quality delivery. It is confirmed by Cronin et al (2000). They address that there is relationship between quality of delivery and satisfaction. Cronin et al propose the behavioral intention as the back ground theory that can help scholar to prove the relationship. In other words, it can be surmised that the higher is the quality delivery, the higher is the satisfaction. Therefore, this research hypothesize:
H2: The higher the Quality Delivery, the higher the satisfaction level
2.4.3 Satisfaction Level and Level of Non-Audit Fee
The issue of relationship between satisfaction and level of fee extensively investigated in service marketing field. For instance, Anthanassopoulos (1999) found the direct link between satisfaction and level of price/fee. It is confirmed by several studies such as Fornell et al (1996), Hallowell (1996), and Ennew and Binks (1999). It clearly describes how satisfaction level has significant association with the level of fee. Therefore, this research surmises the theory by hypothesizing:
H3: The higher the satisfaction level, the higher the non-audit fees
2.4.6 Quality of Delivery Services and Level of Non Audit Fee
Zeithaml and Bitner, (2000) defined that satisfied customer would remain loyal, required service more often, fewer price sensitive and shall talk favorable things about the company.
Moreover, De Angelo (1981) and Palmrose (1986) have stated that client willingness to pay high amount of fees in order to receive a high quality of service. Therefore, this research concludes that:
H6: The higher the Quality service, the higher the non-audit fee paid
2.4.8 The Mediating effect of satisfaction level on the relationship between quality delivery service and Level of non audit Fee
In an addition to measurement issue, developing the conceptual relationship between quality delivery services and level of fee can be mediated by the satisfaction level. The objective is not only to reveal the power of direct relationship but also the power of the mediating effect that could be strengthen the association between quality of delivery services and level of Fee. Most known research that constructed the mediating effect of satisfaction on the association between quality of delivery and level of fee is Hallowell (1996). Hallowell (1996) delivers this postulation by using behavioral intention perspective. Hallowell states that as satisfaction is a value perception. It perception is based on the quality of delivery. Meanwhile, the satisfaction is very relatively close to price. So, it reveals the mediating effect of satisfaction on the relationship between quality of delivery and level of fee. It is confirmed by Athanassoupoulos (2000). He/She states that customer satisfaction is highly associated as the attribution of price. Therefore, this research can surmise that:
H8: The mediating of satisfaction level has effect on the positive and significant relationship between quality of delivery and fee level.