Problems Related To Increasing Auditing Fees Accounting Essay

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This chapter highlights the main features and characteristics of external audit services and audit fees in terms of the identification of the regulatory framework which governs them, the nature of the market for audit services, and the main composition of an audit fee. The chapter is divided into the following sections:

The external audit function and audit fees are of interest to both the legal authorities and the professional accounting bodies. This section describes the regulatory framework by reviewing some of the important legislation and guidelines of the professional accounting bodies which govern them. Some important legislation: The legal authorities devote much attention to the external audit function and audit fees.

A number of provisions are laid down relating 5 to major matters such as, appointment, remuneration, removal and qualifications of auditors, and disclosure of fees: The authorit y appointing the auditor and determining his fee: The U.K. Companies Act 1985 section 38 1, stipulates that each general meeting of the company shall appoint an auditor and determine his fee until the next general meeting.

Such provisions are stated to ensure that the remuneration paid to the auditor has the knowledge of the members. However the most important drawback is that "there is no clear legal 6 definition of the audit fee which is to be disclosed", riston Perks 1977". Qualifications of auditors the qualifications for appointment as an auditor are set out in section 389 of the U.K. Companies Act 1985.

It indicates that a person is not qualified for appointment as an auditor of a company unless either he is a member of a body of accountants established in the U.K., and recognised for the purposes of this provision by the Secretary of State (of the Department of Trade and Industry) or he is authorised by the Sectretary of State to be appointed, as he has similar qualifications obtained outside the U.K., or because he retains authorization formerly granted under section 161 (1) of the Companies Act 1948 (adequate knowledge and experience, or pre 1947 practice). According to the provisions under the previous section 161 (1), all auditors should have equivalent qualifications and knowledge in order to enter the auditing profession.

Therefore, it is deduced that the quality of the routine audit services could be similarly performed and satisfied by any qualified auditor. Although the legal authorities have paid much attention to these previous aspects of auditing matters, the issue of identifying the factors which enter into fixing the audit fees has received no attention, and no attempt has been made to identify and publish official scale rates for audit fees. In addition, the regulation regarding the disclosure of audit fees may need to be revised to define precisely what has to be disclosed in the annual report and accounts. Some important professional guidelines and restrictions: The professional accounting bodies (both national and international) have laid down various ethical guidelines relating to the conduct of auditors.

It also states that it is for the auditor to determine the appropriate rates. According to these statements it is clear that the audit fee is a function of audit cost which in itself a function of the time and seniority (quality) of the staff involved in the audit work. 9 Preclusion of the charging of fees on percentage or contin g enc y basis: An ethical statement of the IFAC Handbook 1985, on Integrity, Objectivity, and Independence, "Contingency Fees" states that Professional services should not be offered or rendered under an arrangement whereby no fee will be charged unless specified findings or results are obtained, or where the fee is otherwise contingent upon the findings or results of such services, and fees should not be regarded as being contingent if fixed by a court or other public authority". In addition, a member in practice is not permitted to charge or accept a fee for professional work which is calculated on a percentage basis except where that course is authorized by statute or has been approved by a member body as generally accepted practice for certain work, IFAC 1987, Section 12 Ethics, "Professional fees", paragraph 11k'. Similarly, the ICAEW 1987, statement 9 - "Fees"° prohibits fees to be charged on a percentage or similar basis, or on a contingency basis.

Research Objective:

The research objective is to find out the audit fees determinants and its acceptance by the followers.

Research Problem and questions:

The research problem is to find out the determinants of the audit fees and get answers from the chartered accountants and managers of the companies related to this issue. The questions may include the followings.

What are the determinants of audit fees?

What is the expected "fair enough" amount of audit fees?

How those determinants are accepted by the practitioners?

Research Source of data:

The data will collected from primary sources via questionnaire and secondary sources like previous studies and researches, book and magazines, and online resources.

Scope and limitations:

The scope of this research is only to the extent of this particular audit fees study in context of Chartered accountants and audit companies. The main limitation of the study is the short time frame.

Significance of the study:

This study will come in handy to serve other manufacturing companies and any related parties Thus; it will be significant for the general public, students of finance and potential customers of mobile services, investors, and may be useful for researchers.

Definition of terms

If the auditor is appointed by the directors or by the Secretary of State (of the Department of Trade and Industry) his fee may be fixed by them. Removal of auditors: As in the case of appointing the auditor and determining his fee, a company may, by ordinary resolution, remove an auditor before the expiration of his period 0f office, notwithstanding anything in any agreement between it and him. These provisions are set out in section 386 of the 1985 of the U.K. Companies Act 90 , and indicate the company's power, "as auditors usually operate in a buyers' market, where the companies choose the auditor, determine his employment conditions, and could also remove and replace him", Goldman l974.

Literature & Related Studies II Chapter

Chapter two

Literature Reviews:

Economic theory predicts price stickiness, among other circumstances, when sellers do not fully understand market conditions. Seller imperfect knowledge is regarded as a market friction. Under these conditions, sellers do not want to risk upsetting buyers with frequent or major price adjustments (Rotemberg, 2002; Zbaracki et al., 2004). Bhaduri and Falkinger (1990) specifically show that a seller who has imperfect market information will base his/her pricing on cost, and adjust pricing gradually and infrequently. We argue that auditors do not fully understand how clients will react to audit fee changes, i.e. if or when clients will consider switching auditors. Therefore, auditors will base their audit fees on cost and adjust audit fees gradually and infrequently. Considerable empirical evidence in the economics literature supports the notion of price stickiness (e.g., Carlton, 1986; Levy and Young, 2004). In the audit fee literature, Ghosh and Lustgarten (2006) show that the explanatory power (or R2 ) of a standard audit fee model is high when levels are considered, but low when year-on-year differences are used.

This result suggests that audit fees do not change in every year by as much as the model would predict. 6 In a working paper, Ferguson et al. (2005) also show evidence of stickiness in a small sample of UK and Australian audit fees. We test for overall stickiness by examining the extent to which changes in actual audit fees are consistent with predicted changes. H1: Audit fees do not immediately adjust to the levels suggested by an audit fee model.

Anderson et al.(2003) advanced three reasons for the difference between positive and negative changes in costs, namely cost lumpiness, adjustment costs, and agency cost. However, it can be argued that these reasons do not apply as strongly to the audit setting.3 In the economic literature, where quality cannot be discerned, price is often used as a proxy for quality (Shapiro, 1983). This is also the case in the audit fee literature (e.g., Craswell et al., 1995). Ferguson et al. (2005) argue that audit clients also use audit fees as a proxy for audit quality. This appears to be a reasonable assumption given the fact that the Big x audit firms are generally known to charge more and assumed to provide higher quality audits.

Because clients see higher audit fees as a mark of quality, clients may resist fee increases less than expected and, when fee decreases are appropriate, clients may demand decreases less than expected (Ferguson et al., 2005). Furthermore, SOX caused additional risk to client managers, who had to start signing off on the adequacy of controls. Thus, during the period of SOX implementation, clients were likely to be more focused on assuring that adequate audit work was performed than on audit fee management. SOX is one example of a general ratcheting of audit regulation over time.

Additional regulation means that audit fees are more likely to increase than to decrease. 3 Cost lumpiness should not be an issue in audit fees, because auditors do not need large investments in heavy equipment typically associated with cost lumpiness. Although salary costs are fixed, audit staff can to some extent be reassigned to other clients, or even other offices of the firm. Adjustment costs can be a factor in replacing auditors, although the cost increases effort by managers, and will not be included in audit fees.

Agency cost (empire-building) should also not be an issue, because manager status is not likely to be affected by the size of the audit fee they pay. Given that audit fees are broadly determined by effort and risk, when the audit effort and/or risk for a given client reduces, auditors may not recognize this before they have already committed a planned number of hours to the (interim) audit. By contrast, a larger required audit can, at least to some extent, be adjusted for and accommodated at a later stage in the audit.

Therefore, late recognition of a change in the profile of the audit client during a given year will result in audit fee stickiness. This is a short-term effect which can be corrected in time for the next year's audit. Even when auditors recognize the need for a reduced audit early, cognizant of the cost to the client to switch auditors and the extended timeframe required to do so, auditors can opportunistically reduce the audit fee by a smaller amount. This can be achieved by overauditing (reducing the audit less than is warranted) or by over-charging (reducing the audit sufficiently, but charging more).

Over-auditing and over-charging under conditions that call for a reduced audit will result in audit fee stickiness.4 We further argue that audit risk is greater for clients that are decreasing in size (or in the other factors that determine audit fees), than for those that are growing. Firms that are decreasing in size may have risk factors such as impaired assets or reduced viability, which would require greater audit work. Growing firms may have an increase in risk but not to the same extent. Audit fees are often contracted between client and auditors.

However, it is customary to have 'escape' clauses that would allow the auditor to perform extra work and to charge for the extra work in case of unforeseen circumstances, e.g., the existence of going concern issues, or other audit risk factors. Audit contracts do not customarily provide for contingencies that would allow the audit fee to be reduced (Palmrose, 1989; Corporate Executive Board, 2005). These contractual arrangements would cause audit 4 Causholli et al. (2011) argue that as auditing is a credence service, there is potential for overauditing and overcharging. 8 fee increases to be more common than that audit fees decreases.

We examine the relative magnitude of predicted increases and predicted decreases. H2: Audit fees decrease less (when a decrease is expected) than they increase (when an increase is expected). In economic theory, it is understood that competitive markets force pricing to revert to the norm, i.e. a seller cannot (indefinitely) extract a premium price from a buyer. Market frictions (e.g. incomplete information) cause stickiness (i.e. prices do not change instantaneously), but competition forces the sellers to reduce higher than average prices over time. Alternatively, buyers switch to less expensive sellers.

Either way, the observed transaction price reverts to the norm over time. Specifically, Martin (1993) shows that prices are less sticky if there are more sellers and less collusion between sellers, implying that prices revert to the norm and prices are less sticky in more competitive markets. Several empirical studies support the notion that prices are less sticky (i.e. adjust quicker) in more competitive markets (Carlton, 1986; Weiss, 1993; Hall et al., 2000).

Anderson et al.(2003) ascribe the reversal of stickiness in subsequent periods to slow manager reactions to downturns and to the fact that it can take time to unwind contractual commitments. If managers and audit committees are slow to recognize a downturn and negotiate their audit fee down, audit fee stickiness will reverse in subsequent periods. It may be that auditors wait to assess whether a change is likely to be permanent. Contractual commitments can also be a factor, because if managers recognize a downturn late, they would not have sufficient time to renegotiate or be able to switch auditors during that period, but might be able to in the subsequent period.

From an auditor point of view, if auditors are late in recognizing the need for a smaller audit, audit fees will be higher in the current period and lower in the subsequent period. Thus, stickiness would reverse in the subsequent period. Alternatively, in a competitive audit 9 market, opportunistic auditors would have to reverse their opportunistic behavior in order to avoid losing the audit. Alternatively, if the auditor does not adjust the audit fee and the clientdecides to switch auditors for a reduction in audit fees, reversal of audit fee stickiness would also be observed.

Anderson et al. (2003) argue that longer periods of time (more than one year) captures complete adjustment cycles and this explains the fact that stickiness reduces over longer periods of time. With audit fees, clients can be expected to manage audit fees down over longer periods of time. In a competitive audit market, auditors would have to adjust their audit fees over time to revert to the norm. H3: Variations of audit fees from the levels suggested by audit fee models will reverse over longer periods of time.

Economic theory suggests that market frictions, such as imperfect information, cause price stickiness (Bhaduri and Falkinger, 1990; Rotemburg, 2002; Zbaracki et al., 2004). Imperfect information includes the seller not fully understanding how the buyer will react to a change in price, i.e. what would cause the buyer to consider switching to a different seller. When a buyer approaches a new seller, the level of uncertainty is reduced, because it is now known that the buyer is considering a switch. Thus one of the sources of market friction that cause price stickiness is removed and the price can thus be expected to more fully revert to the expected value.

Applying these economic insights to the audit market, it is expected that audit fees will more fully adjust to the norm, i.e. to the levels predicted by an audit fee model, when clients switch auditor. Two aspects specific to the audit market may mitigate this general expectation in different directions. One aspect is the fact that a new client initially requires additional audit work to ensure full knowledge of all audit risks. The other aspect is the possibility that audit firms bid aggressively to acquire a new client (low-balling; e.g., DeAngelo, 1981) with 10 the expectation of being able to raise audit fees gradually later.

Because these aspects would influence audit fees of new clients in different directions, we stand by our original (general) expectation, i.e. that audit fees of new clients would more fully adjust to normal levels. H4: When new auditors are appointed, the audit fee adjusts more fully to levels suggested by the audit fee model. References Abbott, L. J., Parker, S., Peters, G. F., & Raghunandan, K. (2003, September).

ResearchMethodologyIII Chapter

Chapter three

Research Design

The research is designed in the form of the questionnaires and other secondary sources of data. The attempt was made to keep secrecy and clarify the questions to the respondent before the filling of questionnaire. Also the interview questions were designed to maintain secrecy of the identity of the person.

Sources of Data

There are two types of data in any research, primary and secondary data. In this reportthe researchers have used the primary source of data through distributing questionnaires along with secondary source of data.

Purpose and research questions or null hypothesis

The purpose of the research is to find out the fair level of audit fees and figure out the right determinants of the fees. Thus the null hypothesis is a follows.

The audit fees should clearly state its determinants.

The audit fees should be informed to all parties through financial reporting at year end.

Sample Size:

The sample size includes the 30 chartered accountants of reputed organizations in Bahrain. Among them range people working from 30 years to people working from last 2 years at least.

Scope and limitations

The scope of the study is to find out the determinants of the audit fees and help understand and fix this audit fees. The limitation is that the 30 Chartered Accountants does not represent the thought of 350 Chartered Accountants working for different organization in the country.

Questionnaire:

Dear Sir/Madam,

This research aims to investigate the opinions of auditors on fixing audit fees in Bahrain. The following questionnaire consists of two parts.

The completion of this questionnaire should not take more than 25 minutes of your precious time. All responses will be treated in the strictest confidence. This study is purely for academic purposes. Your time and cooperation is very much appreciated.

Part A)

1. Name of the Audit Firm ......................................................................................

2 a) Position of Respondent:

â-¡ Partner â-¡ Audit Manager â-¡ Audit Supervisor â-¡ Auditor â-¡ Accountant

â-¡ Asstt. Auditor â-¡ Any other (pl. specify ………………………

b) Nationality: â-¡ Bahraini â-¡ Non- Bahraini

3. Degree:

â-¡ PhD â-¡ Master â-¡ B.Sc â-¡ Diploma â-¡ Others...............

4. Professional Qualification:

â-¡ CA â-¡ CPA â-¡ ACCA â-¡ CMA â-¡ Others..............

5. Respondent's experience of conducting external Audit:

â-¡ Less than 5years â-¡ 5 years - 10 years â-¡ More than 10 years

6. Total Years of Experience:

â-¡ Less than 10 year's â-¡ More than 10 years

7. Total Number of employees within the firm:

â-¡ Less than 50 â-¡ 50 - 100 â-¡ More than 100

8. Number of Clients:

â-¡ Less than 50 â-¡ 50 - 100 â-¡ 100-200 â-¡200 & more

9. Number of partners in your firm:

â-¡ Less than 3 â-¡ 3-6 â-¡ 6 and more

Part B)

The following are the possible list of . Based on your experiences of conducting audits with clients in last TWO years in Bahrain, did you come across with fixing the audit fees (in the preparation of financial statements). Your opinions will greatly help us in completing this research and conclusions drawn there from will contribute to accounting knowledge and practices in the context of Bahrain .

Please tick the appropriate column. If your reply is YES to any statement, then please also state the extent of the abuse by using a SCALE of

To a very large extent (5) …………………………………… To a least extent (1).

Additionally, please also tick whether the abuse was in listed companies or unlisted companies as well as the economic sector i.e. in banking and insurance or manufacturing or others: trading and services.

Audit fees

Yes

No

In listed companies

In unlisted companies

Economic sectors:

Banking &Insurance

Manufacturing

Others trading & services

A)Problems related to increasing auditing fees:

1.Fabrication of fictitious revenues

2.Sales with conditions: Sales is booked even though some terms were not completed and rights and risks of ownership were not passed to the purchaser

3.Matching revenues with expenses principles were violated

4.Premature revenue recognition when recognition criteria were not met.

5.Long term contracts: Violated the percentage of completion and the estimated costs to complete in order to prematurely recognize revenues and conceal contract cost overruns.

6. Channel stuffing or trade loading: e.g. sale of unusually large quantity of a product to distributors through the use of deep discounts and/or extended payment terms.

7.Improper recording of sales returns and allowance.

8.Recording expenses in the wrong period.

9.Expensing capital expenses.

10.Omission of warranty expenses.

11.Under-estimating loan interests.

12.Lowering the allowance for asset impairment.

13.False increasing investment profit.

14.Changing accounting policies without justification.

15. Improper correction of errors.

16.Improper consolidating statements.

17. Any other ( pl specify………………..

B) Problem of showing audit fees in Balance sheet:

1.Over valuation of investments.

2.Omission of liabilities.

3.Recording of fictitious accounts receivables.

4.Improper use of fair value accounting.

5.Improper capitalization of expenses.

6.Failure to establish an adequate allowance for bad debts.

7.Failure to accrue losses on uncollectible receivables.

8.Overstating inventory through fictitious (phantom) inventory.

9.Improperly capitalizing inventory and start up costs.

10.Improper valuation of inventory.

11.Misrepresenting fixed asset valuation ( Land & building, Plant & machinery).

12. Booking fictitious fixed

Assets.

13.Capitalizing non-asset costs.

14. Capitalizing share-based payments.

15. Any other ( pl specify………………..

C) Disclosure related to audit fees:

1.False disclosure of the actual use of raised capital.

2.Concealing lawsuits.

3.Concealing buy or sell goods between related parties.

4.Concealing mortgage of assets or/and equities.

5.Concealing warranty or/and guarantee events.

6.Concealing capital occupied by related parties.

7.Disguising joint-venture investment.

8. Improper disclosure of accounting policies.

9.Concealing others significant events.

10.Concealing any act of frauds committed by officers, executives and others.

11.Concealing disclosure of subsequent events which undermine the reported value of assets or unrecorded liabilities or that adversely reflect on management integrity.

12. Concealing environmental damage violations.

13. Any other ( pl specify………………..

Any comments and suggestions for improving audit fees in Bahrain:

-……………………………………………………………………………………………………………..

……………………………………………………………………………………………………………..

………………………………………………………………………………………………………………….

………………………………………………………………………………………………………………….

……………………………………………………………………………………………………………….

Thanks for your cooperation. Your responses will be treated in strict confidentiality.

Conclusion:

The audit fees need to be fixed as per the fair price and its proper clarification and depiction needs to be done in the end, that is in the financial reports of the company so that things are clear to the authorities related and the investors remain informed.

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