This chapter is a continuation of the previous literature review on non audit service, quality service and performance of the company in financial and non financial. Followed by the explanation on theoretical framework and the hypothesis developed.
Before the collapses of Enron and WorldCom issues relating to auditor's provision of non audit services (NAS) have been examined but only recently its given emphasis in Malaysia. A common argument is whether NAS impairs the auditor independence. The provision of non-audit services (NAS) by auditors to their audit clients has been regarded by regulators in the UK, the US, Australia and various other countries as a threat to auditor independence (Craswell, 1999).
According to Simunic (1984) the NAS will enhances the auditors' knowledge of their client, leading to a more efficient and effective audit. Ryan (2001) argues that restricting NAS can inhibit the auditor's competence and lowers audit quality. Albrecht and Sack (2000) asserts that limiting NAS will have an impact in CPA firms' ability to hire and retain highly qualified individuals.
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NAS has been a widely researched area especially the relationship of fees paid to non-audit services and fees paid to audit services, while others examined whether providing NAS would defect auditor's independence as mentioned earlier and some examined whether the correlation between the provision of non audit services and the impairment of auditor quality is conditional on auditor specialization.
Arthur Andersen, being the auditor of the three biggest bankruptcies, Enron, WorldCom and Global Crossing, was heavily criticized for the collapses. Andersen was allegedly stressing more on non-audit services (NAS) than the audit itself. In the year 2000, Andersen earned US$25 million in audit fee from Enron and another US$27 million from consulting services (Kandiah, 2003). In 1998, Andersen's total worldwide revenue from non-audit services was US$3,216.8 million as compared to US$2,876.6 million only from audit fees (Andersen, 1998). Andersen's total worldwide revenue had grown by approximately 13% annually since 1990 (Andersen, 1998). Andersen cites the growth in their NAS sector as the reason for the increase in revenue. This is supported by a study done by the University of Illinois in the United States (US) which found that on average for every dollar of audit fees, clients paid their independent auditors US$2.69 for non-audit consultation (Kandiah, 2003)
Following the collapses, auditing profession as a whole has been badly blamed and changes were being proposed to ensure that audit firms reduce their over-reliance on NAS (The Star, 2002). In order to ensure the independence of auditors and to protect the interest of investors, the accounting profession in most countries has come up with a code of ethics that spells out guidelines for auditor's competency and independence. In Malaysia, the Malaysian Institute of Accountant (MIA) By-Laws (on Professional Conduct and Ethics) (revised 2002) suggests that audit firms should not accept any appointment if they are also providing NAS to a client; whereby the provision of NAS would create a significant threat to their professional independence, integrity and objectivity.
The SEC in the U.S. has asserted that significant non-audit service fees can adversely impact auditor independence and impair auditor decision-making, especially when those decisions involve a substantial amount of professional judgment. Such concerns over auditor independence and the magnitude of NAS performed for audit clients led to the SEC's adoption of new rules related to the amounts and types of non-audit services supplied by auditors for publicly traded companies. These legislative concerns in the U.S. led to the Sarbanes-Oxley Act 2002 which limits the type of NAS auditors' can perform and requires companies to disclose the amount and type of fees paid to their external audit firm and states that NAS provided to a client should not be more than 5% of the total auditor's remuneration; otherwise, the client must obtain pre-approval from its audit committee, as non-audit fees paid in excess of this percentage would deem the auditor as not being independent. These new restrictions and disclosures have been introduced in the U.K. with only subtle differences (Department of Trade and Industry, 2003). As per Australia and United Kingdom, in Malaysia, Bursa Malaysia (KLSE) also requires all listed companies to disclose non-audit fees in their annual reports effective June 1, 2001. This was empowerment under MIA rules that became effective January 15, 2002, professional independence is considered impaired if total fees arising from provision of NAS to a client is 20% or more of the audit firm's total annual fees received for two or more consecutive years.
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Non assurance services is defined as services 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 ). Accounting, tax compilation, management consulting or advisory services and insolvency and business recovery are some of the examples of NAS. Audit firms are required to separate the non assurance services provided to the clients and they are not allowed to provide both services to the same client at the same time. However taxation services were allowed to be providing together with the audit service (Langan, 2003 ).
In Taiwan the highest proportion for NAS were taxation services, followed by management advisory, finance and investment advisory and lastly information technology advisory ( Chien & Chen, 2005 ). The situation is almost the same in Malaysia (Salleh et.al.,2008). Therefore in this study, services that are taken as benchmark includes taxation ( ie; tax planning, tax return) consultation services ( ie; preparing full sets of accounts, setting up companies computerized accounting system, improve business performance, applying for loan, applying for manufacturing license, prepare customer declaration, accounting training to clients, fund / assets management, assets valuation, working paper for clients, business development ), internal audit (ie; internal audit review, other services ), secretarial practices, and other services.
In Australia 67% of SMEs gets business advice, ranging from financial matters to improving operational performance, from their external accountants for example in matters pertaining corporate finance, business restructuring, financial planning, performance review, benchmarking, risk management practices, information technology resources and control system. (Carey, Simnett, and Tanewski, 2005). The latest study conducted in Malaysia by MIA SME Survey, 2008 indicated that services such as taxation, accounting, secretarial services and business consulting are the key services sought after by the SMEs with taxation service in the top list.
Professional Accountants in Business (PAIB) (2004) conducted a study in various parts of the World (including Malaysia) on the role of accountants in the business world. The findings states a diversity of roles, encompassing enterprise governance, strategic support, internal control, shareholder communications, treasury, project management, corporate finance, information technology, risk management, analysis and information management.
Accountants are used to provide services beyond compliance and audit functions. These services include inheritance/generation transfer/owner transference, business structure (company set-up), budgeting, pensions, marketing/sales/strategic planning, secretary to company boards, administrative routines/ IT management/organization/ HRM Training and skills development, remuneration schemes/salary administration, valuation of firms/mergers/demergers (Doving & Gooderham, 2005). Thus, the professional accountants were encouraged to expand their range of services to respond to the needs of businesses in providing advice. Similarly, the accountants of Malaysia could reconsider their role in the development of SMEs, simultaneously reaping the rewards of expanded services and contribution to the nation.
Quality encompasses every aspect of the organization and is actually an emotional experience for customers. Most customers want to feel good about their purchase and receive the best value for their money. According to Johnson (1991), customers want to know their money has been well spent and take pride in their association with a company with high quality image. According to, Oakland in his book "Total Quality Management", 'quality' simply means meeting the customer requirements and this is not restricted to the functional characteristics of the product or service. Quality gives people in different functions of an organization a common language for improvement. It enables all the people, with different abilities and priorities to communicate readily with one another, in pursuit of a common goal.
Product and services are designed with deliberate differences in quality to meet the different wants and needs of individual customers. Basically for tangible products the customers look at performance, features, reliability, conformance, durability, safety, aesthetics, serviceability and other perceptions (Garvin, 1984). If the product is intangible, as with services such as non audit service, then defining and measuring quality becomes more difficult. It is argued that the customer defines quality in terms of value to him/her of service received (Heskett, Sasser & Hart, 1990)
Many researchers offered various definitions of service. Service has been defined as a performance that one party can offer to another that is essentially intangible and does not result in the ownership of anything (Kotler, 2006) but Ramaswamy (1996) described service as "the business transactions that take place between a donor (service provider) and receiver (customer) in order to produce an outcome that satisfies the customer. The services provided and performance of the services often varies between service providers (Booms & Bitner, 1981). It is very difficult for service provider to reproduce a service consistently and exactly. Moreover, services are inseparable since production and consumption takes place simultaneously (Upah, 1980)
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Lewis and Booms (1983) defined services quality as measure of how well the service level delivered matches customer expectations. Delivering quality service means conforming to customers expectations on consistent basis. This is further emphasized by Parasuraman, Zeithaml, and Berry (1985), service quality is hard to defined or measure because it is intangible, heterogeneous which vary from customers, days or producers.
Gronroos (1984) proposed that there are two types of service quality that is technical and functional quality. The first conceptual model of service quality developed by Gronroos (1984) to increase understanding of customers service quality perceptions and the factors that influence those perceptions. Based on the framework developed by Gronroos (1984) many comprehensive model of service quality were created. Parasuraman et al. (1985) proposed that service quality is a function of the differences between expectation and performance along the quality dimensions. The ten dimensions that determines service quality according to Parasuraman et al. (1985) are : reliability, responsiveness, competence, access, courtesy, communication, credibility, security, understanding/knowing the customers, and tangibles. Thus, they proposed that the differences between perceived performance and expected performance of these ten dimensions determine overall perceived service quality. However these 10 dimensions were grouped into 5 dimensions because the original dimensions are not necessarily independent of one another. Various statistical analyses revealed correlation among items representing several of the original ten dimensions. Analysis of data led to refinement of the original model and confirmed its reliability and validity. The final model, SERVQUAL had only five distinct dimensions but captured aspects of all the ten original dimensions as follows:
Reliability refers to the ability to perform the promised service dependently and accurately.
Responsiveness reflects the willingness to help a customer and provide prompt service.
Tangible refers to the appearance of the physical facilities, equipment, personnel and communication material.
Assurance refers to knowledge and courtesy of employees and their ability to inspire trust and confidence
Empathy refers to caring, individualized attention the firm provides its customer.
The final SERVQUAL instrument consists of 22 items questionnaire split between each of the five dimensions. The instrument has two sections, first to measure expected quality and the second to measure perceived service The measures were recorded on a seven-point Likert scale between 'Strongly Disagree' and 'Strongly Agree' accompanied each statement in both sections. Based from the past research using SERVQUAL model in auditing sector, it was 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 (Haron, Ismail, Ibrahim and Isa, 2006). Therefore again we are going to use partial SERVQUAL model in our study to examine the relationship between SMEs perceptions on service quality of NAS and performance of SMEs.
Performance of the Company
Performance is defined as the outputs or outcomes in utilization of resources. They are associated with organizational ultimate outcomes in terms of annual sales return and growth, profitability and return on investment according to Miller (1983). There are plenty of studies published about the factors of the success of managers. According to Nash (1983), financial profitability is one way to measure company performance and managerial success. This shows that to successfully achieve in business, performance actually depends on the manager's background and the expertise of the manager. Definitions of success can be classified by various categories. Stuart and Abetti (1987) defined success into few categories, subjective versus objective, bimodal and multimodal versus continuous and financial versus non-financial depending on the context of each study.
Traditional financial measures, linked to the organization's strategy, are found in Bible, Kerr and Zanini (2006) research. They include: net income, revenue, return on net assets (ROA), return on equity (ROE), share price, and cash flow as a measure to financial performance. While Tamar (2002) has measured business performance by three variables: sales volume, owner income, and number of employees. Of the three, sales volume appears to be the most efficient measure, correlating strongly with all items representing capabilities: skills, resources, planning, and previous experience in industry.
This research will be measuring financial performance by annual sales turnover and annual profit following the research done by Haron, et al., (2001).In order for SMEs to work strategically, Hashim (2000) recommended that an organizational success can be achieved if manager's characteristics or individual factors, organizational factors and CSR are being handled properly and competently. Therefore, top management or CEOs of SMES who posses the right talents, skills and abilities, eventually will find their ultimate success or goals. In the context of this study, company performance will be measured by looking at the financial and non financial performance.
This study is conducted to determine whether the NAS obtained by SMEs will influence the performance. Phutut (2002) used measures of output and company reputation as non-financial.
Based on the literature review, below is the proposed theoretical framework for this study.
SERVICE QUALITY OF NAS
PERFORMANCE OF SMEs:
- Measures of output
- Average turnover
- Average profit
The classic definition of audit quality that is cited by most audit researchers is that of DeAngelo (1981): "the market-assessed joint probability that a given auditor will both (a) discover a breach in the client's accounting system and (b) report the breach." The definition highlights two aspects of audit quality that many would agree are important, which are : (1) the competence of the auditor that determines how likely it is that a misstatement will be detected and (2) the independence/objectivity of the auditor that determines what the auditor is likely to do about a detected misstatement. The audit quality is influenced by many factors such as the audit firm's size, pricing and non-audit services provided by the firm (Wooten, 2003). In order to increase and maintain the quality, these factors must be controlled.
The basis of the theoretical framework in this research is DeAngelo's (1981) quality theory being applied on non-audit services. The differences in the models used are the usage of non-audit service in this study instead of audit service which was used by DeAngelo (1981). The quality service in the framework is similar to SERVQUAL model used in Ismail, Haron, Ibrahim and Mohd. Isa (2006) which focuses on the appearance, knowledgeable, responsiveness, reliability, empathy and accessibility of the non-audit services.
Based on the theoretical framework , hypothesis was developed using the independent and dependent variable. Mainly the study attempts to test following hypotheses:
H1 The higher the quality service of NAS, the better performance of the company in term of financial.
H2 The higher the quality service of NAS, the better performance of the company in term of non financial.
Studies have shown that SMEs fail due to inability to manage their finances, or as a result of their aspirations falling shorts of their capabilities. (Birkett, 2000) and Greenwood, Suddeby & Hinings, (2002) stated that chartered accountants maintain a board base of expertise, enabling them to contribute to success of business beyond accounting and auditing services.
This research mainly aims to examine the NAS and the quality of NAS whether it will help the company's performance better in terms of financial and non financial. This is because most of the previous studies focused on examining the NAS with the independent of the auditor and the NAS fees.