Reviewing Non-Audit Services and Audit Failure



The reliability and credibility of an audit opinion rests upon the fundamental assumption that the auditor is independent of their client. Chief Justice Warren Burger emphasises "Public faith in reliability of corporations' financial statements depends upon the public perception of the outside auditor as an independent financial analyst" (Pratt and Peursem 1993; 21) [1] 

The occurrence of significant accounting scandals in the past, as well as more recent attacks on the audit profession have reached alarming heights, as the origin of various audit failures in the corporate sector point towards the notion of impaired auditor independence. The recent financial crisis raises questions surrounding auditor independence and what company audits are worthy for. Many institutions are in financial turmoil only months after receiving unqualified audit opinions from supposedly trustworthy auditing firms. At a time when shareholders need to be reassured that financial statements depict an accurate, unbiased view of a company's financial situation, it seems difficult to obtain this assurance by relying upon auditors that clearly lack the mandatory independence required to add credibility to the available corporate financial information. (Sikka 2009)

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The economic downturn has amplified concerns surrounding auditing practices and with a breakdown of trust in financial institutions it is important to address the cause of doubt. Although poor audit opinion was not a direct cause of recent corporate collapse, some attention must be focussed on the fact that auditors have given out unqualified opinions on distressed financial establishments. (Sikka 2009). A range of academic literature suggests that major corporate failures occurred with the provision of non-audit services (NAS), which ultimately led the auditor to impair his/her independence. The aim of this paper is to discuss the need for reform in audit quality by addressing the causes of impairment on auditor independence. There are supposedly many variables that can lead to impairment of independence, but for the purpose of this paper the focus will remain upon the impact of NAS on the independence of an auditor, and whether or not this variable has any significant contribution to audit failure/ impairment.

This paper adopts an approach that portrays this variable as having a negative impact on auditor independence; therefore appropriate protective measures are proposed to prevent impairment of independence. A critical analysis of preventive methods already in existence such as the Sarbanes Oxley Act 2002 will also be conducted. Alternative viewpoints from academics and regulators tend to argue that the variable in question actually improves audit quality or fails to pose any threat to independence whatsoever. These assumptions overlook the objective, independent nature an auditor must hold when conducting an external audit and fail to support the perspective taken in this paper. The next section will focus on the effects of audit failure emulated by corporate collapse. With the main focus on whether the provision of NAS by audit firms was a contributing factor to failure of the firm in conjunction with a discussion surrounding the role of the auditor in the context of recent financial turmoil.

The remainder of the paper is organised by reviewing the prior literature that focuses on the concept of auditor independence, followed by reviewing the hypothesis developed (surrounding NAS and its impact on AI). The remainder of this section concentrates on the threats and protective measures associated with the provision of NAS and lead on to consider the alternative view that the provision of NAS does not have adverse effects on auditor independence. The penultimate section then goes on to discuss issues that arise when considering auditing and the financial crisis, finally concluding with section six, a discussion of the findings.


A. Concept of Independence

"Independence, both historically and philosophically, is the foundation of the public accounting profession and upon its maintenance depends the profession's strength and its stature" (Carey 1970:182)

The concern regarding impaired auditor independence is one that has existed for many years now. Accounting scandals such as those shown by the collapse of large corporations such as Enron and WorldCom have led to unrest surrounding the issue of why financial collapse continues to occur with the provision of external audit, which should potentially promote trust in capitalist corporations. Ultimately, the role of an independent external audit is to add credibility to the financial statements of public companies (Watts and Zimmerman as cited in Kaplan 2003). Shockley (1981) suggests that there is an assumption within the public accounting sector, that auditors are independent of their clients. The credibility of this assumption seems to be diminishing as the independent nature of some public accountants is deteriorating.

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Independence is ultimately one of the most fundamental parts of the audit process, as it increases value of the audit by ensuring that the auditor will perform the audit impartially and objectively. The expertise claimed by conducting a high quality audit will provide a reliable account of a company's financial reports, thereby giving reassurance to investors and potential users, which ultimately support the allocation of optimal capital (Myring 2006). The following quote displays what the public regard the auditor's role to be; "An auditor is thought of as an independent professional who is interposed between investors and managers in order to play a watchdog role that reduces the agency costs of corporate governance" (Coffee 2001;2)

While there have been numerous attempts to define the term independence from an auditing perspective, there is no universally accepted definition of the concept. "Independence is not susceptible to a precise definition." (AICPA Code of Ethics cited in Antle 1984; 1). Flints postulate 3 (1988) refers to independence as an opinion taken 'at arm's length or freedom from bias'. Another fundamental aspect of independence is 'the ability to resist client pressure' (Knapp 1985). When comparing definitions from a range of regulatory frameworks in regards to auditor independence, each makes the distinction between independence in fact and independence in appearance. (Beattie 2004) For the purpose of this discussion, the definition proposed by the International Ethics Standards Board for Accountants is used. The definition consists of two elements;

"Independence of Mind:

The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional scepticism.

Independence in Appearance

The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firm's, or a member of the assurance team's, integrity, objectivity or professional scepticism had been compromised." [2] 

The fundamental requirements proposed by this definition, if adhered to will satisfy the level of independence an auditor is expected to abide by, and therefore enable the auditor to convey a credible opinion. Thus, the importance of independence in regards to a valid audit opinion is crucial.

There is general agreement that objectivity is something that is very difficult to demonstrate. The Conceptual Framework for Auditor Independence amongst other regulatory frameworks reiterates the importance Independence in appearance holds as well as Independence in fact. Ultimately, the appearance of an independence failure can be enough to weaken the confidence of users of financial statement who are reliant upon an objective audit opinion. (Fearnley and Beattie 2004)

If it is quite clear independence has been impaired (in fact) this further undermines investor confidence and a loss of confidence in financial reporting leads to an unstable market place. [3] Consequently, independence in appearance becomes paramount, because independence in the mind (i.e. observable independent behaviour) cannot be monitored due to its nature. 'Independent auditors should not only be independent in fact; they should avoid situations that may lead outsiders to doubt their independence' (AICPA 2001 cited from Beattie 2004). Thus, in order for confidence to be restored, independence in the mind and in appearance must be held with no room for compromise. In order to achieve this it is necessary to underpin the threats that can potentially impair independence. (Fearnley and Beattie 2004)

A survey conducted by Fearnley and Beattie (2004) reveals the following as key factors believed to threaten independence in the UK:

Client-auditor relationship, where personal income depends on client retention

Economic significance and status of the client to the firm

Level of non-audit services

Directors control of the audit appointment fee

These threats reflect most of disparagement shown by Anderson in regards to their role as auditors for Enron.

B. The Impossibility of Independence (Psychological viewpoint)

Although one of the fundamental requirements upon the audit profession is the ability to be independent, due to the nature of the firm, it is often considered psychologically impossible for an auditor to maintain their objectivity. '…Cases of audit failure are inevitable, even with the most honest auditors' (Bazerman 1997; 90). Within the auditor-client relationship, there exists a general psychological dependence, often known as the "self-serving" bias. (Bazerman et al 1997 cited by Francis 2006) Experimental evidence suggests that auditors posses an unconscious bias which does not allow the formation of an impartial audit. This is based upon the reasoning that close relationships and repeated interaction with the client builds up a relationship that prevents the auditor from being completely impartial. In other words, referring to the "cognitive characteristic that individuals cannot separate their own self interest from that of others in close proximity with whom they interact with closely" (Bazerman et al 1997: 90).

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Auditors may find themselves caught in circumstances where there is a clash between what inherent moral principles draw them to and the auditors own economic self interest (Sweeny & Roberts 1997). The term, 'moral seduction' is used by Moore et al (2006) to depict the close relationship the auditor develops with the client in the profession as well as the additional economic interests that challenge the likelihood of a completely independent objective audit. Nelson (2006) questions the use of attempting to comprehend the inevitable subconscious bias towards economic incentives and instead suggests that what is of most importance is how the auditors' incentives affect their decisions. (Francis 2006)

Although it is clear from previous corporate collapses that audit failure can be the result of deliberate involvement of auditors with clients, audit failure rarely results from such a deliberate breach of impartiality, and instead the ability to remain impartial and objective can be something that auditors find psychologically impossible to adhere to (Bazerman 1997). The importance of impartiality to the audit profession is vital to its success as it is often the auditors' responsibility to provide information to shareholders that is imperative if the firm requires funding in the form of publicly owned shares (Bazerman 1997; 90). The American Institute of Certified Public Accountants (AICPA) states in its Code of Professional Ethics:

"In the performance of any professional service, a member shall maintain integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. Members should accept the obligation to act in a way that will serve the public interest, honour the public trust, and demonstrate commitment to professionalism." (Bazerman 1997;90)

Judging by this statement, it is immediately clear that the AICPA realises there are great pressures placed on the auditor in terms of maintaining their integrity and objectivity, yet it suggests that this level of independence is achievable enough for auditors to have the ability to produce reliable and unbiased financial statements regarding the firms' financial position. This assumption is subject to criticism in that it is unrealistic to presuppose that auditors will be able to provide impartial unbiased opinions that regard the interests of the all the potential users of the information instead of the companies that provide their fees? Psychological examination points to an inevitable inference; that 'such impartiality is impossible under current institutional arrangements.'(Bazerman et al 1997; 90)

Thus, an inescapable strain is put on the auditor, because the auditor does not in principle owe their chief duty to the providers of payment for his/her services. Consequently, the auditors' objectivity and independence are potentially threatened by merely taking on the audit commitment.

Previous literature such as that by Sweeny and Roberts (1997) and Bazerman et al (1997) based on empirical evidence, suggests that personality factors have a significant effect on the auditors independence, revealing an ethical inconsistency in response to interaction with management of the client. Evidence suggests that the ability to resist economic incentives may not actually be heavily based upon the requirement of being able to follow ethical guidelines. Instead, the ability to maintain independence is considered to be based upon the individuals' life experiences and personal inclination, rather than just a "state of mind" that can be excised from the auditor's life experiences as described in the code of ethics. (Francis 2006)


A. Threat to Auditor Independence

The matter of whether or not non-audit services affect auditor independence has been the subject of recurring debate. 'The entire debate over whether audit firms should supply non-audit services centres on the argument that the provision of these services impairs the auditor's independence' (Antle 1984; 1). An early requirement by the SEC in 1978 made it mandatory for companies to divulge NAS that their auditors performed for them if the fees paid to the auditor for NAS were a minimum of 3 percent of the audit fees paid. This obligation was revisited in 1982 when the SEC concluded that the required disclosure "was not generally of sufficient utility to investors to justify continuation" (SEC, 1982); despite evidence from academics such as Shockley 1981 and Knapp 1985 showing that knowledge of a consulting relationship creates a perceived lack of audit or independence (Moore et al 2006).

For the accounting industry, NAS has proved to be a very lucrative area providing the platform for dramatic growth of the audit firm. By the late nineties NAS by audit firms had grown substantially. Much evidence points to impaired judgment by auditors due to high consulting fees (Moore et al 2006). Former academic research fails to offer a clear conclusion as to whether independence is altered by the provision of NAS. There is no clear empirical evidence which links NAS with corporate failure or impairment of independence. However, some literature focuses on perceived independence, and shows NAS can potentially affect the appearance of auditor independence (whether or not it affects actual independence is irrelevant to those who need to use the information auditors provide. They require a completely independent opinion from the auditor to make appropriate judgement, and impairment of perceived independence can be as damaging as an actual violation of independence (Francis 2006). Generally, former evidence points to the public perception of NAS and auditor independence as having a negative effect and therefore reduces the quality of audits. A lot of the available literature surrounding this issue was created before the growth of the consulting culture of the 1990s, therefore it is possible that these studies underestimate the importance of the level of concern surrounding the provision of NAS. Evidently, the negative perceptions that surround this issue are not accurately justified, yet there is clear acknowledgement by regulators and the professions itself that "the perception of an independence problem is just as serious as the factual impairment of independence." (Francis 2006: 751)

Fearnley and Beattie (2004) reveal that by 2001UK companies were receiving more revenue from NAS fees than the audit fee itself. The proportion of non-audit to audit fees paid to the auditor rose from 98% in 1996 to 300% in 2001. In 2000 Arthur Anderson earned $52 million in fees from Enron, just over half of this fee ($27 million) was from consulting services (NAS), making it hard to comprehend how a conflict of interest could ever have been avoided by Anderson. There was no requirement to disclose the breakdown of the composition of the fee between service types.

A prevalent issue that arises when observing an audit firm that offers both audit and non audit services to the same organisation are the different contractual relationships that exist. The first relationship that arises is that between the company and the provider of the NAS as a provider of services. Whereas the other relationship exists between the auditor and the company, and aside from being a contractual relationship, there is also the additional requirement for the auditor to owe a duty of care to the shareholders of the company it is auditing, and additionally to any other users of the financial information they allow to be distributed. (Beattie and Fearnley 2004)

On the whole, foregoing evidence consistently points to the likelihood that users may perceive NAS as negatively affecting auditor independence and hence a reduction in the quality of audits. Many academics contend that providing non-audit service increases auditors' financial reliance on the client and hence may weaken auditor independence. Therefore supporting the claim that the provision of NAS increases the auditors' financial reliance upon their clients and thereby leading to an impairment of independence. This is usually manifested by inappropriate audit adjustment in order to enhance the appearance of the financial position of the company. (Duh et al 2009)

There are a range a services an audit firm might offer a client, ranging from normal tax services (very common), to services such as inspection of a companies facilities, involving the audit firm carrying out inspections on anything a company may require inspection of (Kaplan 2004). The provision of surplus services ultimately allows the audit firm to accrue very large revenues. Thus, providing auditors with the economic incentive to keep clients and due to intense competition amongst firms, there is extreme pressure on the auditor to persuade the client to purchase NAS.

"The problem is that auditors supplying NAS have an additional economic incentive to retain clients and are assumed to be less likely to risk dismissal by disagreeing with the management group." (Craswell 1999; 30) and thus likely to satisfy management of the client by depicting the client in a more positive way, regardless of whether this undermines the quality of the audit. Behaving in this way enhances the auditors' relationship with management, and potentially lengthens the period the company will want to spend with the auditor, thus increasing future revenue streams for the auditor (Craswell 1999). This relationship may strengthen the auditors' potential to sell more NAS, but it can be very damaging to the quality of the audit opinion, as this sort of behaviour invalidates the audit due to the obvious impairment of independence.

Another potential issue in regards to NAS is the audit firm's dependency on the client, which ultimately leads to impaired independence. Hartley and Ross (1972) use non-audit fees to determine the level of impaired independence, their results display positive correlation showing that as NAS fees increase the economic dependency on the client by the audit firm also becomes greater. Raghunandan et al 2003 also depict similar findings by examination of the extent of high non-audit fees, stating the possible and probable negative effect on auditor independence. Hence, a reasonable continuation of this debate would lie in suggesting that there is a clear linear relationship between NAS and auditor independence. (The more non-audit services provided by the audit firm, the greater the extent of impaired auditor independence.)

It is therefore evident that there is a clear threat posed by the provision of NAS due to the growing importance of NAS to the revenue of the audit firm (i.e. a strong economic incentive.) This is accompanied by pressure on the audit firm and the auditor to retain the client in order to maintain revenue, thus leading the auditor to find it necessary to sell a substantial amount of NAS to clients. This threat is otherwise known as a 'self -interest' threat (Fearnley and Beattie 2004). Self-interests can potentially cover a broad range of interests; in the context discussed above, the auditor gives rise to a financial self interest by putting the interests of the firm above the duty of being an independent professional who is required to provide reassurance in financial information to potential users.

While it is rational to presume the self- interest threat is the most prevalent in regards to NAS, this is not the only type of threat that exists as a result of NAS. Other threats arise depending on the type of NAS that is being conducted. For example, a service that requires the auditor to act in a managerial manner will ultimately lead to difficulties when trying to give out an impartial opinion. Therefore giving rise to the advocacy threat. Moreover, it is not unusual for a client to be aware of how significant they are to the auditor, especially if they are providing very large revenues to the audit firm. Under these circumstances one can presume that those managers and directors who decide to buy substantial amounts of NAS could potentially apply more pressure onto the auditor. This range of threats caused by the provision of NAS potentially leads the auditor to breach their ability to give an independent opinion. (Frankel et al 2002)

Acknowledgment that the provision of NAS does not simply affect independence of the auditor in mind but also the perception of impaired independence to external users is a fundamental issue. Krishnan et al (2005) suggest that users of financial statements may regard the provision of NAS as detrimental to auditor independence, therefore, even if there is no actual evidence of impairment by the auditor; perceptions regarding auditor independence have been damaged. Research conducted by Cheung and Hay (2002) discovered that shareholders considered NAS to be the most significant threat to auditor independence. For some managers this resulted in the limitation of purchase of NAS due to the high value associated with an independent audit (Firth 1997).Ultimately, the detrimental provision of NAS not only hinders the independence of the auditor in mind but also throws a negative perception on auditor independence, as the economic incentive is clearly evident based on the fact that NAS provide the audit firm with a large proportion of their revenue. Thus, general users of financial statements might assume that the opinion given out by the auditor is biased. The occurrence of corporate scandals such as the collusion of Arthur Anderson with Enron has also reinforced damaged perceptions of NAS in regards to auditor independence.

B. Alternative Views

The opposing view as regards to the provision of NAS and auditor independence generally takes the view that the provision of NAS does not have a negative impact on auditor independence. This stance has been taken by many academics, where the underlying suggestion is that the provision of NAS has the potential ability to restore auditor independence.

For example, Palmrose (1986) and Simunic (1984) propose that the effect of allowing NAS by the audit firm actually creates a positive influence on auditor independence in that it produces efficiency. This position is based upon the premise that the auditors' value to the client is increased by providing extra services, and thus the auditors' power over the client is also substantially increased, therefore allowing the auditor to resist pressure and improve independence (Duh et al 2009). A study conducted by Ruddock, Taylor, and Taylor (2006) adds to a rising compilation of empirical evidence that explores whether or not Non Auditing Services actually restrict or impair the auditor's ability to produce an independent audit. Empirical evidence can at least allow us to come to some sort of justification of whether NAS actually does influence the auditor. Proponents of providing non-audit services emphasize that 'synergies of knowledge spill over and audit efficiency arise from providing both audit and non-audit services.' (Duh et al 2009;34)

Gul (1994) also suggests that by conducting a larger amount of NAS, the auditors actually increase their relative power over the client and enhance independence. These claims would potentially be viable in a world where there is a limited number of auditing firms, however, this is not the case. In today's competitive world, clients have the option of obtaining NAS from many audit firms. Therefore it is in fact the client who will display power over the auditor when he/she has purchased NAS as he/she is a valued client. Hence, the potential loss of a client by the audit firm is not a desirable feat and the auditors' ability to withstand pressure from the client could easily be compromised. Ultimately, the loss of a client means a reduction in firms' revenue. In circumstances where a client purchases substantial amounts of NAS from the audit firm, the withdrawal of that clients business can weigh heavily on the audit firm. Therefore, in order to retain a potentially lucrative client an auditor may compromise their independence. Thus Gul's suggestion that the more NAS provided the more auditor independence is enhanced does not acknowledge this problem. On the other hand De Angelo(1981) suggests the following "Considering that their future quasi rent stream could be forfeited, auditors will not be tempted to compromise their independence"

The reputation of the firm has often been regarded as too important to compromise under any circumstances, therefore De Fond et al (2002) suggest the recognition of impaired independence within the firm could potentially be very damaging to the firm's reputation, therefore leaving auditors determined to be as impartial and independent as possible. Impaired independence could potentially invoke other threats to audit firms, such as the possibility of legal action against the firm because of a breach of independence. Thus, regardless of the amount of NAS provided, the auditor has other incentives to remain impartial. The incentive to maintain reputation, as well as the fear instilled by potential law suits as suggested by De Fond et al (2002) to be enough to prevent NAS from jeopardizing the auditors independence. Dopuch et al (2004) also suggest that the provision of NAS allows the audit firm to grasp high quality audit clients and in turn enhance the firms' reputation, thereby providing auditors with more of an incentive to maintain independence.

There are valid points that arise from claims by De Fond et al (2002), yet proponents of NAS by auditors fall short of acknowledging the power economic incentive can potentially hold over auditor independence, and appears to impair auditor independence time and time again, Arthur Anderson being a prime example. Consequently, it appears that Dopuch et al (2004) may have overestimated the safety measures taken by auditors in order to maintain independence. Furthermore the economic incentive of NAS, invalidates the view taken on by Shockley(1981), which suggests that the eliminating NAS by Audit firms is not likely to improve perceptions by external users.

Overall, the assertion that the provision of NAS does not affect auditor independence in any way, or even improves the auditors' independence is not feasible because academics who have disputed its ability to impair auditor independence are generally ignorant of the economic incentive related to the audit firm conducting NAS and also the power the client can potentially hold over the auditor because of the importance of their custom.

4.3) Protective Measures

Although extensive literature ascertains that NAS has no effect on the auditor's ability to provide an independent and objective opinion, reviewing the issue of NAS by audit firms' clearly suggests that the provision of NAS can threaten the auditor's objectivity. The threat is one which is difficult to control, as measuring the level of independence held by the auditor is a very difficult thing to observe, therefore in order to eliminate the threats posed by NAS, academics and regulators have often suggested the only fail proof solution is to completely eliminate audit firms from conducting NAS. Although the issue has been prevalent for many years, significant action was not conducted until after the financial collapse of Enron, which led to the revelation that the company had purchased very large amounts of NAS from their auditors Arthur Anderson. Subsequent to this highly publicized scandal was acknowledgment of the fact that the provision of NAS systems was in dire need of reformatting in order to reduce or completely eradicate the extent of threat posed.

Immediate action was deployed and the US introduced the Sarbanes Oxley Act (SOX) 2002 which attempts to tackle the issue of the provision of NAS in sections 201/202. These sections propose constraints on certain NAS and calls for NAS that are not restricted to be pre-approved by the corporation's audit committee.

Section 201:

"Section 201 of the Act forbids an auditing firm from providing the following eight

areas of NAS to an existing audit client:

1) Bookkeeping or other services related to the accounting records or statements of the audit client

2) Financial information systems design and implementation

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, or investment banking services

8) Legal services and expert services unrelated to audit."

(Kaplan 2003: 374)

This list is successful in that it restricts services that may lead to impaired auditor independence, yet it fails to restrict certain NAS that are still performed by auditors at present. The most important of these permitted services are considered to be tax services, a traditional service that is offered by most audit firms. The active association of the auditor with the tax preparation alters the role of the audit firm ultimately making it act as the clients advocate. Thus giving rise to the advocacy threat. The ICAEW uses the following to describe when an advocate threat has occurred. 'There is an apparent threat to the auditor's objectivity, if he becomes an advocate (or against) his client's position in any adversarial proceedings or situations. Whenever the auditor takes a strongly proactive stance on the client's behalf, this may appear to be incompatible with the special objectivity that audit requires.' [4] 

Whilst providing tax services to audit clients the auditor must analyse the likelihood of an expenditure classification being disallowed, therefore making it apparent that the auditor may possibly be biased towards their own work, or work of an auditor from the same firm, and therefore unable to do any form of analysis in a truly independent fashion. Thus in these circumstances the auditor gives rise to the self-review threat.

Inevitably the tax service is one that disrupts the ethical requirement of auditor independence and therefore should have been included in prohibited NAS by the SOX act. This service should be reconsidered if the problem of impaired auditor independence has any chance of being resolved. (Kaplan 2003)

Section 202 of the SOX Act describes the requirements necessary to authorise NAS that were not prohibited in section 201 of the SOX. Basically, NAS that are not strictly prohibited are permissible on the condition that they are pre approved by the audit committee. This however, poses a substantial problem, as the precaution should technically prevent NAS that are detrimental to audit independence, yet the actions of the audit committee may also be compromised. An audit committee is made up of a board of independent directors, who do not require financial expertise to be part of the committee. Potentially, the Act allows any members of the committee to approve the proposed NAS, yet considering the threat to independence, approval by an audit committee alone may fall short of being effective.

Fearnley and Beattie (2004) suggest that a wider role for the audit committee would improve independence in that the audit committee provides a safeguard between the auditor and the executive management. The audit committee would also oversee independence issues from the company's perspective. Therefore independence in appearance would be enhanced because of the increased amount of information available in regards to NAS in the audit committee report, including a detailed breakdown of NAS provided.

Overall, the SOX Act 201/202 is a safeguard that fails to completely solve the problem of an auditor impairment issue. A more complete solution would be to ban the provision of all NAS to current audit clients, since that would remove the most predominant threat of self-interest in an economic context. Additionally, there is a provision that allows the audit firm to generate 5% of its total revenues from NAS, yet realistically this precaution is ineffective because 5% of millions is a sufficient enough amount to be considered an economic incentive to impair the auditor's independence. Kaplan (2003) offers a solution that would completely eradicate the risk of any threats derived from NAS by the audit firm, this would be to completely prohibit all NAS, especially considering there are so many other available places to purchase such services.


'Ultimately, any form of corporate collapse threatens to damage the credibility of accountants' claims to be 'objective constructors of reality' (Sikka 1995; 550)

The occurrence of the recent financial crisis stimulates reservations that suggest auditors lack the necessary independence and proficiency to construct the promised objective account of corporate affairs. Yet is it really fair to suggest that lacking independence in the audit profession was a contributor to failure in the financial sector? From the perspective of the auditing profession, the recent financial crisis has shown to be an interesting area. The profession has not really been related to any discrepancies associated with the whole turmoil although attention has been directed towards the inadequate competence of auditing, with specific attention focussed towards NAS and the desperate need for further control, as the constraints currently in place have obviously failed to constrict auditors from producing truly independent opinions. Humphrey (2009) suggests that when considering the crisis we are missing out a fundamental point 'where were the auditors?' As the root of the financial crisis does not lie in the hands of the auditors there has not been much emphasis on their contribution to the crisis. Yet, as apparent watchdogs of large financial institutions, it is necessary for auditors to accept some kind of responsibility. Considering it is the role of the auditor to inspect the financial health of an organisation, the repercussions of this crisis should bear more heavily on the audit profession with a focus on a need for reform in the profession.

''The auditing profession may face some very severe challenges. The continued success of the profession depends in part on its response to these challenges. Research has a role in clarifying the nature of these challenges and in exploring the possible responses. To do this successfully, this research has to explore fundamental questions about why and where the auditor's authority and power in society reside and how this location changes over time."

(Bromwich & Hopwood, 1982: 21 cited by Humphrey 2009:810)

Regulatory authorities that oversee accounting and auditing practices are displaying genuine concern that the financial crisis has exposed many problems and shortfalls. The inability of the auditors to identify potential banking crises whilst observing their finances brings about serious concern over what the auditors were accomplishing. The following suggestion by Hopwood (2009;797) refers to the current position of the audit position in the UK : " the latter are still wondering and worrying if their failures are likely to result in any costly legal challenges - creating a genuine worry that the Big Four could still become the Big Three. For that reason the British audit industry is currently in the midst of intensifying its lobbying of government for legislative changes in the limits on its legal liability.' (Hopwood 2009)

The current economic and financial crisis may have at least stimulated academics and regulators to reflect upon why we are in such a crisis, and therefore may possibly lead to more fundamental accounting research that could potentially result in change in regulations and therefore the possibility of more restriction placed upon NAS by auditors. The value of company audits are under query, as unqualified audit opinions were given out to many financial establishments who had to seek state intervention soon after the unqualified opinion was given to out (Sikka 2009). This is a cause for great concern as it is the auditor's role to pinpoint any financial discrepancies, and once the auditor believes there are no inconsistencies, only then is the distribution of an unqualified opinion appropriate. Something is clearly going wrong and leading us to question the value of the company audit. In the uncertain economic situation we have been left with, audits of large corporations should in principle provide those who have financial interests in the company with reassurance that there has been an external and objective check on the way in which the financial statements have been prepared and presented. Corporate financial statements have conventionally been used by regulators and investors to make sense of bank liabilities; therefore an accurate depiction of this information is expected to have been produced by the auditor. (Sikka 2009)

In order to display the fact that numerous organisations received unqualified opinions by their auditors only months before the financial downturn the following graph shows that each institution spent millions on NAS, therefore arousing suspicions that the high revenues sought by these extra services may have clouded the auditors impartiality in that giving out a qualified opinion to a company who is paying millions in NAS may not seem attractive in terms of economic incentive for the audit firm as it could potentially ruin the relationship between the company and the audit firm.

Figure used to create graph taken from Sikka 2009;870 (Data originally taken from each company's financial statements available from the company's website.)

*(Northern Rock fee amounts are taken from financial statements from Year End '06)

Lehman Brothers is another clear example of a large institution that received an unqualified audit opinion on its annual accounts on January 28th 2008, not long after this it received a clean bill of health on its quarterly accounts. Yet, by early August the company was going through severe financial issues, followed shortly by filing for bankruptcy. How was it possible that auditors approved Lehman's finances when clearly they were not fit enough to be approved? (Sikka 2009).

Auditors have often been a crucial tool in salvaging confidence in the credibility of capital markets. This is evident from the aftermath of the Wall Street Crash 1929 (Zeff). The last 30 years have seen the commercialization of audit and consequently the increased need for regulation because of the auditor becoming economically dependent upon their clients. 'Deregulation of the profession has seen massive corporate scandals where auditors gave clean opinions to companies that ended in bankruptcies and brought on the catastrophic collapse of the once reputable accounting firm, Arthur Andersen.'(Reference?)

Ultimately, it is simply a fact that auditors depend upon their corporate clients, and in turn, the corporate sector is reliant on the expertise provided by the accounting industry in order to ensure reassurance. Therefore, the profession has transformed into a corporate goldmine, but at the price of a loss in public confidence due to the decline in trust provided by credible audit opinions. The reassurance needed by capital markets does not appear to have been provided by the unqualified audit opinion, resulting in the collapse of many financial organisations. Recent events highlight there is clearly a need for reform in the audit profession, the expertise provided by auditors should ensure credible information that depicts a realistic portrayal of the firms' financial position. Without the reassurance that auditors are supposed to provide the opinion is rendered worthless. Intervention is certainly necessary, and an investigation into accounting practices at financial institutions would help to identify the weaknesses of existing methods.


Discussion of Findings

On examination of the impact of NAS on the independence of the auditor, and the issue of the auditors role in the current financial crisis, conclusive comments cannot be made before restating the importance of the concept of independence. This is a notion that is commonly considered an essential ethical requirement which incorporates two elements, one emphasises the importance of perception while the other focuses on the auditor's state of mind. Consequently independence is a complex concept as it is susceptible to impairment through fact and perception. Therefore maintaining independence is a very difficult task in itself, this paper suggests that the provision of NAS limits the ability of the auditor to maintain independence, or in some circumstances makes it impossible to maintain independence, hence the impact of NAS on auditor independence is ultimately negative.

When referring to independence of the mind, it becomes clear that the provision of NAS creates an extensive array of threats to the auditor; dominant threats derived from NAS management and advocacy threats. However, the most predominant threat that emerges is the self-interest threat, in which self-interest is economically motivated. To be more specific NAS render high revenues (as shown by the graph earlier taken from Sikka 2009), thus encouraging the auditor to express a biased audit opinion in order to maximise revenues and minimise the risk of losing the client. Nonetheless, this economic based self interest threat is disregarded by many researchers in the field, therefore leading them to conclude that the provision of NAS is a positive factor of auditing. The viability of this claim however continues to take significant blows in the wake of corporate collapses, namely the very recent financial crisis, not to mention previous corporate scandals such as the illustrative case of Arthur Anderson. Clearly showing us that economic incentive is very much present in today's corporate world and extremely likely to impair independence. In addition, the concept that both managers and auditors will aim to minimise negative perceptions by limiting NAS purchases has also shown to be invalid.

The recent collapses of financial institutions have also contributed to what is now a widespread anxiety of the financial statement user, as they now negatively associate the provision of NAS to auditor independence. It has become evident that regardless of whether NAS actually decreases auditor independence, users already establish negative associations due to past events, subsequently financial statement users cast serious doubt about auditor independence from the directors of the company (Hussey 1999). Emergence of concern rises again due to corporate collapse, although there were clearly concerns previous to the financial turmoil that needed to be addressed.

Therefore, it becomes apparent that a more competent safeguard needs to be implemented (due to SOXs inefficiency), to remove all potential threats to independence. Economic incentive needs to be eliminated. There is potential to completely eliminate threat but SOX fails to seize this opportunity. Instead by allowing 5% of total fees to be taken from NAS, the economic incentive is still rife because 5% of millions is still significant enough to create economic incentive. Moreover there are still are range of NAS that are threatening such as tax services still permissible through the permission of the audit committee, who also struggle to maintain independence from directors. Consequently, the SOX act fails to ensure that any threats associated with the provision of NAS and auditor independence are eliminated. It completely fails to deal with the economically motivated self-interest threat, but is also ignorant of other threats to independence.

The shortcomings of the SOX Act can be explained by observing the approach taken by regulators. Knowing the threats involved with auditor independence and NAS after Enron, the economic incentive should have been more thoroughly considered.

Regulators have approach the provision of NAS with compromise, therefore leading to protective measures such as SOX which are over complicated and unnecessary. It is very evident that the complicated concept of independence cannot be approached in way that allows half measures. As a result the prevention of all NAS to audit clients is the only appropriate uncompromised safeguard that should be implemented. Such a strict safeguard will potentially enhance auditor independence to maintain good quality audits and also fix damaged perceptions.

Overall it is feasible to conclude that the provision of NAS provides a wide range of threats to auditor independence, the most predominant being the economically motivated self interest threat which have frequently impaired the delicate status of auditor independence to disastrous levels. With the provision of NAS providing overwhelming economic incentives to auditors, it is apparent that NAS, a huge part of the audit profession today, is also a root of the self interest threat and hence a threat to independence. Therefore it is clear that appropriate safeguards have not been implemented to eliminate the threats as of yet, and unless effective safeguards are deployed, the auditing industry will lose the credibility that the industry is based upon.