Small medium enterprices play important roles in economic sector

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SMEs or Small and Medium Enterprises play important roles in the economic sector especially in Malaysia. SMEs represent 90 percent of the commercial sector in Malaysia which contribute to 46 percent of national economic growth (The Star, 2006). Naturally, this segment becomes the key market for small and medium accounting practices (SMP) which generally are involved in assisting the SMEs in their compliance of accounting, taxation and other regulatory requirements. Some SMPs have also extended their services into advisory and consulting types of services to cater for business needs of the SMEs in the ever changing business environment.

However, just similar to SMEs, SMPs are also small and medium size organization. They lack of quality control and quality in delivery services. This is because typically 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. Additionally, as it is small and medium size, many SMPs do not follow several regulation such as the Sarbanes-Oxley Act 2002.

It could be deduced that assistance required by SMEs in supporting their growth goes beyond the compliance related services normally provided by their public accountants. Such needs are not necessarily served by internally employed individuals only. SMPs could take advantage of their strong relationships with business owners to extend their service offerings into areas that really matters to the growth of their clients. Therefore, the interest of this research is interested to examine whether quality control used in audit service is suitable to be used in non-audit service and the suitable level of non-audit fee to be charged.

This research wants to address the issue of SMP's quality control towards its non-audit fees. This research also scopes the SMP's quality of delivery services. Hence, the research emphasizes on the SMP as the sample and non-audit service as the topic area. This will be a very interesting research as so far not much research investigates SMP's non-audit services, especially related to the quality of delivery and level of fee. Further, this research will also reveal the potential non-audit services that can be offered to SME including its level of fee.

The research starts with introduction which will generate general viewpoint and research gap about the topic. The introductory begins by providing the background of the study including the brief of research gap. The background of study will brief the SMEs, SMPs, non-audit services, and its current status. After that, the introduction section will address the problem that will be examined in this research. Then, this introduction chapter will address the research question and research objective. In the end, this introduction chapter will scope the research theoretical contribution, research practical contribution, and the key term of the research. The setting of the study will be described in the end of the introduction section.

1.1 Background of SMEs in Malaysia

As reported in the SME Annual Report 2006, SMEs account for 99.2% of total business establishments but the SME sector contributed only 32% of real gross domestic product (GDP) and 19% of total exports.

SMEs account for 96.5% (39,436) of all enterprises in the manufacturing sector. Majorities are engaged in the food and beverages sub sector (32.5%), followed by chemicals and chemical products (15.6%), rubber and plastic products (10.3%) and fabricated metal products (6.6%). These industries accounted for 79.0% of total SME output, 29.8% of total manufacturing output, 26.0% of total value added and 31.3% of total manufacturing employment. (SMI/SME Business Directory)

SMEs is defined by National SME Development Council on 9 June 2005 based on two criteria: Number of employees; or Annual sales Turnover. The definitions apply to the sectors such as primary agriculture, manufacturing (including agro-based), manufacturing-related services (MRS) and services (including information and Communication Technology). Classification of SME economic activities is based on the Malaysian Standard Industrial Classification (MSIC) 2000 codes. Below is the list of economic activities for SME definition:-

Primary Agriculture;

The activities include hunting, forestry, logging, fishing, operation of Fish Hatcheries and Fish Farms.

Manufacturing (including agro-based);

The activities include manufacturing of food products and beverages; tobacco products; textiles; wearing apparel, dressing and dyeing of fur; tanning and dressing of leather; manufacture of luggage, handbags, saddle, harness and footwear; manufacture of wood and products of wood and cork except furniture; manufacture of articles of straw and plaiting materials; manufacture of paper and paper products, publishing, printing and reproduction of recorded media; manufacture of coke, refined petroleum products and nuclear fuel, manufacture of chemical products, rubber and plastic products, other non-metallic mineral products, fabricated metal products; machinery and equipment; office, accounting and computing machinery; radio, television and communication equipment; motor vehicles, trailers and furniture

Manufacturing-Related Services (MRS);

Research and experimental development services on physical science, chemistry and biology, engineering and technology, agricultural sciences, medical sciences and pharmacy; factory bus services, freight transport by road; transport via pipelines; freight transportation by sea and coastal water, storage and warehousing, packaging services, news agency services, rental of furniture and recycling of metal, textile, rubber, casting iron and steel; manufacture of machine tools and technical testing and analysis.

Services (including information and Communications Technology)

Electricity, gas and water supply; wholesale and retail trade; repair of motor vehicles, motorcycles and personal and household goods, hotels and restaurants, transport, storage and communications; financial intermediation; real estate, renting and business activities; education; health and social work and other community, social and personal service activities.

Table below summarises the approved SME definitions based on number of full-time employees:


Primary Agriculture

Manufacturing (including Agro-Based) & MRS

Service Sector (including ICT)


Less than 5 employees

Less than 5 employees

Less than 5 employees


Between 5 & 19 employees

Between 5 & 50 employees

Between 5 & 19 employees


Between 20 & 50 employees

Between 51 & 150 employees

Between 20 & 50 employees

Table below summarises the approved SME definitions based on annual sales turnover:


Primary Agriculture

Manufacturing (including Agro-Based) & MRS

Service Sector (including ICT)


Less than RM200,000

Less than RM250,000

Less than RM200,000


Between RM200,000 & less than RM1 million

Between RM250,000 & less than RM10 million

Between RM200,000 & less than RM1 million


Between RM1 million & RM5 million

Between RM10 million & RM25 million

Between RM1 million & RM5 million

Salleh (1990); Chee (1986), identified in their studies, amongst the important problems facing the SMEs development nationally are the shortage of skilled personnel, poor linkage development, lack of market access, inadequate finance, unintended impact of policy instruments, competitions from foreign SMEs and technological constraints. Salleh (1991); Sarkar et al. (1992); Chee (1986); Aziz (1981) found that academics and practitioners also have advocated that among the main problem involved is lack of funds, no research and development to upgrade quality, unattractive packaging and labeling, plus poor quality and distorted information on the demands of the international markets. Salleh (1991); Sarkar et al. (1992) also suggested that most SMEs are too dependent o the local markets for sale of their products and only a small number have successfully marketed internationally.

SME Accountability is not good. This bad accountability drives the CGA Canada viewpoint report of SME Accountability in International Federation of Accountants (IFAC) 2001. The report addresses that the SMEs require accountants who are business professionals able to contribute to all aspects of management, from financial reporting to strategic planning to human resource management.

1.2 Background of SMP

The emerging of SME encourages the birth of Small and Medium Accounting Practice (SMP). SMEs become the niche market for SMPs, especially after the bad accountability and internal control in SMEs. The lack of human resources in SMEs pushes them to do outsourcing for improving organization. Hence, SMP can also provide the non assurance service to SMEs for tackling organization improvement problems.

Background of Non-Audit Services in Malaysia

The small and medium enterprises (SME) segment forms a very large proportion of business in any economy, developed or otherwise. This segment becomes the key market for small and medium accounting practices (SMP) which generally are involved in assisting the SMEs in their compliance of accounting, taxation and other regulatory requirements. Some SMPs have also extended their services into advisory and consulting types of services to cater for business needs of the SMEs in the ever changing business environment.

The issues on audit fees and non-audit fees have been discussed in accounting and auditing profession since 1980s. In the past decade, there has been a dramatic increase in non-audit fees services (NAS). Since there are no specific regulations or methods in charging the clients, auditors tend to use non-audit fees as a tool or strategy to increase their firm's revenue. The provision of NAS charged to the client has helped to increase a firm's capital reputation because the provision is not being jeopardized by client's demand or satisfaction (Arrunada, 1999). Therefore this provision has a potential to compromise auditor's independence by creating an economic bond between auditor and client (Frankel, Johnson & Nelson, 2002a).

Even though section 201 of the Sarbanes-Oxley Act 2002, has prohibited audit firms to take any specific non-audit service that may impaired their professional independence (SOX, section 201, pp: 772), but still many of the audit firms especially small medium practioners (SMPs) do not follow the act requirement. SMPs normally provide their business to small and medium companies (SMEs).

Research done by Craswell and Guest (2000) has found that the auditors tend to charge high non-audit fees if they only provide the non-audit service. However the non-audit fees will decrease if the auditor provides the audit service at the same time to the same client.

An analysis done in 2005 on non-audit fees for 675 Canadian largest public companies also showed that NAS fees has dropped by from 29% in 2003 with 108 companies engaged with the service to 21% in 2005, the total from $ 38,000 in 2003 dropped to $ 29,000 in 2005. From 21% of the fees in 2005, 14% of the fees were paid for taxation services (Tabone, 2006). In New Zealand, the non-audit fees faced the same phenomenal where fees started to decrease but the amount started to decrease in year 2003 onwards.

In 2002, the Auditing Standard Board (ASB) has been revised and in response to financial reporting scandals, Sarbanes-Oxley act has been adopted to establish the auditing standard. Audit fees standard procedure has been revised. Later, International Standard Quality Control (ISQC) was introduced in conjunction with the introduction of the Practice Review framework as one of the mechanism to monitor auditor' compliance with technical and ethical standard. Furthermore this standard also helps to upgrade the quality of auditor whom performs the audit work.

In general, audit firms provide non-audit services such as taxation, consultancy, management advice, secretarial practice, internal audit review and other services. Lee (2003) as cited in Rose, Arfah, Kumar and Jaafar (2008) found it was 92% or about 1,400 audit firms in Malaysia are classified as small and medium practitioners (SMPs) and their main sources of income are from audit services.

In the United State, despite growing investor concern surrounding auditor independence, nearly three-quarters of total fees U.S. companies paid to auditors was for non-audit services. For instance, Chase paid the highest amount of non-audit service to its auditor PricewaterhouseCoopers, that is $85.9 million (according to Investor Responsibility Research Center, 2002). Companies that paid the highest portion of total fees for consulting work also include Marathon Oil Corp., Ohio Casualty Corp, and Royal Appliance Manufacturing Co. (Investor Relations Business, Dec 2, 2002). In Malaysia, Teoh and Lim (1996) as cited in Shafie (2002) found that consultancy fees made up 20 to 30 percent of the big-6 audit firm revenue.

Problem Statement

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.

This interview result is in line with the Sarbanes-Oxley Act. According to Sarbanes-Oxley Act title II Section 201 point G and H, registered public accounting firm may engage in any non-audit service, including tax services, only if the activity is approved in advance by the audit committee of the issuer. The Non-audit services 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, is impermissible.

By combining the interview results and the SOA classification, the services can be broadly categorized 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 will be willing to pay a higher fees. As SMPs are small-medium size, the quality of audit can be low in term of control and delivery services. The independence of the SMPs can also be jeopardized. The MIA By-Law B1-6 has defined that the level of audit fees as any amount of fees charged to the client as long as it does not jeopardized auditor's professionalism. In other side, the level of fees depends on the quality control and quality of delivery services. It becomes the interesting gap to investigate further.

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 professionalism. The value received shows the value that has been given away. The lower the audit fee received, the lower will be the quality of audit given.

Research Questions

Based on the problem statement, the specific research questions that want to be investigated are:

What is the type of non-assurance services potentially needed by SMEs?

What is the type on non-assurance services currently offered by small practice audit firms to SMEs?

What is the size characteristic of the SMPs?

What is the quality of non-assurance given by SMP?

What is the amount of fees paid by SMEs for the various non-assurance services?

Is there any relationship between Quality Service and Satisfaction level?

What is the relationship between Quality Services and Level of Non Audit Fee?

Is there any mediating effect of satisfaction level on the relationship between Quality services and Level of non Audit Fee?

Research Objectives

Generally, the objective of the study is to examine the SMEs' viewpoint to what kind of SMPs' non-audit services would be useful to SMEs, SMEs' perceptions of quality of services of SMPs, SMEs' perceptions with regards to the "conduct" of the non-audit services by SMPs, and whether they are satisfied with the services given. This issue will rise interesting the linkage among SMPs' Quality Control, SMPs' Quality of Delivery Services, SMEs' Satisfaction Level, and the Level of Fee that paid by SMEs. In brief, the objectives of this study are to:

Describe the type of the potentially needed Non-assurance services of SMEs

Describe the currently type of non-assurance service that offered by SMP to SME

Describe the major characteristic of SMPs in term of size

Describe the level of quality of non-assurance service that given by SMP

Describe the amount of fees paid by SME to SMP for the various non-assurance services

Investigate the relationship between Quality Service and Satisfaction level.

Investigate the relationship between Quality Services and Level of Non Audit Fee

Examine the mediating effect of satisfaction level on the relationship between Quality Delivery services and Level of Non Audit Fee

Definitions of Key Terms

1.7.1 Non-assurance service

Non-assurance service or non-audit service refer to are secretarial practice, taxation, consultation such as preparing full sets of account, setting up company's computerized accounting system etc, internal audit review and external audit work.

1.7.2 Quality service

According to Lewis and Boom (1983) as cited by Che Din (2004), quality service is a measure of how well the service level delivered matches customer expectations. Delivering service means conforming to customer expectations on a consistent basis. Conner 2003, as cited by Che Din (2008) cited the service performed also meets the client's expectation and perceptions. Parasuraman, et al. (1988) as cited by Bungsu (2004) had developed an instrument called SERVQUAL for measuring customer's perceptions of service quality

1.7.3 Satisfaction

Zeithaml and Bitner, (2000) defined that customer satisfaction is the customers' evaluation of a product or service in terms of whether that service has met their needs and expectations. The satisfied customer would remain loyal, required service more often, fewer price sensitive and shall talk favorable things about the company.

1.7.4 Small and Medium Accounting Practice (SMP)

SMP refer to firm those providing non-assurance services to SMEs. For examples of non-assurance service are taxation, secretarial practice, internal audit review and consultation - applying for financing, preparing accounting, applying manufacturing license.

1.7.5 Small and Medium Enterprise (SME)

SME is defined by National SME Development Council on 9 June 2005 based on two criteria: Number of employees; or Annual sales Turnover. In addition, SMEs has been further defined by SMIDEC into following sectors:

1. Manufacturing, Manufacturing-related services and Agro-based industries with full time employees not exceeding 150 or annual sales turnover not exceeding RM25 million.

2. Services, Primary Agriculture and Information & Communication Technology (ICT) with full time not exceeding 50 or annual sales turnover not exceeding RM5million.

SMIsis defined in SMIs Development Corporation Bill 1995 under Part I of Clause 2 as "a company engaged in manufacturing activities and related activities". In this study, the term used is SMEs because by looking at the definition it can be said that SMIs is component of SMEs which reflected in the first category. As such, since the sample is from all type of categories, therefore the term SMEs is more relevant to be used in this study.

Significance of the Study

Generally, this research would enable to shed some lights on the needs of SMEs and whether the SMEs are satisfied with the services that they obtained. The service providers including the industry, educators and the regulators would then be able to come out with services that are more in line with the SMEs' needs. The study will enable one to gauge the SMP's capacity and ability to provide "value added" services to SMEs. To date there is no comprehensive studies that are looking at the issue. Through understanding the needs of SMEs, various parties can then come out with the various business solutions to assist SMEs to improve its performance. For more detail, we addressed the significance of the study in two sections: (1) Theoretical Contribution, and (2) Practical Contribution.

1.8.1 Practical Implication

The practical implication of this study belongs to 3 main entities. First,


Practically, this research can contribute to the accountant in term of non-audit planning, the workfield engagement, and the non-audit reporting. In term of non audit planning, the research can contribute to the dimension that auditor has to notice in non-audit planning such as quality control and its quality delivery services to enhance the level of fee.

For the work field engagement, this research can contribute by revealing the factor that has to be notice in work field engagement. By describing the role of quality control, accountant or auditor can fix their engagement for better quality delivery and level of fee. Lastly, for the non-auditing report, this research can contribute in emphasizing the important of report in quality delivery service to enhance the level of fee.

Regulatory Body

This research can give implication in term of regulation. The result can contribute to the regulation body such as MIA and IIA. In regards of MIA, this result can have implication to regulation and policy making. The relationship between quality control and level of fee will affect the integrity of auditor, therefore it is important to have regulation tackling this issue. Therefore, MIA has to set a specific standard regarding the quality control, quality of delivery, and level of non audit fee. This issue can overcome the entrustment of clients to accounting professionalism. Moreover, this study will also give an idea to the MIA in term of changing the procedure and standard, or modified the adapted ISQC to suits the non audit service.