The issuance of ATR 14 by ICAP

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Before the issuance of ATR-14 by ICAP, audit fee was used to be measured based on the mutual terms & conditions of audit firms & companies at the time starting an audit engagement. That audit fee was used to be increase by 5 to 10% in the proceeding year.

The problem with audit fee started rising with the increase of over 200% in the stipend rates of audit trainees & also with the inflationary pressures in Pakistan. Where, audit firms consider themselves at loss due to increase in audit costs arising from the increased stipend rates & inflation.

1.2 Problem Statement

Given the company's data of total assets, turnover, current ratio, leverage ratio, turnover, inflation in the economy & minimum stipend rate set by ICAP, the problem is to determine the actual factors affecting the audit fee & to obtain a model that determines the audit fee.

1.3 Hypotheses:

Based on our respective variables & intended research our hypothesis will be:

H1 : Entity's total assets has a significant impact in determination of audit fee in Pakistan. H2 : Current Ratio has a significant impact in determination of audit fee in Pakistan.

H3 : Leverage Ratio has a significant impact in determination of audit fee in Pakistan.

H4 : Inflation in the country has a significant impact in determination of audit fee in Pakistan.

H5 : Entity's Turnover has a significant impact in determination of Audit Fee in Pakistan.

H6 : Increase in the minimum stipend rate for trainees has a significant impact in the determination of audit fee after 2008.

These hypotheses are tested with a confidence level of 95% and with an Alpha of 5%.

1.4 Outline of the study

The objective is to establish a model to assess the audit fee by incorporating new factors such as minimum stipend rate, inflation & entity's turnover affecting the evaluations of audit fee in Pakistani Market. Along with the new factors as discussed above, previously studied variables will be considered as well in establishing the model that determines the audit fee in Pakistani Market.

As far as audit fee is concerned, it is the basic source of revenue for audit firm & it is very important for audit partners to assess the basic determinants of audit fee and the factors due to which audit fee may vary.

ATR-14 was issued by Institute of Chartered Accountants of Pakistan, in August, 2008 regarding minimum audit fee to be kept for audit engagements. That notification from ICAP makes mandatory, for the firms doing audit of listed and public sector entities to charge a minimum audit fee. Minimum audit fee is now also dependant on the entity's turnover. e.g set a minimum audit fee of Rs.2,50,000 for entities having turnover of Rs.500 million.

Further, it was also notified by ICAP, that decision of audit fee will take into account the inflationary effects & the increase in minimum stipend rate over the last few years.

1.5 Definitions:

Auditing: Auditing is an autonomous assessment of financial statements of an entity in order to conduct a detailed opinion whether such financial statements give a true & fair view.

Audit Requirement: As per Companies Ordinance, 1984, every company whether public or private is required to have detailed audit of their financial statements from an external auditor.

Audit Service: These external audits are provided by audit firms which must be in the form partnership having all partners with the qualification of chartered accountants.

Audit Fee: This audit service will be provided to a company by charging a certain fee. This fee is called audit fee. Other then audit, audit firms also offers non-audit services to the company i;e to her clients services such as writing books of accounts, compilation & tax services. Fee charged against providing these services are non-audit fee for an audit firm.

Turnover: It is basically the revenue generated by a company from sale of goods and services. Turnover is the yearly sales volume after adjusting the amounts for discounts and sales taxes.

Current Ratio: It is a liquidity ratio that measures a company's ability to pay short-term obligations.

Leverage Ratio: According to Lund, (2007) Debt to Equity Ratio is also referred to as Debt Ratio, Financial Leverage Ratio or Leverage Ratio.

Debt to Equity Ratio = Short Term Debt + Long Term Debt

Total Shareholders Equity

The debt to equity (debt or financial leverage) ratio indicates the extent to which the business relies on debt financing.

Minimum Stipend Rates: Stipend here is the fees payable by an audit firm to its trainees for conducting a certain audit. These stipend rates are affixed by ICAP to audit firms as minimum stipends payable to a certain trainee. Two sets of stipend rates have been taken in our analysis, namely Stipend-1 & Stipend-2.

Stipend-1: It is the stipend rate for audit trainees who are at the stage of CA-Intermediate.

Stipend-2: It is the stipend rate for audit trainees who are at CA-Final Stage.



One of the studies related to this subject was the work done by Simon & Jere(1988). The objectives of the study by Simon & Jere(1988) was to determine whether price cutting systematically occurs on initial audit engagements and if it does, then, to determine when audit fee recover or return to normal levels. There were allegations, however, that firms sometimes offer relatively low fee for the first year or the first few years of an audit, with the expectation of recovering the initial loss in subsequent years. It was believed that accommodating an audit engagement with the anticipation of offsetting initial losses or lower revenues with cost to be charge in future audits creates the same condition and represents the same threat to independence. The work in their study was extended in two important ways. First, a large sample of 214 public companies changing auditors over the period 1979-1984 is tested along with 226 control firms not changing auditors over the same period. Second, the presence of price cutting is tested for the second through sixth years as well as the initial engagement year. The purpose of this test is to determine if price cutting persists beyond the initial year, and if so, to determine when the audit fee returns to the normal (control sample) level for a continuing engagement. Test results show an average discount of 24 percent in the initial engagement year and 15 percent for each of the next two years. By the fourth year, audit fee are not significantly different from normal levels for continuing engagements. This finding shows that systematic price cutting appears to occur, that it is of a substantial amount, and that it persists on average over several years.

Study by Markelevich & Charles (2007) was intended to observe the association between fee audit fee & its quality. They used data of 4 years during the period 2000-20003. Their work assembles a measure for profitability of auditor that can be employed as a substitute for auditor's independence. The tactic was stranded in the belief that auditor's independence is prejudiced by exertion of risk-adjusted fee rather than the stage of fee received from clients. Because the risk & effort are unexamined, the paper uses alternatives based on client's dimension, density & risk to approximate irregular fee. Fee which is abnormal are consequent of estimation of fee model concluded from earlier studies. This study further utilizes two metrics to evaluate quality of audit i;e the SD of residuals associating accruals which are current to cash flows& the fixed values of performance adjusted discretionary accruals. The study manuscripts a significantly inverse association amid audit fee & audit value alternatives over all years. These results are healthy for a range of supplementary tests & some other blueprint terms.

The study of Michael, Peter, Robert & Amy (1992) describes the behavior of audit fee during a period of apparent increasing competition in the market for independent audit services. The purpose of their study was to determine whether real audit fee decreased between 1977 and 1981. The interval started with federal investigations of anticompetitive behavior in the accounting profession, included several changes in the accounting profession that, coupled with the economic downturn of the late 1970s and early 1980s, could have increased competition in the market for audit services. The study sample was developed from a set of publicly traded companies reporting external audit fee in a University of Michigan database. Of the 98 companies reporting these data for 1977 and 1981, the two years of interest, 20 were expelled to curtail the likely puzzling effects of major changes in internal auditing, the impact of auditor turnover, and changes in regulation of the banking industry on external audit fee. The study finds a significant decrease in real audit fee between 1977 and 1981. These findings were not sensitive to alternative specifications of the audit fee model and were not driven by any particular industry or audit firm. The results of their study were consistent with claims of increasing fee competition in the market for independent audit services. In view of the number of changes occurring in the audit profession and the market during that period, it is difficult to make causal inferences about the effects of particular changes in the profession on audit fee. Thus, this article should be viewed as a descriptive study of the behavior of audit fee in a time when the market for audit services was allegedly becoming more competitive.

David & Richardson,(2003) studies the association amid the fee paid to auditors for audit & non-audit service. They used a joint sample of large firms & establish a ratio of non-audit fee to total fee has a direct impact with the absolute value of accruals similar as concluded by other studies such as Frankel, Johnson and Nelsen (2002). The sample consists data of 5815 firms for 2000 & 2001. But the positive relation only occurs for 8.5% firms of the sample who were having homogenous regression structure. Whereas, in contrast to the fee ratio results, consistent facts was found of a contrary alliance between the stages of both types of audit fee (audit & non-audit fee) paid to the auditors & accruals. So, Higher fee were associated with smaller accruals. It was also indicated that the inverse association was most common for clients having weak governance. In general, outcome of this work was more regular for auditor behaviour being controlled by the effects related with permitting clients to engage in unusual accrual choices.

In spite of widespread study on the determinant of external audit fee, there is modest study on the impact of internal audit involvement on the external audit fee. Study by William, Audrey & Mario (1999) initiated the concept for role of internal audit in determining audit fess for companies. They used cross-sectional regression replica based on previous audit fee research. Their research gives indication that the role of internal audit is a major determinant of the external audit fee. Moreover, a second form that provides confirmation on the determinants of internal audit contribution was formed and verified. This second framework signifies that internal audit's role is dependent on quality of internal audit and, provisional on the stage of natural risk, the accessibility of internal audit and the scope of synchronization between internal and external auditors. These findings are based on an exclusive data-set inclusive of publicly available data in time with survey replies from internal and external auditors associated with 70 non-financial services, Fortune 1000 companies. The sample consists of all of the ex- "Big 6" international accounting firms and clients from 29 diverse industries. outcome signifies that the greater the contribution of the internal auditors to the financial statement audit, the lower the audit fee. Examination of the factors influencing internal audit contribution suggests that role of internal audit is subjective by internal audit quality. We also find that as inherent risk increases, the effect of internal audit availability on contribution diminishes, while the effect of coordination on contribution increases. Overall, findings suggests that internal audit contribution can result in reduced external audit fee, and that client firms can potentially affect internal audit contribution by investing in internal audit quality, managing availability, and facilitating coordination between the internal and external auditors.

The study by Craswell & Jere (1999) examines initial engagement pricing in Australia during a time period when comparable U.S. studies reported discounts of 25 percent .This Australian evidence finds initial engagement discounting only for upgrades from non-Big 8 to Big 8 auditors. The study examines initial engagement pricing in Australia for a sample of 224 initial engagements from the mid-1980s. The empirical results reveal that no significant discounts occur for three of four distinct types of initial audit engagements. Specifically, no discounts were observed for initial engagements arising from within Big 8 auditor changes or within non-Big 8 auditor changes or even changes from Big 8 to non-Big 8 auditors. Fee discounts were observed only for the changes from a non-Big 8 to Big 8 auditor. The purpose of this study was also to determine whether initial engagement audit fee discounts do or do not occur in settings where audit fee are publicly disclosed. Audit fee are publicly disclosed in Australia and no evidence was found of fee discounting except when the initial engagement is an upgrade in audit quality from a non-Big 8 to Big 8 auditor. The observed initial audit fee discount for upgrades to Big 8 auditors is consistent with the well-established economic theory of discount pricing of higher priced higher-quality experience goods (like Big 8 audits) as an inducement to purchase when there is information a symmetry between buyer and seller regarding product quality that is resolved only through purchasing the good.

The primary motivation for the study by Pong & Whittington (1994) was to gain an understanding of the working of the audit market & particularly with respect to issues of Big-8 audit firms & low-balling. In this study by Pong & Whittington, it was determined that the size of the company (auditee) is of fundamental importance for the calculation of audit fee. An auditee size can be measured in terms of entity's total assets or total turnover. Further, complexities of audit & the enterprise's profitability also have a very significant impact on audit fee. Complexity in this study was considered in terms of the quantity of subsidiaries each company(auditee) is having. In this study, relation between complexity of audit & audit fee was also been associated with the Big-8 effect. By their results it was found that Big-8 audits were more expensive than non-Big-8 audits. But the premium for complexity for Big-8 audit firms was lesser than that charged by the non-Big-8 firms, suggesting that they are relatively efficient in doing complex works. On these grounds it was unable to conclude that the Big-8 is relatively inexpensive in doing larger audits. With regard to the low balling, a persistent tendency was observed for newly appointed auditors to charge lesser than on average to incumbent auditors. It was specially observed in the case of newly appointed auditors when they were not Big-8 auditors. However, the Big-8 also charged slightly less when newly appointed. So, it is possible to argue that low-balling takes place when the new auditor does not charge a premium to cover set-up costs.

The purpose of the article by Mark, Raghunandan & Subramanyan (July,2002) was to empirically verify the connection between non-audit (and audit) fee paid to current auditors and auditor independence, where auditor independence is substituted by the tendency of auditors to report the issue of opinion going concern. They carry out their study on 1158 troubled firms with proxy statements that incorporate disclosure of audit fee. Their work also constitutes the study of 96 firms who were issued going concern audit reports for the first time.

Ismail Adelpo(2009) indicated possible misspecification in the single linear equation model and the potential for simultaneous equation basis in the SEM. The panel data analysis confirms the findings of prior literature that there is a relationship between audit and non-audit fee but statistically insignificant. The purpose of his paper was to examine modeling issues in the research of the relationship between audit and non-audit fee by comparing the outcome of a single-equation model of fee to the results of simultaneous equation model (SEM) of these interactions for a sample of 2072 UK listed companies and also by exploring the benefits of using a panel data approach. Results by Ismail revealed that although the documented positive relationship in the single model is stable between audit fee and non-audit fee, this result suffers from simultaneous equation bias. The panel data analyses also indicated a positive relationship between audit and non-audit fee but statistically insignificant. Furthermore, a number of the variables that were previously found to be statistically significant in determining auditors' fee were not found to be statistically insignificant under the fixed effects model.

The study by Kamal Naseer & Rana Nuseibeh (2007) examines the audit fee structure in a developing economy. The replica for audit fee was experienced by use of cross sectional regression on variables such as profitability, risk, status of the audit firm, corporate size, degree of corporate complexity, corporate accounting year and the delay amid the audit report and the accounting year end. The fallout of the study concealed that audit firm's status, type of industry, level of complexity, industry type & risk are the prime factors for audit fee. Nevertheless, factors such as corporate accounting year end, profitability & time delay amid year end & audit report date appeared to be immaterial factor for audit fee determination. A major contribution of their study is the use of total number of employees as a size measure. Since, total assets are likely to be affected by age, asset replacement decisions and the choice of accounting policies in use within the company. It is possible to see similar companies reporting similar assets at different values. Hence, the employee number engaged by a corporation forms a more objective measure of size.

Paper by Santanu Mitra, Donald R.Deis & Mahmud Hossain examines the empirical association between expected and unexpected audit fees and reported earnings quality for a sample of Big 4 client companies over a period from 2000 to 2005. For data analysis, they used the data of 1142 firms for 5 years during the period of 2000 to 2005.The purpose of the paper was to evaluate the relation between both expected and unexpected audit fees and performance-adjusted discretionary accruals. Results revealed that increase in the earnings quality have a positive association with expected & unexpected audit fees which was also indicated by the reduction of both absolute & signed discretionary accrual adjustments. Moreover, in some specific these trends were found to be consistent in the period after the implementation of Sarbanes-Oxley Act. They segregate the audit fees into expected & unexpected audit fees in order to separately capture the effect of the two fee constructs having different fee constructs having different economic implications for auditors. Final result holds that expected audit fees is based on auditor's efforts is consistent with client-specific risk, profitability growth & the complexity of client's business. Whereas, unexpected audit fees which was may be dependent on the client specific business relation.

Another study was made by Santanu Mitra,(2009) on the subject of audit fees with relation to SOX act. The purpose of his paper was to verify the relation of audit fess with pervasiveness, severity & remediation of internal control material weakness (ICMW) as reported by the SEC registrants under SOX section 404 & audit fees. His paper employs a multivariate regression models for a sample of 854 firms having their data for 3 years i;e 2004,2005 & 2006. These 854 are those firms that disclosed ICMW for the first time in these 3 years. Attempt was to investigate the association of pervasiveness and severity of ICMW and its subsequent remediation with audit fees. The results reveal that audit fees are positively associated with severity, pervasiveness when the companies were disclosing ICMW. Also, the audit fees was found negatively associated in the years when the companies when ICMW remediation took place. The results also shows that audit fees have a higher impact when the remediation of systematic control weaknesses took place as compared to the remediation of non-systematic ICMW.

The study by Andrew Ferguson, Jere R.Francis & Donald J.Stoke (2002) takes into account the role of expertise of an auditor in terms of either industry or office level. They examine these roles in pricing of audits by Big-5 audit firms in Australia. they tests whether an audit market prices an auditor based on its wide industry expertise or or alternatively based on its office level expertise. It was concluded that there was a premium of 24 percent overall for an industry expertise when the auditor is both city specific industry leader & of the top two firms nationally in the industry. No premium was found as earned for top two nationally ranked firms where they are not city leaders. It was finally documented that office level industry leadership in city specific audit markets plays a vital role in the development of market perception & pricing of audit assignments. As their results provide support for the office level expertise rather than industry wide expertise.

Individual study by Zoe-Vanna Palmorse,(1989) examines the effect of audit fees in relation to the nature of audit contract type. These natures were either based on fixed fee or cost reimbursement basis. The background of his study was the hypothesis of earlier researches that audit fees would be higher for fixed fee audit structure with low number of audit hours. His study verifies the association of contract type to audit fees & hours. Results indicated that audit fee was comparatively found lower with no relation to audit hours. He used data of 361 public or closely held companies for his analysis. The research also implies that contract choice whether fixed or cost-reimbursement is neither dependant on the type of auditor (Big Eight or non-Big Eight), company's year nor neither on the auditor's owned schedule (busy or non-busy season). Moreover, fixed fee audit contract type was found predominant in the early years of auditor-client relationship with no effect of price cutting on audit fees. Finally, the study values both types of contract in terms of task uncertainty as hypothesized by the concerned auditors & their incentives.

The primary focus of the work by Iain Gerrard, Keith Houghton and David Woodliff ,(1994) were to form a descriptive model of audit fee variability, the existence and role of the internal audit in audit fees determination, industry differences in explanatory audit fees models. Auditee size & the audit complexity were taken as the primary variables. Their study also examined some alternative measures for auditee size & complexity which can be used to form a model for some level of descriptive power. Marked industry differences will play a role in determination of model for audit fees. But importantly, no role was found of internal audit as a constituent of audit fee determination.



3.1 Method of Data Collection

Data collection was based on extraction from Web Sites. The web sites used for data collection were of the 40 companies on which research has been carried out. Further, database of ICAP & SBP was also used to quote the rates of inflation & stipend rate for trainee's respectively.

3.2: Sampling Technique & Sample Size:

A representative data of 40 public limited companies out of 818 listed in Karachi Stock Exchange was selected for the last 4 years to test the hypothesis. These 40 companies' data was chosen based on the basis of their total assets as on 30th June,2010. It means that 40 companies having the highest figure for total assets were selected for our analysis. These companies belong to different sectors such as Oil & Gas, Cement, Textiles, Chemicals & Telecom.

Due to complex nature of financial statements from the financial sector, all those companies were excluded from the analysis such as Banks, Leasing Companies, Investment Companies etc,

The data was of last 4 years financial statements of these above mentioned sectors i;e from 2007 to 2010.

3.3 Research Model Developed:

Consistent with the prior audit fee literature ( e.g. Mitra et al , 2009 ; Ferguson et al, 2003 ; Mitra, 2009 ; Palmrose, 1986 ; Palmrose, 1989 ), the research has employed the multi linear regression model to examine the association of our proposed variables i;e inflation, turnover & stipend rate with audit fees.

Moreover, other three Variables i;e Entity's Total Assets(TA) , Leverage Ratio(LEV) & Entity's Current Ratio (CR) were found as the most common variables in determination of audit fee ( AF). These variables have been used by almost all of the previous researchers.

AF = α + β1TA + β2LEV + β3CR + β4INF + β5LnTO + β6Stp1 + β7Stp2 + E


AF =

Audit Fee.

TA =

Entity's Total Assets,


Leverage Ratio

CR =

Current Ratio.

LnTO =

Log of Entity's Total Turnover.


Inflation at each Year End.

Stp-1 =

Stipend Rate for CA-Inter Trainees

Stp-2 =

Stipend Rate for CA-Finalist Trainees

E =

Error Term

Our hypothesis will be tested based on the above model with a confidence level of 95% and with an Alpha of 5%.

3.4 Statistical Technique

On the basis of all variables as scale or numeric, technique of multiple linear regression for testing our hypothesis.


Table-A above describes the respective correlations among each variable in our data. These correlations were obtained of all variables with their actual values i;e without applying any transformation.

The above table describes three independent variables which were finally used for our data analysis. These three variables are reciprocals of Stipend_2, Total Assets & Total Turnover with the independent variable as Ln of reciprocal of Audit Fees.

Table-C exhibits the result of R & R- Square. R-coefficient of correlation of 0.672 indicates a mildly strong correlation between our observed & expected values.

Whereas value of R-Square, coefficient of determination, .451 indicates that the model is overall explaining 45% variation of the data. Whereas, remaining 55% variation in data is due to other factors not defined by our model.

Table-D above of Anova shows significant value of less than 0.05. It means that regression technique can be applied in our model.

Also, the ratio of sum of squares of Regression & Residual, 45:55 supports our results of R-Square as described in Table-C above.

Table-E depicts the results of significant values of variables which are finally found as significant from running regression technique.

These values were obtained after excluding those variables which were found as insignificant for our analysis. Also, all outliers of the data were removed in later part of the study.

As illustrated by the coefficients results below, variables such as leverage ratio, current ratio & inflation were excluded from the model.

Further. Transformations of Lon & Reciprocal were applied to get the residuals of our variables as normal.

Now our model will be:

Ln_Rec _ AF = -0.676 + 657_Rec_TA +1236 Rec_ TO + 3595_Rec_ Stp-2

The above model interprets that,

Positive associations are observed between our predictors ( Turnover, Total Assets & Stipend Rate for CA-Finalist ) & the dependant variable i;e audit fees.

With 1 unit increase in Reciprocal of total assets, Ln of Reciprocal audit fee will increase by 657 units,

With 1 unit increase in Reciprocal of turnover, Ln of Reciprocal audit fee will increase by 1236 units,

With 1 unit increase in Reciprocal of Stipend-2, Ln of Reciprocal audit fee will increase by 3595 units,


Hypothesis assessment is made on the results of significant values obtained from testing each hypothesis on our data.

Based on our Alpha of 0.05, hypotheses having significant values of greater than 0.05 were rejected & therefore excluded from our final model.

Whereas, hypotheses with significant values of less than 0.05 were found as significant, therefore are accepted and included in our final model.

Therefore, H2, H3 & H4 are rejected.

Whereas, significant values for hypothesis of Total Assets,Turnover & Stipend Rate were greater than 0.05, therefore we are unable to reject H1, H5 & H6 .



In this study an attempt was made to examine a relation between audit fees & some new variables such as Entity's turnover, inflation & minimum stipend rates for trainees.

Like previous research works & studies on audit fee, Total Assets, Current Ratio & Leverage Ratio are found as the common variable in the determination of audit fee.

Consistent with the studies of Mitra, Ferguson, Craswell variable such as total assets was also found as a significant variable in fees determination for audit in Pakistani Market.

Moreover, in the new variables incorporated, entity's turnover & Stipend Rate for CA-finalist were found as significant variables in the determination of audit fee.

Whereas, other variables i;e current ratio & leverage ratio were found as an insignificant variable for the determination of audit fee in Pakistan.

In the end, we finally conclude that, increase in minimum stipend rate over the last 2 years has significant influence on audit fee determination.


The conclusion of this cram can be used by audit firms to examine audit fee. Management of auditee companies can also exploit the outcome of this study to predict the amount of audit fee that they will reimburse each year.

In this respect, this study contributes to the audit fee literature by examining an important facet of the audit fee economics in a Pakistani market and provides an avenue for extending future audit fee research in this area.

Importantly, the study can be used by audit firms for analyzing & predicting their audit fees in future. As audit fee is the main source of income for audit firms so it is very important for them to keep an eye on the pros & cons associated with the variable of audit fee.


Future research in the area of Audit Fees can be made more attractive & worthwhile if sample size of the data can be extended. With stipend rate as a significant variable in audit fees determination, now more focus can be made on this variable.

Due to status of audit firms as "Partnership", limited or no data was available related the internal cost of these audit firms. Availability & applicability of that data in our thesis can add value to the conclusions of our thesis.