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    Auditor-provided nonaudit services and audit effectiveness...
    research summary posted March 10, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 11.0 Audit Quality and Quality Control, 11.08 Proxies for Audit Quality 
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    Title:
    Auditor-provided nonaudit services and audit effectiveness and efficiency: Evidence from pre-and post-SOX audit report lags
    Practical Implications:

    The results of this study have important implications for regulators, the accounting profession, and clients concerned with the escalating costs of the audit:

    • This study extends prior empirical evidence by showing that the joint provision of audit and nonaudit services does not reduce audit quality even when audit lags are shorter due to potential knowledge spillover
    • It also suggests that audit efficiencies may flow from the joint provision of audit and nonaudit services. The loss of potential synergies between audit and nonaudit services following the SOX ban on most auditor-provided nonaudit services will impose a greater cost burden on firms and may lead to lower audit quality.
    • The significance of audit lag as a determinant of reporting timelines is even more important in an era of accelerated SEC filing.

    For more information on this study, please contact Robert Knechel.

    Citation:

    Knechel, W. R., and D. S. Sharma. 2012. Auditor-provided nonaudit services and audit effectiveness and efficiency: Evidence from pre-and post-SOX audit report lags. Auditing: A Journal of Practice & Theory 31(4): 85-114.

    Keywords:
    audit quality; fee; lag; nonaudit; knowledge spillover; Sarbanes-Oxley
    Purpose of the Study:

    The debate about auditor-provided nonaudit services and whether they adversely affect audit quality or auditor independence has been a controversial topic in the profession for many years. The accounting profession generally disagreed with the prohibition against nonaudit services and argued that the joint provision of audit and nonaudit services improves the performance of the audit, claiming that knowledge spillover between the audit and nonaudit functions improves the quality of both. In academic area, empirical research has concentrated on the stream of the literature that focuses exclusively on audit effectiveness, because regulatory allegations pointed to auditors compromising their independence. Another stream of the literature that focuses on the association between nonaudit services and audit efficiency has received limited academic attention.  This study examines the relationship between nonaudit services and both audit effectiveness and efficiency using evidence from fees paid for nonaudit services and lags in audit reports.

    Design/Method/ Approach:

    The authors’ final sample consists of 5,004 firm-year observations of Big 5/Big 4 audit firms over the period 2000 to 2003 inclusive (data available in Compustat). The study used nonaudit service fees as a proxy for the extent of nonaudit services provided by the audit firm. 

    Findings:
    • Higher nonaudit service fees are associated with shorter audit report lags—a potential indicator of audit efficiency— prior to the passage of SOX, but such effects dissipate after SOX.
    • Audit quality, as measured by discretionary accruals and financial restatements, does not deteriorate when audit report lags are shorter for clients purchasing high levels of nonaudit services.
    • Discretionary accruals and financial restatements—potential indicators of audit effectiveness—do not increase when shorter audit lags occur in conjunction with high nonaudit service fees. This study also find that the firms with the highest levels of nonaudit service fees prior to SOX have the largest increase in audit lags after SOX.

    The authors claimed that taken together, the results are consistent with the concept of the auditor accumulating client-specific knowledge and expertise (i.e., knowledge spillovers) through the joint provision of audit and nonaudit services that can benefit both the audit and nonaudit services provided to clients. Additionally, the authors state the results imply that joint provision of audit and nonaudit services does not undermine the effectiveness of the audit but yields audit efficiency, and any gains in audit efficiency do not come at the loss of audit effectiveness.

    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of SOX, Proxies for Audit Quality