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    Perceived Auditor Independence and Audit Litigation: The...
    research summary posted October 15, 2013 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
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    Title:
    Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees
    Practical Implications:

    This study provides evidence to suggest that fees from audit clients, including NAS fees, which became publicly available under the SEC’s fee disclosure mandate, are used as evidence of auditor independence impairment and are a source of audit litigation risk. While specific NAS have been banned by SOX, substantial tax and other NAS fees continue to be cited as evidence in recent litigation. Thus, these findings document important links between SEC fee disclosure mandates, NAS-induced impairment arguments, and perceptions of audit quality in audit litigation.

    For more information on this study, please contact Jaime J. Schmidt.
     

    Citation:

    Schmidt, J. J. 2012. Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees. The Accounting Review 87(3): 1033-1065.

    Keywords:
    Auditor independence; nonaudit services fees; audit litigation; auditor settlements; financial statement restatements.
    Purpose of the Study:

    In audit litigation, the plaintiff attorneys (i.e., plaintiffs’ bar) often exploit and enhance the perception that fee dependence is related to an audit failure by arguing that economic pressure to retain fees and, in particular, nonaudit services (NAS) fees led to a conflict of interest for the auditor and compromised the auditor’s independence. The purpose of this study was to investigate whether audit litigants act as if they believe jurors will perceive that substantial NAS fees contribute to an audit failure through impaired auditor independence, and thus substandard auditor performance. The author examined the initiation and resolution of audit restatement-related litigation to provide evidence on whether NAS or another source of fee dependence (e.g., client importance, audit fee dependence) impairs perceived auditor independence.

    Design/Method/ Approach:

    The author collected information concerning restatements of previously audited financial statements disclosed from January 2001 through December 2007, the auditors involved with the restatements, and the amount of fees billed during the misstated time period. The author also identified all instances of litigation disclosed as of June 2008 against the restating companies. The author then estimated a model and ran a regression to investigate whether NAS fees are associated with the initiation of audit litigation following a restatement.

    Findings:
    • Restatement-related audit litigation is more likely when NAS fees are higher.
    • This association is driven by the unspecified (i.e., ‘‘other’’) fees component of NAS rather than by tax or financial information systems design and implementation (FISDI) fees.
      • The ratio of NAS fees to total fees is positively associated with the likelihood that audit litigation results from a restatement.
    • The association between audit fees or client importance and the likelihood of litigation is statistically insignificant.
    • A restatement-related lawsuit is more than seven times as likely to reach resolution by an auditor settlement and to settle at a greater amount when the plaintiffs’ bar argues that an auditor’s reliance on client fees resulted in an auditor independence impairment.
    • The plaintiff attorneys’ arguments about NAS fees and/or client importance are associated with greater likelihood and amount of settlement.
       
    Category:
    Accountants' Reporting, Independence & Ethics
    Sub-category:
    Non-audit Services, Restatements