Normative Possibilities for Non-Audit Services

  • Benito Arruñada


In this Chapter, the analysis in previous chapters is applied to shed light on the normative question: What if any is the most appropriate type of regulation of non-audit services provided by auditors? Firstly, it briefly explains the background to the debate, highlighting the most relevant points raised in the many reports which have dealt with this topic. A normative proposal is then articulated. This basically consists of leaving market forces free to find an efficient equilibrium in terms of both the mix of services and the right combination of quality safeguards, with regulation intervening, at most, to oblige audit firms to disclose the percentage of their total fee income which their biggest client accounts for.


Audit Committee Audit Firm Audit Quality Mandatory Disclosure Auditor Independence 
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    See Briloff (1976), Benston (1979–80, p. 30) and Metcalf (1976, p. III). For earlier references, see Carmichael and Swieringa (1968).Google Scholar
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    Own translation from CNMV ( 1998, Section 11. 2 ).Google Scholar
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    See European Contact Group (1996). Idem, p. 9.Google Scholar
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    See Sections 3.7 to 3.35 of the Green Paper.Google Scholar
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    This final Section of the Green Paper is virtually identical to the recommendations of the European Contact Group, created in 1993 by the eight main networks of firms, whose conclusions were referred to in Section Scholar
  6. 8.
    Within the European Union, regulation of these matters is in the hands of the authorities in each Member State, with substantial differences found, since there is no EU regulation in terms of providing non-audit services. The Eighth Council Directive of 10 April 1984, based on Article 54.3.g) of the EC Treaty, relating to the authorization of persons responsible for the legal control of accounting documents (84/253/EC), only provides in Article 24, with respect to independence, that “Member States shall prescribe that such persons shall not carry out statutory audits which they have required if such persons are not independent in accordance with the law of the Member State which requires the audit”.Google Scholar
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    A recent example can be seen in a stock exchange context by an incident connected with the privatization of the Spanish public company Auxini. The Privatization Consultative Board, an independent public agency, believed that the advisor would not be subject to any incompatibility because it was also responsible for temporarily maintaining the list price, or exchange value, of the acquiring company, since for the latter service it merely received annual income of less than one million pesetas, insignificant compared with total invoicing of 6,600 million pesetas (see “La independencia del millón,” Expansion, 24 May, 1997, p. 4).Google Scholar
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    In this respect, DeAngelo (1981b, p. 192).Google Scholar
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    At the time of writing, an exposure draft is also under discussion in Australia which would address overdependence of the statutory auditor on a particular client.Google Scholar
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    Specifically in the case of Great Britain, Grout et al. (1994, p. 326) indicated that amongst the 100 companies making up the FTSE 100 index, fees from non-audit services accounted for between 23.3 and 0.02 times audit fees, although the maximum was atypical and the second highest figure was only three times the audit fees. SEC data also reveals a very wide range, as well as a decreasing weight of fees for non-audit services compared with audit services between 1979 and 1992 (SEC, 1994, pp. 29 and 32).Google Scholar
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    See on this Grossman and Hart (1980), Grossman (1981) and Milgrom (1981).Google Scholar
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    For an account of the main issues involved in corporate disclosure which holds a similar line to the one argued here, see Easterbrook and Fischel (1991, pp. 276–314).Google Scholar
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    Jovanovic (1982), Verrecchia (1983) and Dye (1986) model situations in which uninformed parties do not always infer bad quality from nondisclosure, due to the presence of disclosure costs. As a consequence, voluntary disclosure is less than optimal. In particular, disclosure is not profitable for those providers of bad but not the worst quality at some point in the quality scale.Google Scholar
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    This can be particularly important when limiting discretion controls the informational content of the disclosure because discretion affects how the disclosed information is seen by recipients, as modeled in Fishman and Hagerty (1990).Google Scholar
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    According to Buijink et al. (1996, pp. 80–1).Google Scholar
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    See the SEC’s Accounting Series Release (ASR) no. 250 (SEC, 1978 ). One year later, the SEC issued an interpretative release (SEC, 1979) describing several factors that auditors and registrants should consider when contracting non-audit services.Google Scholar
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    Disclosure of fees was first contemplated but finally discarded. The precise requirement was to disclose “the percentage relationships to the audit fees of the fees for the aggregate of all non-audit services and for each non-audit service that results in a fee o three percent or more of the audit fee” (SEC, 1978).Google Scholar
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    See SEC (1981; 1982; 1994, pp. 27–31). At the time of rescission, the membership provisions of the accounting profession self-regulatory body, the SEC Practice Section of the AICPA (SECPS) were revised in response to an SEC belief that information was still needed to continue monitoring non-audit activity, expressed by the SEC in ASR 296 (SEC, 1981 ). As a consequence, since 1982 SECPS members are required to disclose in their annual public report to the SECPS the total amount of fees earned for audit, tax and management advisory services, as well as certain percentage relationships of their non-audit fees to their audit fees on an aggregate basis for all of its SEC audit clients.Google Scholar
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    Auditing standards for publicly quoted corporations in the United States do require, however, that each audit firm discloses annually to the audit committee of their clients the nature and amount of the fees received for non-audit services provided to such clients.Google Scholar
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    See SEC (1981, p. 3810; 1994, pp. 28–9).Google Scholar
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    At least one study claimed that the rules did not significantly reduce the quantity of services provided (Schemer, 1984). This result is questionable, however, on at least two accounts. First, the estimation did not consider the expected growth of non-audit services. In other words, the comparison was made between quantities before and after the rules and not with and without the rules. Second, the impact of the rules on clients with the largest ratios of non-audit to audit fees (the ones claimed to be most affected) might have been underestimated. The impact on clients buying substantial non-audit services was indeed tested, but this test was made considering as “substantial” those clients with total non-audit services greater than the audit firm median. Both problems likely have the effect of substantially underestimating the alleged reduction in non-audit services.Google Scholar
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    DeAngelo (1981b, p. 193) mentions one case in this respect: the 1977 annual report of Peat, Marwick, Mitchell, which stated that the single largest audit fee comprised only 0.5 percent of total revenues.Google Scholar
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    When computing the level of diversification in all of these rules, it seems reasonable to apply a decision unit criterion to both client and auditor. In practice, this means that the auditor’s income from all companies included in the group of companies of each client would be taken into account. For the same reason, those audit firms with subsidiaries would have to compute the income they receive from each client by all companies in their group.Google Scholar

Copyright information

© Springer Science+Business Media New York 1999

Authors and Affiliations

  • Benito Arruñada
    • 1
  1. 1.Pompeu Fabra UniversityBarcelonaSpain

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