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Factors inﬂuencing auditor independence: Malaysian loan ofﬁcers’ perceptions
Nur Barizah Abu Bakar, Abdul Rahim Abdul Rahman and Haﬁz Majdi Abdul Rashid
Department of Accounting, Faculty of Economics and Management Sciences, International Islamic University Malaysia, Kuala Lumpur, Malaysia
Purpose – Auditor independence is fundamental to public conﬁdence in ﬁnancial reporting and the auditing profession. The study aims to provide further understanding of the factors inﬂuencing auditor independence from the perspective of commercial loan ofﬁcers. Loan ofﬁcers formed the sample as they are relatively sophisticated ﬁnancial statement users who would understand the importance of audit report and the issues related to auditor independence. Design/methodology/approach – The study examines the perceptions of commercial loan ofﬁcers in Malaysian-owned commercial banks and a total of 86 ofﬁcers responded to the self-administered questionnaire. Findings – Results indicate that smaller audit ﬁrms, audit ﬁrms operating in a higher level of competitive environments, audit ﬁrms serving a given client over a longer duration, larger size of audit fees, audit ﬁrms providing managerial advisory services, and, the non-existence of an audit committee, are perceived as having a higher risk of losing independence. Audit ﬁrm size appears to be the most important factor that affects the auditor independence, followed by tenure, competition, audit committee, audit ﬁrms providing managerial advisory services and size of audit fee. Originality/value – The paper provides important insights into the factors affecting auditor independence and contributes towards better understanding on the ways to improve the conﬁdence in ﬁnancial reporting and credibility of the auditing profession. Keywords Auditors, Independent experts, Malaysia, Commercial banks Paper type Research paper
Managerial Auditing Journal Vol. 20 No. 8, 2005 pp. 804-822 q Emerald Group Publishing Limited 0268-6902 DOI 10.1108/02686900510619665
Introduction The impairment or lack of auditor independence is a main cause of many corporate collapses and corporate scandals across the world, including the US case of Enron. This important issue has been raised by the media. Media comments have demonstrated that auditor independence is the main concern when talking about corporate scandals. The paper supplies valuable input and feedback regarding auditor independence so that these corporate scandals and collapses may be minimized or reduced. The study aims to provide further understanding of the factors inﬂuencing auditor independence from the perspective of commercial loan ofﬁcers in Malaysia. To achieve this objective, all the 12 Malaysian-owned commercial banks are included. A sample of 86 commercial loan ofﬁcers responded to the self-administered questionnaire. The ﬁndings of this study will provide better understanding on the factors that inﬂuence auditor independence in Malaysia giving a better understanding of the factors that inﬂuenced the quality of auditing as perceived by the ﬁnancial
Pany and Reckers (1983) emphasize that the concept is closely originated from the reason for the existence of auditing itself. his or her ability to make objective and unbiased audit decisions (Dykxhoorn and Sinning. Without auditors’ independence. 1985). Since independence in appearance relies on the perceptions of users of ﬁnancial statements.e. (1999) deﬁned “independence in auditing” as taking an unbiased viewpoint in the performance of audit tests. and this may be detrimental to the auditing profession itself. since the credibility of ﬁnancial information relies heavily on their independence. 1977. Bank loan ofﬁcers also represent the lenders’ or creditors’ point of view. The authors then synthesise the previous empirical ﬁndings into themes that later helps to develop research questions for the study. In discussing the foundation of the concept of auditor independence. Independence in fact (or actual independence) can be deﬁned as the auditor’s state of mind. an auditor may be breaching his/her responsibility to maintain clients’ conﬁdentiality.statement users. 1982). the literature on the basic meanings of auditor independence mainly from standard auditing textbooks is ﬁrst reviewed. independence in appearance (or perceived independence) refers to the public’s or others’ perceptions of the auditor’s independence. According to them. perceived audit independence – PAI) is one of the cornerstones of auditing theory and the sine qua non of auditing practice. It is vital that auditors maintain their independence and ensure that they provide a high quality of auditing. the rationale for the external auditor’s work (i. Dykxhoorn and Sinning. the credibility of ﬁnancial information will be reduced. Among others. objectivity and impartiality. for example. actual and perceived independence. In this situation. Another perspective of conﬂict is in terms of the auditors’ duty to either the client or the public or both might conﬂict with the perceived self-interest of the auditor. On the other hand.e. Gunz and McCutcheon (1991) found that there is a relation between independence and professional ethics especially on the issue of conﬂict of interest. as one of the major users of ﬁnancial statements. It basically refers to the mental attitude of the auditor in terms of professional objectivity (Gul and Tsui. independent audit) – indeed a primary justiﬁcation for the existence of the public accounting profession – arises from the need for reliable ﬁnancial information There are two types of auditor independence. the evaluations of the results and the issuance of audit reports. Auditor independence: a review of the literature Since the main objective of this study is to examine the factors that inﬂuenced auditor independence. by passing Auditor independence 805 . 1992). The main objective of this study is to examine the factors that inﬂuenced auditor independence. The literature on empirical studies mainly from academic journals is then reviewed with the main aim to identify and examine the factors that have been found inﬂuential to either improve or impair auditor independence. This notion of independence (i. conﬂict of interest between the duty of the client and to the public at large. 1981). Independence includes the qualities of integrity. thus. Arens et al. it is an empirical concept (Busse von Colbe and Lutter. Conﬂicts of interest might arise in many situations. Commercial loan ofﬁcers of conventional banks are chosen as the sample because they can be regarded as relatively sophisticated ﬁnancial statement users who would understand the importance of the independent audit function (Knapp.
(8) the degree of competition in the audit services market (Knapp. 1992). The second type of study on PAI focused on the differences in the positions of auditor independence among various groups.8 806 relevant information between partners. Thus. Dykxhoorn and Sinning. Lavin. Dykxhoorn and Sinning. and assessing their impact upon perceived independence since independence in fact is unobservable. 1982). For example. (4) the provision of management advisory services (MAS) by the audit ﬁrm (Shockley. 1996). whereby they did this among others. on the perception of independence. to avoid audit failure resulting in litigation against the auditor. Gul. Firth (1980) argues that if the auditor is not seen to be independent. 1981. For example. The majority of empirical studies on the PAI focused upon identifying the factors which potentially inﬂuence independence. (2) the purchase discount arrangement (Pany and Reckers. Patel and Psaros. 1993. 1981. (6) the nature of conﬂict issue (Knapp. Pany and Reckers. Another group try to rank these factors according to their degree of inﬂuence on PAI (Shockley. Their opinions are to be compared with the Securities Exchange Commission (SEC) . we will only focus on “independence in appearance”. Three groups involved in the study are AICPA members. 1989). Knapp. 1981. 1985. 1993). Gul and Tsui. 1996). Some of these studies try to ﬁnd the relationship of these factors with PAI. for this study. Others do the combination of both approaches (Teoh and Lim. since the actual independence of an auditor is unobservable. Bartlett. 1996). 1980). Most of the literature on auditor independence suggests that the credibility of ﬁnancial statements depends on the perceived independence of the external auditor by the users of the ﬁnancial statements (Firth. 1985. 1976. 1992). Gul. Bartlett. This may be the result of auditors’ self-interest. Both actual as well as perceived auditor independence are critical elements in the maintenance of public conﬁdence in the auditing profession (Pany and Reckers. 1993. 1980). 1980. Teoh and Lim. just as importantly. Among the factors that affect PAI that have been studied are (1) the effects of gifts (Pany and Reckers. Some studies focus on the differences of opinions among different groups of preparers and users (Lavin.MAJ 20. 1976. (7) the audit ﬁrm’s tenure (Shockley. 1989. Jenkins and Krawczyk. 1989. Teoh and Lim. 1980). 1996. and then whether they are positively or negatively related with PAI (Pany and Reckers. the credibility of auditors depends not only on facts but also. bank loan ofﬁcers and ﬁnancial analysts. Gul. 1992. 1989). 1981. (3) the audit ﬁrm size (Shockley. 1985. Bartlett. 1989. Gul and Tsui. Gul. Teoh and Lim. 2001. 2000). 1989. 1980. However. users will have less conﬁdence in the ﬁnancial statements. whether they are signiﬁcantly or insigniﬁcantly related with PAI. Gul. on auditor’s independence by presenting 12 auditor-client relationships. 1981. 1996). (5) the client’s ﬁnancial condition (Knapp. Teoh and Lim. 1985). and (10) the audit committee (Gul. (9) the size of the audit fees or relative client size (Gul and Tsui. and the auditor’s opinion on the company’s ﬁnancial statements will be of no value. 1980). Lavin (1976) studies the opinions of CPAs and two groups of users of ﬁnancial statements.
it has been argued that large ﬁrms. and the existence of audit committee. An audit ﬁrm’s tenure. 1983.e.. level of competition in the audit services market. In fact. the greater the auditor’s independence. Some critics invoke the vested interest argument to support the assertion that auditors might compromise their independence to gain continuing audit engagements. the few court cases which challenge the assumption that CPA ﬁrms acted independently indicate that the use of a large CPA ﬁrm is no guarantee of its ability to resist pressures from clients. Dopuch and Simunic. 1981b. provision of managerial advisory services by audit ﬁrms to the audit clients. More to the point. 1985. independent CPA ﬁrms. support this view. Tenure of an audit ﬁrm serving the needs of a given client. Size of audit ﬁrm. 1981. it appears that the SEC rulings on independence are more conservative than these users feel necessary in these situations. almost casual erosion of “honest disinterestedness”. and opportunities of providing non-audit services later (Hoyle. as happened with Arthur Andersen and Enron. The six factors are size of audit ﬁrm. 1980. On the whole. a positive relationship means that the larger the audit ﬁrm size. Basically. due to their very size. Factors inﬂuencing auditor independence There are at least six factors that have been examined by previous studies on perceptions of auditor independence. 1981). the prospect of raising audit fees if the client ﬁrm expands. Shockley. 1985. tenure of audit ﬁrms serving the needs of a given client. thus maintaining higher audit independence. Level of competition in the audit services market. gradual. size of audit fees received by audit ﬁrms. has been mentioned as having an inﬂuence on the risk of losing an auditor’s independence. less rigorous audit procedures and a learned conﬁdence in the client may arise after a long association. The US Congressional Subcommittee on Reports. Mautz and Sharaf (1961) pointed out that in a many cases. A number of empirical studies have proven that the high level of competition in the audit ﬁrm has resulted in less auditor independence (Knapp. Competition among the ofﬁces of some large ﬁrms for clients may be as great as the competition among small. Gul (1989) found the opposite. Complacency. Using a mail survey. as pointed out by Goldman and Barlev (1974). Accounting and Management (the “Metcalf Committee” (1976)) considered that the above dangers are serious enough Auditor independence 807 . he found that the consensus of the CPAs and users agrees more with the AICPA than with the SEC. However. They prove that large ﬁrms are more resistant to client pressures. the greatest threat to (the auditor’s) independence is a slow. which is the length of time it has been ﬁlling the audit needs of a given client. who discuss the relationship between tenure and AI. found that there is a positive relationship between them (DeAngelo. McKinley et al. The majority of empirical studies that attempted to ﬁnd the relationship between audit ﬁrm size and AI. SEC and AICPA) at times characterize relationships as not independent that the consensus considers as independent. 1989). Nichols and Smith. Gul. A long association between a corporation and an accounting ﬁrm may lead to such close identiﬁcation of the accounting ﬁrm with the interests of its client’s management that truly independent action by the accounting ﬁrm becomes difﬁcult (US Senate. 1983. Most writers. Shockley. lack of innovation. and that the authorities (i. Shockley and Holt.rulings and AICPA positions on auditor independence. 1976). may be more able and motivated to provide better audits. one should not conclude that large CPA ﬁrms are immune to pressures from their clients. 1978).
Noordin (1990) expresses his concern that a code of ethics should provide guidance to limit over-dependence on one client for revenue. both the IFAC’s (1996. He also found size of audit fees to be an important determinant of bankers’ PAI. Such attention has prompted research into the inter-relationship between size of audit fees and other independence-related issues such as the provision of MAS. there is a study that proves otherwise. They advocated that the size of the client relative to the audit ﬁrm has a signiﬁcant . in a highly competitive environment. the size of the audit ﬁrm and competition on a third party’s PAI actually arise because of the linkage of these variables to audit fees. Size of audit fees received by audit ﬁrm (in relation to total percentage of audit revenue). Another study related to the size of audit fees was by Pany and Reckers (1980). Shockley (1982) suggests that the adverse effects of MAS. the EFAA (1998. instead they inter-relate it with other factors. 4) clearly states that. Teoh and Lim (1996) also ﬁnd the same and report that there is a negative relationship between tenure and AI. the auditor is also perceived to be less independent due to the increased likelihood of losing a client and the revenue the client generates. This 15 per cent criterion has also been the level generally used in Australia at which auditors have to consider their independent position and there is even a suggestion that the 15 per cent is too low. the size of the audit ﬁrm and competition. 1996). tenure was not found to have a signiﬁcant impact on perceptions of independence. this suggestion has been opposed (Shockley. namely MAS. 1981.8 808 to recommend the mandatory rotation of auditors as a possible remedy. p. when talking about the relationship between size of audit fees and AI. 1978) directed attention to the importance of size of audit fees as one of the crucial independence-related issues. Normally.7) Code of Ethics for Professional Accountants and the EFAA (1998) suggest that client size (measured from size of fees) could raise doubts as to independence. The Accountants International Study Group (1976) recommended that auditors be restrained from accepting engagements for which the fees constitute 10 per cent or more of the auditors’ total fee income. Further. large size of audit fees are associated with a higher risk of losing the auditor’s independence. Burton and Fairﬁeld (1982) point out that there may be a close linkage between MAS and size of audit fees. Gul (1991) hypothesized and tested the notion that size of audit fees is a major determinant of bankers’ PAI regardless of other variables. Nevertheless. p. It also seems plausible that smaller audit ﬁrms will be more dependent on the client if the size of audit fees generated is a signiﬁcant proportion of its overall revenue. The Cohen Commission (AICPA. but do not state what constitutes an unacceptable proportion of total fees. Additionally. competition and the audit ﬁrm size. As a result. Thus. Rotation ensures that the auditor remains independent since tenure will be limited and any vested interest will no longer be relevant (Teoh and Lim. Nevertheless. most empirical studies conducted on size of audit fees do not look at that factor per se. In Malaysia. the auditor is likely to be more dependent on the client due to the size of the fees generated.MAJ 20. 1981a). “the (total) fee from one client should not exceed a certain percentage of the total turnover of the audit ﬁrm”. However. For example. The ICAEW has ruled that the size of audit fees of a major client should not exceed 15 per cent of total fees to avoid impairment of auditor independence. He showed that each independence-related variable affects bankers’ PAI in its own right. 8. DeAngelo. For example. In a study conducted by Shockley (1981). As the provision of MAS increases.
they note that respondents express less conﬁdence in the auditor’s independence when a client was large (size is deﬁned in terms of the audit fee measured as a percentage of ofﬁce revenues). Several empirical surveys were conducted in order to ﬁnd how third parties. Pany and Reckers (1983. The results are. auditors and ﬁrms view this issue. even though the effect of client size do not show any signiﬁcant results. McKinley et al. the studies by Shockley (1981). Consequently. 1999. 1996). Coreless and Parker (1987) ﬁnd similar results. the replacement of the consulting auditor may result in a loss of valuable advice to the ﬁrm. (1985) report that early research related to ﬁnancial statement users indicated that auditor independence is negatively affected when non-audit services are performed for audit clients. The bargaining position. therefore. some other studies found a positive relationship between MAS provision and PAI. becomes stronger. similar to its debate. 1982. which is inconclusive (Goldman and Barlev. Contrary to the above. Wallman. Reckers and Stagliano (1981) conclude that the loss of conﬁdence in the external auditor increased signiﬁcantly if non-audit fees paid to the auditor exceeded 50 per cent of the audit fees. a positive relationship between audit committees and AI means that the existence of an audit committee will enhance auditor’s independence. 1987) and other factors such as cultural differences of the subjects may also be a signiﬁcant factor in the way MAS is viewed in the context of auditor independence. On the contrary. There is much support to suggest a positive relationship between audit committees and auditor independence. Shockley. Knapp (1985) and Lau and Ng (1994) ﬁnd that the existence of an audit committee increases the likelihood of bankers’ approving a loan. Teoh and Lim (1996) in their study ﬁnd that the formation of audit committees has a strong positive impact on enhancing auditor independence. 1984) and Knapp (1985) all ﬁnd that the provision of MAS negatively affected PAI. Similarly. (1985) ﬁnd that the provision of MAS did not signiﬁcantly affect bank ofﬁcers’ PAI. which is a reﬂection of an increased conﬁdence in the auditor. 1974). They argued that this occurs because most consulting-type services are non-routine and because these services beneﬁt the client ﬁrm directly. For example. According to Goldman and Barlev (1974) who support this view. the addition of management services increases the power and independence of the auditors. there are studies that have shown that the provision of MAS has no effect on PAI.direct or modifying effect on the PAI. They deﬁne size in terms of the audit fee measured as a percentage of ofﬁce revenues. They found that it has no signiﬁcant effect on perceived independence. However. The conﬂicting results suggest that the effect of MAS on perceptions of auditor independence is complex (Gul. in their study of 1983. Basically. Coreless and Parker. Auditor independence 809 . thus increasing the auditor’s objectivity (Goldwasser. Patten and Nuckols (1970). s/he is better equipped to resist interference in the performance of auditing duties and is more likely to retain independence. McKinley et al. They believe that MAS provision enhances the auditor’s knowledge of the client. Audit committees. their perceptions of ﬁnancial statement reliability or their loan decisions. Management advisory services (MAS). Similarly. Finally. however. 1989. They believe that these collateral services create a working relationship between the auditor and the client that is too close. Gul (1989) ﬁnds that audit committees did not signiﬁcantly affect the perceptions of auditor independence.
the remaining ﬁgure of 1. The formation of audit committees is found to have a strong positive impact on . as well as its responsibilities in the advancement of the practice and the study of accountancy. it adopts the International Accounting Standards (IAS). in its goals has broadened its scope of services so as to keep step with the challenges of the times. Its training programmes and schemes are best described as the only means of selecting the best or the “creme de la creme” of accountants.1 per cent are of the large size audit ﬁrms with more than nine partners. about 91. The non-rotation of audit ﬁrms is not a dominant factor. public practice. While medium size audit ﬁrms with three to eight partners constitute 7.8 810 Malaysian accounting and auditing profession In Malaysia. MICPA. Results show a large audit fee received from a single client is the most important factor leading to the impairment of PAI. which is established under the Financial Reporting Act 1997 (the Act) as an independent authority. one of the few studies undertaken by Gul and Teoh (1984) investigate the effects of combined audit and management consulting services by public accounting ﬁrms on a sample of the Malaysian public comprising public accountants. To date. They found that the expansion by audit ﬁrms into non-audit services reduced their conﬁdence in the auditor’s independence. Shareholders also believe that auditors could still remain independent if the audit ﬁrms provide non-audit services. The Institute is a member body of regional and international professional bodies which play a signiﬁcant role in the development and advancement of the accountancy profession globally. bankers. Gul and Teoh conclude ` that shareholders are less sophisticated users of ﬁnancial statements vis-a-vis the other groups. managers and shareholders. They employ a repeated measures experimental design. Teoh and Lim (1996) investigate the effects of ﬁve selected variables on the PAI of Malaysian public and nonpublic accountants. The body which develops and issues accounting and ﬁnancial reporting standards is the Malaysian Accounting Standards Board (MASB). while there are no deﬁnite conclusions for other categories of respondents. It was also found that majority of respondents (except for shareholders) felt that it was not possible to separate the rendering of management services from participating in decision-making. With regards to qualiﬁcation in becoming a Certiﬁed Public Accountant. the only local body in Malaysia which conducts a professional accountancy examination which is recognised under the Accountants Act. The MICPA instituted its examination system in 1961. the MICPA (formally known as MACPA) has trained more than 1.4 per cent of Malaysian audit ﬁrms fall into the category of small ﬁrms with one to two partners. commerce and industry.500 qualiﬁed accountants. some of whom are in senior positions in Government.5 per cent of the population of audit ﬁrms. 1967 is Malaysian Institute of Certiﬁed Public Accountants (MICPA). Basically. followed by the provision of management consultancy services. In Malaysian.MAJ 20. which is established under the Accountants Act 1967. the authoritative body which regulates the accountancy profession is the Malaysian Institute of Accountants (MIA). Research methodology There are not many studies on perceptions of auditor independence outside the Anglo-American countries. With regards to size of audit ﬁrms in Malaysia.
To what extent is an audit report important for the loan ofﬁcers to make their lending decisions? RQ2.e. Since they occupy strategic decision centres in the ﬁnancial community. which are among the major users of ﬁnancial statements. all the ten conventional commercial banks and two Islamic commercial banks in Malaysia are included. They were selected as the sample population of this study because they are regarded as relatively sophisticated ﬁnancial statement users who would understand the importance of the independent audit function (Knapp. Research questions The following research questions have been developed. Prior to 2001. all included in this study. (Dalila. The commercial banks are the main players in the banking system and they operate within the ambit of the provisions of the BAFIA (Banking and Financial Insitutions Act 1989) and under the direct supervision of Bank Negara Malaysia (1999) (the Malaysian Central Bank). What kinds of relationships (i. However. Both conventional as well as Islamic commercial banks are included since they have more or less the same characteristics.enhancing auditor independence. audit ﬁrm size. mainly based on the development of literature on auditor independence: RQ1. tenure. they are chosen as the third-party population to be studied. 1985). Lack of studies on factors inﬂuencing perceptions on auditor independence prompted the need for such a study. MAS and audit committee) and the auditor’s independence? RQ4. its direction) exist between the six factors (i.e. MAS and audit committee) is the most important factor inﬂuencing auditor independence? Data collection The subjects are bank loan ofﬁcers who are charged with assessing the loans applied for by companies (regardless of the company size or the amount of the loan). currently there are only ten Malaysian-owned (conventional) commercial banks. while the positive impact of disclosure of non-audit fees is considerably less. size of audit fees. The only difference is that Islamic banks operate based on the Syariah law. competition level. Do the loan ofﬁcers think that the six factors (i. size of audit fees. for example. In this study. 2000). audit ﬁrm size. They were also selected. audit ﬁrm size. there were 17 Malaysian-owned (conventional) commercial banks.e. because the loan ofﬁcers of banks make use of accounting information in business decision situations. Auditor independence 811 . tenure. tenure. MAS and audit committee) have any inﬂuence on an auditor’s independence? RQ3. competition level.e. in terms of the nature of their businesses and products and services offered. Bank loan ofﬁcers also represent the lenders’ or creditors’ point of view. size of audit fees. This study extends studies done by Gul and Teoh (1984) and Teoh and Lim (1996) in the Malaysian context. due to the merger and consolidation programme among domestic banking institutions. competition level. Which of the six factors (i. especially in a non-Anglo-American environment. while conventional commercial banks do not.
27. Out of the 12 banks. The questionnaire has been self developed by the researchers taking into consideration factors such as the level of difﬁculty of the questions and the length of time needed by the respondents in answering it. Accompanying each set of questionnaires were letters addressed to the contact persons explaining the research and requesting them to cooperate in distributing as well as collecting back the questionnaires to and from their relevant ofﬁcers.3 per cent. Samples are chosen using stratiﬁed random sampling. 240 questionnaires were sent out. Twenty sets of questionnaires were sent to each of the 12 banks. standard deviation 42. 116 were received. It was pilot tested to check reliability. obtained a mean score of 8. The respondents were a heterogeneous group with an average age of 30. range from 2 to 180 months). These unusable replies are excluded from the analysis due to the failure of the respondents to complete certain parts of the questionnaires.8 per cent.45. The mean score. The range of 1-9 is chosen simply for comparable purposes with prior studies. when comparing this result with Firth’s (1980). the questionnaires were sent to the contact persons. There are two types of audit report. The level of importance is verbally anchored at the end points with “1” indicating unimportant and “9” very important. He concluded that the loan ofﬁcers regarded an audit report as being “very important” in making lending decisions (Table I).355 years. The mean score for this question is 7.92. producing usable replies of 35.8 812 In short. However. namely the ﬁnancial statement audit report and the special purpose audit report. the mode is 9 and the median is 8. range from 22 to 48 years) and a mean experience in lending decisions of 52. out of the 116 questionnaires returned.07 years (standard deviation 5.26 months (equivalent to 4. However. It was pilot tested on ﬁve academicians from the Department of Accounting. International Islamic University Malaysia (IIUM) and ﬁve postgraduate students undertaking Master of Sciences in Accounting from the same department. understandability and language. including both conventional as well as Islamic commercial banks in Malaysia. Data were collected using the survey method. Firth (1980) in asking the loan ofﬁcers the importance of an audit report in making lending decisions. Results and discussions Of the 240 questionnaires. a response rate of 48. the present study score is slightly lower. the sample population of the study comprises the commercial loan ofﬁcers of all local commercial banks. The questionnaire included six main elements with three main parts A. The respondents could choose any point on the scale. only 86 are usable. This question does not exclusively refer to only one of them. After the necessary technical and other revisions and amendments had been made.814 (standard deviation ¼ 1:2128Þ. which is quite high. The degree of importance of the audit report The ﬁrst question in part A asked the respondents to give a score on how important they think an audit report is in making their lending decisions. indicates that the respondents regarded an audit report as being “very important” in lending decisions. .MAJ 20. B and C. In total. but rather refers to either or both. one bank refused to participate at all in the study. Self-addressed and post-paid envelopes were provided by the researchers to facilitate the process.
2 and 3). since the respondents view the role of the audit report as very important in making their lending decisions. However. It is found that 75. The implication of this ﬁnding is that it can be used to determine how the respondents perceived auditor independence. This notion has been brought up by Firth (1980). 86 and 87. and any number before that reﬂects the unimportance of an audit report in making lending decisions.7.814 Standard deviation 1.2 per cent said that the audit report is not important. while only 1. with 90. To answer. it is discovered that CLOs perceived that an audit report is “very important” in making their lending decisions.1 per cent chose scale 8. Auditor independence 813 Mean 7. whereby Firth mentioned that the importance placed on the audit report reﬂects how respondents view auditor independence. Here.5 per cent of responses mentioned that an audit report is important in making their lending decisions.2128 Mode 9 Median 8 Scale: 1 – unimportant. Bearing in mind that number 5 on the scale may signify a neutral position. surprisingly.4 per cent of them mention that the level of competition in the audit services market inﬂuences auditors’ independence. while only one respondent chose scale 4.e. The remaining 2. None of the respondents chose the ﬁrst three scales on the continuum (i. which is 9. it can be seen that 96. and (3) the existence of an audit committee have some inﬂuence on auditors’ independence.e. i.The mode. 47. a high percentage of the respondents. thus making it parallel to the ﬁndings of the previous study by Firth (1980).6 per cent of the respondents indicate that the size of the audit ﬁrm does affect auditors’ independence. respectively. This shows that almost none of them think that the audit report is unimportant in making their lending decisions. (2) the provision of MAS by an audit ﬁrm to the audit client company. shows that the majority (41.3 per cent are in the neutral position. A high percentage of respondents (30. A relatively higher percentage of respondents mention that (1) the tenure of an audit ﬁrm serving the needs of a given client. 1. while any number after ﬁve signiﬁes its importance.7 per cent indicate that the size of audit fees received by the audit ﬁrm does not affect auditors’ independence. In this case.2 per cent. it reﬂects that that they do not perceive that there is a lack of independence in the auditing profession in general.9 per cent) of respondents think that an audit report is very important in making their lending decisions. 9 – very important Table I. and 15. It shows that they have conﬁdence (regardless of the degree of conﬁdence) in the credibility of the auditing profession.2 per cent) chose scale 7. Factors inﬂuencing auditor independence The second question in part A asked the respondents whether each of the six factors listed has any inﬂuence on auditors’ independence. and supported by Gul and Teoh (1984). respondents just have to circle either “yes” or “no”. Level of importance of an audit report in lending decisions . which can be translated as “important”. while 74.
slightly agree (or disagree). Part B of the questionnaire asked subjects to indicate whether they are strongly agree (“1”). Per cent No. at this point.4 100 64 22 86 74. agree (“2”). and (4) the existence of an audit committee in the audit client company – the greater the auditor independence will be. the mode tend to agree with the negative relationship between those factors and AI.3 47.MAJ 20. Table IV above shows the mode (or most common response) for each question regarding the respondents’ level of agreement with the statements given. Table II. Per cent Yes No Total 65 21 86 75.6 24. disagree (“6”) or strongly disagree (“7”) with the statements given. Results also show that the majority neither takes the position of “strongly agree” nor “strongly disagree”. The 7-point Likert-scale was provided based on past studies and thus for comparable purposes. or. and those who believe that size of audit fees does not have any inﬂuence on AI (Table II). Per cent No. Per cent No. the direction and the strength of these relationships are not explored. (3) the smaller the amount of audit fees paid by the audit client company to the audit ﬁrm (in relation to the total percentage of audit revenue). the mode is “Yes”. size of audit fees and MAS.2 12. Frequency and percentage indicating “Yes” and “No” regarding factors which inﬂuence auditors’ independence Audit Firm size Competition Tenure Fees MAS committee Frequency Per cent No. The majority also “slightly agrees” that (1) the higher the level of competition among audit ﬁrms. tenure. while for competition level. Part B will try to explore the direction of these relationships while part C will try to explore their strengths. and (2) the provision of MAS by the audit ﬁrm to the audit client company. Each statement provides either a positive or negative relationship between the factors and auditor independence. which shows that a majority of respondents think that there is some sort of relationship between all the six factors and auditor independence.3 100 45 41 86 52. slightly agree (“3”). However. the mode tend to agree with the positive relationship between the factors and AI. Table III shows the frequency of occurrence and percentages for the level of agreement for each of the factors and their relationships with auditor independence.4 25. (2) the shorter the duration an audit ﬁrm serves an audit client.7 9. for all the factors discussed. Per cent No.6 100 78 8 86 90. For the ﬁrm size and audit committee factor. Nevertheless.8 814 There seems to be a balance between the number of respondents that indicate that the size of audit fees has some inﬂuence on AI.7 100 74 12 86 86 14 100 75 11 86 87. the more it will impair auditor independence. slightly disagree (“5”).8 100 . neutral (“4”). The mode or the majority of the respondents “agree” that: (1) the larger the size of an audit ﬁrm. They seem to prefer choosing a more moderate position by choosing a mere agree (or disagree).
0 20 23.6 18 20.3 19 22.5 0 0 3 3.7 6 7.5 0 0 0 0 6 7.0 7 8.8 2 2.3 15 17.3 23 26.1 20 23.0 21 24.0 5 5.0 29 33.9 4 4.1 13 15.6 22 25.1 10 11.1 18 20.0 20 23. Perhaps this reversal of answers happens because most respondents think that the ﬁrst six questions and the last six .1 10 11.6 20 23.3 18 20.7 4 4.3 9 10.0 0 0 10 11.3 12 14.5 21 24.7 4 4.9 5 5.1 32 37.7 12 14.6 10 11.0 18 20.9 7 8.9 7 8.5 6 7.7 24 27.4 9 10.2 26 30.Factors Size of audit ﬁrm R/ship 6 7 4 5 2 3 1 Strongly Slightly Slightly Strongly agree Agree agree Neutral disagree Disagree disagree 3 3.9 6 7.8 4 4.0 9 10.3 17 19.0 12 14. the mode of the opposite direction will be to disagree (or slightly disagree).1 24 27.7 8 9.9 12 14.4 24 27.6 0 0 5 5.2 12 14.2 4 4. Mode for each factor If we compare the mode between the two contradicting statements for each factor. This remains true for all of the six factors except for the size of audit fees where one direction is to agree and another is neutral.5 Auditor independence þve Frequency Per cent 2ve Frequency Per cent Level of þve Frequency competition Per cent 2ve Frequency Per cent Tenure of þve Frequency services Per cent 2ve Frequency Per cent þve Frequency Size of audit fees Per cent 2ve Frequency Per cent MAS þve Frequency Per cent 2ve Frequency Per cent Audit þve Frequency committee Per cent 2ve Frequency Per cent 815 Table III.0 23 26.2 3 3.6 22 25.8 12 14.0 3 3.2 20 23.1 1 1.3 14 16.3 6 7. Frequency and percentage of occurrence of responses for each question Factors Firm size Level of competition Tenure of service Size of audit fees MAS Audit committee Relationship Positive Negative Positive Negative Positive Negative Positive Negative Positive Negative Positive Negative Agree/disagree mode 2 6 6 3 6 2 4 2 5 3 2 5 (agree) (disagree) (disagree) (slightly agree) (disagree) (agree) (neutral) (agree) (slightly disagree) (slightly agree) (agree) (disagree) Table IV.4 8 9.3 7 8.7 7 8.1 14 16. we will ﬁnd that if the mode is to agree (or slightly agree) with one direction of the relationship.0 26 30.5 25 29.0 10 11.3 4 4.1 6 7.8 1 1.6 37 43.7 25 29.5 16 18.6 18 20.9 12 14.7 13 15.9 14 16.
On the other hand. (2) “the longer the duration an audit ﬁrm serves an audit client. (2) “the smaller the amount of audit fees paid by the audit client company to the audit ﬁrm (in relation to the total percentage of audit revenue).71 3. The statement that has been “agreed” most by the respondents according to ranking is that: (1) “the existence of an audit committee in the audit client company may enhance the auditor’s independence”.90 4. This is then followed by the statement. (3) “auditor’s independence will be weakened if the audit ﬁrm provides MAS to the audit client company”.52 2. the greater the auditor’s independence”. the more likelihood that it will weaken the auditor’s independence”. Factors Size of audit ﬁrm Level of competition Tenure of service Size of audit fees Table V. (4) “the existence of an audit committee in the audit client company may not enhance an auditor’s independence”. This is then followed by the statement. Mean score of the level of agreement for each factor and its rank MAS Audit committee Relationship with auditor independence Positive Negative Positive Negative Positive Negative Positive Negative Positive Negative Positive Negative Mean 3. is: (1) “the smaller the size of an audit ﬁrm.62 4. Thus. according to ranking.56 Rank (according to degree of agreement) 5 12 8 6 10 2 11 4 7 3 1 9 .8 816 questions are dependant on each other (please bear in mind that out of the 12 questions statements given. the more likelihood that auditor’s independence will be weakened”. the more likelihood that it will weaken the auditor’s independence”.31 4. the more likelihood that auditors’ independence will be impaired”. they tend to answer the questions in a mirror image to each other (Table V). (3) “the shorter the duration an audit ﬁrm serves an audit client. the more likelihood that the auditor’s independence will be weakened”.31 3.49 3.MAJ 20.65 4.74 4. and (6) “the higher the level of competition among audit ﬁrms. (4) “the larger the size of audit fees paid by the audit client company to the audit ﬁrm (in relation to the total percentage of audit revenue). the statement that has been “disagreed” with most by the respondents. (5) “the larger the size of an audit ﬁrm.88 4. the last six questions are stated in just the reverse manner of the ﬁrst six). the greater the auditor’s independence”.79 3.
followed by the size and MAS factors. In parallel to that. in this study. These three circumstances show some consistencies between this study’s results with those done previously. Auditor independence 817 . these two statements are being disagreed with most by the respondents compared to other relationships for other factors. Almost similarly. and (6) “the auditor’s independence will not be weakened if the audit ﬁrm provides MAS to the audit client company”. Comparing these results with prior studies. except for the MAS factor which is ranked last after the other two factors.e. the most important factors that inﬂuence auditor independence. the positive relationship between audit committee and AI seems to have the highest level of agreement. and (6) size of audit fees. (2) the tenure of an audit ﬁrm. where all the modes are 6. certain results seem to be parallel with them. For example. Comparing the rank with the mode. One study which involved factors ranking is Shockley (1981). and (2) the negative relationship between ﬁrm size and AI. Also. part C). it is found that these two statements obtain the lowest and second lowest mean regarding the degree of agreement by the respondents. the size of audit fees is found as the factor with the highest percentage of responses that mentioned it has “no inﬂuence” on AI. it can be seen that they are almost similar. in prior studies. Quite parallel. Thus. the respondents’ views regarding that particular factor are reﬂected here in part C when they rank the size of audit fees as the least important factor which may affect AI. Level of importance of the factors inﬂuencing auditor independence According to ranking. Quite in line with that. (5) the provision of MAS. there are no supporters for (3) the negative relationship between the existence of an audit committee and AI. the tenure factor is found to be the second most important factor that may inﬂuence AI (Table VI). Comparing part C results with the ﬁndings in part A: question 2. Shockley reports the competition variable was ranked as most important. In other words. (3) the level of competition among audit ﬁrms. the tenure factor has the highest percentage of responses that agree that it has some inﬂuence on AI. The same goes for the “tenure” factor. except for the last three factors. in prior studies. are (1) the size of the audit ﬁrm. in part C. In part A: question 2. In part A: question 2. (4) the existence of an audit committee.(5) “the lower the level of competition among audit ﬁrms. in this study. there are a few cases that show some parallel answers. in this part (i. the more likelihood that auditor’s independence will be weakened”. the results of this study seem inconsistent with Shockley’s. there are no supporters for (1) the positive relationship between size of audit fees and AI.
65 Rank 1 3 2 6 5 4 Mode 1 3 2 6 6 6 Table VI. only the audit ﬁrms themselves know the size of audit fees. will be seen as highly important in decision-making. regarding the factors of (1) The size of an audit ﬁrm.97 3. The factor size of audit fees is ranked as the least important. and most importantly. which are the auditors. be it lending or investment decisions. which is ranked as the second most important factor affecting AI. mandatory rotation of audit ﬁrms) may have a strong (positive) effect on PAI.8 818 The tenure factor.36 2. For the other four factors. Usually they only assess the ﬁnancial statements of the loan applicants. Normally. that an audit report will be seen as useful and.08 3.MAJ 20. which they receive from their clients. (4) An audit ﬁrm’s tenure of service. objectivity and independence on the part of those preparing it. It is rare that the loan ofﬁcers will ask the auditor of the loan applicants to hand over their ﬁnancial statement. It cannot be denied that it is only when auditors appear to be highly independent. where this information may be available.g. as a percentage of their total revenue. Mean and rank of factors . Commercial loan ofﬁcers generally perceived that the larger the size of an audit ﬁrm. there is an important link or relationship among the auditor’s independence. the more likely it is that it may enhance the auditor’s independence. The existence of an audit committee in an audit client company is also believed to increase the external auditor’s independence. namely: (3) The level of competition among audit ﬁrms. the commercial loan ofﬁcers perceived that their relationship with auditor independence is of a positive kind. if there is no integrity. Generally. in turn. has a signiﬁcant implication. (5) The size of audit fees. (2) The existence of an audit committee. Factors Firm size Competition Tenure Fees MAS Audit Mean score 2.99 4. It implies that any policy action taken to reduce the average tenure of auditors (e. An audit report will not be seen as very important in making any decisions.94 3. the usefulness of the audit report and the importance attached to the audit report. Thus. One possible explanation is that the loan ofﬁcers themselves do not have that information available. Conclusions The high level of importance attached by the commercial loan ofﬁcers to an audit report in making their lending decisions can be attributed to their views on the auditor’s independence in Malaysia. of those who are given the right to provide an opinion regarding it is true and fair representations.
New York. and ﬁnally (6) size of audit fees. It ignores any interaction effects which may exist between any two factors. Independence of Auditors. Notes 1. commercial loan ofﬁcers believe that the auditor’s independence will easily be weakened. It is suggested that further studies could be undertaken by adding subjects such as accountants and ﬁnancial analysts. AICPA. “Special purpose audit report” basically provides the auditor’s opinion on statements other than the normal ﬁnancial statements. Study No. Secondly. Among the situations are when there is a higher level of competition among audit ﬁrms as compared to when the competition level is lower. Commission on Auditors’ Responsibilities (1978). Finally. accountants) and users (i. when there is a longer duration of service provided by the auditor for a given client as compared to when the auditor serves a given client over a shorter duration of time. It is important to note that the term “Malaysian-owned” is different from “local”. The main limitation of the study is that it only considers each factor per se. (2) competition and tenure. The commercial loan ofﬁcers seem to believe that an auditor’s independence is more easily impaired in four situations. according to their importance in inﬂuencing the auditor’s independence. (4) existence of an audit committee. (3) fees and MAS.(6) The provision of MAS. 2.e. The ranking of factors. (2) tenure of an audit ﬁrm serving the needs of a given client. References Accountants International Study Group (1976). Auditor independence 819 . AICPA. a negative relationship between them and auditor independence seems to gain more support from the commercial loan ofﬁcers. Report. in a few of the prior studies.e. American Institute of Certiﬁed Public Accountants. “Local” bank does not necessarily mean that it is owned by Malaysians. when there is a larger size of audit fees provided by the audit client to the auditor as compared to when the auditor receives a smaller size of audit fees. CLO and ﬁnancial analysts). Thirdly. NY. are: (1) audit ﬁrm size. they ﬁnd the interaction effects between (1) ﬁrm size and fees. (3) level of competition among audit ﬁrms. and (4) fees and competition. Comparisons could be made among these three groups which represents preparers (i. (5) provision of MAS. Conclusions and Recommendations. New York. For example. 16. In all these four situations. NY. when there are MAS provided by the auditor to its audit client as compared to when there is no provision of MAS by the auditor to its audit client.
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0 (1999).U. Federal Publications. OK. Lowe. 2nd ed. Schulte. Understanding Banking Services and Facilities. Pirok.T. NY. IL. “A case for the establishment of audit committees”. (1996). AICPA. Zikmund. (1996). W. October.. (1966).B. 12-13. Kuala Lumpur. (2002). “An examination of the effects of type of engagement. The Accounting Review. New York.K. 6th ed.K. 2nd ed. IL.J. T. 721-8.J. Selangor. and Reckers. . 10 No.MAJ 20. pp. L.M. “Management services: a challenge to audit independence?”. June. pp. SPSS Inc. IL. 8. Accounting Horizons. Pelanduk Publications. 2nd ed. Financial Institutions in Malaysia. The Edge. materiality and structure on CPA consulting engagements with audit client”.8 822 Further reading American Institute of Certiﬁed Public Accountants (1991). New York. Business Research Methods.A.. and Pany. K. Messier. 4. R.. (2000). and Boh. pp. Jr (Ed. CPA Handbook. (1995).. (1988). SPSSw Base 10.S. K. the Capital Issues Committee. (1998).. The Business of Banking in Malaysia. W. E. Pany. Commercial Loan Analysis. McGraw-Hill. Accounting Horizon. Dryden Press. Peng. L. Yin. Guan. C. Trans. pp. and the Kuala Lumpur Stock Exchange. (1994). Raja Tun Arshad. The Basics: SPSS 10. Selangor. “Auditor independence”.. Pang. M.G.T.F. 11 November. SPSS Inc. Selangor. Chicago. (a memorandum submitted to the Registrar of Companies. A.). (2002). The American Institute of Accountants. Wilcox. (1952) in Robert. 31-8. Auditing and Assurance Services in Malaysia. Malaysian Institute of Accountants (1990). K. D. Institut Bank-Bank Malaysia. 32-51. reproduced in summary form in) National Accountant (Malaysia) October. p. J. Oklahoma. AICPA Professional Standards 1 & 2. Chapter 13. P. Chicago.. Probus Publishing.R.0 for Windows (1999). Vol. “Auditor performance of MAS: a study of its effects on decisions and perceptions”. Application Guide. Chicago. NY.