Week 3 Markelevich & Rosner

Students:

Samnoon Ahmed 14081482 ACD

Sicco Barendregt 14075652 ACD

1. There are concerns about the independence of an auditor when providing both audit as
nonaudit services, like consultancy and a year’s audit. In addition it is questioned if the
auditors fees affect the auditors independence.
2. The first theory implies that the auditor is economically stimulated by the fees they receive
and therefore are economically bonded. This may possibly impair an auditors independence.
The second theory implies by providing both audit as nonaudit services to the same client it
will increase the auditors knowledge of the client. As Audit and nonaudit services could
change information. This will increase the audit quality.
The third theory implies that more efforts being made by the auditor, the better the quality is
from de audit itself.
The last theory implies the ratio between risk of the audit/client and the audit fees. The
theory implies the higher the audit risk, the higher the audit fees claimed by the auditor will
be.
All the theories above imply some sort of link between the fees and the audit quality. For
theory two it is less clear than for theory 1 and 4. Theory two the link lies in providing both
audit and nonaudit services. So more fees due to providing two services and therefore
quality of the audit will increase. For the third theory it is also not stated obvious. The third
theory implies more effort and therefore more billable hours, hence more fees, and
therefore a higher audit quality.
3. They chose for fraud because fraud is measurable as the SEC has recorded these cases. In
addition the audit fees in cases of fraud where significantly higher than in cases of no fraud.
Fraud is a real flaw in the financial statements whereas other mistakes or errors are less
precise and not easy to measure and therefore conclude on. Advantage of focusing on fraud
is that since SEC sanctioned firms, ready data is available to use in the research. Another
advantage is that fraud indirectly relates to auditor independent, which on itself Is a difficult
variable to quantify and measure. Disadvantage of using fraud is the assumption of
involvement of the auditor which doesn’t always have be that way, since auditor cannot
provide 100 % assurance as this is not possible.
4. Fraud requires three elements to be present
a. Opportunity
b. Motivation
c. Rationalization
5. The variable fraud indicates that some form of material misstatment took place in the
financial reporting of firms. When linking these misstatements to the audit fees, an indirect
measure of independancy of auditors can be derived, which is the main purpose of the
article, assessing independence.
6. The authors find support for the Economical bonding theory, so theory one. This is based on
the finding that there is a positive relation between the Nonaudit services fees and the firm
which are sanctioned by the SEC.
7. To overcome auditor independance issues, auditor rotation can be made mandatory. In
addition it is also possible to regulate the auditor fees to a certain maximum, or at least
provide general guidelines for determining the audit fee. It is also possible to assign a third
party between the auditor and auditee to improve the indepence . Lastly review can be done
by a third party auditor.