Auditor‐provided nonaudit services: Post‐EU‐regulation evidence from Denmark

• Date: 01 March 2019
• Author: Bent Warming‐Rasmussen,Reiner Quick,Dennis Liempd
• Published date: 01 March 2019
• DOI: http://doi.org/10.1111/ijau.12131

ORIGINAL ARTICLE

Auditor‐provided nonaudit services: Post‐EU‐regulation

evidence from Denmark

Dennis van Liempd |Reiner Quick |Bent Warming‐Rasmussen

University of Southern Denmark, Kolding,

Denmark

Correspondence

Dennis van Liempd, University of Southern

Denmark, Universitetsparken 1, Kolding,

Denmark.

Email: dvl@sam.sdu.dk

This survey study focuses on the relationship between the simultaneous provision of

audit and nonaudit services and auditor independence‐in‐appearance as perceived by

Danish stakeholders. Thereby, the perceived usefulness of the new EU public‐interest

entity regulation and audit directive is evaluated.

Our findings indicate that the joint provision of nonaudit and audit services is nega-

tively associated with perceived auditor independence. However, this differs accord-

ing to the type of stakeholder group. Many individual services, even those not on the

EU blacklist, are regarded as problematic. Nevertheless, the relation to independence‐

in‐appearance differs by type of service. The EU cap on nonaudit services fees seems

to be too high. The separation between audit firms' staff that provides auditing ser-

vices and staff that provides nonaudit services, and an approval of nonaudit services

by the audit committee, are not regarded as helpful in enhancing auditor indepen-

dence. Finally, respondents see a need to expand the strict EU regulations for audits

of public‐interest entities to audits of large non‐public‐interest entities.

KEYWORDS

Auditing, auditor independence, EU auditregulation, nonaudit services, stakeholder perceptions,

survey

1|INTRODUCTION

This paper studies the impact of the provision of nonaudit services on

auditor independence, as perceived by Danish stakeholder groups,

after the new EU regulation on statutory audits of public‐interest enti-

ties and enactment of the new EU audit directive (Directive 2014/56/

EU) into national law. Through a survey, the perceived appropriate-

ness of the EU regulation and of the amendment of the Danish Audi-

tor Act is evaluated with respect to auditor independence.

The global financial crisis was instrumental in a renewed focus,

both by users and regulators, on the suitability and adequacy of the

legislative framework for statutory audits of financial statements.

The question was raised as to how to enhance audit quality to mitigate

future financial risks and crises (EC, 2010). Audit quality can be

defined as the market‐assessed joint probability that a given auditor

will both discover a breach in the client's accounting system (compe-

tence) and report it (independence) (DeAngelo, 1981). In the EU Green

Paper on audit policy (EC, 2010), the independence of auditors in

general, and the provision of nonaudit services in particular, were a

major element, referring to independence as the “unshakable bedrock

of the audit environment”(p. 10).

The International Federation of Accountants (IFAC, 2016) distin-

guishes between independence of mind and independence in appear-

ance. Independence of mind is defined as “the state of mind that

permits the expression of a conclusion without being affected by influ-

ences that compromise professional judgment, thereby allowing an

individual to act with integrity and exercise objectivity and profes-

sional skepticism”(Sec. 290.6a). Independence in appearance is

defined as “the avoidance of facts and circumstances that are so sig-

nificant that a reasonable and informed third party would be likely to

conclude, weighing all the specific facts and circumstances, that a

firm's, or a member of the audit team's, integrity, objectivity or profes-

sional skepticism had been compromised”(Sec. 290.6b). Both forms of

independence can be affected negatively by the provision of nonaudit

services, as the IFAC Code of Ethics also acknowledges (IFAC, 2016,

Sec. 290.154).

Received: 9 January 2017 Revised: 14 May 2018 Accepted: 10 June 2018

DOI: 10.1111/ijau.12131

Int J Audit. 2019;23:1–19. © 2018 John Wiley & Sons Ltdwileyonlinelibrary.com/journal/ijau 1

To strengthen auditor independence, amongst other things, the

European Council, the European Parliament, and the European Com-

mission agreed on April 16, 2014, to reform the audit sector, changing

the audit directive and adopting a new regulation for public‐interest

entities (European Parliament & Council of the European Union,

2014). EU Regulation 537/2014 specifies that audit firms of public‐

interest entities are prohibited from providing nonaudit services to

audit clients, which are fundamentally incompatible with their inde-

pendence function, and lists such services (blacklist approach). By

way of derogation, member states may allow the provision of certain

tax and of valuation services. In addition, the law caps nonaudit fees

to 70% of the average audit fees over the last three consecutive finan-

cial years. Member states may allow exemptions from this require-

ment for a period not exceeding two financial years; they may also

apply a more stringent cap on nonaudit fees.

Previous empirical studies have mainly shown that the provision

of nonaudit services does not compromise independence of mind

(e.g., Ashbaugh, LaFond, & Mayhew, 2003; Chung & Kallapur, 2003;

Craswell, 1999; Hope & Langli, 2010), while independence in appear-

ance does seem to be compromised by the provision of nonaudit ser-

vices (e.g., Dart, 2011; Francis & Ke, 2006; Krishnan, Zhang, & Sami,

2005; Quick & Warming‐Rasmussen, 2005, 2009).

Most studies on independence are US based, and there are very

few studies from continental Europe and Scandinavia, even though

the contexts differ substantially. In addition, these studies are mostly

prior to the global financial crisis and, as far as we are aware, all of

them before the implementation of the EU audit reform. Yet, the

global financial crisis has had extensive and major consequences for

the European economies. Trust in financial markets, financial institu-

tions, and general businesses has suffered. This has probably also

changed the perceptions of stakeholders negatively, with respect to

the supposed watchdog; that is, the independent auditor.

Two studies investigate independence in appearance after the

financial crisis, but before the EU audit reform. Quick and Warming‐

Rasmussen (2015) conducted an experiment with German investors

in 2010, before the EU Green Book, testing threats to independence

for three nonaudit services. They found that a high self‐interest and

a high‐familiarity threat may impair auditor independence in appear-

ance, while they did not reveal a significant effect of an existing advo-

cacy threat. Campa and Donnelly (2016) investigate annual reports in

the UK over the period 2006–2011, finding that independence of

mind is indeed compromised by high nonaudit services fees. They also

find that independence in appearance (proxied by the client's earnings

response coefficient) is compromised by nonaudit services fees, but

this is balanced by the simultaneous recognition of benefits arising

from the nonaudit services. This suggests that the EU is justified in

implementing reforms, but it does not provide evidence on whether

the changes are in line with stakeholders' expectations and

perceptions.

To summarize, it can be noted that there is a lack of contemporary

and comprehensive European research on the impact of auditor‐pro-

vided nonaudit services on perceived auditor independence. The

objective of the study is to close this research gap. Owing to a volatile

and dynamic audit environment, a reexamination of issues investi-

gated by prior research alone is reasonable. Beyond that, we expand

prior research in a number of ways. A major contribution of this pres-

ent paper, therefore, is that we analyze a broad range of stakeholder

perceptions directly (i.e., not proxied), and in a European (Danish),

post‐audit reform context. We extend previous research in a number

of ways. First, we differentiate between other assurance services

and consulting services. Second, we analyze the association with 38

different nonaudit services, whereas Quick and Warming‐Rasmussen

(2005) only examined four nonaudit services. Third, our subjects also

include lawyers and financial analysts. Fourth, we also test whether

the fee cap set by the EU is too high. Fifth, we test whether there is

a demand from stakeholders to expand the strict rules on the provi-

sion of nonaudit services for public‐interest entities to large,

medium‐sized, and small nonpublic‐interest entities. Finally, we test

whether an approval of nonaudit services by audit committees

reduces perceived threats to independence. Overall, this study con-

tributes to an evaluation of the perceived usefulness of the new EU

Regulation 537/2014 on specific requirements regarding statutory

audit of public‐interest entities.

Our findings indicate that the joint provision of nonaudit and

audit services is negatively associated with perceived auditor indepen-

dence. However, participant perceptions differ by the type of stake-

holder group. Many individual services, even those not on the EU

blacklist, are regarded as problematic. Nevertheless, the impact on

independence‐in‐appearance differs according to the type of service.

In the light of our results, the EU cap on nonaudit service fees does

seem to be too high. The potential safeguard of the separation

between audit firm staff that provides auditing services and audit firm

staff that provides nonaudit services and an approval of nonaudit ser-

vices by the audit committee are not regarded as helpful in enhancing

auditor independence. Finally, respondents see a need to apply simi-

larly strict regulations to nonpublic‐interest entities that exceed cer-

tain size limits.

The remainder of the paper is organized as follows. In Section 2

we give an overview of the particularities of the Danish setting. Sec-

tion 3 discusses theoretical reasoning and prior research findings

regarding the relationship between providing nonaudit services and

independence of mind and in appearance, and develops our hypothe-

ses. Section 4 then describe our survey and the participating subjects

in the study. Section 5 presents and discusses the empirical results.

Finally, Section 6 summarizes the main findings, concludes, and points

out the study's limitations.

2|THE DANISH ENVIRONMENTAL

SETTING

In many ways, the Danish context is similar to other European coun-

tries, and to global settings. There are some specific characteristics

though. Like other Scandinavian countries, Denmark scores high on

feminine values and gender egalitarianism, valuing equality, care, inter-

personal trust,

1

close social relationships, low hierarchical structures,

social obligation, and social control (Emrich, Denmark, & Den Hartog,

2004; Hofstede, 1991).

With regard to the Danish financial reporting system, this has tra-

ditionally meant that almost all Danish companies have had to be

2VAN LIEMPD ET AL.