Effect of Regulatory Changes on Auditor Independence and Audit Quality

Abstract

This study investigates the impact of CLERP 9 on auditor independence and audit quality. Audit quality is measured by performance‐adjusted discretionary accruals and the auditor's propensity to issue a going‐concern opinion for a financially distressed company. The results show a significant and positive association between auditor‐provided non‐audit services (NAS) fees and the propensity to issue a going‐concern opinion for a financially distressed company post‐CLERP 9, but an insignificant association pre‐CLERP 9. The results show a significant and positive association between NAS fees and the performance‐adjusted absolute value of discretionary accruals pre‐CLERP 9, but this significant association was mitigated by the introduction of CLERP 9. To address the potential impact of the level of abnormal NAS fees on auditor independence, the analysis is extended by incorporating predictions of abnormal NAS fees. Abnormal NAS fees are significantly and negatively associated with the propensity to issue a going‐concern opinion for a financially distressed company and positively associated with discretionary accruals pre‐CLERP 9, but they are not significant post‐CLERP 9. The results provide evidence of improved audit quality after the implementation of CLERP 9. The results will be useful to regulators for the justification of regulatory changes. The findings provide evidence of the effectiveness of regulatory changes, specifically the CLERP 9, on the improvement of auditor independence and audit quality.

The Developments on Audit Quality in Indonesia, The Qualitative Analysis on the Practitioners' Expectations

“…Regulations are also inseparable from government's intervention as well as the professional bodies, because regulations exist to protect the interests of the many, and serve as a response to the current events. The most popular regulatory changes were The Sarbanes-Oxley Act (SOX) of 2002 in the US [24] and the Corporate Law Economic Reform Program Act (CLERP) 9 of 2004 in Australia [25]. Since then there were many researches that studied the impact of SOX and relate it to in a AQ whether in a direct or indirect relationship, such as studies were conducted by [25]; [20]; [26]; [19]; [26]; [27] and [18].…”

Trends in Auditor Reporting in Australia: A Synthesis and Opportunities for Research

“…More recent models focus on predicting modifications for going concern uncertainty. Carey and Simnett () and Hossain () include explanatory factors, such as prior year non‐standard reports, profitability measured by ROA, incidence of losses, cash from operations, financial risk measured by leverage, and default risk captured by summary measures such as Altman's Z–score or Zmijewski's bankruptcy score, size of audit firm, time period and industry. There are still opportunities to examine issues related to going concern reports within the Australian context including first time issuance as well as removal of going concern reports, industry‐specific uncertainties and many other issues.…”

Review of Post‐CLERP 9 Australian Auditor Independence Research

“…In response to concerns that auditor‐provided NAS are a threat to auditor independence, CLERP 9 introduced mandatory disclosure in the annual report of fees paid for NAS, and an audit committee declaration that any purchased NAS is compatible with auditor independence. There are mixed results in this regard in studies using data prior to CLERP 9 (Ye et al ; Ruddock et al ; Gul et al ; Carey et al ; Patel and Saune ; Bugeja ), and contemporaneous with CLERP 9 (Rusmin et al ; Wines , ; Bugeja ; Hossain ).…”

“…Using data from the period 2002–2007, Hossain () investigates the impact of CLERP 9 on the relationship between NAS and audit quality, with performance‐adjusted discretionary accruals and the auditor's propensity to issue a going concern opinion for a financially distressed company used to proxy for audit quality. The study reports a positive association between non‐audit fees and a going concern opinion post‐CLERP 9, which indicates that auditors are more likely to issue a going concern opinion when providing NAS after the introduction of CLERP 9.…”