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The Impact of Reputation, Audit Contract Type, Tenure, Audit Fees and Other Services on
Auditors Perceptions of Audit Quality

Millicent Chang
Department of Accounting and Finance
The University of Western Australia
Nedlands, W.A 6907.

Gary S. Monroe
School of Accounting
Edith Cowan University
Churchlands, W.A 6018.

Abstract

Audit quality is important in that a high quality audit results in reliable financial information for capital
markets. This paper investigates auditors' perceptions of audit quality. Prior studies have tended to
concentrate on the auditors independence, which is only one component of audit quality. It is
important to understand the factors that auditors perceive as affecting audit quality since these are
the factors that affect actual audit quality. This study investigates whether audit reputation, length of
auditor-client relationship, audit contract type, provision of non-audit services and level of fee
dependence affect auditors' perceptions of audit quality and independence.

Data were obtained via auditors responses to a case study questionnaire. After reviewing the
information in the case study, auditors made judgments about the quality of audit services likely to be
provided, the risk of the auditor's independence becoming impaired, the likelihood of a material
misstatement being discovered, and the likelihood of the auditor requiring management to adjust the
financial statements or following management's refusal to adjust the financial statements, reporting the
misstatement in the audit opinion. Auditor reputation, length of audit-client relationship, audit contract
type, provision of non-audit services and level of fee dependence were manipulated in a 2 x
(2x2x2x2) mixed design with auditor reputation being the between-subjects factor and the latter four
variables being the repeated factors.

The results indicate that auditors' perceptions of audit quality are affected by contract type and the
risk of independence being impaired becomes a major concern when the auditor is economically
dependent on a client for fee income. With respect to discovering material misstatements in the
client's financial statements, the length of the auditor-client relationship, contract type and level of fee
dependence influence the likelihood of discovering the material misstatement.

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1.0 INTRODUCTION

There have been dramatic changes in the market for audit services during the 1980s and 1990s. One
of the most significant changes was the revision of the rules pertaining to advertising and competition
by the Institute of Chartered Accountants (ICA) and the Australian Society of Certified Practising
Accountants (ASCPA). In addition, several mergers between large accounting firms took place. The
Big Eight became the Big Six after the mergers between Arthur Young and Ernst & Whinney, and
Touche Ross and Deloitte, Haskins and Sells. As a result, competition for clients is rife among
auditing firms. In general, competition takes on two forms: price competition and product
differentiation. Audit tendering has become a tool for price competition and audit firms engage in
marketing strategies to differentiate themselves from the competition
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.

Recent corporate collapses and audit failures have threatened the credibility of auditors and affected
the publics perception of audit quality. Allegations of audit failure have resulted in the accounting
profession undertaking several measures to strengthen the effectiveness of the independent audit,
both in fact and in appearance. For example, Statement of Auditing Practice AUP 32 "Audit
Independence" (1992) was issued by the Australian Accounting Research Foundation (AARF).
Arond that time, the AARF also issued several exposure drafts on related issues (ED 43
"Knowledge of the Client's Business", ED 44 "Communication to Management on Matters Arising
from the Audit" and ED 48 "The Auditor's Responsibility for Detecting Irregularities Including Fraud,
Other Illegal Acts and Errors") that have since become AUPs.

Audit quality is important in that a high quality audit results in reliable financial information for capital
markets. Two important aspects of audit quality are perceived and actual audit quality. Whereas the
former is audit quality as perceived by financial statement users, the latter is a function of the audit
technology and resources directed to a particular audit engagement. Audit firms compete on the
quality of audit services. However, product differentiation is a difficult dimension to compete on
because auditing is a service, the quality of which cannot necessarily be observed. Due to the
unobservable nature of audit services, only auditors have the opportunity to observe actual audit
quality. Understanding the factors that affect actual audit quality and perceived audit quality are
important research areas.

This paper investigates auditors' perceptions of audit quality. Prior studies have tended to
concentrate on the auditors independence, which is only one component of audit quality. It is
important to understand the factors that auditors perceive as affecting audit quality since these are

1
As an example of the effects of this competition, Craswell [1992] reported a 40% drop in audit fees between
1980 and 1989 despite considerable inflation during that period. However, this could have resulted from cost
savings due to increased efficiency and/or a reduction in audit quality.

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the factors that affect actual audit quality. This study investigates whether audit reputation, length of
dependence affect auditors' perceptions of audit quality and independence. The effect of
acculturation on auditors' percpetions are also studied

2.0 PRIOR RESEARCH

Research into audit quality has taken a number of approaches. Simunic [1980], Simon [1985],
Palmrose [1987], Francis and Simon [1988], Palmrose [1988] and Turpen [1990] examined audit
quality from the differential pricing viewpoint, while other studies considered audit quality differences
between auditing firms by using surrogates for audit quality (Palmrose [1982], Nichols and Smith
[1983], Shockley and Holt [1983], Simunic and Stein [1987], Ettredge et al. [1988], Imhoff
[1988], Palmrose [1988], Beatty [1989], Eichenseher et al. [1989], Wilson and Grimlund [1990]
and DeFond [1992]). The third approach which is of direct relevance to this paper are studies that
have examined audit quality from a behavioural perspective (e.g., Schroeder et al. [1986], Knapp
[1991] and Carcello et al. [1992]).

Several studies have examined the effects of a number of auditor characteristics on financial
statement users and auditors perceptions of auditor independence, which is one of the components
of audit quality. Shockley [1981] examined the effects of competition for clients, provision of
management advisory services, size of audit firm and tenure on perceptions of independence.
Financial statement users (financial analysts and commercial loan officers) and auditors participated
in his study in a repeated measures design. Competition, size and the provision of management
services significantly affected perceptions of independence. The judgments for the three subject
groups were similar.

Knapp [1985] investigated how contextual factors affected commercial loan officers perceptions of
the ability of auditors to resist management pressure. His repeated measures design included the
nature of conflict issue, clients financial condition, provision of management advisory services and
competition as independent variables. He found that the perceived ability of the client to influence the
outcome of an auditor-client conflict increased as the subjectivity in technical standards increased
and the clients financial position improved. The effect of providing management advisory services
and competition only weakly increased the likelihood of the conflict being resolved in the clients
favour.

McKinley et al. [1985] reported that although bank loan officers believed that financial statements
audited by Big Eight audit firms were more reliable than those audited by local firms, their confidence

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that the financial statements were free from fraud increased if the audit firm also provided
management advisory services.

Gul et al. [1990] examined the effect of audit tendering and audit committees on bankers
perceptions of independence. He found a significant interaction between audit tendering and audit
committees. The bankers perceived that auditors were more independent when the audit was
obtained through tendering. Gul [1991] found that the size of the audit fee, the provision of
management advisory services, audit firm size and competition affected bankers perceptions of the
auditors ability to withstand management pressure although the portion of variance explained was
low. Gul and Windsor [1991] reported that the financial condition of the client, and size of fees
affected auditors perceptions of their independence. However, tendering had no effect.

The more recent behavioural studies have extended previous work by incorporating the two aspects
of audit quality, namely the auditor's ability to discover material misstatement and independence.
These studies show that there are diverse and conflicting perceptions of the factors that affect audit
quality and auditor independence. Individuals such as financial controllers and auditors who are
directly involved in the audit process perceive audit quality differently to third parties such as audit
committee members, bankers and fund managers. Even those parties actually involved in the audit
process assess audit quality differently.

Schroeder et al. [1986] evaluated the perceptions of audit committee chairpersons and audit
partners on factors that affected external audit quality. Audit committee chairpersons were chosen
because of their role in corporate governance. A questionnaire was used to obtain the participants
perceptions of six audit team factors and nine firm wide factors on audit quality. The team factors
included: level of partner/manager attention given to the audit, planning and conduct of audit team
work, communication between audit team and management, independence exhibited by audit team
members, mix of skills and depth of experience of team, and communication between audit team and
audit committee. The firm wide factors were: provisions to keep auditors up to date technically,
quality control procedures used by the firm, regulatory agency expertise, overall reputation, sizes and
locations of offices, provision for team rotation, litigation experience, recency and outcome of peer
review and the relative significance of total professional fees. The audit committee chairpersons
judged audit team factors as more important to audit quality than firm wide factors. Generally, the
audit partners perceptions were consistent with those of the audit committee chairpersons.

Knapp [1991] investigated the effect that audit firm size, length of tenure and general audit strategy
had on audit committee members' audit quality assessments. Being third parties to the audit process,
audit committee members experience difficulty in observing variables such as audit team factors
known to affect audit quality. Thus, they have to rely on observable auditor characteristics such as

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auditor size. The subjects were presented with a case study that described a client company. There
was a material error in the accounts, which was known by management, but unknown to the
auditors. Audit firm size, length of tenure and general audit strategy were manipulated in the case
study in a full factorial 2x3x2 between-subjects design. Each subject estimated the likelihood of the
auditor discovering the error and the conditional likelihood of the auditor requiring management to
correct the error or, if management refused to correct the error, reporting the error in the audit
opinion. The audit committee members audit quality assessments were significantly influenced by
audit size class, length of tenure, but not by audit strategy.

Carcello et al. [1992] endeavoured to identify the audit quality attributes perceived by participants in
the financial reporting process. Questionnaires containing a list of 41 attributes identified by the
literature as possibly influencing audit quality were sent to random samples of auditors, financial
statement preparers and financial statement users. Consistent with Schroeder et al. [1986], the
highest rated attributes were related to audit team rather than audit firm characteristics. Among the
three groups of financial reporting participants, there were also significant differences in the
importance assigned to each factor. Controllers and users placed more importance on adherence to
the general auditing standards than auditors. Auditors believed that it was more important that the
audit firm maintain a sceptical view than controllers, while controllers placed more importance on
firm's responsiveness to client's needs. However, users found it more important that an auditor
comply with general audit standards. Generally, audit partners differed with users in that they placed
greater importance on the audit firms executive involvement.

3.0 RESEARCH METHOD

This study extends the work of Knapp [1991] in an Australian environment by considering additional
factors that may have an impact on audit quality and the impact of these factors on auditors
assessments of audit quality. Data were obtained via auditors responses to a case study
questionnaire. After reviewing the information in the case study, auditors made judgments about the
quality of audit services likely to be provided, the risk of the auditor's independence becoming
impaired, the credibility of the financial statements, the likelihood of a material misstatement being
discovered, and the likelihood of the auditor requiring management to adjust the financial statements
or following management's refusal to adjust the financial statements, reporting the misstatement in the
audit opinion. Auditor reputation, length of audit-client relationship, audit contract type, provision of
non-audit services and level of fee dependence were manipulated in a 2 x (2x2x2x2) mixed design
with auditor reputation being the between-subjects factor and the latter four variables being the
repeated factors.

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A mixed design was chosen primarily because of the length and repetitiveness of the task and
potential problems of a low response rate. However, there is the possibility of bias associated with
practice and order effects. That is, in addition to specific treatment effects, subjects responses will
be affected by some previous learning experience with the test variables and the order in which they
are presented. These effects were overcome in the experiment by randomising both the order of the
16 scenarios and the four auditor characteristics within the scenarios for each subject
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.

3.1 Research Instrument

The research instrument was based on the case study developed by Knapp [1991] with certain
changes to suit the Australian environment. It involved a medium sized household electrical appliance
company with the point of focus being a material misstatement in the current year's unaudited
financial statements. The material misstatement was located in the inventory account and represented
a portion of inventory that had become obsolete. The companys directors were reluctant to write
down the value of inventory to its market value due to its impact on the current year's profit. The
directors wanted to delay the write down to the next financial year because of plans to issue shares
to finance further acquisitions and repay outstanding bank loans. Given this hypothetical situation, it
was interesting to examine subjects' judgments of how auditor reputation (firm size), length of
dependence affected auditors perceptions of the likelihood of the auditor discovering the material
misstatement and subsequently reporting the misstatement to management.

The independent variables were selected because of their impact on auditor independence in prior
studies and their inclusion in AUP 32. It is interesting to examine their impact on the overall audit
quality and the individual components of audit quality. The five independent variables were
dichotomously manipulated through the instructions as shown in Appendix 1.

Two pretests of the research instrument were conducted. The first pretest involved 14 academic
staff members to determine the face validity and realism of the auditor attributes and their various
combinations in the case study. Revisions to the research instrument were made based on the first
pretest. The second pretest consisted of administering the research instrument to 34 accountants
undertaking the ICAs Accounting 2 professional year module. Discussions held with pretest
subjects provided feedback on the comprehensibility and clarity of expressions and terms used. The
discussions revealed that instructions and wording of the questionnaire followed a logical sequence

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There is also the potential for demand effects in a within-subjects experiment because multiple scenarios are
presented to each subject. This allows the subject to "guess" the hypothesis and therefore give responses
that they think the researchers desire. Alternatively, given that the subjects know that they are involved in
an experiment, they may respond differently to the way they would otherwise respond in a "real world'
situation. This problem has been controlled for by making the case study as "real" as possible.

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and was easy to understand. The subjects also indicated that the presentation of that materials did
not cause them to guess the hypotheses and unduly bias their responses.

Two variations of the research instrument were used, one describing a "Big Six" auditor and the
other a "non-Big Six" auditor. The research instrument contained background information about the
company, its financial profile, two years audited financial statements and the current year unaudited
balances, information about the incumbent auditor and the current year's audit, a practice session
and 16 different scenarios based on the four auditor characteristics. A multiple stimulus approach
was used, where all 16 scenarios were presented so that the complete set of stimuli was available
and could directly influence each subject's assessment. Each scenario contained a combination of the
four manipulated auditor characteristics. The practice session contained three cases, which were
repeated later in the instrument. The practice scenarios were included to enable the subjects to
familiarise themselves with the various terms used to describe the auditor characteristics.

After reading each scenario, each subject answered five questions. These questions were measured
using a nine point scale. Three of the questions (2, 4 and 5) related to auditor independence. The
questions and their scales were:
1. What is your assessment of the quality of audit service likely to be provided
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? A "1" on the scale
represented low quality while "9" represented high quality.
2. What is the risk of the auditors independence being impaired? A "1" on the scale represented
low risk while "9" represented high risk.
3. What is the likelihood that the auditors will discover the inventory overstatement? A "1" on the
scale represented very unlikely while "9" represented very likely.
In answering the next two questions, please assume that the auditors discovered the inventory
overstatement.
4. What is the likelihood that the auditors will request management to adjust the inventory balance?
A "1" on the scale represented very unlikely while "9" represented very likely.
5. What is the likelihood that the auditors will report the overstatement in the audit opinion if
management refuses to make the adjustment? A "1" on the scale represented very unlikely while
"9" represented very likely.

To minimise the potential problem of order and practice effects, the order of the 16 scenarios was
randomised and printed separately for each subject. In addition, the order of the four auditor
characteristic variables was randomised for each scenario. Five different versions of the practice
cases (e.g., five different combinations of three scenarios) were utilised to ensure that the practice

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To minimise any potential misunderstandings about what audit quality means, the subjects were provided
with the following definition in the case instructions: audit quality is defined as the auditor's ability to
discover and willingness to report material errors or misstatements in the client's financial statements.

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cases did not lead the subjects to our hypothesised responses
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. The instructions and wording of the
questionnaire were expressed in a neutral tone to reduce the possibility of demand effects. Subjects
were encouraged to go back and change their assessments if they felt that it was necessary.

A biographical questionnaire was also included at the end of the case study. The subjects provided
information such as their employer's name, current position, number of years in their current position,
approximate time required to complete the questionnaire, the extensiveness of their auditing
knowledge and prior experience with audit reports. Subjects were assured of the confidentiality of
the information provided and were informed that the information volunteered would be used
exclusively for research purposes.

4.0 HYPOTHESES

This study investigates whether auditor reputation, length of auditor-client relationship, audit contract
type, provision of non-audit services and level of fee dependence affect auditors' perceptions of
audit quality. The hypotheses for each of these variables are discussed in turn.

4.1 Auditor Brand Name Reputation (audit firm size)

The effect of the auditor's brand name on perceptions of auditor independence and audit quality has
been well researched. Financial statement users differentiate between large and small auditors where
the terms "Big Six" and "non-Big Six" have been used to describe these two types of auditors (e.g.,
Beatty [1990], DeFond [1992], Healy and Lys [1986], Balvers et al. [1988], Dopuch and Simunic
[1980, 1982], Shockley and Holt [1983], Shockley [1981], Palmrose [1982], Simunic and Stein
[1987], Palmrose [1987], Ettredge et al. [1988], McKinley et al. [1985], Deis and Giroux [1992]).
Since brand name is one of the most visible, low cost and easily available information regarding an
incumbent auditor, it should be included in any experimental study on the perceptions of auditor
independence and audit quality because these assessments cannot be complete if the auditor's brand
name is excluded or unknown. The brand name variable was operationalised at two levels, Big Six
and non-Big Six auditors.

Healy and Lys [1986] regard the auditor's investment in reputation capital as a bond, which
guarantees audit clients that they will receive the audit quality that was contracted for and the brand
name of the auditor signals to financial statement users the quality of the audit firm. High reputation
auditors maintain a high level of audit quality by diligently detecting misstatements and disclosing

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The practice cases did not have a significant impact on the subjects subsequent responses. The practice
cases were used as an alternative to repeating the first few cases later in the instrument and not informing
the subjects of the repeated cases.

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them in the audit report.

DeAngelo [1981b] argues that audits conducted by Big Eight firms were
more likely to discover the presence of material errors in financial statements compared to smaller
firms as they possess technological advantages over their competitors.

This leads to the following hypotheses:

H
1a
: Auditors assess audit quality as higher when the audit is conducted by a Big Six auditor
compared to when the audit is conducted by a non-Big Six auditor.

H
1b
: Auditors assess the auditor to be more independent when the audit is conducted by a Big
Six auditor compared to when the audit is conducted by a non-Big Six auditor.

H
1c
: Auditors assess the auditor to be more likely to discover the material misstatement when the
audit is conducted by a Big Six auditor compared to when the audit is conducted by a non-
Big Six auditor.

It is expected that auditors from different size audit firms possess differing views of audit firm
competence. It is hypothesised that Big Six auditors will impute a greater likelihood of discovering a
material misstatement to Big Six auditors, while non-Big Six auditors will assess no difference in the
discovery abilities of Big Six and non-Big Six auditors. H
1d
and H
1e
test these respective effects.

H
1d
: The Big Six auditor group's estimate of an auditor discovering a material misstatement is
higher for Big Six auditors than non-Big Six auditors.

H
1e
: The non-Big Six auditor group's estimate of an auditor discovering a material misstatement is
not affected by auditor reputation.

According to DeAngelo [1981b], in a situation where an auditor discovers a misstatement in the
client's accounts and the client tries to influence the auditor not to report the misstatement, the
auditor's incentive to "cheat" is measured by the loss of the present value of client specific quasi-rents
if the engagement is discontinued. Alternatively, the countervailing disincentive to cheat is the present
value of quasi-rents specific to the auditor's other current clients. If the auditor "fails to report" the
misstatement and the "failure to report" is discovered, the auditor is in danger of losing these other
clients and/or reduced fees from the clients that continue to retain the auditor. Therefore, it follows
that auditors with a larger client base have more to lose, i.e. greater disincentive to cheat than smaller
auditors. Shockley [1981] reported that Big Eight audit partners, loan officers and financial
analysts perceptions of independence were significantly influenced by audit firm size. The risk of
independence becoming impaired was more likely for small auditors.

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Therefore, Big Six auditors and non-Big Six auditors are expected to respond differently to the
effect of auditor brand name on independence. Based on Shockleys [1981] results, it is expected
that Big Six auditors perceptions of auditor independence will be influenced by audit brand name
reputation while the non-Big Six auditors perceptions will not be affected. Big Six auditors will rate
auditors in their same brand name class as more independent, i.e., more likely to report a discovered
misstatement (H
1f
) and there will be no difference in perceived independence between the two types
of auditors for non-Big Six auditors (H
1g
).

H
1f
: The Big Six auditor group's estimate of an auditor's independence is affected by auditor
reputation.

H
1g
: The non-Big Six auditor group's estimate of an auditor's independence is not affected by
auditor reputation.

4.2 Length of Auditor-Client Relationship

The length of the auditor-client relationship could affect an auditors perceptions of audit quality. In
the earlier part of the relationship, the auditor is less familiar with the client's business environment
and accounting system and will therefore have more difficulty discovering misstatements, especially if
management is deliberately concealing them. As the relationship progresses, the auditor becomes
more knowledgeable about the client's system such that his/her ability to discover misstatements
increases. DeAngelo [1981a] and Williams [1988] discuss the auditors increasing effectiveness
over the length of the client-auditor relationship where a better understanding the client's system
leads to a greater likelihood of discovering material misstatements. It is expected that the length of an
audit relationship is positively correlated to an auditor's likelihood of discovering a material
misstatement. However, at some point in the relationship, due to complacency and a learned
confidence in the client, the likelihood of discovering misstatements is reduced (Shockley [1981]).
Mautz and Sharaf [1961, p. 208] described this as "a slow, gradual, almost casual erosion of his
'honest disinterestedness'."

Shockley [1981] used a less than five years and more than five year tenure dichotomy, while St
Pierre and Anderson [1984] found that audit failures were more common when tenure was less than
three years. It is hypothesised that auditors perceptions of audit quality and independence are
affected by the length of auditor-client relationship. In this study, the length of audit relationship is
manipulated at two levels. The first level represents the first year of the audit relationship, i.e., when a
new auditor is appointed. The second level characterises the fifth year of the audit relationship where
the auditor has previously performed four successive audit engagements.

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DeAngelo [1981a, 1981b] argues that the existence of client specific quasi-rents to incumbent
auditors lead to a lower "perfectly accepted" level of auditor independence. Incumbent auditors
make client specific investments on which the expected return is future quasi-rents. These future
rents represent the excess of audit fees over the avoidable cost of production. Although both a
newly appointed auditor and an auditor for five years are incumbent auditors, the newly appointed
auditor has more to lose if the engagement is terminated because he/she has more future quasi-rents
to recover and they may not have recover their start-up costs in the first year of the engagement
5
.
The greater the future stream of client specific quasi-rents, the less likely an auditor is to report a
material misstatement
6
. However, it should be recognised that the existence of future economic rents
is necessary, but not sufficient, for selective disclosure. The auditor must believe the expected benefit
of "cheating to outweigh the expected costs, which includes the loss of future audit fees from other
clients due to the loss of reputation should the selective disclosure be discovered. Empirical studies
(Beck et al. [1988a] and Ragunathan [1987]) have shown that the length of an audit relationship is
inversely related to the likelihood of an auditor reporting a discovered material breach.

In light of the above, the following are hypothesised:

H
2a
: Auditors perceptions of audit quality are higher for the auditors with a tenure of five years
than for the newly appointed auditors.

H
2b
: Auditors assessments of independence are higher for the auditors with a tenure of five years
than for the newly appointed auditors.

H
2c
: Auditors' estimates of the likelihood of discovering a material misstatement are higher for the
longer auditor-client relationship.

4.3 Audit Contract Type

The type of audit contract was manipulated at two levels: fixed fee contract obtained through
tendering and variable fee contract. According to Palmrose [1989] and McDonald and Monroe
[1991], a fixed fee contract is one where the audit fees are determined before the performance of

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This would be more likely if the auditor has lowballed to obtain the audit engagement. Under lowballing,
the auditor is counting on the client continuing the relationship so that the losses in the early year(s) of the
engagement can be recovered in later years. In this situation, the auditor would be particularly sensitive to
making decisions that could result in loss of the client, thus impairing his/her independence.
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An alternative argument is that the auditor with more tenure is less likely to be independent. This is because
the auditor has been making investments specific to that client over the past four years, e.g., tailoring
computer-assisted audit programs to the client's system and unique needs such that termination will result
in not only the loss of future audit fees but also the loss of the client specific expertise investment.

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audit work and the risk of task uncertainty is borne by the auditor. Fixed fee contracts provide
incentives for a least cost audit effort since any excess of fees over costs will be retained by the
auditor. In contrast, under a variable fee contract, audit fees are only determined after evidence
acquisition so that auditors are more likely to expend more effort to discovering material
misstatements. However, incentives for audit inefficiencies exist. Palmrose, however, found that audit
contract type did not significantly influence audit hours and fixed contracts had significantly lower
fees.
7

When a fixed fee contract is obtained through tendering, the auditor has more incentive to expend
less effort in evidence acquisition because the fee tendered may already have been "discounted" to
bid competitively for the audit. It is proposed that a fixed fee contract coupled with the fact that the
engagement was obtained through a tendering process aggravates the "lack of effort" problem with
respect to evidence acquisition. This argument is supported by Anderson et al. [1987], who cautions
the impairment of auditor independence as a result of auditor tendering because of the client's ability
to threaten termination of the engagement.

It is hypothesised that the audit contract type will affect auditors' perceptions of audit quality and
independence. The issue as to whether an auditor under a variable contract is more likely to report a
discovered breach in the client's financial statement is a complicated one and can take three possible
directions. First, it is feasible that an auditor under either contract type is equally likely to disclose a
discovered breach. This is because both auditors have performed the evidence acquisition process
and both stand to lose future quasi-rents if terminated. The auditor under the fixed fee contract
obtained through tendering will be paid the pre-determined fee regardless of any disputes with
management. Even though the variable contract auditor's fees have not been previously determined,
the auditor has to be paid for audit work done.

A second possibility is that an auditor engaged under a fixed fee contract obtained through tendering
is less likely to report the breach than the variable fee contract auditor. This is because the client has
the power to exercise pressure on the auditor as a result of tendering, i.e., the client has more
bargaining power. Anderson et al. [1987] found that clients use tendering to reduce audit fees and
are willing to replace an auditor to reduce their audit fees. Therefore, an auditor under a fixed
contract obtained through tendering might be less likely to report a discovered misstatement than an
auditor with a variable contract because of client pressure.

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Using Australian data, McDonald and Monroe reported that the lowest fees were associated with variable
contracts, the highest fees associated with fixed contracts with renegotiation. The audit fees for fixed fee
contracts were higher than those for variable fee contracts, but less than those for fixed contracts with
renegotiation.

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The third possibility of the variable contract auditor succumbing to management pressure should also
be considered. Alexander [1984] and Kitchener [1983] argue that audit tendering actually reduces
the risk of independence being impaired. This is because the audit tenderer actually speeds up the
audit process by being more efficient and works better with the client's staff. Gul et al. [1990]
examined bankers' perceptions of auditor independence and found that they placed more reliance on
the financial statements when audit tendering had occurred. In a subsequent study, Gul and Windsor
[1991] showed that auditors did not believe that audit tendering influenced their ability to resist
management pressure.

It is also predicted that an auditor engaged under a fixed fee contract obtained through tendering is
less likely to discover a material misstatement than an auditor engaged under a variable fee contract.
The following hypotheses are tested:

H
3a
: Auditors perceptions of audit quality are lower for fixed fee contracts than for variable fee
contracts.

H
3b
: Auditors assessments of independence are lower for fixed fee contracts than for variable
fee contracts.

H
3c
: Auditors' estimates for an auditor discovering a material misstatement are lower for fixed fee
contracts than for variable fee contracts.

4.4 Provision of Non-audit Services

Provision of non-audit services was operationalised as the provision of management consulting
services, accounting services and tax services to an audit client. It was manipulated at two levels: (1)
only audit services were provided and (2) both audit and non-audit services were provided to the
client.

Much of the controversy surrounding the "scope of services" issue has centred on auditor
independence. This study differs from previous studies in two ways. First, it not only evaluates the
effect of providing other services on auditors independence but also the auditor's ability to discover
material misstatements. Second, it is not limited to management consulting services, but instead
includes other services that can be provided by an accounting firm.

As an auditor becomes more familiar with a client's business, it becomes increasingly difficult for the
client to conceal problems from the auditor. Providing non-audit services could allow the auditor to
gain additional insights into the client. The additional knowledge gained about the client could assist

14
the auditor in performing the audit, thus increasing the likelihood of discovering material
misstatements. However, it is difficult to predict the directional impact on quality due to the
conflicting impact on the likelihood of discovering material misstatements and independence.
Therefore, an auditor that provides both audit and non-audit services would be more likely to
discover material misstatements than an auditor who only provides audit services. In large accounting
firms, this "advantage" might be partially offset by the separation of audit and non-audit staff.
However, there is still a sharing of knowledge to a large extent between audit and non-audit staff.
Beck et al. [1988a] investigated the effect of management advisory services on economic bonding
and found that knowledge spillovers actually increased the level of bonding in non-recurring
engagements and decreased incremental bonding in recurring engagements.

The auditors independence, however, might be impaired as a result of these other services because
a decision to qualify the audit report on a clients financial statements could be quite costly to the
auditor if it could affect more than just the audit fee. In addition, the provision of other services could
result in the situation where the auditor is providing an opinion on the financial statement
consequences of their advice. If those services adversely affect the client and the financial statements
do not adequately disclose that effect, the auditor may be reluctant to qualify his/her opinion on the
accounts.

Empirical evidence on the provision of other services on perceived auditor independence is
conflicting. Schulte [1965] and Hartley and Ross [1972] provided evidence that auditor
independence increased when management advisory services were provided since it increased the
client's dependence on the auditor. Other studies (e.g., Briloff [1966], Titard [1971], Shockley
[1981], Knapp [1985] and Gul [1991]) support the argument that with the provision of management
advisory services, the auditor becomes in effect an employee of the client, is an advocate of the
client, has financial interest in the success of the client and is in a position of auditing his own decision
(Gul [1991]). Although Shockley [1981], Knapp [1985] and Gul [1991] found that the provision of
management advisory services significantly affected bank loan officers' perceptions of the auditor's
ability to resist management pressure, the variance explained by that factor was minimal. Carcello et
al. [1992] found that the factor, "firm provides no consulting services to the client", was the second
lowest rated attribute of audit quality, which implies that providing consulting services actually
enhanced audit quality. Goldman and Barlev [1974] contend that when non-routine services such as
management consulting were performed and the client benefited from the services, the balance of
power actually tipped in favour of the auditor, thus increasing independence. Nichols and Price
[1976] substituted these power relationships with dependency relationships. They argued that
routineness actually increased the auditor's power. This is because it is very difficult to convince an
auditor to deviate from established standards. If other sources of management advisory services are

15
unavailable, the power imbalance between client and auditor is reduced. However, when substitutes
exist, auditor independence becomes more problematic.

In this study, the following hypotheses are tested:

H
4a
: Auditors perceptions of audit quality are affected by the provision of non-audit services.

H
4b
: Auditors assessments of independence are lower when the auditor provides non-audit
services compared to when they provide only audit services.

H
4c
: Auditors' estimates of the likelihood of an auditor discovering a material misstatement are
higher when the auditor provides non-audit services compared to when they provide only
audit services.

4.5 Fee Dependence

Previous studies have recognised the effect of economic dependence on auditor independence.
However, fee dependence has not been examined in the context of audit quality. DeAngelo [1981b]
argued that fee dependence on a client can be seen as a surrogate for audit quality where it
represents the relative magnitude of client specific quasi rents.

The level of fee dependence was manipulated at two levels: (1) fees from the audit client represent
approximately 18% of total gross fees; and (2) fees from the audit client represent approximately
5% of total gross fees. These levels of fee dependence test the effect of the "fees not exceeding 15%
of the gross fees of the practice" rule in AUP 32 "Audit Independence". By fixing the cut off
percentages at 18% and 5% on either side of the 15% mark, the effect of fee dependence on audit
quality and auditor independence can be examined
8
. It is hypothesised that auditors perceptions of
audit quality and independence will be affected by the level of fee dependence.

Mautz and Sharaf [1961] were concerned that financial dependence on a client affected
independence. That is, the more economically dependent an auditor becomes on an individual client,
the more likely the auditor is to comply with the client's wishes. Gul [1991] showed that when the
size of fees on an individual client was significant, bankers perceived auditor independence was
impaired. Gul and Windsor [1991] found that auditors believed that their ability to resist

8
Unlike previous studies, which operationalised fee dependence as dependent or not dependent (e.g., Gul
[1991] and Gul and Windsor [1991]), we manipulate fee dependence through the percentage of fees derived
from the client. This allows the subjects to make their own judgments about the effect of a percentage of
fees on fee dependence.

16
management pressure was affected by the size of audit fees
9
. It is hypothesised that auditors will
perceive a reduction in independence when an auditor is economically dependent on a client.

The degree of economic dependence on a client should not affect an auditor's competence. That is,
regardless of whether the total fees from any one client are a significant or insignificant proportion of
gross total fees, the likelihood of the auditor discovering a material error or misstatement is the same.
This assumes, of course, that the relative effort expended on the audit is the same across different
levels of fee dependence. However, Watts and Zimmerman [1980] have cautioned that the amount
of effort an auditor exerts when searching for breaches is dependent on his expectations of
subsequent disclosure. Therefore, if an auditor knows that a dispute with management over material
errors or misstatements will jeopardise the chances of the audit engagement being renewed, he/she
will exercise less effort when gathering audit evidence. It is hypothesised that an auditor who is
economically dependent on a client is less likely to discover a material misstatement in the client's
financial statement compared to an auditor who is not economically dependent on that same client.

H
5a
: Auditors' perceptions of audit quality are affected by the level of fee dependence.

H
5b
: Auditors' assessments of independence are higher when fees are 5% of total gross fees than
when fees are 18% of total gross fees.

H
5c
: Auditors' estimates for an auditor discovering a material misstatement are higher when fees
are 5% of total gross fees than when fees are 18% of total gross fees.

4.6 Interaction Effects

It is expected that the five auditor characteristics will interact with each other. Therefore, in addition
to considering each attribute in isolation, the interaction between variables is considered. H
6

represents the hypotheses that consider all the interactions between auditor reputation, length of
audit relationship, contract type, provision of non-audit services and fee dependence for audit
quality, independence and the likelihood of discovering a material misstatement respectively.

H
6a
: Auditors' estimates of audit quality are affected by the interaction between auditor
reputation, length of the audit relationship, contract type, provision of other services and fee
dependence.

9
An argument for mutual monitoring among partners in an accounting firm exists especially when a specific
partner is in charge of an audit engagement and the frim is perceived to be economically dependent on this
enagagement.

17
H
6b
: Auditors' estimates of independence are affected by the interaction between auditor
reputation, length of the audit relationship, contract type, provision of other services and fee
dependence.

H
6c
: Auditors' estimates of the likelihood of discovering a material misstatement are affected by
the interaction between auditor reputation, length of the audit relationship, contract type,
provision of other services and fee dependence.

5.0 RESULTS

5.1 Subjects

Auditors were utilised as subjects in this research study because it was interesting to examine their
perceptions of the factors that affected audit quality and auditor independence. Given their actual
involvement in the audit process, auditors' perceptions can act as surrogates for actual audit quality
and independence. A total of 232 case studies with a covering letter outlining the importance of the
research project and encouragement to participate were sent to audit partners of Big Six and non-
Big Six firms in the six Australian capital cities. They then distributed the case studies to their staff.
Follow up letters were mailed approximately two weeks after the original distribution of materials.
Seventy case studies were returned, which represents a 30.2% response rate.

The 70 participants had the following demographic characteristics: their average experience was 3.8
years with a range of 3 months to 23 years of audit experience; 52 auditors were from Big Six firms
and 18 were from non-Big Six firms; and 40 were less experienced auditors (seniors and below)
and 30 were more experienced auditors (supervisors, managers and partners).

5.2 Dependent Variables

After reading each scenario, each subject answered five questions, which are repeated below. Three
of the questions (2, 4 and 5) related to auditor independence.
1. What is your assessment of the quality of audit service likely to be provided?
2. What is the risk of the auditors independence being impaired?
3. What is the likelihood that the auditors will discover the inventory overstatement?
4. What is the likelihood that the auditors will request management to adjust the inventory balance?
5. What is the likelihood that the auditors will report the overstatement in the audit opinion if
management refuses to make the adjustment?

18
The three dependent variables, audit quality, independence and the likelihood of discovering a
material misstatement, were measured on a nine point scale. DeAngelo [1981b]'s definition of audit
quality as "the joint probability of discovering a material misstatement in the client's financial
statements and reporting the discovered misstatement to client's management" was the measure of
audit quality used. The responses to question 1 were used as a measure of audit quality, "1"
represented low quality and "9" represented high quality The responses to question 2 were used to
measure the risk of independence being impaired, "1 " indicated low risk while "9" indicated high
risk
.
The likelihood of discovering a material misstatement was measured as 1 representing a low
likelihood and 9 representing a high likelihood.

5.3 Descriptive Statistics

Table 1 shows the means and standard deviations of audit quality estimates for each of the 32
situations presented to auditors.

[Insert Table 1 here]

At an aggregate level, there appears to be some support for the hypotheses. Audit quality for the
hypothesised "worst" case scenario where the auditor was from a non-Big Six firm, newly appointed
under a fixed contract , other non-audit services were also provided and the auditor was fee
dependent, the mean estimate was 6.32 (1.50) compared to the "best" case scenario where the
mean estimate was 7.77 (1.16). The hypothesised "best" case scenario was when a Big Six auditor
who had been performing the audit for five years, employed under a variable contract, was fee
independent and only provided audit services.


Table 2 exhibits the risk of auditor independence becoming impaired for each of the thirty two
possible scenarios. Consistent with the estimates for audit quality, the mean estimates for the "best"
case scenario was 2.33 (1.58). The "worst" case scenario estimate was 5.07 (2.02).Therefore, it
seems to support the hypothesised relationships between the independent variables. The mean
estimates also appear to congregate around the lower end of the scale indicating that are regardless
of auditor characteristics, auditors perceive the risk of independence being impaired not to be a
major problem.


19
The mean likelihood estimates of the auditor discovering the material misstatement are presented in
Table 3. The mean estimate for the auditor hypothesised as "most" likely to discover the
misstatement was 6.46 (1.92) while the estimate for the "least" likely was 5.39 (2.01). Therefore, in
general, the mean estimates were in the expected directions.


Table 4 shows the differences in estimates for each manipulated variable for auditor reputation,
length of auditor-client relationship, contract type, provision of non-audit services and fee
dependence. Subjects perceived significant differences between Big Six and non-Big Six auditors at
the .05 level when assessing audit quality and independence. The length of audit relationship only
affected the likelihood of discovery (p = .000) where the auditor of five years was more likely than
the newly appointed auditor to discover the misstatement.

There were also significant differences between fixed and variable contracts for estimates of audit
quality, independence and the likelihood of discovery at p < .01. Only independence was affected
by the provision of other services (p = .000) where auditors assessed a higher risk of independence
being impaired when other non-audit services were provided. The degree of fee dependence also
affected perceptions of independence (p = .000).

5.3 Multivariate Analysis of Variance

Multivariate analysis of variance (MANOVA) was used to determine which, if any, of the main
effects or interactions affected auditors' assessments of audit quality, independence, likelihood of
discovery, likelihood of adjustment and likelihood of reporting. All main effects were significant at p
< .01. Therefore, composite audit quality as measured by the five dependent variables is affected by
auditor reputation, length of the audit relationship, contract type, provision of other services and the
level of fee dependence.


Univariate analyses was also conducted at the overall level, i.e., for all auditors, within each Big
Six/non-Big Six auditor group and within the junior/senior audit group. This was done to determine if
perceptual differences exist between groups. The omega-squared (?
2)

statistic was also measured
for all significant effects as it provided a measure of explained variance. It was necessary to measure
?
2
because the F statistic is dependent on sample size (Hays [1973], Shockley [1981]).

20
Univariate analysis of variance with audit quality as the dependent variable showed that the main
effects, reputation and contract were significant at p = .002 and p = .000 respectively. The two-way
interaction between contract and reputation was also significant (p = .032). Therefore, H
1a
and H
3a

are supported as auditor reputation and contract type affect auditors' estimates of audit quality.
Under a fixed contract, the audit quality estimates for a high reputation auditor was 7.08 (1.40) while
for a low reputation auditor it was 6.56 (1.30). For the variable contract, audit quality estimates
were 7.84 (1.21) and 6.90 (1.30) respectively for high reputation and low reputation auditors.
Contract type explained 18.6% of the variance and therefore significantly affected perceptions of
quality.


To determine whether differences in perceptions exist between auditors in Big Six firms and those in
non-Big Six firms, separate analyses were carried out. The results showed that auditor reputation (p
= .000) and contract type (p = .000) affected Big Six auditors' audit quality perceptions while
contract type (p = .002) and provision of non-audit services (p = .020) affected non-Big Six
auditors' estimates. Therefore, as expected, while Big Six auditors considered reputation important
for quality assessments, non-Big Six auditors did not. However, there is a consensus among the
auditors that an auditor engaged under a variable contract will perform a higher quality audit
compared to an audit with a fixed fee contract obtained by tender. Non-Big Six auditors found the
provision of other-non-audit services to affect audit quality. A possible explanation for this effect is
that since non-Big Six firms provide fewer non-audit services relative to their Big Six counter parts,
their reservations about the effect of non-audit services on the quality of audit services is
understandably related to diminished independence.

Assessments of audit quality can also be affected by the everyday responsibilities and decisions
made by auditors. It is argued that auditors in senior positions such as managers and partners make
decisions which directly affect audit quality, especially with respect to independence issues.
Therefore, it is expected that the audit quality estimates of senior and junior members of the audit
team will be influenced by different factors. The MANOVA results showed that for junior auditors,
contract type (p = .000), non-audit services (p = .023) and the interaction between non-audit
services and fee dependence (p = .012) were significant. For the senior auditors, reputation (p =
.000), contract type (p = .000) and the interaction between contract type, provision of non-audit
services and fee dependence (p = .039) were significant. It is believed that the perceptions of junior
auditors are more aligned with external financial statement users than senior auditors. It was
expected that senior auditors' audit quality perceptions would not be affected by any of the factors
presented because of their ability to judge each audit on its own merit and not be influenced by any

21
exogenous factor. However, the results do not indicate any significant perceptual differences
between senior and junior auditors.

For independence, univariate analysis indicated that contract type, provision of non-audit services,
fee dependence, and the four-way interaction between length of auditor-client relationship, contract
type, provision of non-audit services and reputation were significant at p < .05. Therefore, H
1b
,
H
2b
, H
3b
, H
4b
and H
5b
are supported. This means that estimates of independence are affected by
all five variables. This finding is consistent with Knapp [1991], Shockley [1981] and Gul [1991].
When the auditor is economically dependent on a client, the risk of auditor independence being
impaired was 4.75 (2.16) while for a fee independent auditor, the risk was 3.11 (1.75). Although
the four-way interaction accounted for 2.6% of the variance, the ?
?
?for fee

dependence was
46.4%. This means that auditors perceive fee dependence to be the most important factor affecting
perceptions of independence.


Separate analyses of Big Six and non-Big Six respondents revealed some interesting information.
Contrary to predictions, Big Six and non-Big Six auditors' perceptions of independence were
affected by the same factors. Contract type, provision of non-audit services and fee dependence
were significant at the .05 level for both auditor groups. Auditor reputation did not affect the Big Six
auditor group's perceptions of independence. Therefore, H
1f
is rejected and the results support
H
1g
. This is contrary to Shockleys [1981] findings with respect to Big Six auditors but consistent
for non Big-Six auditors. It would seem that other less observable characteristics play important
parts in independence assessment. A possible explanation for this result is that auditors differ from
general financial statement users and actually consider real as opposed to perceived independence.
A counter-argument is that if each audit is evaluated on an individual basis, factors such as contract
type and fee dependence should not affect independence.

Analyses were carried out separately for junior and senior auditors. For the former, provision of
non-audit services (p = .001), fee dependence (p = .000) and the interaction between length of audit
relationship and contract type (p = .030) were significant. Senior auditors' assessments of
independence were also affected by the same factors. Therefore, experience does not appear to
play a part in the independence judgments of auditors.

Table 8 shows the univariate analysis results of auditors assessments of the likelihood of discovering
a material misstatement. Length of auditor-client relationship (p = .001), contract type (p = .000)
and fee dependence (p = .010) significantly influenced the likelihood of discovery. However,
contract type accounted for 23.8% of the explained variance.

22


The likelihood of a newly appointed auditor discovering a material misstatement was 5.61 (2.05),
compared to 6.03 (1.99) for an auditor for five years. For a variable contract, the likelihood of
discovery was 6.15 (1.97) while for a fixed contract, it was 5.50 (2.04). The assessments for fee
dependent and fee independent auditors were 5.74 (2.07) and 5.91 (1.99) respectively. Auditor
reputation does not seem to affect the probability of discovery, consistent with Knapps [1991]
findings for audit committee members. The results support H
2c
, H
3c
, and H
5c
and reject H
1c
and
H
4c
.

An analysis between Big Six and non-Big Six auditors for assessments of the likelihood of
discovering a material misstatement was also carried out. For Big Six auditors, only contract type
was significant at p < .05. However, for non-Big Six auditors, contract type (p = .008), provision of
non audit services (p = .012), two-way interaction between provision of non-audit services and
auditor reputation (p = .047), and the four-way interactions between contract type, provision of
other non-audit services, fee dependence and auditor reputation (p = .021) and length of audit
relationship, contract type, provision of other non-audit services and fee dependence (p = .010)
were significant. Big Six auditors perceived contract type as the only variable affecting the likelihood
of discovery while non-Big Six auditors were influenced by all five variables including auditor
reputation. Therefore, both H
1d
and H
1e
are rejected.

Separate analysis between junior and senior auditors revealed interesting results. Junior auditors'
assessments of the likelihood of the material misstatement being discovered were affected by auditor
reputation (p = .017) and the interaction between tenure and contract type (p = .048). For senior
auditors, contract type and fee dependence were significant at p < .05.

6.0 IMPLICATIONS AND SUMMARY

Perceptions of audit quality were affected by the two-way interaction between contract type and
auditor reputation. Audit contract type also affected auditors' perceptions of independence and
competence (probability of discovering the material misstatement). The results indicate that under a
fixed contract obtained through tendering, an auditor believed that they were less likely to discover a
material misstatement due to time constraints. In addition, if a material misstatement is discovered, an
fixed contract auditor is less likely to report the misstatement. A possible explanation is client
pressure on the auditor. As the audit engagement was obtained under a tendering process, the threat
of termination gives the client bargaining power. Anderson et al [1987] found that clients utilised the

23
tendering process as a means of reducing fees and were willing to replace auditors to reduce their
fees.

The fact that audit contract type significantly influenced the perceptions of audit quality raises
concerns about the effect of fixed fee contracts resulting from tenders on the auditing process in
Australia. The effect of audit contract type on audit quality questions the quality of audits in this
country in the face of rampant competition among auditing firms. It appears that some of the
concerns expressed in the professional literature may have some justification. However, it should be
noted that the manipulation of audit contract type where the fixed fee contract was combined with
tendering did not allow us to separate the "lack of effort" effect, which was directly comparable with
the variable fee contract, from the tendering effect. Thus it was not possible to determine the direct
effect of the fixed contract on quality, independence and competence. Further research should
address this issue.

Perceptions of independence were affected by fee dependence where an auditor who was not
dependent on the client for fee income was considered more independent than one who was
economically dependent. This finding confirms the fee dependence test in AUP 32 where "fees not
exceeding 15% of the gross fees of the practice" benchmark was used. However, we should bear in
mind that even though fee dependence accounts for almost 50% of the variance explained in auditor
independence, its effect should not be estimated in isolation. Case specific characteristics and
circumstances, which could abate or exaggerate the independence problem, should also be
considered.

Auditors' perceptions of their ability to detect material misstatements were affected by the length of
auditor-client relationship, contract type and fee dependence. Therefore, an auditor who was more
familiar with the client's business environment, engaged under a variable contract and fee
independent was more likely to discover material misstatements. This indicates that an auditor's
competence is related to case specific circumstances rather than audit firm characteristics.

In summary, the results indicate that auditors' perceptions of audit quality are affected by contract
type and the risk of independence being impaired becomes a major concern when the auditor is
economically dependent on a client for fee income. With respect to discovering material
misstatements in the client's financial statements, the length of the auditor-client relationship, contract
type and level of fee dependence influence the likelihood of discovery.

24
APPENDIX 1
Auditor Reputation (audit firm size)
ABC Ltd is presently audited by a "Big Six" auditor. The "Big Six" refers to the six largest
accounting firms in the world, each having offices in all major Australian cities and in many other
cities throughout the world. They are Arthur Andersen, Ernst & Young, Coopers & Lybrand,
Deloitte Ross Tohmatsu, KPMG Peat Marwick, and Price Waterhouse.
ABC Ltd is presently being audited by a local accounting firm which has offices in Brisbane and
Perth. It is also affiliated with other small public accounting firms.
Length of Auditor Relationship
Newly appointed auditor means that this is the first year of the audit relationship between the
client and accounting firm.
Auditor for 5 years means that the accounting firm has been engaged for a continuous period
of 5 years.
Type of Audit Contract
Fixed fee contract obtained through tendering refers to a contract where fees were agreed
upon before audit work is carried out. Regardless of how long it takes the auditor to complete
the audit, the client will be charged the fixed fee agreed at the start of the audit. The current audit
engagement was obtained through a tendering process where 5 accounting firms submitted bids.
The present auditor was appointed because the firm submitted the lowest bid.
Variable fee contract refers to a contract where audit fees are agreed upon after conclusion of
the audit. The audit fee is based on how many hours it takes the auditor to complete the audit.
Other Services
Provides other services means that the accounting firm provides management consulting
services, accounting services, and tax services in addition to audit services to ABC Ltd.
Does not provide other services means that the accounting firm provides only audit services to
ABC Ltd.
Size of Audit Fees
The contribution of ABC Ltds fees to total fees has been expressed as approximately 18% or 5% of
the accounting firm's total fees. The accounting firm's total fees refers to the total revenues of the
accounting firm from all professional activities, e.g., tax services, auditing services, consulting services,
etc.
Fees from ABC Ltd represent approximately 18% of total gross fees indicates that fees from
ABC Ltd comprise 18% of the total fees of the accounting firm's Perth office.
Fees from ABC Ltd represent approximately 5% of total gross fees indicates that fees from
ABC Ltd comprise 5% of the total fees of the accounting firm's Perth office.

25
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30

Table 1
Mean Assessments (standard deviations) of Audit Quality for Each of the 32 Scenarios

Newly Appointed Auditor Auditor for five years
Fixed Variable Fixed Variable
18% 5% 18% 5% 18% 5% 18% 5%

Big
Other
services
7.03
(1.74)
7.05
(1.12)
7.95
(1.26)
7.77
(1.09)
7.08
(1.44)
6.95
(1.23)
7.85
(1.39)
7.85
(1.09)
Six Only
audit
services
7.28
(1.61)

7.00
(1.41)
7.82
(1.32)
7.82
(1.05)
7.21
(1.44)
7.05
(1.17)
7.92
(1.37)
7.77
(1.16)
Non-
Big
Other
services
6.32
(1.50)
6.65
(1.20)
6.71
(1.58)
6.90
(1.11)
6.39
(1.38)
6.74
(1.09)
6.84
(1.39)
7.03
(1.43)
Six Only
audit
services
6.48
(1.53)
6.71
(1.04)
6.87
(1.31)
6.94
(1.06)
6.45
(1.41)
6.74
(1.26)
6.90
(1.19)
7.03
(1.35)

Table 2
Mean Likelihood Estimates of Independence for Each of the 32 Scenarios

18% 5% 18% 5% 18% 5% 18% 5%

Big
Other
services
5.18
(2.33)
3.77
(2.15)
4.72
(2.24)
3.05
(1.89)
4.92
(2.41)
2.97
(1.63)
4.82
(2.41)
2.95
(1.89)
Six Only
audit
services
4.77
(2.28)

2.85
(1.69)
4.44
(2.01)
2.54
(1.71)
4.46
(2.33)
2.64
(1.53)
4.33
(2.25)
2.33
(1.58)
Non-
Big
Other
services
5.07
(2.02)
3.61
(1.71)
4.87
(2.14)
3.61
(1.69)
5.39
(2.09)
3.87
(1.80)
4.87
(1.98)
3.58
(1.77)
Six Only
audit
services
4.84
(2.13)
3.19
(1.58)
4.23
(1.88)
2.74
(1.26)
4.81
(1.85)
3.36
(1.76)
4.45
(1.91)
3.07
(1.57)

31

Table 3
Mean Likelihood Estimates of Discovering a Material Misstatement
for Each of the 32 Scenarios

18% 5% 18% 5% 18% 5% 18% 5%

Big
Other
services
4.87
(2.15)
5.18
(1.97)
5.87
(2.03)
5.89
(2.08)
5.69
(2.00)
5.69
(1.97)
6.26
(1.98)
6.46
(1.86)
Six Only
audit
services
4.92
(2.02)

5.13
(2.05)
5.82
(1.93)
6.00
(2.15)
5.64
(2.06)
5.74
(1.97)
6.31
(2.02)
6.46
(1.92)
Non-
Big
Other
services
5.39
(2.01)
5.71
(1.97)
6.00
(1.86)
6.03
(2.03)
5.61
(2.32)
5.97
(1.85)
6.19
(2.01)
6.39
(1.94)
Six Only
audit
services
5.39
(2.32)
5.74
(1.90)
6.03
(2.03)
6.16
(1.97)
5.81
(2.04)
5.87
(1.98)
6.23
(2.01)
6.23
(1.91)

32

Table 4
T Tests for Each Independent Variable

Audit Quality Independence Discovery
Mean
(S.D.)
prob
one-tailed
Mean
(S.D.)
prob
one-tailed
Mean
(S.D.)
prob
one-tailed
Auditor Reputation

Big Six

7.46
(1.36)

3.79
(2.24)

5.75
(2.05)

Non-Big Six

6.76
(1.38)

.000

4.11
(1.98)

.007

5.92
(2.01)

.073

Relationship Length

Newly appointed
auditor

7.13
(1.40)

3.96
(2.12)

5.61
(2.05)

5 years as auditor

7.15
(1.37)

.373

3.90
(2.14)

.312

6.03
(1.99)

.000

Contract Type

Fixed

6.85
(1.38)

4.09
(2.16)

5.50
(2.04)

Variable

7.43
(1.33)

.000

3.77
(2.09)

.007

6.15
(1.97)

.000

Non-audit services

Yes

7.11
(1.40)

4.19
(2.18)

5.82
(2.02)

No

7.17
(1.37)

.252

3.67
(2.05)

.000

5.83
(2.04)

.448

Fee Dependence

18%

7.12
(1.52)

4.75
(2.16)

5.74
(2.07)

5%

7.16
(1.24)

.326

3.11
(1.75)

.000

5.91
(1.99)

.090

33

34

Table 5
Multivariate Analysis of Variance for Auditors' Assessments of Audit Quality,
Independence, Probability of Discovery, Probability of Adjustment and
Probability of Reporting

Effect DF Pillai-
Bartlett's
trace
Hotelling-
Lawley's
trace
Wilks's
lambda
F-value

Main Effects
Reputation (A) 5,64 .241 .317 .759 4.054**
Tenure (B) 5,64 .233 .303 .767 3.883**
Contract (C) 5,64 .476 .910 .524 11.650**
Services (D) 5,64 .235 .307 .765 3.929**
Fee (E) 5,64 .682 2.141 .318 27.403**

Two-way
Interactions

AB 5,64 .146 .171 .854 2.193
AC 5,64 .107 .119 .893 1.526
AD 5,64 .025 .026 .975 .328
AE 5,64 .113 .128 .887 1.635
BC 5,64 .089 .097 .911 1.244
BD 5,64 .067 .072 .933 .921
BE 5,64 .022 .023 .978 .291
CD 5,64 .046 .048 .954 .611
CE 5,64 .084 .092 .916 1.176
DE 5,64 .110 .123 .890 1.575

Three-way
Interactions

ABC 5,64 .072 .077 .928 .990
ABD 5,64 .024 .024 .976 .310
ABE 5,64 .042 .044 .958 .564
ACD 5,64 .111 .124 .890 1.590
ACE 5,64 .065 .069 .935 .883
ADE 5,64 .015 .015 .985 .197
BCD 5,64 .018 .019 .982 .241
BCE 5,64 .036 .037 .964 .477
BDE 5,64 .033 .034 .967 .441
CDE 5,64 .012 .012 .988 .155

Four-way
Interactions

ABCD 5,64 .081 .088 .919 1.123
ABCE 5,64 .004 .004 .996 .055
ABDE 5,64 .054 .057 .946 .732
ACDE 5,64 .046 .048 .954 .613
BCDE 5,64 .074 .080 .926 1.025

35
Five-way
Interaction

ABCDE 5,64 .080 .087 .920 1.112

* p<.05
** p<.01

36

Table 6
Univariate Analysis of Variance for Auditors' Assessment of Audit Quality

Source of Variation SS df MS F

Reputation (A) 147.135 1,68 147.135 10.247**
Tenure (B) .267 1,68 .267 .077
Contract (C) 84.441 1,68 84.441 33.077**
Services (D) .889 1,68 .889 1.306
Fee (E) 0.879 1,68 0.879 .320

AB .388 1,68 .388 .112
AC 12.191 1,68 12.191 4.776*
AD .039 1,68 .039 .057
AE 7.558 1,68 7.558 2.748
BC .116 1,68 .116 .275
BD .038 1,68 .038 .083
BE .028 1,68 .028 .101
CD .321 1,68 .321 .614
CE .179 1,68 .179 .528
DE .474 1,68 .474 2.190

ABC .016 1,68 .016 .039
ABD .024 1,68 .024 .366
ABE .028 1,68 .028 .101
ACD .249 1,68 .249 .477
ACE .722 1,68 .722 2.126
ADE .002 1,68 .002 .011
BCD .008 1,68 .008 .029
BCE .000 1,68 .000 .001
BDE .002 1,68 .002 .007
CDE .115 1,68 .115 .262

ABCD .000 1,68 .000 .002
ABCE .008 1,68 .008 .025
ABDE .024 1,68 .024 .074
ACDE .165 1,68 .165 .376
BCDE .367 1,68 .367 1,174

ABCDE .453 1,68 .453 1.448

* p<.05
** p<.01

37

Table 7
Univariate Analysis of Variance for Auditors' Assessment of the Risk of
Independence being Impaired


Reputation (A) 24.920 1,68 24.920 .704
Tenure (B) .450 1,68 .450 .134
Contract (C) 28.014 1,68 28.014 10.175**
Services (D) 72.923 1,68 72.923 15.050**
Fee (E) 730.972 1,68 730.972 122.251**

AB 10.358 1,68 10.358 3.071
AC .114 1,68 .114 .041
AD .030 1,68 .030 .006
AE 10.072 1,68 10.072 1.684
BC 1.219 1,68 1.219 1.318
BD .140 1,68 .140 .173
BE .327 1,68 .327 .394
CD .248 1,68 .248 .272
CE .105 1,68 .105 .173
DE 1.542 1,68 1.542 2.170

ABC 2.269 1,68 2.269 2.454
ABD .011 1,68 .011 .014
ABE .948 1,68 .948 1.143
ACD .955 1,68 .955 1.048
ACE 1.034 1,68 1.034 1.704
ADE .092 1,68 .092 .130
BCD .037 1,68 .037 .047
BCE .004 1,68 .004 .005
BDE 1.380 1,68 1.380 1.579
CDE .030 1,68 .030 .035

ABCD 3.809 1,68 3.809 4.774*
ABCE .040 1,68 .040 .047
ABDE .137 1,68 .137 .157
ACDE .052 1,68 .052 .060
BCDE .481 1,68 .481 .900

ABCDE .181 1,68 .181 .339

* p<.05
** p<.01

38

Table 8
Univariate Analysis of Variance for Auditors' Assessment of the Probability of
Discovery


Reputation (A) 8.422 1,68 8.422 .161
Tenure (B) 44.254 1,68 44.254 12.678**
Contract (C) 107.500 1,68 107.500 44.782**
Services (D) .075 1,68 .075 .071
Fee (E) 7.473 1,68 7.473 6.941*

AB 8.018 1,68 8.018 2.297
AC 6.379 1,68 6.379 2.657
AD .004 1,68 .004 .004
AE .080 1,68 .080 .074
BC 1.069 1,68 1.069 1.970
BD .055 1,68 .055 .141
BE .251 1,68 .251 .652
CD .000 1,68 .000 .000
CE .679 1,68 .679 1.719
DE .069 1,68 .069 .154

ABC .319 1,68 .319 .588
ABD .055 1,68 .055 .141
ABE .001 1,68 .001 .003
ACD .043 1,68 .043 .118
ACE .515 1,68 .515 1.303
ADE .226 1,68 .226 .505
BCD .136 1,68 .136 .482
BCE .788 1,68 .788 1.801
BDE .406 1,68 .406 .870
CDE .075 1,68 .075 .183

ABCD .136 1,68 .136 .482
ABCE .081 1,68 .081 .185
ABDE .406 1,68 .406 .870
ACDE .004 1,68 .004 .009
BCDE .154 1,68 .154 .471

ABCDE .211 1,68 .211 .645

* p<.05
** p<.01

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