The association between non-audit services and accrual quality in EEA countries (2015-2017)

Abstract

The main purpose of this study is to examine whether there is a relationship between accrual quality and non-audit services for medium and large listed companies in EEA countries from 2015 to 2017. The further tests are conducted based on the sample of the Nordic region and 4 individual countries such as Norway, Sweden, Denmark and Finland. The dataset included 3,648 medium and large listed companies with their available financial information in the selected period. Accrual quality is measured by using discretionary accrual which is calculated following the Modified Jones Model (1995). The high accrual quality (i.e. low discretionary accrual) indicates a low level of Earning Management and high audit quality. We choose non-audit fees ratio (NAF ratio) which is the ratio of the current year‟s NAF to the average of prior three years audit fees to investigate the correlation between this indicator and absolute discretionary accrual, incomeincreasing accrual and income-reducing accrual. We found the strong positive association between NAF ratio and absolute discretionary accruals and income-increasing accruals but, negative relationship with income-reducing accrual. Additional tests show the positive connection between using non-audit service in company and accrual quality. The test of limitation cap on non-audit service fees according to the EU Regulation No 537/2014 indicates that the total fees for non-audit services shall be limited to no more than 70% of the average audit fees in last three consecutive financial years that can increase the quality of audit (accrual). Furthermore, investigating detailed Nordic groups provide the same results, except we found no significant relation between NAF ratio and incomeincreasing accrual. Followed by this, we also found no relation in Norway and Sweden, but the evidence of a positive relationship can be found in Denmark and Finland. In short, when a company uses non-audit services and limits the NAF ratio up to an acceptable level of 70% of the average audit fees in the last three years, it will increase the audit (accruals) quality. However, due to some limitations, further tests should be conducted to get the correct implication about this relation to specific objects and contexts.