The Development Of External Audit Accounting Essay

This survey aims at finding the factors refering the degree of audit fees paid by companies to their hearers. At the beginning all the likely factors associating to the degree of audit fees were identified through a literature study. These factors were categorised into three groups, viz. size, complexness, and hazard. The comparative importance of these factors was determined both through empirical observation and statistically.

Preliminary readings were done in order to place if the most of import factors collected through the literature were suited for farther inclusion in the concluding analysis. The research is based on quantitative informations derived from financials and one-year studies of the companies. The research will besides include informations derived from stock exchange publications, diaries and articles which will measure up to the relevancy of the survey. In transporting out the statistical analysis, the Multiple Regression theoretical account would be defined while other trials would be used to cipher the significance and hardiness of the theoretical account.

The research identifies the company size ( in footings of entire assets and speedy ratio ) , its complexness ( in footings of figure of subordinates held ) and the hazard ( in footings of long footings debt to entire assets and ratio of current assets to entire assets ) which are the major nonsubjective determiners of audit fees.

The research demonstrated on how external auditing patterns, competition in the audit market, hazards involved with audit work and regulative demands in the geographical section of Sri Lanka and has provided an penetration to the relationship on factors which would find the audit fees. In add-on, the statistical analysis revealed that the factors entire assets which determined the size of the client and figure of subordinates which determined the complexness were the most important forecasters of audit fees.

Table of Contentss

Index of Tables

Index of Figures


An overview to the development of external audit

Following recent prostrations in the corporate universe that have caused a ripple consequence on the economic systems in most developed states, the strength with which we need to see proper auditing patterns and the focal point on advancing a civilization of “ Good Corporate Administration ” have increased significantly. To this consequence several steps have been introduced globally to guarantee that companies contribute positively to its stakeholders, community, economic system and the state. However there is a big country of concern that is yet to be addressed.

The Colombo Stock Exchange experienced immense growing in the wake of the war and saw major listings of in private held companies. From a strategic base point this important growing and enlargement in the capital market has led to possible foreign direct investing of listed companies. In the aftermath of these developments it is of import that the market and listed companies be regulated and proactive action be taken to avoid any sort of indefensible state of affairs.

To this consequence the Securities and Exchange Commission of Sri Lanka, holding recognised how of import the function of the external hearer particularly to listed companies, which come within its legal power and which are required to keep complete and accurate fiscal studies on a go oning footing, has determined cardinal standards to be adopted in choosing their external hearers and besides in supplying counsel to these companies on pull offing struggles of involvement, which may be damaging to the company and its stakeholders. The external audit map and audit fees are of involvement to both the legal governments and the professional accounting organic structures.

The external audit services and fees paid by listed companies to the designated hearers are of much involvement to both companies and hearers and companies are required to hold their histories audited by external audit houses, as per the ordinances of the Colombo Stock Exchange.

From the companies ‘ perspective the fees paid to the hearers must be sensible and should be justified to both stockholders and managers. In this position audit houses need to supply such services and want to guarantee that the fees they charge are capable of supplying a satisfactory service. It is every bit of import to turn to the concerns of companies, hearers, the general populace and stockholders, in peculiar that the audit fee is non set of such a degree – either excessively high or excessively low – which may sabotage assurance in the audit sentiment.

This survey focuses on the designation of the factors that enter into the finding of audit fees, factors which may impact straight the clip of the audit work or indirectly the degree of audit fees. Given the importance of holding an accurate external audit, it is emphasised that the factors impacting the audit fees should be suitably identified at its best, in order to supply an audit service at a competitory rate and in higher quality.

The research aims to show the significance of external audit for the listed companies in the geographical section of Sri Lanka and will supply an penetration to the relationship sing factors which would find audit fees.

Addressing the research job

The importance of external audit pricing has continued to be an country of uncertainness over the old ages. Despite the Securities and Exchange Commission, Colombo Stock Exchange have developed certain guidelines for naming external hearers for the listed companies that come under their legal power, understanding the determiners and the factors that influence external audit fees is an country, where minimum research has been done.

The turbulency of the fiscal landscape, tenseness between stockholders, managers and the direction hold given rise to many complications in quality of scrutinizing and good corporate administration.

The chief motive for set abouting this survey is to understand how external audit pricing is arrived at and its pertinence in the Sri Lankan context. Besides the research workers ‘ involvement, merely a limited attempt has been done in this domain and the research worker hopes to supply penetration on audit pricing for indiscriminately selected listed companies on the Colombo Stock Exchange.

Research motivations

The chief aims of the research are:

To find the impact of house size in finding of audit fees in the listed companies of the Colombo Stock Exchange.

To find the impact of the significance of hazard in finding of audit fees in the listed companies of the Colombo Stock Exchange.

To find the impact of house complexness in finding of audit fees in the listed companies of the Colombo Stock Exchange.

Contributions of the survey

This research charts an undiscovered country of the fiscal auditing landscape in the Sri Lankan context. Merely a limited sum of research has been done to understand the audit fee procedure and its relevancy for the listed companies on the Colombo Stock Exchange. Give the accelerated growing, debut of new Torahs and good administration, the research worker feels that this research would assist to bridge the spread in supplying valuable penetration into the finding of audit fees. The part of this research can be used to prove the bing theoretical account across a broad scope of listed companies across diverse industries and composings. This will therefore enable the hereafter research to be based on the basicss of this thesis and to develop more accurate theoretical accounts based on the situational context.

Structure of the research

The thesis is structured in the undermentioned mode aimed at accomplishing the research aims.

Chapter One: Introduction

This includes an debut to the diverse concern landscapes of Sri Lanka via focal point on the listed companies. It includes the regulative model which governs them, the nature of the market for audit services and identifies the purpose for research and its chief aims.

Chapter Two: Background to the Research

This chapter sets the phase and reviews the fiscal market in Sri Lanka and discusses the audit market with particular accent on the Big 4 audit houses. The demand and supply of companies and the general audit patterns used by companies are discussed subsequently. The background to the research further explains the ordinances on external audits while foregrounding both professional and legislative guidelines. Some appraisal of the external audit fees, secondly, its composing and services offered will besides be discussed.

Chapter Three: Literature Reappraisal

An debut and development to scrutinizing from a planetary position, anterior researches conducted in the South Asiatic and Sri Lankan context, the designation of factors impacting the degree of audit fees and designing of the audit fee theoretical account would be discussed, therefore supplying an overall reappraisal of both historic and modern-day literature.

Chapter Four: Theoretical Model

Deals with the theoretical model and purposes at discoursing the general theories aligned with the research job. In peculiar this chapter emphasises the Agency theory, Stewardship theory and the Stakeholder theory.

Chapter Five: Research Methodology and Hypotheses

This chapter illustrates the research doctrine which represents the research design, procedure, types and the attack. The development of the hypotheses is so discussed along with the appropriate empirical theoretical account including the defined independent variables ( i.e size, complexness and hazard ) . The analytical process will be so explained.

Chapter Six: Findingss

Presents the consequences and treatment of the statistical analysis i.e. , it discusses the findings of the preliminary statistical processs. It besides presents comparing between the consequences of the empirical survey and the statistical analysis.

Chapter Seven: Research Conclusions & A ; Recommendations

This chapter summarises the research consequences and provides research recommendations. It besides goes on to explicate the restrictions of the research and goes on to explicate the avenues for farther research.



The purpose of this chapter is to put the phase and reexamine the fiscal market in Sri Lanka and to discourse the audit market with particular accent on the Big 4 audit houses. The demand and supply of companies and the general audit patterns used by companies are discussed subsequently. The background to the research further explains the ordinances on external audits while foregrounding both professional and legislative guidelines. Some characteristics of the external audit fees are discussed later.

Fiscal market in Sri Lanka

Sri Lanka ‘s fiscal system continues to stay stable and resilient underpinned by strong domestic economic growing in the face of increased hazards from the planetary macro-financial environment. This stableness is instrumental in making a favorable environment for depositors and investors, while promoting fiscal establishments and markets to work efficaciously and expeditiously, advancing investing and economic growing. Financial system stableness requires a stable fiscal and economic environment within an effectual regulative model and a safe and robust payment and colony system.

The local fiscal landscape can be divided into the Money Market and the Capital Market severally. The Money Market where short-run interest- bearing assets with adulthoods of less than one twelvemonth, such as exchequer measures, commercial paper, and certifications of sedimentations are traded and ease the liquidness direction in the economic system. The Capital Market on the other manus is the market for trading in assets for adulthoods longer than one twelvemonth, such as exchequer bonds, private debt securities ( bonds and unsecured bonds ) and equities ( portions ) . Its intent is to ease the elevation of long-run financess.

The Financial Market can be besides be classified harmonizing to instruments, such as the debt market and the equity market.

The debt market is besides known as the Fixed Income Securities Market and its sections are the Government Securities Market ( exchequer measures and bonds ) and the Private Debt Securities Market ( commercial paper, private bonds and unsecured bonds ) .

The fiscal system consists of the Central Bank, as the apex fiscal establishment, regulative authorization, fiscal establishment, a payment and colony system and a legal model. The fiscal system carries out the critical fiscal intermediation map of borrowing from excess units and loaning to shortage units.

The Central Bank through its behavior of pecuniary policy influences the different sections of the Financial Market in changing grades. The Central Bank ‘s policy involvement rates have the greatest impact on a section of the Money Market called the inter-bank call money market and a section of the Fixed Income Securities Market, i.e. the Government Securities Market. The Central Bank may besides step in in the inter-bank Foreign Exchange Market, which is closely connected to the Money Market.

One of the most of import maps of the fiscal system is to guarantee safety and efficiency in payments and security minutess. Fiscal substructure refers to the different systems that provide for the executing of both large-value and small-value payments. Payment and colony systems enable the transportation of money in the histories of fiscal establishments to settle fiscal duties between persons and establishments. ( Fiscal System Stability Review – Central Bank 2011 )

Audited account market in Sri Lanka

With Sri Lanka ‘s convergence to International Financial Reporting Standards ( IFRS ) , a major function must be played by the Institute of Chartered Accountants of Sri Lanka ( CA, Sri Lanka ) , which is the state ‘s exclusive authorization in explicating Accounting and Auditing Standards.

The Sri Lankan audit landscape is chiefly dominated by the Big 3 audit houses which are Pricewaterhouse Coopers, Ernst & A ; Young and KMPG. These audit giants account for the bulk of audit services across the listed companies.

In add-on to these major participants BDO Partners, B. R. De Silva & A ; Company, Amerasekera & A ; Company, SMJS Associates, De Zoysa Associates, R N Associates, Nandimuttu & A ; Co, Ranwatta & A ; Co are some of the other auditing houses that compete in the general audit industry of Sri Lanka. These participants largely are involved in scrutinizing companies that are non listed on the Colombo Stock Exchange.

The game of Big 4 & A ; Non Big 4 audit houses

When analyzing the audit landscape from an international context the Big 4 are known as the four largest international professional services webs in accounting and professional services, which handle the huge bulk of audits for publically traded companies every bit good as many private companies.

The Big 4 are sometimes referred to as the “ Final Four ” due to the widely held perceptual experience that competition regulators are improbable to let farther concentration of the accounting industry and that other houses will ne’er be able to vie with the Big 4 for top-end work, as there is a market perceptual experience that they are non believable as hearers or advisers to the largest corporations.

However in Sri Lanka it is noted that Deloitte Touche Tohmatsu is non a outstanding participant and merely the other three audit houses are important within the industry. The stableness, credibleness and planetary presence that these companies offer are in fact significant. In a Sri Lankan context these companies have an border and go a formidable rival for about all the listed companies.




Fiscal Year


Pricewaterhouse Peter coopers

$ 29.2bn



United Kingdom

Deloitte Touche Tohmatsu




United States

Ernst & A ; Young




United Kingdom






Table: Financials of the Big 4 Audited account Firms

Mention: Company Financials ( PWC 2011, E & A ; Y2011, KMPG 2011, Deloitte 2011 )

Demand and Supply

In footings of geographics, the American part histories for a 40 % and worsening portion of planetary combined grosss. From 2010 to 2011 nevertheless, the American part had a strong public presentation growing of 9.9 % . Europe has 44 % of combined house grosss and increased 5.4 % from 2010 to 2011, turning the slowest due to regional uncertainness. Asiatic grosss have more than doubled from $ 7 billion in 2004 to $ 17 billion in 2011, and grew a dramatic 17.4 % from 2010 to 2011. ( The 2011 Big Four Firm Performance Analysis )

Harmonizing to statistics indicated in the Big 4 Performance analysis study 2011 the Big 4 houses cumulatively employ more than 650,000 staff globally, with a sum of 35,000 spouses supervising a steep pyramid of about 490,000 professionals. It besides indicates that the net employment increased by 36,000 from 2010 to 2011. This gives an indicant of how important these companies are and to what extent they dominate the full audit landscape.

Regulations on external auditing

The Board of a listed company should set up formal and crystalline agreements for sing how they should choose and use accounting policies, fiscal coverage and internal control rules and keeping an appropriate relationship with the Company ‘s Auditors. Once this is finalised a listed company should obtain the services of a professional audit house. To this consequence the company must make out to the model on Sri Lankan Auditing criterions. The Companies Act of 2007 besides has a series of ordinances that need to be adhered to when choosing and commissioning the services or an external hearer. This is besides applicable in the event of altering the bing audit house.

Listed companies are required to follow with Sri Lankan Accounting Standards when fixing audited fiscal statements which are included in their Annual Report. However, the Listing Rules of the Colombo Stock Exchange require the Annual Report to include some extra information.

The Annual Report, as defined by the Colombo Stock Exchange Listing Rules, must include the audited fiscal statements of the Company, Director ‘s study and the revelations required by regulation 7.6 of the Listing Rules and must be circulated to stockholders before the termination of five ( 5 ) months from the terminal of the fiscal twelvemonth.

This is one of the chief considerations that the listed companies must run into in order to follow with the demands mandated by the Securities and Exchange Commission and the Colombo Stock Exchange.

Professional guidelines

The Sri Lankan Auditing Standards are based on the International Standards on Auditing ( ISA ) published by the International Auditing and Assurance Standards Board ( IAASB ) of the International Federation of Accountants ( IFAC ) , with little alterations to run into local conditions and demands. It sets out the basic rules and related patterns and processs that apply to audits of fiscal statements. Hence conformity with the Sri Lankan Auditing Standards ensures conformity in all material respects with the International Standards on Auditing.

Under the Act ( Sri Lanka Accounting & A ; Auditing Standards Act No. 15 of 1995 ) , conformity with these Standards is mandatory when transporting out the audits of entities specified in the said Act. This Act non merely places the duty of following with these Standards on the Auditors entirely, but besides places a corresponding duty on the entity ‘s direction to take all sensible stairss to guarantee that these Standards are complied with in the behavior of the audits of their histories.

Legislative guidelines

When analyzing the legislative model for the listed companies, it is the duty of the audit commissions of listed companies to find the audit procedure both internal and external. Audit commission duties in companies are to be greatly enhanced harmonizing to the Sri Lanka subdivision of the Association of Chartered Certified Accountants which will make an extra bed of administration and answerability. This will guarantee that naming audit houses to carry on external audits will now rest in the custodies of these audit commissions which will supervise and supply transparence to the audit procedure.

Stairss are taken to guarantee that all listed companies provide information publically on hearer independency. Hearers should besides supply more elaborate information about the fees earned by hearers for non-audit services and publish one-year studies of the audit commission ‘s work including hazard direction and internal control reviews. This has enabled more transparence into the statute law and audit processs.

In the aftermath of important disagreements in corporate revelations in listed companies it is of import to observe that hearers merely give an sentiment of the true and just position of the fiscal statements taken as a whole, in footings of materiality, which is termed as a sensible confidence and non an absolute confidence, in conformity with the international accounting criterions.

Features of external audit services

An external audit is a reappraisal of the fiscal statements or studies of an entity, normally a authorities or concern, by person non affiliated with the company or bureau. External audits play a major function in the fiscal inadvertence of concerns and authoritiess because they are conducted by outside persons and hence supply an indifferent sentiment. External audits are normally performed at regular intervals by concerns, and are typically required annually by jurisprudence for authoritiess.

External audits are performed to verify that the fiscal statements of an entity are right presented with a true and just position. They do non affect an existent accounting of a concern ‘ or company ‘s fiscal histories, but instead external audits are an independent reappraisal of fiscal paperss provided to the party, that carries out the audit.

For a private-sector concern, an external audit will typically include a reappraisal of the company ‘s quarterly or monthly fiscal studies every bit good as statements on grosss and expenditures to guarantee they are right tabulated and reported. For authoritiess, an external audit will include a reappraisal of the budget, the allotment of financess and the existent disbursals to guarantee the budgeted grosss and disbursals were right compiled and used.

An external audit will have a study sketching the hearer ‘s findings. This will by and large be a sum-up of the overall cogency of the fiscal statements and paperss as presented by the company or authorities which is normally presented as the Statement of Auditors in the Annual Reports. Should the external hearer uncover disagreements between the statements presented by the company and his findings, these will be noted in the study as good. The audit will frequently include fiscal suggestions for the entity as ways to better its overall fiscal standing and accounting patterns.

The more of import characteristic of an external audit is the decision of the hearer. A favorable decision is indifferent grounds that the entity is describing fiscal informations right while a negative decision is a ruddy flag for hapless accounting patterns.


The stableness of the fiscal market in Sri Lanka is a cardinal driver of economic growing and nutriment. Similarly the capital markets provide a gateway for foreign investing and excite growing flights. The Sri Lankan Auditing Standards board and the Institute of Charted Accountants are the top government organic structures that guarantee good patterns and transparence in the industry.

In drumhead it was revealed that in Sri Lanka a bulk of the listed companies prefer to seek the services of three of the Big4 audit houses, viz. , Ernst & A ; Young, KMPG and Pricewaterhouse Coopers. There are some smaller audit houses that are non so important in supplying services to the listed companies. This chapter discusses the ordinances on external audits while emphasizing the importance of both professional and legislative guidelines. Appraisal of the external audit fees, its composing and services offered have been discussed from a Sri Lankan position.



This chapter mostly deals with the critical point of current cognition, extended secondary research and publications related to the subject of the survey. It classifies and elaborates on the constructs of debut and development of external audit fees from a planetary position ; anterior researches conducted in the Sri Lankan and South Asian context and the designation of factors impacting ageless audit fees. The reappraisal is besides an attempt to understand the determiners of audit fees and hypotheses for an audit fee theoretical account for the listed companies in Sri Lanka.

Review of old researches in relation to external audit fees and the determiners of such, influences a better apprehension to supply a worthy foundation for this survey. This subdivision presents a generalized reappraisal of the surveies on audit fee determiners in a globalised position.

External audit pricing and the factors which determine the audit fees have been a much debated subjects throughout decennaries and assorted positions have been identified based on initial researches during 1990 ‘s and 1980 ‘s.

The intent of this reappraisal is to analyze literature on the audit landscape, thereby to measure the current apprehension of the major subjects relevant to turn toing the research inquiry of this thesis: What are the determiners of audit fees in the Sri Lankan context? There is an copiousness of literature on determiners of audit fees, refering to what will be classified in this thesis as the audit fee theoretical account. However there is merely a limited sum of literature available on audit fee research from a Sri Lankan administration point of view. Similarly it must be noted that audit fee determiners on listed companies in Sri Lanka are invariably germinating due to major alterations in the concern environment and how administrations do concern.

Development of audit fee in a planetary position

During the last twosome of decennaries the ‘ ‘ bubble explosion and major corporate prostrations took topographic point ; the echos from the events of 11 September 2001 ; the debut of Sarbanes Oxley ( SOX ) demands in 2002 ; the passage in 2005 to International Financial Reporting Standards ( IFRS ) ; scrutinizing criterions going lawfully enforceable in 2006 and being farther ‘clarified ‘ in 2010 ; the 2008 Global Financial Crisis ( GFC ) doing fiscal hurt on a graduated table non seen since the 1930s ; a post-Global Financial Crisis debt crisis blighting the United States and the European Union sum up the volatile planetary sweep. Sri Lanka nevertheless may non hold been significantly impacted by universe events, yet natural catastrophes like the Tsunami, a ramping 30 twelvemonth cultural war which brought about unprecedented stock market activity and devaluation of the rupee calls for proper reform and fiscal ordinance. The way given in the Colombo Stock Exchange Annual study 2011-2012 shows that the monopolised activity witnessed on the Colombo Stock Exchange could hold been better monitored and regulated taking to harmonious investings and foreign capital influx. To this consequence recommendations of the codification of best pattern on administration issued jointly by the Securities Exchange committee and the Institute of Charted Accountants of Sri Lanka have been set and naming regulations have been revised in February 2012.

Globalization and the ensuing mutualities in economic systems and supply ironss, progresss in engineering, rapid population growing and increasing planetary ingestion have significantly impacted on the quality, handiness and monetary value of resources, including H2O, nutrient and energy. The demand for a broader information set is clearly demonstrated by the little per centum of market value now represented by physical and fiscal assets – down to merely 19 per cent in 2009 from 83 per cent in 1975. ( The Global Reporting Initiative ‘s G3.1 Sustainability Reporting Guidelines ; Water Act 2007 ) .

The balance represents intangible factors, some of which are explained in fiscal statements, but most of which are non. The type of information needed to measure past and current public presentation and future chances is much wider than is provided for by the bing financial-reporting theoretical account.

External coverage is now due for a moving ridge of reforms. The International Integrated Reporting Council ( IIRC ) is developing an integrated coverage model that will steer the development of external coverage over the coming decennaries. It has issued a treatment paper ( IIRC, 2011 ) and intends to publish an exposure bill of exchange in 2012.

For hearers, these alterations have increased the hazard and complexness of scrutinizing financial-statements and highlighted the importance of audit quality to market assurance. As the ‘contracted regulators ‘ of fiscal coverage, hearers have necessarily increased audit attempt in response to these higher hazards. One step of greater hazard is the increasing rate of corporate insolvencies.

To this consequence Simunic ( 1980 ) ab initio developed a positive theoretical account in the market for audit in publically listed companies with regard to the monetary value competition and the survey was chiefly based on a sample of 397 observations.

The theoretical account identified three basic variables which are,

loss exposure variables represented by the entire assets and the complexness in footings of decentralization ( Number of subordinates ) and variegation

loss sharing variables represented by the ratio of net income to entire assets, the loss incurred by the house as a silent person variable and the sentiment of a qualified hearer through a silent person variable

production map variable represented through the hearer term of office

The initial analysis on the whole sample scored an R squared value as 57 % where he identified a nonlinear relationship between assets and audit fees. Therefore secondarily he used a square root transmutation of assets variable in order to linearize the relationship between audit fees and assets.

Next he classified industries specified as public-service corporation houses and banking sector delegating them values 0 and 1 ( dummy variables ) and identified that the R squared value as 42 % . In order to prove the impact of size of the audit house on audit fees he categorised the whole sample into two on the footing of gross revenues size ( Gross saless more than $ 125 and less than $ 125 ) and the R squared value was severally 28 % and 51 % . He found that the variables counted for loss exposure are statistically important in finding the audit fees. Despite designation of the determiners he besides concluded that there is no monopoly pricing which leads large houses to bask economic systems of graduated table to bear down lower fees.

The restrictions of this survey is that the information has been collected through questionnaires, a qualitative method and this gives rise to measurement mistakes, inquiry of dependability of collected informations and is besides a moral jeopardy to empirical research analysis. The findings of the survey are besides limited to a peculiar clip frame and hence farther surveies have to be taken topographic point with a wider span of clip.

Elliot and Korpi ( 1978 ) undertook an empirical survey with 60 fabrication companies and 42 fiscal companies by roll uping informations through questionnaires to develop an audit fee theoretical account. They considered a figure of factors, i.e. size of gross revenues and assets of the companies, grade of complexness and applied the transmutation of square root in order to linearise the relationship with the audit fees. Their theoretical account explained 94 % and 84 % of the audit fees discrepancy for fabrication and fiscal companies severally which is statistically important. However in order to prove the truth of this theoretical account it is critical that a wider scope of companies be covered runing across diverse industries.

The findings of this survey provide lucidity around fiscal & A ; fabrication companies and can be used to specialize audit fee theoretical accounts that would be consistent merely within these two industries.

Briston and Perks ( 1977 ) estimated the entire audit fees paid by all the 592,243 companies ; 3,555 listed companies & A ; 589,688 unlisted companies, ranked by turnover registered in England, Scotland, and Wales to be around ?200 million consisting ?109.70 million for the listed companies plus ?90.0 million for the unlisted companies for 1975 / 1976, and ?250 million during 1977. They used the norm of the audit fees as a per centum of turnovers ( i.e. , 0.1 % . ) to gauge the entire audit fees. Their survey indicated that the proportion of audit fees to turnover lessenings as the company ‘s size additions e.g. , audit fees as a per centum of turnover was 0.1 for the companies with entire turnover ?2.2 billion, and it decreases to 0.04 % for the companies with entire turnover ?69 billion.

Faning ( 1978 ) besides estimated the entire audit fees of limited companies in the U.K. including the top 100 quoted companies by market value, 500 other quoted companies, and 300,000 unlisted companies in 1976 / 1977 to be ?416 million comprising of ?54.42 million for the top 100 companies, ?212.85 million for the other 500, and ?148.75 million for the 300,000 unlisted companies. Additionally the estimated audit fees for 1978 was about ?450 million presuming a go oning tendency in fees additions between 15 % and 30 % . The increasing hazards, complexness and costs of financial-statement audits would propose significant additions in audit fees, peculiarly station 2008 period.

These theoretical accounts give an indicant that the size of a company in footings of turnover is a critical constituent that needs to be considered. However it may non supply plenty lucidity to find that higher turnovers entirely are inversely relative to the audit fees charged. Further research countries could be performed to analyze the companies across industries and in footings of market capitalization and other fiscal ratios.

Taylor and Baker ( 1981 ) carried out a survey with 126 fabrication companies in the UK and found that square root transmutation of informations improves the relationship between dependant ( audit fees ) and independent variables. As a information decrease technique they applied factor analysis and identified the most feasible steps of size and complexness are entire assets and figure of subordinates severally. The developed audit fee theoretical account has explained 79 % of the fluctuation in the audit fee which is treated as extremely important.

A cross state survey has been done by Wayman and Bavishi ( 1983 ) in finding the factors in 640 companies across four states ; India, Malaysia, United Kingdom and Australia. The size of the company, multi-nationality, size of the audit house and fiscal close month were treated as the independent variable whereas audit fees ; the dependent variable of their arrested development theoretical account. The account of the variable of the audit fees were explained as 69 % , 51 % , 88 % and 49 % severally in Australia, India, Malaysia and UK. They found an opposite relationship between audit fees and the size of company common to all four states. This survey goes on to back up the opposite relationship between size and audit fees. The states nevertheless are geographically dispersed and may non supply a holistic position on the audit research. Further countries for research would be to analyze a more specific geographical country such as in specified parts ( Internet Explorer: European part, South Asian part ) and develop the audit fee theoretical account.

Chan et Al. ( 1993 ) assumes as a fact that a high insider ownership mitigates bureau struggle between director and stockholders. Using an initial sample of 985 UK listed companies that they divided in two sub-samples ( large houses vs. not large houses ) , Chan et Al. shows that insider ownership is negatively associated to scrutinize fees for the whole sample and for the sub-sample of large houses. However, the consequences are non-significant for the little houses sub-sample.

Using the same statement as Chan et Al. ( 1993 ) on a sample of Norse houses, Firth ( 1997 ) finds a non-significant relation between insider ownership concentration and audit fees. In France, Piot ( 2001 ) finds a non-significant relation between insider ownership and the pick of large audit house ( audit quality ) . Finally, Niemi ( 2005 ) trials Chan et Al. ‘s ( 1993 ) theoretical account on Finnish houses and finds a non-significant relation between audit fees and the step of the combined managerial and non-managerial ownership concentration ( i.e. insiders ) . Then, the writer explains these assorted consequences by the fact that managerial and non-managerial ownership concentration should hold opposite effects on audit fees. After holding distinguished between houses that are controlled by the direction, by a foreign retention or by the province, he finds ( 1 ) a significantly negative relation between audit fees and direction control of the house ; ( 2 ) a positive relation between audit fees and province control and foreign keeping control.

The writer acknowledges the choice prejudice in that the states selected, all have strong “ European ” ties, “ therefore they may non reflect a varied set of international audit fee pricing patterns ” . It is acknowledged that, although anterior literature indicates some consensus on the variables chosen, other variables had besides been identified which could farther explicate audit fees. They deserve recognition for their attempts, although the grounds is by no agencies clear as to whether choice of other variables would hold produced any more powerful explanatory theoretical account ( s ) . The consequences are by and large positive and important, across states and houses, although the degree of pertinence varied from between state and house. The research worker considered this showed consistence in the theoretical account across scopes of houses and states nevertheless may non keep true for Asia centric states.

Fan and Wong ( 2005 ) survey audit fees determiners in Asia, where household ownership is high and investors are less protected. They test whether hearers ask for an extra premium to their clients when bureau struggles are high. The writers find a positive relation between audit fees and ownership concentration and explicate that hearers assume a higher hazard to scrutinize those houses. Previous research therefore nowadayss assorted grounds of the impact of bureau struggles on the supply of audit services and points out the necessity to see the differentiation between managerial and commanding stockholders ownership.

Hay et Al ( 2006 ) summarises the big organic structure of audit fees determiners research utilizing a meta-analysis and conclude that the consequences on the relation between ownership construction and audit fees are assorted. Previous surveies focused chiefly on the impact of insider ownership ( defined as both director and commanding stockholders ) on audit fees.

Anterior researches in the Sri Lankan & A ; South Asian context

Sri Lanka is considered an appropriate focal point for the current survey because it is a underdeveloped state, has mostly converged its accounting and auditing criterions to International Financial Reporting Standards ( IFRS ) and International Standards on Auditing ( ISA ) equivalents, severally, and has acknowledged the issues associated with Fair Value Accounting ( FVA ) .

In footings of background to the scrutinizing landscape in Sri Lanka the Institute of Chartered Accountants of Sri Lanka ( ICASL ) athleticss a rank of over 3,500 members and was constituted by the Act No. 23 of Parliament in 1959. It is the exclusive organic structure authorised under the Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995 to publish both Sri Lankan Accounting Standards ( SLAS ) and Sri Lankan Auditing Standards ( SLAuS ) . Under the latter Act, conformity with SLAS is compulsory for “ specified concern endeavors ” , while SLAuS must be applied for audits of entities specified in the Act. As noted in the Introduction, ICASL has issued a scope of criterions which prescribe FVA for peculiar assets and liabilities.

Despite a few high-profile corporate failures, which have generated treatments by stakeholders with respect to the hearers ‘ function, there have been no legal instances or other punitory countenances against hearers. Sri Lanka has had few high-profile corporate failures. In the aftermath of the prostration of several finance companies in the late 80s and early 90s, the Government of Sri Lanka established the Presidential Commission on Finance and Banking to look into the causes of such failures and to urge steps for beef uping the state ‘s fiscal sector agreements. The Commission stressed the demand for acceptance and enforcement of accounting and auditing criterions for set uping a high-quality corporate fiscal coverage government. Furthermore, the Commission recommended better public presentation of duties by hearers in forestalling such failures. Even with these steps, every bit recent as 2003, there was a failure of a nest eggs and development bank in Sri Lanka. Despite such failures, there have been no legal actions or other administrative steps taken against hearers harmonizing to the study on the “ Observance of criterions & A ; codifications ” ( ROSC ) Sri Lanka 2004.

Prior research done on the Sri Lankan context was non available, nevertheless from a Commonwealth and South Asiatic context peculiarly, the literature includes researches set in Bangladesh ( Karim & A ; Moizer, 1996 ) , Singapore ( Low et al, 1990 ) , Singapore and Malaysia ( Poitras et al, 1995 ) , Singapore, Malaysia and Hong Kong ( Simon et al, 1992 ) , India ( Dugar et al, 1995 ) and Pakistan ( Ahmed & A ; Goyal, 2005 ) .

Poitras et Al ( 1995 ) selected a sample of 50 companies by largest capitalisation as at December 31, 1991 listed on the Stock Exchange of Singapore ( SES ) . These companies had operations chiefly in Singapore and Malaysia. Based chiefly on the Simunic ( 1980 ) theoretical account, with accommodations for local conditions and the debut of few more variables such as audit fees/total assets, and found happen assorted consequences in their survey. However the Pearson ‘s correlativity analysis suggests audit fee, as the dependant variable is correlated to scrutinize size and term of office. Singapore exhibits the presence of Big six premium but the consequences are assorted with an adjusted R square of the empirical theoretical account of 92 % , with major volatility in audit pricing being observed at due largely at industry degree and on clip series footing, the intercept indicates both negative and positive.

The research by Ahmed & A ; Goyal ( 2005 ) illuminates a weakly-researched issue as to how hearers charge for their services by through empirical observation analyzing audit fee determiners in three emerging economic systems in South Asia. Using 1998 informations from 118 Bangladeshi, 219 Indian and 229 Pakistani houses, the consequences show that size of describing entity, transnational association and size of audit house are the three most of import determiners across the three states. They find no important relationship between audit fee and a house ‘s fiscal state of affairs and auditee complexness. Additionally, no important dealingss were found between audit fees and the house ‘s fiscal status and auditee complexness. The consequences of this survey provide utile penetrations into the function of undertaking cost variables and hearers ‘ charge patterns in comparative and emerging economic systems in general, and South Asia in peculiar.

Naser & A ; Nuseibih ( 2007 ) studied the construction of audit fees in Jordan utilizing traditional steps of finding such as size and complexness. In line with anterior research, these writers find similarity in their findings with nucleus determiners being both size and complexness in Jordan. In much the same geographics, Al-Shammari et Al ( 2008 ) studied the determiners of audit fees in Kuwait. This would supply lucidity on the determiners that impact audit fees from a Middle Eastern position. This survey is in line with the audit variables that are used and size and complexness are critically analyzed for all purposes and intents.

Simon et Al ( 1986 ) found similar consequences similar to old research in India. Again, Size and Complexity were cardinal determiners of audit fees. They determined that audit fees in India are determined chiefly by audit size, complexness and hazard. They besides suggest that bigger houses with spread shareholding are progressively demanding Big 4 hearers – therefore possibly extenuating bureau struggles – as the bulk of “ big ” stockholders are still “ households ” who have commanding involvements in the houses. They besides suggest that while audit premia is non apparent in their research, hearers may bear down higher fees than Non-Big 4 houses through puting lower making degrees. This suggests that houses with lower bureau issues deploy the services of Large 4 hearers more than houses with a high grade of bureau jobs. Later research by Dugar et Al ( 1995 ) is of relevancy. This research is consistent with the construct of including the analysis of the large 4 audit houses as a variable to understand its relationship to find the audit fee theoretical account.

Designation of factors impacting the degree of audit fees

Hobgood and Sciarrino ( 1972 ) predicted factors through responses for a study conducted in 155 Canadian companies. These were identified as, size and quality of the audit house staff, range of the audit, size of the client and comparing of audit fees paid by other companies similar in size and industry.

Morgan ( 1973 and 1974 ) severally studied on the aim and subjective factors which influences in finding the audit fees and he established that clip is the chief nonsubjective component whereas value of the service to the client and trouble of battle as the subjective elements. Zweig ( 1978 ) specified that the value of the service be the basic component of the fee finding.

Flesher and Loroosh ( 1980 ) recognized nine factors in finding the audit fees through a study of indiscriminately selected 232 CPAs which are ;

aˆ? Time spent on the undertaking

aˆ? Cost of the service rendered

aˆ? Ability of client to pay

aˆ? Value of the service rendered

aˆ? Customary fees

aˆ? Legal restrictions

aˆ? Established client ( position )

aˆ? Fixed fees

aˆ? Urgency for work to be completed

Reasoning the study, clip, cost and the value of the service to the client were identified as the most of import factors and others were treated as less of import by the respondents.

One typical characteristic in the instance of Bangladesh in 2007 is that there are officially no Big Four houses with an established presence in the state, as in India and Pakistan, even though the population of Bangladesh is about 147.4 million. Consequently, Karim & A ; Moizer ( 1996 ) in their research set in Bangladesh, used as a placeholder for Big Four houses, local audit signifiers with links to international audit houses. In their survey of determiners of audit fees in Bangladesh, Karim and Moizer attempted to find the factors towards explicating the audit services market in the Country and province that “ audit is a purchaser ‘s market ” . Their survey suggests a limited Big Six premium consequence ; nevertheless they do province that audit size, audit hazard and audit complexness form the foundations for audit monetary value. This research focuses on the large 4 audit houses in the local context to understand their relationship to the theoretical account.


Finally a decision will be drawn placing the cardinal points addressed, the struggles in the literature and the countries this survey will turn to. The chief aim would be to understand the determiners for external audit in the listed companies and thereby to understand the development of an ideal audit fee theoretical account.

The explorative nature and limited range of this research points to a scope of related farther research. It would be utile to construct on this survey by widening the scope of research into audit fee theoretical accounts from this research, and develop more qualitative determiners, as appropriate. This would make a balanced attack that would hone the result of finding audit fees.

Having respect to the old researches done on planing the audit fee theoretical account this research attempts to show relationships between variables that would stand for hazard, size and complexness and related audit fees in the fiscal statements of the listed companies in the Colombo Stock Exchange.



This chapter describes the general theories aligned with the research. The research attempts to concentrate on the Agency theory, Stewardship theory and the Stakeholder theory which create a sound theoretical model.

The Agency theory discusses the bureau relationship and the issues that arise from the quandary that the principal and agent, while nominally working toward the same end, may non ever portion the same involvements. The literature on Agency theory mostly focuses on methods, systems and their effects that align the involvements of the principal and agent.

The Stewardship theory on the other manus is an alternate position of Agency theory, in which directors are assumed to move in their ain opportunisms at the disbursal of stockholders.

Stakeholder theory suggests that the intent of a concern is to make as much value as possible for stakeholders. Harmonizing to Drucker ( 1990 ) , today corporations have to equilibrate their duties towards society in which they function, while run intoing the of all time increasing demands of their stakeholders to be competitory in a planetary economic system.

Agency Theory

The construct of Agency theory is a utile economic theory of answerability is defined as ‘one in which one or more people ( the principal ) engage another individual ( the agent ) to execute a service on their behalf which involves deputing some determination doing authorization to the agent ‘ ( Jensen & A ; Meckling, 1976 ) . Although this is chiefly meant to be the relationship between the stockholders and managers, it has been besides argued by Jenson & A ; Meckling that there are other contracts which could be considered within an bureau model such as managers and other involvement groups and such relates to understand the function of external hearers.

The deputation of authorization involves the trust between the agent and the chief whereby the Agency theory takes a position that people can non be trusted to move in the public good and in the involvement of the stockholders. This gives rise to the demand of monitoring and controlling of the public presentation of agents and hence demands to set in topographic point mechanisms such as the external audit to reenforce this trust.

External hearers do prosecute as agents but they are expected to be independent from the agents who manage the operations of a concern and are expected to supply an aim, believable and independent sentiment on the fiscal statements to the stakeholders including stockholders.

The job of agent and chief arises as a consequence of separation of direction and ownership in a big graduated table where the involvements of parties diverge accordingly. This is where the managers have the full control over the financess of stockholders and be given to be self-seeking by maximizing their ain pockets. The bureau theory had been tested upon the positive accounting theory in 1978 by Watts and Zimmerman and has identified the grounds as to why directors ( agents ) cook their ain books.


When understanding the operating theoretical account of listed companies in Sri Lanka the most of import footing of Agency theory is that the directors are normally motivated by their ain personal additions and work to work their ain personal involvements instead than sing stockholders ‘ involvements and maximizing stockholder value. For illustration, directors may be attracted to purchasing munificent offices, company autos and other excessive points, since the cost is borne by the proprietors. However the construct of scrutinizing and command carried out by a reputed audit house will guarantee that the operating theoretical account comes under proper examination.

Therefore, the cardinal quandary indicated by Agency theory is guaranting that directors pursue the involvements of stockholders and non merely their ain involvements. Eisenhardt ( 1989, p. 58 ) explains that bureau jobs commence when “ The ends of the principal and agent struggle and it is hard and dearly-won for the principal to verify what the agent is really making ” .

Controversy occurs because principals are unable to supervise the public presentation of agents ( Jensen & A ; Meckling 1976 ) . The chase of self-interest additions costs to the house, which could include the costs of the formation of contracts, loss due to determinations being taken by the agents and the costs of detecting and commanding the actions of the agents. Leuz et Al. ( 2003 ) assert that the effects of such behaviors finally reflect in the company net incomes. It is now apparent that the investing in an audit demands to be apportioned to guarantee that the public presentation of the agents or directors is monitored and proper feedback is provided.


It is besides of import that the direction has an inducement to pull off the company ‘s reported net incomes in order to run into or crush net incomes marks and, therefore, to have any fillips that may be tied to the company ‘s net incomes ( performance-related wage ) . This creates an information dissymmetry in that directors can exert the discretion they have on accumulations, which in bend reduces the relevancy and dependability of reported net incomes, and the whole fiscal statements. Davidson et Al. ( 2004 ) argues that when direction provides inaccurate fiscal coverage information, it introduces net incomes direction as a type of bureau cost. To counter this state of affairs an internal audit may non be sufficient and the importance of an external audit must be conducted to understand the discrepancies and alterations that happen in the operating theoretical account of a company. The rigorous monitoring of directors by the principals or their representatives, such as the house ‘s board, is seen as cardinal to protecting stockholders ‘ involvement from being compromised when directors maximise their opportunism at the disbursal of the administration ‘s profitableness.


In order to efficaciously restrict bureau costs caused by the separation of ownership and control, Fama and Jensen ( 1983b, p.309 ) propose that houses need a system that can divide determination direction from determination control. This would restrict bureau costs by commanding the power of direction and guaranting the proper consideration of stockholders ‘ involvements. It is clearly mentioned that the function of the external hearer is to cut down bureau costs by cutting information dissymmetry in fiscal coverage ( Poit, 2001 ) . This constitutes the importance of external audit and how it can positively impact the transparence in fiscal coverage.

Agency theory recognises external auditing as the most of import monitoring mechanism because it controls struggles of involvement and diminishes bureau costs. Watts and Zimmerman ( 1983 ) confirm that high quality external auditing will sabotage the timeserving behavior cost ( bureau cost ) introduced by management.A

These proctors act on behalf of the stockholders. As a consequence, high audit quality affecting specialised independent hearers like the Big 4 audit houses can diminish chances for directors to prosecute opportunism at the disbursal of proprietors and, therefore, principals obtain more favorable returns. Hence the bureau theory can be looked upon as a footing to develop theories for finding the relevancy and composing of audit fees for companies public quoted companies in Sri Lanka.

Stewardship Theory

Unlike the Agency theory, the Stewardship theory, based on a psychological and sociological attack, maintains that the involvements of corporate executives ( as stewards ) are aligned with those of the administration and its proprietors ( Albrecht et al. , 2004 ) . The stewardship theorists focus on constructions that empower and facilitate instead than supervise and command. They reject the extremely individualistic theoretical account of Agency theory that promotes a leery “ police officer ‘s ” attitude, assumes that principals and agents have different involvements and sees agents as basically self-seeking and egoistic. This is a theory that contradicts and challenges to a certain extent the construct of external auditing for all purposes and intents of monitoring direction and employees of houses. The theory besides goes on to reject the position that principals need to proctor the timeserving agents by supervising them and use countenances or inducements as agencies of control.

Stewardship theory takes an opposite position in proposing that the agents are trusty and good stewards of the resources are entrusted to them, which makes monitoring unneeded ( Donaldson, 1990 ; Donaldson & A ; Davis, 1994 ; Davis et al. , 1997 ) . Since directors are non timeserving and act in the best involvements of the proprietors, they should besides be given autonomy based on trust, and this reduces the cost of monitoring and commanding their behavior. This means that harmonizing to the Stewardship theory directors are considered loyal and their behavior does non necessitate to be scrutinised. However Donaldson and Davis ( 1994, p. 51 ) observe, “ organizational role-holders are conceived as being motivated by the demand to accomplish and exert duty and authorization, to derive satisfaction through efficaciously executing basically disputing work, and to derive acknowledgment from equals and foremans ” .

In most listed companies in Sri Lanka we see a important proportion of dividend paying companies ( i.e. Hayleys PLC, John Keels Holdings and etc. ) . From a Sri Lankan perspective a dividend paying company is considered stable and attractive to most investors. Harmonizing to Stewardship theory, the behavior of the steward is corporate, because the steward seeks to accomplish the administration ‘s ends ( e.g. profitableness ) . This, in bend, benefits the principals through the positive effects of net incomes on dividends and portion monetary values ( Davis et al. 1997 ) . In most local companies directors believe that their involvements are aligned with those of the house ‘s proprietors. Therefore, Stewardship theory maintains that the optimal administration constructions are those that enable effectual coordination in the endeavor. The stewardship position sees managers, every bit good as directors, as stewards of the house and therefore likely to increase the stockholders ‘ wealth. Davis et Al. ( 1997 ) postulate that stewards gain greater satisfaction from accomplishing organizational ends than through chase of their ain ends.

Davis et Al. ( 1997 ) argue that accomplishing organizational success besides satisfies the personal demands of the stewards. Therefore, the stewardship theory considers that directors ‘ determinations are besides influenced by non-financial motivations, such as demand for accomplishment and acknowledgment, the intrinsic satisfaction of successful public presentation, and regard for authorization and the work moral principle. However it is interesting to analyze, if this would be more outstanding as opposed to the fiscal incentives a director would visualize. This may good belie the Stewardship theory in the Sri Lankan context.

However, harmonizing to this theory, it makes sense for corporate administration to be based on the position that the managers, on behalf of stakeholders, want to be good stewards of the corporate assets, and there is no struggle of involvement or timeserving behavior at the disbursal of stakeholders. They work diligently to derive high degrees of corporate net income and stockholder return. These constructs have been documented in organizational surveies, such as in Muth and Donaldson ( 1998 ) . To this consequence the importance of an audit process may look far-fetched and the value proposition may non be as clear, if this theory were to be considered.


When understanding the impact of the Stewardship theory from a degree of the board, it considers the board of managers as an instrument of aid to a steward main executive officer instead than a commanding mechanism ( Albrecht et al. , 2004 ) . It besides considers that direction is less likely to pattern net incomes direction. However, the job lies in the extent to which the direction aspires to achieve a good corporate public presentation. This could besides take a bend where main executive officers ‘ may draw a bead on for personal inducements & A ; benefits over broader stockholder outlooks. From the stewardship theory position, a house ‘s superior public presentation is linked to the board holding a bulk of executive managers since these managers understand the concern better than outside managers, and can therefore do superior determinations ( Donaldson, 1990 ; Donaldson & A ; Davis, 1994 ) .

Besides of import to observe is the construct of dichotomy of the board chair, that is the same individual keeping the place of chair and main executive, is viewed favourably since, it is argued, it leads to break public presentation by the house due to clear and incorporate leading ( Donaldson & A ; Davis, 1994 ; Davis, et al. , 1997 ) . Bhagat and Black ( 1999 ) find that houses with boards dwelling of a higher figure of outside managers ( stand foring the Agency theory position ) perform worse than houses with fewer outside managers.

The construct of placing cardinal people and drivers is common in most local companies. This enables a selected clump of troughs to take on more duty and authorization to drive a house towards success. Davis et Al. ( 1997 ) suggest that cardinal directors identified within the house leads to a personal relationship with success or failure of the house. Daily et Al. ( 2003 ) argue that directors and managers besides want to protect their reputes as adept determination shapers. As a consequence, directors run the house in a mode that amplifies fiscal public presentation, including stockholder returns, as the houses ‘ public presentation impacts straight on perceptual experience of their single performance.A


The Stewardship theory goes on to reason that the effectual control held by professional directors empowers them to maximize the house ‘s public presentation and corporate net incomes. Consequently, boards that are dominated by executive managers are preferred because of their expertness and cognition, entree to indispensable information and committedness to the house. Several surveies support the position that directors make superior determinations because they possess more and better information ( e.g. Boyd, 1995 ) . In the listed companies a commission is appointed to do determinations of the audit patterns both internal and external. This would intend that the commission would be a transverse subdivision of directors, managers and the board who would jointly take determinations on behalf of the audit pattern within t