Audit committee members may be surprised to hear that audit fees are on the decline. After a sharp rise in fees due to the increased requirements and rigor demanded by the Sarbanes-Oxley Act of 2002 (SOX), audit fees have fallen steadily since 2007. What’s more, companies are increasingly shopping for better deals from audit firms.
Companies with revenues between $100 million and $250 million enjoyed an average 8 percent decrease in audit fees from 2007 to 2008, while those with revenues of $250 million to $500 million experienced a drop of 5 percent, according to a recent study published by CFO magazine.
For audit committee members, who bear the responsibility of selecting and monitoring a company’s audit firm, this is welcome news. But the fluctuation in fees also creates the need for them to a gain a better understanding of what they are paying their auditors to review their finances and why. “It’s a good idea for audit committee members to get a better feel for what they are paying compared to similar companies,” says Cynthia Jamison, national director of CFO Services at Tatum, who also chairs the audit committees at Tractor Supply Co. and Cellu Tissue Holdings. Audit committee members should also look out for audit firms that come in with a low bid to win the business and then slowly inch up rates. A periodic review of audit costs can protect against such practices.
The current softening in the market for accounting services is largely the delayed reaction to a rule change from the Securities and Exchange Commission a decade ago. In 2000, prompted by concern over the growing proportion of auditor fees derived from consulting, the SEC required that companies begin disclosing all payments made to their auditors in the annual proxy statement. While the effects of that rule were masked by the initial increased audit requirements of SOX, that transparency in fees gave audit firms more information to underbid existing audits. Now that the SOX has become de rigueur the effects of price transparency are driving audit fees lower.
Another factor contributing to the decline in audit fees is an increased willingness on the part of companies to replace their audit firm, increasing competition. In some ways, the negative perception associated with the announcement of a change in auditors has diminished. Before SOX, a change in auditor could be a red flag to shareholders that something was amiss with the finances. While that concern isn’t gone completely, companies feel more comfortable changing auditors, especially if they can justify it with a savings in audit fees. “It used to be that companies were afraid to change auditors because of the signal it sent [to shareholders]. While companies still need to be careful about making a change, there is less of the stigma than it was before, as long as they can explain why they are making a change,” says Blythe McGarvie, who sits on the audit committee at Viacom. Given the current state of the economy, lower costs are an increasingly acceptable reason.
Certainly, changing auditors is a decision no audit committee takes lightly. To increase the information at hand, many governance experts suggest that boards should conduct benchmarking to see how their auditors stack up. The same rule from 2000 that brought more transparency to audit fees makes it easier for companies to compare their fees with similar companies. “Your obligation as an audit committee member is to get the best work for the best fee,” says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, and a member of the audit committee at HealthSouth. “Auditors need to charge a responsible fee for the services they provide,” he says.
As a result of the past recession, finance departments have been looking at any opportunity to tighten the belt and more recently, the audit has come under scrutiny as a possible place to cut costs. While companies are not required to disclose why they are changing their auditor, some accounting experts suspect that many of the recent changes are due to the fact that filers are negotiating a better deal with another firm. If so, it would stand in sharp contrast to the period just after SOX was passed when many auditor changes were the result of audit firms dumping risky clients.
By the Board
In large part, much of the audit shopping has been driven by the finance department. In fact, during an April meeting of PCAOB’s Standing Advisory Group (SAG), Lynn Turner, former SEC chief accountant, suggested that in many cases, it was CFOs that effectively were doing the hiring and firing rather than the audit committee, creating a high-risk area. This is cause for alarm for many audit committee members. “It’s very clear that it is up to the audit committee to shop the audit and not the finance department,” says Elson. “While audit committees want input from the finance department, it would be troubling if they are the ones that are driving the process.”
While it’s clear that audit committee members bear the responsibility of making key decisions on whether to make a change in auditor, they also have a responsibility to monitor the current audit firm. According to Ruth Aguilera, a professor at the University of Illinois who specializes in corporate governance and accounting, increased scrutiny of audit committee members resulting from recent scandals in the financial services sector has pushed them to reevaluate their choice of auditor. “There is a lot of scrutiny on their decisions these days and they want to make sure they can back those decisions up. Having more data from activities like benchmarking makes it easier for them to justify the end decision,” says Aguilera.
According to Jamison, many audit committees conduct informal benchmarking of audit fees by making comparisons with what other companies pay, based on the experience of board members who serve on other boards. “If it seems out of line, you need to push back,” she says. Jamison doesn’t go as far as to say that the audit has become a commodity, but she does say that there is less differentiation among the firms. “There is not a huge amount of difference among the big firms, unless there are industry specific specialties,” she says. “Price is not the top differentiator, but it has gotten more important.”
A recent study by the University of Illinios’ Aguilera shows that three factors drive audit costs: the company’s size; the complexity of the business–especially the number of offices or units overseas–and the inherent risk associated with the business. For these reasons, she says benchmarking inside your own industry may not provide the best comparisons. When choosing a peer group to conduct benchmarking, Aguilera says audit committee members will want to look at these factors.
New services are becoming available to help audit committees benchmark audit fees. One application, CFO Audit Fee Report will generate a customized, downloadable analysis. The report automatically identifies outliers that can skew results and are normally hidden among multiple filings, including restatements, management- or auditor-reported control failures and auditor changes.
How Low Is Too Low?
Benchmarking audit fees makes sense even for companies that aren’t looking to get a better deal on audit fees. Why? Because paying too little for the audit can be just as bad as paying too much. Of course, some audit committee members are uneasy about the idea of comparison shopping among audit firms. “There are better places to look for cost savings than on the audit,” says Elson. But audit experts say that the idea is not to squeeze auditors to get the best price, but rather to ensure that your audit fees are not an outlier with a comparable peer group. “This is one of the cases where you want to be on the fairway. You don’t want to be paying too much or too little,” says Jamison.
“You want to be in the ballpark,” agrees Aguilera. “If you are paying too little, shareholders will worry that you aren’t getting a quality audit. Pay too much and they worry that you are paying for other services and that the auditor has an incentive to be kind when conducting the audit.”
Indeed, paying too little for an audit can be worse than paying too much. “Money spent on the audit is money well spent. You have an obligation to shareholders not to waste money, but the risk of an improper audit far outweighs the benefits of cost cutting,” says Elson. It could also draw the scrutiny of regulators. During the PCAOB SAG meeting, members suggested that the decline in audit costs could be a troubling trend, and that PCAOB inspectors may consider fee reductions as a potential audit risk when determining which firms to scrutinize.
“Don’t be pennywise and pound foolish” advises McGarvie. She says audit committee members should spend more time communicating with their auditor about what they are paying for. “There is a saying among CFOs: ‘beware of the profits you don’t understand more than the losses you do.’ In this scenario, beware of the services you don’t understand more than the costs that you do.”
But just because companies are getting a good deal on the audit fees doesn’t necessarily mean that they are getting a low-quality audit. According to the University of Illinois’s Aguilera, there is no correlation between what companies pay for the audit and the quality of the audit they get. “The data suggests that companies that pay more don’t have better results, it is usually a factor of more complexity and risk,” she says.
While many audit committee members say that fees shouldn’t be the driving factor in making a change in auditor, they agree that it is something they should all have a solid grasp on. Says McGarvie: “It makes sense to look at what others are paying, but you have to review that in context of the overall service the auditor provides and the relationship you have with them.”
Benchmarking Audit Fees Made Easy
Do you know how your audit fees compare with those of companies like yours? A new online application from CFO.com provides a fast and accurate way to benchmark your audit fees against what your peers paid, over a three-year period.
Type in your company name (or industry and revenue size) to generate a peer group and, for a fee, the CFO Audit Fee Report will generate a customized, downloadable analysis. The CFO Audit Fee Report automatically identifies outliers that can skew results and are normally hidden among multiple filings, including restatements, management- or auditor-reported control failures, and auditor changes.
The report allows you to view the full list of companies and auditors in your peer group before you finalize your purchase. The final report includes the following:
Summary: Provides an immediate benchmark of what your company pays and how it compares with your selected peer group
Adjustments for Outliers: Analyzes how outlier events affect audit fees within your industry and peer group; provides a summary of outliers within your peer group; and allows you to exclude or include outliers from your overall analysis
Auditor Analysis: Analyzes what each auditor charges the companies in your peer group and how much those fees varied; estimates what each firm hypothetically would charge your company; and shows you each auditor’s market share within your peer group
Complete Data: Provides a complete list of the companies in your peer group, their individual audit firms, fees, and additional data used in the report analysis. CFO sources its data from Audit Analytics, a leading provider of audit-fee information.
Joseph McCafferty is a freelance writer and former editor of Directorship magazine.