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Compliance Weekly: Robert Rostan on “Audit Costs Rising Again”

Tammy Whitehouse

Audit costs appear to be inching back up after the financial crisis and recession, as audit firms are under pressure to improve the quality of their audit work and appear to be gaining more leverage over rates.

“I don’t see audit costs going up dramatically,” says Andy Burczyk, a managing director and attest practice leader with CBIZ, an advisory firm affiliated with audit firm Mayer Hoffman McCann. “I see them recovering from what they had given up over the last several years. We are coming back to normal pricing as opposed to heavily discounted pricing.”

The latest data from research firm Audit Analytics based on the fee disclosures of more than 2,400 public companies finds that those companies paid a combined $8.1 billion in 2012 for audit services related to their financial statements and internal control over financial reporting. They paid an additional $2.3 billion in 2012 to their auditor for other services not related to the financial statement audit, the research shows. Those numbers are up slightly from the collective $7.9 billion they paid for audit services in 2011 and the $2.2 billion for other services.

While the dollar figures are bigger in 2012 than the year before, they are not bigger when stacked up against revenue growth, says Don Whalen, director of research for Audit Analytics. Companies paid on average $472 in audit services for every $1 million in revenue in 2012, compared with $476 per million in 2011.

Comparing audit cost to revenue puts the audit cost into context, says Whalen. “How else do you take into consideration inflation and the larger size of companies, which makes them harder to audit?” he says. Imagine, he says, what could be assumed by looking at the raw costs of auditing a company like Apple over the past decade or more. “Their audit fees shot up like crazy,” he says, but so did the scope and complexity of the audit.

Although audit costs held relatively steady compared to revenue in the past year, experts say there’s plenty of anecdotal evidence that audit costs are rising, and audit firms are beginning to gain pricing power. One significant factor is the pressure that audit regulator, the Public Company Accounting Oversight Board, has exerted on audit firms. The PCAOB has delivered a string of unflattering reports to major firms during the past few years telling them they aren’t doing enough work to support clean audit opinions.

“The elephant in the room is PCAOB inspection reports,” says Jim DeLoach, managing director at consulting firm Protiviti. “The findings that the boards’ inspectors have surfaced are fairly labor-intensive requirements.” Auditors are being told to gather more evidence, rely less on the work of others, do more walk-throughs, and do more audit testing, he says. “Those are strong messages that are driving more audit work, and that has an impact on cost.”

Pricing Power

According to Burczyk, audit firms are increasingly gaining the upper hand with audit committees when it comes to audit pricing. “Over the last several years, companies were winning that battle,” he says. “However, we see the tide is starting to shift there. Companies have squeezed audit fees as much as they can and are coming to realize you get what you pay for.”

“Auditors are being told to gather more evidence, rely less on the work of others, do more walk-throughs, and do more audit testing. Those are strong messages that are driving more auditing, and that has an impact on audit cost.”

—Jim DeLoach,
Managing Director,
Protiviti

PCAOB Chairman James Doty has even cautioned audit committees to resist the urge to skimp on audit costs. “The audit is the linchpin of the investing public’s confidence in the company,” he said in a speech last December. “It is not something to be procured from the lowest cost supplier.”

Dave Capitano, vice president of accounting and auditing for regional audit firm ParenteBeard, says the best fee dialogue between auditors and audit committees happens when both parties fully understand the company’s key risks. “Then they usually both come to the same conclusion on pricing,” he says. “The pressure comes when the audit firm doesn’t understand the business, or the audit committee doesn’t understand the key risks they have. Then you have a headache.”

Audit costs are creeping up, Capitano says, because of the cost of additional audit work that is getting passed along and increasing pricing power. The market for audit talent is somewhat neutral he says, meaning there’s no imbalance between supply and demand for audit talent, so it’s not a talent problem that’s driving pricing. Still, firms are finding some incremental success in pushing through rate increases, he says.

Other factors also have cost implications, Capitano says, so it’s difficult to pin an answer on any one issue. For example, auditors are doing more work, but they’re also leveraging more technology and getting more efficient in the process. “What’s probably driving a lot of it now is the opening up of the economy,” he says.

A recent survey by Financial Executives International also supports the notion that audit costs are rising, says Bill Sinnett, director of research for the organization. The response from public companies showed an average audit fee increase of about 4 percent over the prior year, he says. Companies offered a variety of explanations for the increase: increased scope of the audit, increased internal audit work, an acquisition, a significant growth in assets, and a system implementation, among others. A few companies also said their costs were going up because the hourly rate had gone up, says Sinnett. Half of companies said they believed audit rates were rising because of PCAOB inspections.

Beyond the audit of financial statements and internal control, the cost for other services provided by the principal audit is also rising, according to the Audit Analytics data. Non-audit fees rose from $132 per million in revenues to $134 from 2011 to 2012 in the firm’s sample.

Robert Rostan, Principal and CFO of training firm Training The Street, says that can be explained by the rising demand for “comfort letters” as companies issue debt and resume merger and acquisition activity while climbing out of recession. Comfort letters are often demanded by banks, underwriters, prospective buyers, and others when a company is looking to borrow money or pursue a business combination. It’s an attestation by the external auditor about the company’s financial condition subsequent to a published, audited financial statement. “It goes above and beyond the audit so a securities firm has comfort that the numbers are good,” he says. “It’s a high-value proposition for the company and high billing rates for the audit firm.”

As companies have gotten more active in M&A, they’ve also been sobered by some high-profile M&A-related accounting scandals, Rostan says, such as at H-P over its acquisition of Autonomy, and at Caterpillar. “Board members don’t want to be the ones to have the next big accounting blow up,” he says. “It makes them think maybe I should stop beating up on the auditor about fees.”

DeLoach says fee pressure will continue through 2013. “Until audit firms see more equilibrium in their inspection reports, we’re not going to see more equilibrium in audit costs,” he says.