Growth Companies

Declining Audit Fees Raise Risk of Restatements

When public companies pressure their auditors to reduce fees or they switch auditors to pay lower fees, audit quality can deteriorate, according to...
Vincent RyanMarch 3, 2014

In the last few years, publicly held companies have pressured their accounting firms to lower their audit fees. CFO even introduced a tool for a company to benchmark its audit fees against its peer group. In many cases, this has worked, helped by the recession: Audit fees peaked at $592 per $1 million of revenue for accelerated filers in 2004 and 2005, according to Audit Analytics, but have fallen since, to $472 per $1 million of revenue in 2012.

Now, regulators and at least one academic study are questioning whether this trend is healthy. A study by researchers at Texas A&M University and the University of Nebraska-Lincoln found that the overall pricing trend may “increase the possibility of [financial] misstatements going undetected,” reported The Wall Street Journal on Monday, because auditors may not be compensated for the risk they incur.

Looking at the audit fees paid by Big 4 clients between 2006 and 2010, the researchers found that when high-risk corporate clients paid lower audit fees, they had a 29 percent higher risk of restatement. There is evidence, in other words, that “audit quality declines in the presence of extended periods of reduced audit fees that do not adequately incorporate financial reporting risk.”

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The authors of the paper, “Pork Bellies and Public Company Audits: Have Audits Once Again Become Just Another Commodity?” believe the situation is not sustainable. Paul Beswick, chief accountant at the Securities and Exchange Commission, appears to agree with them. At a Practising Law Insitute conference in late February, Beswick said that the pressure on auditors to reduce fees could lead to subpar audit quality. Fee cuts can put “pressure on the nature of the services,” Beswick said, according to CFO Journal.

Beswick said regulators are worried that some audit committees are hunting for lower fees and  switching auditors to get them. When a material misstatement follows, it could raise questions of whether the directors violated their fiduciary duty, he added.

Not everyone agrees that the audit-fee decline since 2005 is result of companies seeking cut-rate audits. Some of the decline in costs since 2005, CFO has reported, is due to companies getting their “arms around the requirements of the Sarbanes-Oxley Act and [making] substantial progress in streamlining the auditing process.”