Mending Fences

CFO-auditor relationships aren't as fractured as they once were. But there's still room for improvement.
Janet KersnarMarch 3, 2008

Shortly after Daniel Bednar clinched a new job as deputy CFO at Bureau Veritas, CFO François Tardan assigned him to a project that would have left other, less hearty finance executives heading for the door. It was 2004 and companies across Europe were facing a veritable mountain of auditing work thanks to the knock-on effects of the Sarbanes-Oxley Act, not to mention the looming EU deadline to adopt IFRS. Under these conditions, the relationship between companies and their external auditors was reaching a breaking point.

Bureau Veritas, a Paris-based professional services firm specialising in industrial testing and certification, was no exception. Bednar, having recently arrived from an auditing firm, sensed the tension at his new company and how “[Tardan], who does not come from an audit background, was very frustrated with what he considered back then to be pure bureaucracy, requiring things that weren’t helping the business.”

Bednar’s new project didn’t just involve repairing the company’s relationship with its auditors. He also needed to improve the quality of the audit, as Bureau Veritas’ private equity owners were preparing it for an IPO. And he was expected to do all this without letting fees spiral out of control, as they were at numerous other companies.

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To shake things up, he first asked PricewaterhouseCoopers — one of the firm’s two lead auditors — to re-tender for its business, and then he went looking for a new co-lead auditor (as required by French law), choosing Bellot Mullenbach & Associés, a small, local firm. Bednar also began a multi-year review of the company’s financial systems and controls to help streamline the auditing process. This would eventually involve, among other things, rolling out a new ERP system across its offices in 170 countries.

Today, Bednar gives his auditors the thumbs up. “They have really contributed to helping us raise the bar,” he says. This was a timely improvement given Bureau Veritas’ IPO in October — the first in Europe following the summer’s subprime turmoil.

That’s not the only reason both Bednar and Tardan are pleased. “Our group audit fees have remained stable,” boasts Bednar. “We have been spending a little over €1m every year even though our turnover has grown from €1.3 billion when I joined to more than €2 billion now. That’s a 30% reduction despite all the increased regulations. I’m very happy with that.”

Not many CFOs can say the same, according to new research from CFO Europe. In a poll of nearly 200 finance executives of medium-sized and large firms from across Europe, nearly 75% said their fees have risen over recent years. And while 49% report that they have been spending an increasing amount of time with their lead auditors — which can be good or bad, depending on the circumstances — 36% said they feel they aren’t getting value for money and another 22% are undecided.

Yet while CFO-auditor relationships aren’t as good as they could be, they have been worse. When CFO Europe ran a similar survey in late 2004, 28% of respondents said that their relationship with external auditors had changed for the worse over the previous year; in our new survey, only 17% said the same.

However, it was shortly after the first survey was conducted that CFO-auditor relationships were at their frostiest. “2005 in particular was quite difficult,” recalls Ken Lever, chair of the financial reporting committee at The Hundred Group, the influential club of FTSE 100 CFOs. Lever, who until last November was CFO of £3 billion (€4 billion) UK engineering group Tomkins, uses the term “standoffish” to describe many auditors as they tried to shift from being their clients’ close business partners to a role that included being chief interpreter of all the new governance codes.

What’s more, uncertainly over the first-time application of IFRS led to further tensions. As Lever recounts, audit partners felt they needed to rely heavily on their technical departments before answering client queries, often slowing down discussions. “People were learning as they went along,” he says. “Your partner became an intermediary [between the CFO and the technical department], which caused all sorts of stresses and strains.”

The Rapprochement

But then the new regime turned a corner. “In 2006 we started to mend fences,” says Lever. “If anything, relationships had started to improve.” Part of the reason, he reckons, was that auditors acknowledged the deterioration of their relationships, having swung dramatically from being “business partners” to “policemen,” and began working harder to re-connect with clients. Encouragingly, CFO Europe’s research confirms a change for the better — for example, in the 2004 survey, nearly 80% of finance executives felt that the advice provided by their auditors was becoming more cautious; in the latest survey, that was 60%.

Even so, “the relationship will never go back to where it was,” says Lever. “The auditors must regret the passing of time when a business relationship was where you sought their advice.”

Some CFOs must also look back nostalgically, say auditors. For one thing, “the more complex accounting standards are not as intuitive and remove certain judgements,” which require more consultation, says Richard Bennison, head of UK audit at KPMG. It is “inevitable that our clients feel this.”

There’s something else that CFOs feel when their audit bills arrive. European companies in general have been spared the massive fee inflation that American companies experienced after Sarbanes-Oxley — where fees among companies complying with Section 404 jumped 66% between 2003 and 2005 — but they haven’t escaped higher costs entirely. “With audit fees, there seems to be an immediate assumption [among auditors] that clients will accept an increase every year,” sighs Jürg Wenger, CFO of Feintool International Holding, a SFr520m (€324m) Swiss industrial technology and systems supplier. “We live in a competitive world, where our customers come to us and tell us the price they’re willing to pay — not the other way around.” (See “Keep a Lid on It” at the end of this article.)

Shrinking Choice

Unfavourable fee trends lead to another CFO bugbear — competition. “I’d like it if there were more,” says Wenger, who recalls his early days as an auditor when there were eight big audit firms. Indicative of a Europe-wide trend, the Big Four — PwC, Deloitte, KPMG and Ernst & Young — handled all but 11 of the UK’s FTSE 250 audits as of August last year.

CFOs have even less choice if they are also using the Big Four for non-auditing services, such as tax advice. As Lever notes, at Tomkins, “we had a relationship with every one of the Big Four. If we wanted to change, someone else would have had to give something up.” More worrying, he adds, “if one disappeared, we’d really have no choice. We would need a regulatory body — God forbid — just to preserve pricing in the market.”

A solution to the lack of competition that’s often discussed, but doesn’t strike many CFOs as viable, is hiring a second-tier auditor, such as BDO, Grant Thornton or PKF. In CFO Europe’s latest survey, nearly 60% of the 176 respondents who are currently using a Big Four firm said they would not consider a tier-two auditor the next time they have a tender. One major barrier cited were the key decision makers in their companies — the audit committee, for example — who want to stay with the tried-and-tested. The other frequently cited reason was scale. “The second tiers are too local,” says Wenger of Feintool. “They need to bulk up and build an international practice. Then I think they would stand a chance.”

That, of course, is easier said than done, notes Martin Wheatcroft, chief accountant of National Grid, a £8.7 billion UK and US utility. Auditor choice has been a concern for Wheatcroft in recent months. As part of a project to increase auditor competition in the UK, National Grid was among several companies that responded to recommendations developed by the Financial Reporting Council (FRC), the national reporting and governance regulator. The 15 recommendations, published in October, ranged from improving access to client information shared between incoming and outgoing auditors to mandating greater comparability between audits performed by a firm.

“We are against developing a UK-specific regime for auditing because it could end up being a bigger barrier to audit choice,” Wheatcroft explains. “We suggested to the FRC that the recommendations weren’t that important on their own, because a global approach is needed.”

He might have a point, but the recommendations are a good start, retorts Paul George, the FRC’s director of auditing and of its Professional Oversight Board (POB), which is in charge of audit regulation. “There is no quick fix that is palatable,” he says. “But just putting the issue on the table has created a bigger opportunity for the non-Big Four to get in front of an audit committee and see whether they can offer their services.”

Meanwhile, national regulatory bodies in Europe have been working on another programme that will have a more immediate impact on auditor governance. With a mid-2008 deadline looming, member states have been setting up independent auditor oversight bodies under the EU’s Eighth Company Law Directive. In Germany, for example, that’s meant “upgrading our system to achieve international competitiveness with countries that are very good in this regard,” such as the US and the UK, explains Siegfried Luther, the former CFO of Bertelsmann and a member of Germany’s first public auditor oversight body called APAK (for Abschlussprüferaufsichtskommission). Starting this year, the APAK, which was set up in 2005, is authorised to undertake formal reviews of the auditors of major public entities, including assessing their policies and internal controls as well as carrying out a handful of random reviews of some actual audits, which it discusses with the auditors.

It’s a practice that the FRC has been undertaking for some time. But now the UK body is going one step further than the APAK — and even the US’s PCAOB, considered the standard bearer among oversight bodies. Starting this year, it will publish separate reports on each of the big audit firms that it inspects, rather that a general, consolidated report as it had done in the past. Moreover, it will issue reports on the findings of the reviews of the 100 or so audits it undertakes every year, which will be sent to the auditors for them to discuss with their clients’ directors.

The FRC says there are a number of reasons why it is adding this additional level of transparency. “One is that it’s been given a push by audit committees, which [under UK code] are required to assess auditor effectiveness,” George explains. “It also links to market competition — if directors know more about the quality of individual firms and the performance of their own auditors, they might get a better idea of who to select. It will help companies distinguish auditors in different ways than merely using size for a proxy for quality. It may or may not be helpful, but one can be sure that recipients of such independent reports will take notice of them.”

On Edge

One can also be sure that CFOs in the UK, and eventually in other countries, can expect “a more cautious approach [from their auditors] because there is someone always looking over our shoulders,” grants KPMG’s Bennison. But he adds there’s something beyond stricter oversight that’s now keeping auditors on the edge of their seats — the economy.

To complement our survey of finance executives, CFO Europe polled some 170 Big Four auditors in Europe, asking them about what could negatively impact CFO-auditor relationships in the months ahead. Far more than regulations or disputes over fee levels, the auditors voiced concern about the knock-on effects of the credit crunch and economic slowdown.

Bennison expects “some quite fraught discussions” as clients assess the damage of the current economic downturn on their businesses. “Our job is to ensure that the board and the CFO understand why we are asking the questions that we are, why we want to see the bank facilities, why in some cases why we want to talk to the bank director,” he says.

Jock Lennox, a senior partner at Ernst & Young and head of its CFO programme, agrees that some relationships will feel the strain, requiring more care and attention than during more buoyant economic times. “If you just rely on the formal process when times are tough, you won’t have a good outcome… Sometimes it’s just a five-minute phone call that does it.”

But Lennox adds that lurking in the shadows during all this is the biggest unanswered question that has simmered under the surface of every CFO-auditor relationship over the past years: “What characterises a successful CFO-auditor relationship and how do you balance that with independence? You can be independent and have no relationship but if that were the outcome, we would never be able to do our job.”

There’s no easy answer, agrees Bednar of Bureau Veritas, but he reckons that’s not a problem. After all, he explains, any healthy relationship needs some conflict and “I always say, Keep things under tension and you’ll continue to drive improvement.”

Janet Kersnar is editor-in-chief of CFO Europe.

Keep a Lid on It

Unlike most other CFOs, Sven Erik Nielsen keeps his cool when the subject of auditors’ fees comes up. In fact, he’s downright laid back about the fees that other CFOs protest are spiralling out of control. The reason, says the CFO for northern Europe at UK tour operator Thomas Cook, is his company’s strong internal audit team. “We have a very comprehensive risk management programme and the auditors are happy with that. If we didn’t, they would have asked a lot more questions about the future and the risks we’re facing,” says the Stockholm-based finance chief. “As long as we have the compliance in-house, we don’t need that help from auditors.” Indeed, beefing up internal audit staff is just one way that experts say CFOs can keep control of auditor fees.

Recent research of 1,000 companies by The Hackett Group found that the average company spends $584,000 per $1 billion of revenue on audit fees. But companies that the researchers identified as “world class” — that is, companies in the top-quartile of a ranking based on a number of factors — are paying nearly 50% less than the average firm.

As part of CFO Europe’s latest auditing analysis, we polled 172 European partners at the Big Four to find out how they think clients can make the auditing process more efficient, and possibly cheaper. Many respondents cited basic project management skills — setting realistic deadlines, preparing documentation around major accounting decisions so that they are “auditable,” and running detailed planning sessions that involve both internal audit and external auditors. Another frequently cited area of focus was communication — many auditors said that clients waited too long before getting in touch about a problem or held back important information. (See “Tell It Like It Is” at the end of this article.)

Nielsen agrees that both good communication and project management are key to building a good relationship. As he puts it, that way “we understand their tasks and responsibilities, and they also fully understand ours.”

For more on how to control costs, see