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.”

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.”

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5 responses to “Declining Audit Fees Raise Risk of Restatements”

  1. Vincent-

    Can you give us a littel more color on this – we need more detail – the statment below has no credibility unles as readers, we have more infrmation than this statement:
    “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.”

  2. Part of the problem with declining fees also arises from competition. Unless an incoming auditor can demonstrate how they are able to reduce the cost of an audit, audit committee members should be very careful about selecting lowest cost proposals. Auditors should also be careful about entering into “price wars” as the profession as a whole will suffer. I am of the view that at least on the first year of an engagement, the proposed fees should not be less than what is being charged by the incumbent auditors.

  3. It appears that for the greater part, the value of the external audit is not appreciated. An effort should be made to provide value added services so that fee is not the deciding factor in the selection of an external auditor.

  4. There are many ways to measure the result of a financial statement audit. The amount of fees per the amount of revenue has nothing to do with whether there will be a restatement. Restatements are caused by auditors failing to understand the risk of the business and failing to scope the audit on the weaknesses relating to the internal controls of that business.

    The tool provided by CFO is just that a tool! It is a tool raise the question as to why are the fees higher or lower in relationship to others. That is a benchmark. Nothing more and nothing less. It is a starting point. Each company has its own audit risk based upon the industry, geographical locations, etc. Internal controls are to minimize the business risk and also assist in scoping the amount of audit work that needs to be done.

    This tool will not determine whether there will be restatements. It is like how fast can a car go from 1 to 60. You then analyze why the car cannot go faster and make the changes. This principle is the same for all professional fees (e.g., income tax returns, IT), not just audit.

    The tool used by the researchers is absolutely wrong in making a conclusion as to restatements.

  5. Interesting analysis of reduction in audit fees, with the sarbanes-oxley act in effect it will be interesting to see how this will impact private companies. I work with McGladrey and there’s an article on our website about SOX Act that highlights the need for a newly re-focused evaluation of internal controls that readers of this article may find it useful @ “SOX Reset 2014”

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