How reasonable are your audit fees?
Like most costs to American businesses, fees paid to independent CPA firms for their annual audits are attracting increasing scrutiny. Executives responsible for negotiating audit fees are concerned with controlling their costs. As are corporate officers, audit committees of boards of directors are expected to assess the reasonableness of audit fees. Even non-director, non-officer shareholders may be concerned about the issue, since major accounting firms have identified audit fees as one of the more commonly discussed shareholder issues at annual meetings.
It is therefore useful for officers, directors, and shareholders, to have information on the determinants of audit fees for a large sample of U.S. corporations in order to compare the fees of their companies with others. This article suggests how this can be done in a relatively quick and efficient manner. The intention is not to determine exactly what your company's audit fee should be but, instead, to assess whether the audit fee seems to be reasonable given the characteristics of your company.
Since 1980, there have been several academic studies that developed statistical models of audit fees. While these have been useful, they have been based on fairly small samples and have a statistical formulation that does not allow for an intuitive interpretation of the results. This article attempts to make these results more readily useful by avoiding statistical complications. It also makes use of a far larger sample (over 4,000 reports of audit fees) than previous studies.
After describing the data source, the way in which the results may be used to assess a company's audit fees will be described at two levels. First, a table of expected audit fees will indicate an expected fee range based on client-company size. Second, based on this study and other research, factors that change fees (up or down) from the expected range will be discussed. While a formal statistical model of fees will not be presented, this is available upon request from the author.
The data used in this study came from questionnaires sent to a large number of U.S. companies asking for the fees paid to their external auditors for audit services only (exclusive of any consulting and tax services, for example). A total of 4,382 responses on audit fees was received from 1,157 industrial, service, and retail companies of varying size over the period 1980-1993. All of these corporations were publicly traded.
Using the Audit Fee Table
The table accompanying this article provides the basic tool to evaluate the reasonableness of your company's audit fees. It presents ranges of audit fees classified by company size as measured by total assets. Total assets is used as a measure of client-company size because it gives a better prediction of audit fees than other size measures, such as total revenue.
The table is read as follows. The left-hand column lists company size as measured by total assets in millions of dollars. Listed immediately to the right is the range of audit fees in thousands of dollars paid by a majority of the surveyed companies. The lower number represents the lowest amount paid by this group and the larger amount the highest. This range represents what can be considered an "expected" audit fee for a company in the given size category.
As an example of using this table, suppose your company had total assets of $960 million. Locating 900-1,000 in the assets column would indicate that a majority of companies in this size group paid audit fees of between $400,000 and $650,000. Thus, if your audit fees were within this range, they could be considered "typical."
In using the table, two points should be noted. First, while audit fees obviously increase with increases in company size, they do so at a decreasing rate. That is, if company A is twice as large as company B, A's audit will cost more, but not twice as much. More importantly, the table should not be used in a purely mechanical fashion; there are other company-specific factors that affect audit fees. These should be considered in using the results of the table and are discussed in the next few paragraphs.
Factors Affecting Fees
While company size (assets) is the most important factor affecting audit fees, there are several other important considerations that may cause fees to differ significantly from what size alone would predict. The data used in this study and the results of prior research have identified several important factors that can cause actual audit fees to differ from what would be expected using the audit fee table (company size) alone:
1. Use of a "Brand Name." Studies have shown that an audit done by one of the largest accounting firms costs about 15% more than an audit by other CPA firms. While no conclusive reason for this has been documented, it has been well-established as an empirical phenomenon. Many have suggested that this is an indication of superior audit quality, but testing: such an assertion is beyond the scope of this article.
Audit Fees by Client Size
Client Size Audit Fee ($ mil) ($ thous)
$1-2 $15-25 2-3 16-26 3-4 19-28 4-6 21-37 6-8 25-44 8-10 27-46 10-15 29-55 15-20 36-72 20-30 42-86 30-40 48-100 40-60 58-110 60-80 70-148 80-100 85-185 100-150 95-190 150-200 135-245 200-250 150-290 250-300 165-335 300-400 180-395 400-500 200-500 500-600 215-510 600-700 235-620 700-800 280-630 800-900 350-640 900-1,000 400-650 1,000-1,200 550-1,220 1,200-1,400 580-1,250 1,400-1,600 640-1,370 1,600-1,800 800-1,390 1,800-2,000 870-1,650 2,000-2,500 990-1,980 2,500-3,000 1,180-2,000 3,000-4,000 1,500-2,400 4,000-5,000 1,650-2,450 4,000-5,000 1,800-4,200 5,000-6,000 1,900-4,300 6,000-8,000 2,900-4,400 8,000-10,000 3,000-5,400
2. Foreign Operations. The more extensive the overseas operations of a company, the more difficult and expensive the audit will be. Therefore, if your company has a large number of foreign subsidiaries, for example, you should expect the audit fee to be higher than predicted by the table.
3. Difficult Audit Issues. There are many problems that auditors might encounter that will increase the amount of effort the auditors will have to expend (and/or increase their risk of litigation). Among these are significant uncertainties or "going concern" problems. Uncertainties are significant potential losses which the auditor must consider in evaluating the financial statistics. A "going concern" problem means that the auditor believes there is a reasonable possibility thai: the client will not be solvent within the next year. Each of these problems means considerably more work (and more risk) on the part of the auditor and therefore can be expected to increase audit fees. This will mean an increase in audit fees regardless of whether the auditor's report accompanying the financial statements makes reference to the problem.
4. Difficult to Audit Assets. Certain assets are more difficult to audit than others. For example, it is more difficult (time-consuming) to audit inventory and receivables than to audit fixed assets, such as land and equipment. The average amount of inventory and receivables as a percentage of total assets is about 35% to 40%. If your company is substantially higher or lower than this overall average, the expected audit fee should be adjusted up or down.
5. Stock-Listing Status. The results of this and most other published studies are based only on publicly traded companies. While the relationship between company size and audit fees is likely to be similar for all companies, it is possible that audit fees for non-publicly traded companies might be lower due to the lower risk of lawsuits faced by the auditors of these companies.
6. Initial Public Offering. An initial public offering (IPO) of new securities presents additional problems for the auditor due to the complexity of Securities and Exchange Commission reporting requirements and increased lawsuit liability exposure under the Security Act of 1933. Thus, if your company is involved in an IPO or any issue of new securities, you can expect your audit fees to be higher.
Some final considerations and caveats must be mentioned. First, while statistical models are very useful in predicting "average" or "expected" audit fees, there may be considerations specific to an individual company that may cause the actual fee to differ from the predictions of a statistical model. Consultation by management and/or the audit committee with the independent auditor may clarify apparent discrepancies.
A second caveat is that the results presented here, and in most other academic studies, are for industrial, service, and retail companies. They may not be generalizable to regulated utilities or to financial services companies, such as banks or insurance companies.
As a final point, I suggest that you trust your auditor. Most CPA firms are well aware of the very competitive market that exists for their services. Departures from expected fees based on this study may well be justified. An inquiry of your auditor may clarify why there are major differences between what is predicted by this article and what your company is actually billed.
Daniel T. Simon has been Associate Professor in the College of Business Administration, University of Notre Dame, since 1989. He is a CPA and is the author of numerous publications in the accounting field.
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|Title Annotation:||corporate audit fees|
|Author:||Simon, Daniel T.|
|Publication:||Directors & Boards|
|Date:||Jan 1, 1995|
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