GAA Accounting

The Journal of the Global Accounting Alliance

The Politics of Audit Pricing

By Zowie Murray CA

Can audits be more profitable while achieving quality?

The answer to the question posed here – whether audits can be more profitable while achieving quality – is a resounding “yes”. It is possible to increase efficiency and improve your realisation rate, yielding more profit on audit assignments both large and small, without compromising quality. Some accounting firms view their audit business as a loss leader to attract more profitable tax, financial planning and business advisory work. But this does not have to be the case, there can still be good margins in auditing, which in turn can further promote increased audit quality.

There have been significant changes in auditing standards over the past few years, including adoption of the International Standards on Auditing in New Zealand (ISAs (NZ)). This has resulted in more demands on auditors, who have therefore had to continuously upgrade their skills in order to comply with these professional requirements. In addition, organisations are becoming increasingly complex, which from an audit perspective often involves more professional judgment – a skill generally limited to the more senior members of the audit team. This article provides guidance on some of the principles of charging audit fees, along with some techniques to help firms audit smarter.

Audit fees

Auditors are advised by PES 1, Code of Ethics for Assurance Practitioners that when charging fees they should ensure that their objectivity is not impaired by the hope of financial gain, and that such fees are proportional with the responsibilities they assume. On this basis, the charging of any sort of contingent fees for audit engagements is prohibited. Auditors should be particularly careful to ensure that there is no threat that audit quality will be adversely affected because the fee charged is insufficient to allow the necessary amount of time and skill to be spent for this purpose. There are many different bases for the computation of audit fees, and the value-based and time-based methods are explored later. The computation of an appropriate audit fee involves value judgment. It should take into account the value of the service rendered by the auditor, along with the benefits, tangible and intangible, derived by the client.

A substantial proportion of the costs of running a practice are salary related. Auditors are justified in increasing their audit fees to ensure their remuneration is competitive, particularly considering the auditor’s responsibility and commitment to continuing professional development (CPD). Furthermore, a reasonable level of remuneration should encourage auditors to maintain or even improve the quality of the audits they carry out. On the other hand it is the auditor’s obligation to give their clients value for the fees charged. Accordingly, auditors should make sure that the methods used in their offices are current and efficient.

Fee increases Surprisingly for a profession that is so closely associated with money, many auditors prefer to avoid talking about fee increases. Many auditors either discount their prices or do not increase their prices because they are afraid of having a difficult conversation with clients and losing their business. Auditors often do not increase their fees as they see it as a way to retain clients over the long term, but this is a dangerous route to go down.

An even riskier path is that of fee reductions, as this can adversely affect audit quality. There is a significant amount of fee pressure in the market place, and the collective mentality of undercutting to buy market share should be avoided. The Financial Markets Authority (FMA) recently indicated at the national NZICA Audit Conference that it does not expect audit fees to decrease, except in cases where the client’s operations have become markedly simplified.

Clients should expect fees to go up so that auditors can cover the increasing overhead costs, and to recognise that audits are becoming more complex, requiring further involvement from the more experienced members of the audit team. The FMA is reinforcing this message to the market at every opportunity, but it is likely to take a collaborative effort to change market attitudes towards audit fees. Auditors need to get into the habit of regularly reviewing their fees and adjusting them accordingly, because if they have not done so for a few years it becomes increasingly hard to put them up.

Audit typically does not just come down to price, and people often confuse pricing and costing. It is a difficult balance to strike at the best of times, and the current economic climate makes the challenge even harder. Be up front by communicating with clients – explain fees to manage their expectations, and either work towards an agreed fee schedule linked to a service plan, or only set an indicative price.

Invoices should be brief yet educative, and charges for other lines of service should be unbundled. For example ensure that any secretarial, tax, accounting and consulting is not included in the audit fee. Disbursements should also be disclosed separately. You should consider billing as near as possible to completion of the work and contact clients in advance of overruns.

Alternative pricing options When applying value-based billing, the auditor must uncover the value drivers of the service provided. Value drivers are those elements that assist the auditor in satisfactorily discharging their professional obligations. Generally knowledge, information technology and quality of internal processes are the drivers of value. During the course of the audit, the auditor should impress upon clients the value that is being delivered. Fees charged for audits should be a fair reflection of the value to the client and should recognise the following attributes:

  • the skill and knowledge required for the type of work involved
  • the professional judgment that was called upon
  • the level of training and experience of the people engaged on the work
  • the time occupied by each person engaged on the work
  • the degree of responsibility and urgency that the work entails.

Time-based billing has been very useful in the past in working out how much to charge a client for an audit, and it appears to be a fair and transparent principle in that it rewards efficient and organised clients. Traditionally this hourly rate was calculated on the basis of a third salary costs, a third overheads, with the remaining third being profit. However, this composition does not necessarily hold true now, in many cases both salaries and overheads have increased, so the profit margin is being squeezed. Under this method there is a danger of arbitrary fixing of charge-out rates due to erroneous recording of time sheets, resulting in undervaluing the audit fees being billed to the client. Also time-based billing provides little incentive to provide excellence in client service.

Many practitioners like the idea of value-based billing but struggle with how to change from their current time-based methods, as it involves a programme to replace timesheets and hourly billing. However, whichever method is used, tracking of time spent on jobs is imperative for good practice management.

Best practice

The key to greater profitability is efficiency, not in the sense of cutting corners but in that of greatest results from minimum outflow of resources. Quality and efficiency are not mutually exclusive. Efficiency means better use of time and a higher realisation rate and there are various practices to increase efficiency. Client and staff behaviour both drive margin, in terms of quality client records and efficient staff.

The auditor’s job is to perform procedures on data, not collect them. That is the client’s job, and do not be afraid to ask the client to do it, staff should not be “mining” for information. The better trained a client is to provide data, the more efficiently the audit can be performed. There is no time like the present to review last year’s audit and draw up a list of deliverables. Clients respond to financial incentives, so it is worth considering a statement in the engagement letter that overruns will be charged if deliverables are not provided in a timely manner. Nothing concentrates a client’s mind like showing them how they wasted money. A discussion atthe clearance meeting of how the audit deliverables could have shortened an engagement will reverberate throughout the year.

Technology can also enhance efficiency dramatically by cutting down on the paper trail and increasing a firm’s analytical capacity. But it is all too easy to let it increase a firm’s workload by taking on tasks that should be delegated to the client, just because the firm has the technology to do it. Keep a firm hand on the audit deliverables list despite this temptation. Cull your client list by actively fashioning the most lucrative and worthwhile client base by dropping high-risk, low-margin clients and acquiring stable clients with good reputations.

The most profitable firms plan ahead and a little advance planning now can pay tremendous dividends. An extensive planning process to make sure the whole team is on the same page may be right in one situation but not in another. Obviously some planning is necessary to prevent inefficiencies and over-auditing, such as a site visit, learning about the client’s operations, business and industry and considering client risks. An experienced firm auditing a familiar client might have that information already and will need to do little more than look over last year’s audit file and think about what should be done differently.

Risk assessment at the assertion level is a major contributor to audit efficiency, and allows the auditor to concentrate on the areas of greatest risk. Practice review results show that this is an area where there is scope for improvement. Analytical procedures are more efficient than substantive tests of detail, and in low-to-moderate risk areas can even be used exclusively. Appropriate replacement of substantive tests of detail with analytical procedures can reduce the time required for an audit.

Dedicated, loyal and experienced staff means continuity and familiarity with clients, which is key to efficiency. Ensure the your staff are adequately compensated, provided with interesting work and empowered in firm decision making. Extra steps might include casual dress, flexible hours and a growth plan that clearly sets forth opportunities for advancement.

The way forward

Audit is generally more stable than some other service lines and audit is rarely the lowest margin line of service. Consulting, for example, can have a higher risk profile than audit. Audit has a more steady income stream, more stable cost base and a higher proportion of repeat business and significant long-term clients.

The important thing is probably not what you do, but how you do it. There is no magic to profitable audits, just the diligent application of sensible practices and methodologies. Firms that streamline the audit process, adopt an approach based on risk and materiality, manage their clients and carefully shape their client base, commit themselves to enlightened policies of staff retention, and use all of these practices to leverage their experience and judgment are positioning themselves to achieve higher realisation and greater success.

Zowie Murray CA is a Technical Advisor on NZICA’s Technical Services Team.

AT A GL ANCE – TOP 10 TIPS

  • Plan ahead
  • Delegate data collection tasks to the client
  • Perform a risk assessment at the financial statement and assertion levels
  • Replace substantive tests of detail with analytical procedures where possible
  • Track time spent on jobs accurately
  • Contact clients in advance of overruns
  • Impress upon clients the value that is being delivered
  • Make use of technology
  • Carry out a customer profitability analysis
  • Reward staff with appropriate motivators

Author: GAA Accounting

GAA Accounting is the journal of the Global Accounting Alliance.

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