by Glenn Cheney
Audit fees at public companies are soaring, and it looks like they’re going to soar more.
The new, improved financial reports and beefed-up audits mandated by the Sarbanes-Oxley Act account for much of the increase.
But are audit committees complaining?
In general, no.
And neither are audit firms, not even the ones that have no public company clients.
A recent survey conducted by Financial Executives International found that the auditor attestation required to meet the requirements of Sarbanes-Oxley Section 404 is expected to cost the average public company 38 percent more now than attestation cost a year ago. Companies of all sizes, from those under $25 million to those with revenues over $5 billion, foresee proportionately large increases.
The smaller companies expect to spend an average of $52,200 more. The bigger ones are spending an average of $1.531 million.
“I think we’re seeing this increase in two levels,” said Wayne Kolins, national director of assurance at BDO Seidman. “In some cases, fees have gone up 20 percent or so, while in others, they’ve gone up a little more because of preparation for Section 404 reporting. And of course next year and at the end of this year, these fees should go up significantly as a result of the audit requirement for accelerated 404 reports.”
Section 404 requires the annual reports of public companies to contain a statement of management’s responsibility for internal controls. It also requires auditors to attest to and report on management’s assessment of the effectiveness of the company’s controls and its procedures for financial reporting, in accordance with the standards of the new Public Company Accounting Oversight Board.
Kolins said that audit committees are aware of the new audit environment, but are not “just rolling over and accepting the higher fees.” Rather, they are recognizing the benefits of better audits. Better audits, they believe, will protect them from accusations of negligence or malfeasance. At this point, their main concern, Kolins said, is that the quality of the new audits reflect the increase in fees.
“The primary criterion for audit committees is whether the audit quality is satisfactory,” Kolins said. “When you think about the ramifications of a potential problem with a financial statement, the increased audit fee is a drop in the bucket. It’s very cheap insurance for them.”
Kolins declined to predict how much audit fees would rise, but said that 100 percent was possible in some cases. Many factors are increasing the fees, including the training of auditors and company personnel to assess internal controls, the extent of preparedness at the company, and “innumerable discussions about what constitutes a significant deficiency.”
“An audit of internal controls in a big, far-flung company can be extremely complex and very judgmental,” BDO’s Kolins said. “Right now, in terms of the magnitude of the work, this is a black hole.”
A culture of controllership
General Electric saw a 45 percent increase in its fees, rising from $38.7 million in 2002 to $55.4 million in 2003.
GE spokesperson David Frail explained that much of the increase was due to audits relating to acquisitions. Big Four firm KPMG is the company’s primary auditor. Frail said that audit fees would have been even higher if GE hadn’t already been meeting many SOX requirements. The company brought itself into compliance 12 months earlier than required.
“We start from a financial corporate culture that puts the idea of controllership — good controls and accurate audits — at the forefront,” Frail said. “We were fine with doing Sarbanes-Oxley. We took it as an opportunity to look at processes from another angle, another perspective, and see what we could learn. It was another opportunity to assure investors that they are dealing with a company that puts governance and transparency at the top of the list.”
The FEI survey also found that companies expect to spend quite a bit on external consulting software and other vendor charges to comply with Section 404. Smaller companies expect to spend a staggering average of $170,000 for such services — more than three times the average increase they’re seeing just for audits. Larger companies expect to spend an average of $1,390,100.
Only a quarter of the respondents had already deployed a permanent tool for compliance with Section 404. About half expected to do so in 2004, 10 percent plan to do so in 2005, and 13 percent had no plans.
Kolins said that some not-for-profit organizations are also seeing higher fees as they try to comply with Sarbanes-Oxley for the sake of an appearance of seriousness and to avoid financial questions that could destroy an organization’s reputation.
Steven Gaylord, a partner with the Indianapolis firm of Katz, Sapper & Miller LLP, said that Sarbanes-Oxley has not impacted his audit fees because the firm has no public company clients. Nonetheless, the impact on his firm has been substantial. Non-public companies, he said, have been abandoning the Big Four firms and flocking to his regional firm.
Non-public companies have been seeking smaller firms, he said, for several reasons. Some, seeing how compliance with Sarbanes-Oxley leads to a higher-quality audit, now recognize that audits are not a commodity. Looking for quality — and the protection it offers audit committees — they look for a new firm.
Others have found themselves sloughed off or inadequately cared for by the big firms, which are overwhelmed with the attention they must now give to their public company clients.
“I suspect that the big firms are trying to apply Sarbanes-Oxley standards to the private-company arena and priced those audits out of the market, and those businesses said ‘Ouch! We can no longer afford the Big Four. Is there an alternative out there that serves our needs and those of the users of our financial statements?’” Gaylord said. “We’ve been winners there.”
What auditors can’t do
In New Haven, Conn., Paul Rohan, director of audit and attestation at Scillia Dowling & Natarelli LLP, reported additional business helping public companies prepare for audits by other, larger firms.
“We’re helping them with systems documentation work and the testing that is the responsibility of management, which is something that auditors cannot and should not do,” Rohan said. “In fact, this business has spilled beyond public companies to include public institutions — hospitals, universities and that sort of thing — because their board members sit on the boards of public companies. They see what’s being done at their companies, and they want similar things done — perhaps with less intensity, rigor and formality, but the same things: documentation of internal control, having mechanisms for whistleblowers to use to report problems, and helping audit committees hire auditors.”
Colleen Sayther, president and chief executive of FEI, said that it was too soon to evaluate how much the first-year costs of gearing up for SOX compliance would actually benefit shareholders.
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