October 17, 2018

Can Low Audit Fees Translate to Higher Risk Exposure?

Can Low Audit Fees Translate to Higher Risk Exposure?

The major challenge with proposals is understanding exactly what you are getting from each bidder. The core deliverable may appear to be the same; audited financials and tax returns prepared, but how and why do proposals vary so much in pricing? And, is a lower fee really the lowest cost? How do you compare audit fees when looking at proposals? The easy answer is to select the lowest bid, but that makes for a pretty short and misleading article.

Proposals are intended to gather data so you can evaluate service alternatives. Unfortunately, many Requests for Proposals (RFPs) are exclusively filtered by price, which can create significant, hidden deficiencies for an organization.

Four Primary Drivers Impact Price

  1. Rates. On the surface this is a straightforward comparison. If one firm’s hourly rates are 25% higher than another firm, the outcome is somewhat predictable. It’s not that easy though so the question should be “why are the one firm’s rates 25% higher? You need to ask that question because it’s part of the equation. The rates of a firm are often higher because they add more value and have specific training or industry dedication which is extended to your organization in the engagement process.
  2. Hours. Firm A estimates 100 hours and firm B is at 140 hours. Is firm A more efficient? What if B also has the 25% higher hourly rate? What if firm C just gave a fixed price with no hours or rates? Is the firm who bid less hours more efficient or just doing less? This is where the Board or evaluating executives need to ask, what is missing from each proposal? It’s often hard to see what is being delivered and it’s very easy to make a decision based on price because the proposal and presentation and qualifications can look the same.

    The hours used to create the final fee are the blueprint of the level of effort planned to assist the organization. In any bid it is easy to mask short-cuts in the audit process by not defining the number of hours in the audit. Furthermore, the level of partner and manager hours is important to compare as this higher level commitment is essential to the quality of the audit. Lack of disclosure is how firms can cover up what they are not doing. How does a board member understand this when their expertise may be in different discipline areas? Their default becomes fees and personalities which both are pieces of the equation, but should not be the main consideration. The fiduciary risk executives have to protect their organization and this should be a decision factor. A thorough audit can help to prevent negative publicity in the press resulting from a fraud or improper financial reporting, which stems from weak internal controls and lack of risk management.
  3. Reason. What is the purpose of an audit? Is it just to satisfy compliance? If so, it is not a complete audit and you are missing the point of the engagement. An audit to meet minimum standards provides a potentially compromised process because risk management and assessment is what an audit is intended to achieve. An organization should be conducting the audit because they are trying to objectively measure their financial position, internal controls, effectiveness of processes, and ongoing sustainability, as well as getting advice on the forward needs of the organization. A price driven decision is not going to provide an audit firm or team that will fulfill those goals.
  4. Experience. No firm advertises they do minimal quality audits. High quality, value added audits is a standard line of the accounting profession.

Three Simple Questions can help a Buyer Really Understand a Firm’s Experience

  1. What percentage of the firm’s revenue comes from the industry they are in? Not how many clients they support, but what percentage of their firm is invested in the industry? A large firm is going to have volumes of clients in every industry, but that does not mean they have deep experience in an industry and significant resources dedicated to that industry.
  2. Where is the firm active? Where a firm spends time networking and/or supporting the CPA profession is a sign of where their interest levels lie. Peel back one more layer. A firm says they are involved in 10 industry groups. Is that dedication or just a dilution of their firm focus? How can a firm be effectively knowledgeable in every industry type?
  3. Training. Is their Continuing Professional Education (CPE) generic or in areas that really do not apply to your needs? Does a nonprofit need a CPA who received 20 of their CPE hours in cost accounting or estate planning? Maybe you don’t need a specialist, but make sure this is a conscious decision since so many nonprofits depend on grants and donor funding which requires compliance to specific metrics in order to continue to receive funding. A generalist will lack the experience to recognize or even know what to look for during the engagement.

    Bargains are typically driven by a reason. Low priced audits are the result of a firm who has too many auditors sitting with little to do. If they are so good, and have the experience, why is their best team available and at such a good price? A bargain audit is normally the result of a decreased number of hours on a job or a significantly discounted rate. So circling back around, if the firm has a low price is it because they don’t have the experience or are they reducing their engagement hours to win the job?

To Recap How to Compare Auditor Fees

  1. Rates. Comparing hourly rates can explain some of the fee difference, but keep in mind a higher hourly rate often means a more specialized workforce is being delivered.
  2. Specialization.
  3. Assess the firm’s understanding of your industry by looking at the percentage of their client base and not just the number of clients and what kind of training they receive.
  4. Hours. Understand the hours included in the bid. Differences in hours mean you are getting different services delivered. Auditors are required to comply with certain standards and processes, so material differences in time/hours means something is not getting done in the engagement. If a firm with less industry dedication is bidding fewer hours than an industry specialist, you have to consider what you are really getting.
  5. Purpose. Make sure your evaluation team and board understands the risk assessment element of the audit. If this is not their primary evaluation factor, it needs to be.

Related Industry

Nonprofit & Social Sector