Audit Fees Are Up, But The Story May Not Be Complete

Audit fees are up, but if you consider the increase in revenues plus inflation, the fees appear not to have gone up dramatically, according to a recent study published in June 2004 by Glass Lewis, an analytical research firm.

In its report, Glass Lewis concluded that “the amounts paid to auditors for the audits of financial statements have increased but not significantly more than the growth in the operations of the companies themselves,” and added, “The numbers disclosed by companies do not support some of the whining about audit fees discussed in the press.”

When Financial Executives International produced an informal survey on audit fees in June 2003, it showed that companies expected fees to increase by an average of 35 percent from 2002 to 2003—compared to 27 percent from 2001 to 2002—to cover Sarbanes-Oxley 404 attestations.

Then, in a two-part survey conducted by FEI in January 2004 and July 2004, responding companies again gave estimates of their expected Section 404 annual auditor attestation fees. These estimates rose from an average of $590,100 in January to $823,200 in July. By July, FEI posited that companies had presumably begun to receive actual quotes from auditors, thereby leading to this projected 40 percent increase in fees (See "Compliance With Section 404 Costing More Than Expected" in box at right).

Impact Of Revenue, Tax Fees

According to the Glass Lewis study, actual fees paid for the audits of financial statements of the Fortune 500 did increase 16 percent from 2002 to 2003. But during the same time period, the revenues and assets of the Fortune 500 companies surveyed increased 9 percent and 10 percent respectively, and inflation increased 2.3 percent.

For non-Fortune 500 companies, the study found that audit fees increased 22 percent during this same period, and this group’s revenues and assets increased 13 percent and 14 percent, respectively.

In addition, other fees paid to auditors have simultaneously decreased. As of February 2001, the SEC has required companies to break out fees for audit and non-audit services in the proxy statement. Due to the new disclosure requirements, companies must disclose under separate captions their “audit fees,” “audit related fees,” “tax fees,” and “all other fees.” The intent of more meticulous documentation is to improve disclosure to investors, and the effect has been to place auditors under greater scrutiny.

The new disclosure rule has created a unique opportunity for companies to understand the breakdown of payments made to auditors within an industry or region. Joseph Cyr, director of marketing and business development at the research firm AuditAnalytics, says, “The main question I’ve gotten [from public companies] is, ‘How do we compare to our peer groups?’”

The Glass Lewis study concluded that fees paid to auditors for tax work—as a percentage of audit fees—decreased from 57 percent in 2002 to 43 percent in 2003 at Fortune 500 companies. Over a quarter of these companies (126) paid their auditors less than 10 percent of their audit fees for tax work in 2003, compared to 94 companies at this rate in 2002.

For the 1,805 non-Fortune 500 companies that responded, fees paid for tax work as a percentage of audit fees declined from 47 percent in 2002 to 38 percent in 2003.

Audit-related work such as consulting on internal controls, as a percentage of audit fees, fell from 27 percent of the 2002 audit fees to 26 percent in 2003 at Fortune 500 companies, and from 23.9 percent to 22.3 percent for non-Fortune 500 companies.

Relationships, Not Dollars

Glass Lewis saw this downward movement as a positive trend, noting that many companies are paying their auditors a nominal amount for tax or other consulting services—if they are employing them at all for these purposes. They also view the decline as a reflection of better oversight by audit committees, and suspect the SEC and The Sarbanes-Oxley Act have played a role in reducing the level of financial conflicts that could affect an auditor’s independence and the quality of the audit.

A recent survey by AuditAnalytics confirmed the decrease in fees paid for tax work. The firm took a look at the 68 Fortune 500 companies that, as of September, had filed their 2004 audit fees, and found that, “As fees and audited-related fees rise, tax related fees are on the decline,” says Cyr. “From 2003 to 2004, there has been an increase of approximately 22 percent in audit fees, but a decrease of approximately 38 percent in non-audit work, for a total decrease in fees paid to the independent auditor of 13 percent.” Cyr adds, “There was also an increase of approximately 13 percent in fees paid for audit related services.”

AUDITOR RESIGNATIONS

First 3 Quarters, 2004

181

First 3 Quarters, 2003

136

First 3 Quarters, 2002

74

First 3 Quarters, 2001

65

Source: AuditAnalytics

Interestingly, Cyr believes the finding “ties in neatly with the auditor resignation trend that AuditAnalytics has seen over the last four years with the Big Four and national firms.” He adds, “Given independence rules, these firms are resigning from the more lucrative consulting work and risky accounts to do more audit work.” (See chart at left for details).

But experts note that it may be too early to extract significant intelligence from the more detailed audit fee disclosures. “SOX 202 tells us a lot about filer/auditor relationships, but is insufficient to provide enough information about larger fee issues,” says Karl Nagel, principal of Karl Nagel & Co. “Then again, it wasn’t designed for that purpose, so it’s a bit of a stretch to attempt to delve any great meaning from the numbers provided other than for the original intent.”

In addition, Nagel acknowledges that a lot of the data is still not available. In some cases, he notes, “We’re not seeing the numbers reported. That is, only the auditor has to report fees; if an audit firm is providing 404 services for a client that uses another firm as its auditor, then those fees will be reported by neither firm. That’s because the auditor isn’t charging the fees, and the consulting engagement isn’t an audit client to the other CPA firm. In addition, legal fees aren’t showing up anywhere.”

Indeed, the SEC does not require that all fees be reported. In addition, says Cyr, “Companies have the option of reporting financial information systems design and implementation, and benefits fees or not.”

“Again, SOX is about disclosure and governance: the keys are relationships, not necessarily total dollars filers are incurring,” notes Nagel.

The complete study from Glass Lewis, as well as other resources, are available in the box above, right.