Audit Pricing Played A Part In Increased 2004 Audits Costs

Unusual increases in hourly rates for audit services contributed at least in part to increased audit costs that public companies experienced in their first year of compliance with Sarbanes-Oxley internal controls reporting.

Quigley

That's according to James Quigley, CEO of Deloitte & Touche USA, who said in an exclusive interview with Compliance Week that audit fees for Deloitte clients were up about 40 percent in 2004 (see interview in box at right).

The fees are likely no surprise to most public company executives, and in fact are in line with recent surveys tracking overall increases in audit costs. Financial Executives International, for example, recently noted that external audit fees rose about 38 percent in the first year of compliance with internal control testing and documentation requirements.

Similar surveys and projections also say costs will drop in year two of internal controls reporting for most companies because they’ve now established their processes and procedures and will be more efficient the second time through.

The increase in audit activity, and therefore total cost, is due to numerous factors, including the additional time that registered independent accounting firms allocated to financial statement audits under heightened regulatory scrutiny and the new, watchful eye of the Public Company Accounting Oversight Board. In addition, internal control testing and documentation, which had never before been part of the audit process, contributed to increased costs.

And while companies have long been required to maintain internal controls over financial reporting, there was significant “deferred maintenance” to be done in year one of SOX-required reporting, said Quigley.

“We’ve invested tens of millions of dollars into training our professionals,” Quigley said. “We’ve added 2,000 professionals to our audit teams. Our costs are up. This is what our public policymakers expected.”

Nailing Jell-O To The Wall

To what degree, however, can cost increases be attributed to activity vs. pricing for audit services? Apparently, no study performed to date has made such a distinction.

Quigley conceded hourly rates might have been a factor. “I believe rates are higher,” he said. “We continued to see the rate step up in the past year.”

He couldn’t define the hourly increase in any numerical way—“that's not a number I carry around in my head,” he said—but he added the increases in rate per hour will not be the same in 2005 as they were in 2004. No other major audit firm even responded to a Compliance Week inquiry about billing practices and patterns.

Finance professionals at some public companies, some of whom have audit experience with Big Four firms, say aggressive billing and hourly rate increases at least contributed to the increase in the final bill.

In classic supply-and-demand fashion, audit firms exhibited a kind of “take-it-or-leave-it attitude,” said Curtis Dinan, senior vice president and chief accounting officer with ONEOK and a former partner for Arthur Andersen before its collapse.

Brian Bronson, chief accounting officer and treasurer for $245 million RadiSys Corp., said the company’s overall audit bill jumped from $200,000 in 2003 to $700,000 in 2004. “Two-thirds of the increase was associated with rate per hour, and one-third associated with an increase in audit hours,” he said.

Audit billing is complex because audit firms typically state hourly rates for various professionals based on level of experience, then discount the rates depending on a variety of factors, including demand, according to Dinan. Defining causes for increases in audit costs and in hourly rates specifically is “like trying to nail Jell-O to the wall,” he said.

Based on the climate—high demand for audit services and low supply of qualified auditors—audit firms did little or no discounting, Dinan said. He estimated ONEOK realized a 20 to 25 percent increase in its hourly rates as a result.

Dinan said audit firms put more of their partner- and manager-level staffers on direct audit work than usual to help meet demand, which also contributed to overall cost increases.

Partners, for example, typically bill at rates four to five times greater than a starting auditor, and they usually divide their time about in half between “billable” client service and “nonbillable” activities like internal administration and new business development, he said. In the past year, partners spent as much as 90 percent of their time on billable service.

Lubushkin

Others reported they saw increases in hourly rates, but not increases they considered excessive. Greg Lubushkin, chief accounting officer at ECC Capital and a former staffer at PricewaterhouseCoopers, said he’s seen hourly rate increases in the range of 8 to 10 percent. Jean Bua, vice president, controller, and chief accounting officer for Iron Mountain, said she saw an increase in hourly rates, “but it was not egregious.”

Bua

Ann Marchetti, practice director with Parson Consulting, said based on available information the increase in overall costs is apparent, but “there’s not a lot of information on how or why,” she said. Consumed by the compliance activities themselves, “companies are not really stopping to think about why or where their costs are up,” she said.

Marchetti

Marchetti said accelerated filers—larger companies who have already been through the internal controls reporting process for the first time—will exercise more leverage in year two of reporting. They’ll be more efficient, she said, and they’re reviewing their auditors and considering whether to make changes in audit firms.

Some might even considering breaking with tradition and giving more audit work to second-tier or other mid-market audit firms, which would disperse demand and help suppress pricing. “There are a lot of very talented mid-tier accounting firms out there,” she said.