Financial restatements and poor internal controls definitely cost a company money. Now, for the first time, companies can try to pinpoint how much those errors and weaknesses might cost them in audit fees.
According to a study of audit and audit-related fees paid by companies in 2006, accelerated filers that reported some sort of issue—a restatement, a poor auditor’s report, material weaknesses in internal controls—saw their audit fees jump 16.1 percent from the prior year. Accelerated filers with clean opinions and financial statements, in contrast, actually had fees edge downward from 2005.
Cheffers
“The data suggest that companies that have poor internal controls—those that had financial-reporting issues such as restatements or those that didn’t get clean 404 opinions from their auditors—pay more in external audit fees,” says Mark Cheffers, chief executive of Audit Analytics.
The analysis looked at data for 3,160 accelerated filers that disclosed the audit and audit-related fees they paid to external auditors for the fiscal year prior to their first Section 404 (generally 2003) report and for their first two years of Section 404 compliance (2004 and 2005). The study also looked a 2,631 companies still not required to comply with Section 404, and which reported revenue of at least $1 million and fees disclosed for each of the three years during the same 2003-05 period.
Overall, the 2,181 accelerated filers with no financial-reporting issues saw their audit and audit-related fees decrease 1.55 percent in the second year of Section 404 compliance, from $5.34 billion in the first year to $5.26 billion in the second, according to Audit Analytics.
“That decline in tells me there was a first-year premium to be paid that wasn’t indicative of the long-term costs of 404 compliance,” Cheffers says. “It’s consistent with the theory that audit firms would know more and would be more efficient.”
Meanwhile, the 979 companies filing under Section 404 that did have financial-reporting issues saw their combined audit and audit-related fees rise 2.59 percent in the second year of compliance, with total fees rising from $3.16 billion in the first year to $3.24 billion in the second.
While those numbers may appear large at first glance, Cheffers says audit fees don’t add up to much when you consider that the 3,160 Section 404-compliant filers had a combined $15.1 trillion in market cap and $10.9 trillion in revenue.
FEES
The data below, provided by Audit Analytics, show the audit and audit-related fees (i.e., not total fees) paid by companies that have gone through at least two years of compliance with the internal control provisions of Sarbanes-Oxley. "Issues" are defined as companies that have gone through a restatement, have received a poor auditor’s report on 404, or have disclosed a material weakness in their internal control over financial reporting:
Audit Fees, No Issues
When
Audit Fees &Audit-Related Fees
PercentChange
Prior To 404
$3,239,748,643
First 404
$5,345,825,977
65.01%
Second 404
$5,263,176,358
-1.55%
Cumulative Impact
62.46%
Audit Fees, With Issues
When
Audit Fees &Audit-Related Fees
PercentChange
Prior To 404
$1,881,597,488
First 404
$3,163,739,659
68.14%
Second 404
$3,245,728,355
2.59%
Cumulative Impact
72.50%
Source: Audit Analytics Analysis Of Audit Fees
“To put it in perspective, those companies paid a combined $8.5 billion in audit fees,” Cheffers says. “Essentially, that’s saying that for every revenue dollar these companies have, they spent seven one-hundredths of one cent on audit and audit related fees.”
Meanwhile, issuers that haven’t yet had to comply with Section 404 saw double-digit increases in fees, whether or not they had financial-reporting issues, the data show. The 2,110 non-accelerated filers with no reporting issues saw their audit and audit-related fees increase 12.8 percent to $2.62 billion in 2005, while the 421 filers with reporting issues saw fees rise 24.5 percent that year, to $553.46 million.
Overall, the “clean” accelerated filers’ combined fees increased 62.46 percent from the year prior to Section 404 through the second year of compliance. Those in the group with financial-reporting issues saw an overall increase of 72.5 percent. Likewise, non-accelerated filers with good financial statements saw audit fees jump 39 percent from fiscal 2003 to fiscal 2005, and non-accelerated filers with reporting difficulties had fees jump 55.17 percent over the same period.
“404 filers seem to have an advantage over their non-404 counterparts in terms of the fees paid to their external auditors when they had an issue,” Cheffers says. Non-accelerated companies that had financial-reporting issues paid a 41.5 percent premium in audit fees, compared to a 16 percent premium paid by 404 filers that had issues.
Cheffers says the valuation premiums for Section 404 filers versus non-404 filers tell an even more interesting story. “There’s a substantial swing in the market cap to revenue ratio,” he says. “The market really does discount for companies with issues.”
Overall, the market cap-to-revenue ratio for all of the Section 404 filers was 138.5 percent. Those with clean financial statements, however, enjoyed a ratio of 145.5 percent—and those with troubled financial statements had ratios of only 120.8 percent.
Non-accelerated filers with clean reports had a market cap to revenue ration of 119 percent, while those filers with reporting issues had a market cap to revenue ratio of 104.8 percent.
“There seems to be an inherent discount for being a non-404 filer,” Cheffers says.
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