Big 4 audit firms are quietly offshoring portions of the external audit work for publicly held companies, raising a bevy of questions about whether the work is visible to the companies themselves, their investors, and even regulators.
Brian Daugherty, assistant professor at the University of Wisconsin, says he first learned of the effort in 2007 when he attended a faculty forum at KPMG where he heard a description of a “pilot program” to begin moving low-risk, non-judgmental repetitive tasks to offshore offices. He and Denise Dickins, a professor at East Carolina University, decided to study the practice more closely. They interviewed audit partners at Big 4 firms and discovered that all four firms—Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers—engaged in such initiatives to some extent.
Dickins
“This is very cutting-edge,” Dickins says. “The piloting of offshore audit procedures has been going on now for at least a year. They’re testing it with a limited number of clients to see whether it works. It’s not being done on every audit.”
Through a spokesman, PricewaterhouseCoopers did tell Compliance Week: “We are piloting alternative delivery options both onshore and offshore,” but the firm would not comment further. Ernst & Young and KPMG declined to comment, while Deloitte did not answer Compliance Week’s requests for information at all.
Equally silent is the Public Company Accounting Oversight Board. PCAOB inspectors pore over audit documentation to confirm that audit opinions measure up to Board standards and are properly supported by evidence, but it isn’t clear exactly where the documentation for audit work done offshore resides; the paperwork could be in U.S. audit files readily available to inspectors, or stored in those overseas offices where it’s tougher for inspectors to reach.
The PCAOB declined to discuss the offshoring practice with Compliance Week. But the Board has not had an easy time fulfilling its mandate to inspect overseas audit firms; instead, it has slowed the pace of its inspection schedules and increasingly relies on overseas regulators to inspect U.S. audit work.
Ferguson
Of course, U.S. companies have been shipping low-skill, labor-intensive activities to cheaper parts of the world for years, and even the Big 4 have openly shipped tax preparation work and some outsourced internal audit work abroad as well. But offshoring external audit work for public companies is a different matter, says Lewis Ferguson, a partner with Gibson Dunn & Crutcher and former general counsel for the PCAOB.
“This raises many, many, many questions” about compliance with auditing standards, audit quality, the transparency of the audit work to regulators, he says. It can also leave companies wondering about the privacy and security of sensitive data that they are required to protect.
Blenkinsopp
Damien Blenkinsopp, associate director for Kennedy Information and a consultant to Big 4 firms, says the technical challenges of doing audit work from India or Eastern Europe are few. Advance in technology and the push for continuous auditing have paved the way.
“There’s nothing experimental about it,” he says. “It has been building up for some time.”
Gramling
Audrey Gramling, president of the Auditing Section of the American Accounting Association and a professor at Kennesaw State University, says the movement to offshore external audit work was a topic of discussion at an AAA conference in January. She says the firms positioned the practice as a staff development effort to move mundane, repetitive tasks outside the United States and leave U.S. personnel with more challenging (read: more expensive) work.
The Supposed Benefits
Daugherty
Daugherty says that when he researched the practice of offshoring, audit firms were eager to tout the cost benefits. One firm reported the “all in” cost of a staff auditor—the cost of salary, benefits, training, and other overhead—is four times greater in the United States than in India. “The primary impetus” of offshoring external audit work “was to fight fee fatigue by their publicly traded clients,” he says.
Fee fatigue is a legitimate point. In the first years after the Sarbanes-Oxley Act arrived, corporations watched almost helplessly as their audit bills soared. They eventually mounted a fierce counter-attack, and prodded the Securities and Exchange Commission and the PCAOB to issue new, more relaxed compliance rules. Audit firms are now feeling a squeeze of their own, as SOX-related revenues stagnate. The lower costs of offshore work, therefore, have an obvious appeal.
Hanish
Arnie Hanish, chief accounting officer at Eli Lilly & Co. and chair of the corporate reporting committee at Financial Executives International, says he’s unaware of any move by the Big 4 to offshore external audit work for public companies. Lilly relies on offshoring to meet its own competitive pressures, so Hanish isn’t opposed to the idea per se—but he would have plenty of questions for his audit firm, he says.
OFFSHORE OPTION
Below is an excerpt from the study “Offshoring the Independent Audit Function: Considerations, Implications, and Research Opportunities.”
The increase in offshoring has been fueled by advancements in technology; with
primary benefits relating to the cost savings available from lower personnel costs.
Today, over 75 percent of major financial institutions have offshore operations (Deloitte
2007); and some economists estimate that up to one-third of total U.S. employment in
services may ultimately be offshored (Lohr 2007).
The benefits of offshoring have not been ignored by the accounting profession.
In recent years several large public accounting firms have begun using COEs to perform
certain non-audit procedures for their U.S.-based clients. For example, Ernst & Young
uses COE employees to prepare client tax returns (Houlder 2007) and a number of
accounting firms use COEs to print documents for delivery to clients. At least two large
accounting firms have recently begun pilot testing the offshoring of certain non-judgmental audit procedures, and discussions with partners at other large accounting
firms indicate that offshoring of non-judgmental audit procedures is being considered.
This shift in processes requires that the auditing profession consider the
implications of offshoring on its own processes. Discussions with a number of partners
at major accounting firms suggest that a primary impetus to offshore certain audit
procedures is an effort to fight ‘fee-fatigue’ by clients, due in large measure to the
increased reporting and compliance requirements mandated by SOX. One partner
commented at a 2007 KPMG faculty symposium that the ‘all-in’ cost of a chartered
accountant at the firm’s Indian COE is approximately 25 percent that of the employee’s
U.S. equivalent. Two other partners at separate large accounting firms have remarked
that their perception of the quality of the work performed at COEs is equal or superior to
the work performed by staff domestically.
The major accounting firms have thus far indicated that the initial phase of
offshoring will only involve the performance of non-judgmental audit work by COE
personnel and strict review regiments will be enforced domestically to ensure that the
work has been appropriately performed, supervised, and documented. While recognizing
that the offshoring of certain auditing procedures has the potential to contribute positively
to the audit function, we suggest there are certain considerations—and potentially
negative implications—that might arise from the process.
Potential Client Concerns
On the surface, it seems reasonable to conclude that clients would be fully
supportive of any initiative that could simultaneously reduce audit fees without
sacrificing the quality of audit procedures performed. However, there is the possibility of
resistance by clients on at least two fronts. First, from a practical perspective, some
clients—especially those that have historically resisted outsourcing portions of their own
operations due to political cost and perception concerns—may desire that their service
providers not engage in offshoring.
A second, albeit important, issue relates to the confidentiality of client
information. Rule 301 of the AICPA’s Code of Professional Conduct states that “a
member in public practice shall not disclose any confidential client information without
the specific consent of the client” (AICPA 2007). Further, legislation has previously
been proposed in Congress concerning notification and consent of the transfer of private
information to offshore entities (U.S. House of Representatives 2004). While the concept
of offshoring in its current form envisions only non-judgmental audit procedures, the
client information that is exported (electronically or otherwise) to a COE is likely to
contain some degree of confidential information. Some clients may be uncomfortable
with the thought of having their confidential information in the hands of individuals at a
foreign COE—even though the professionals are the firm’s employees—that they have
never met or established a working relationship with.
This issue has important policy implications. An argument could be made that
Rule 301 requires audit firms to inform clients that a portion of the audit will be
offshored, and that the process will entail the transmission of the client’s proprietary
information to the COE. To retain their independence, auditors may not allow clients to
dictate the scope or timing of audit procedures, nor the personnel assigned to the audit;
hence, the process of offshoring presents auditing firms with a tightrope that must be
carefully navigated. Audit firms will need to assure clients that procedures are in place to
appropriately safeguard client information after the audit procedures have been
completed, reviewed, and documented.
Source
“Offshoring the Independent Audit Function.”
“I would want to know the nature and the scope of the work that’s being offshored, and where it’s being performed,” he says. “I would want to know that what they’re offshoring is not of a sensitive nature. I would be concerned if they were offshoring activities that require judgment and knowledge of U.S. GAAP.”
Hanish says he also sees no consistent global approach to quality and training among the Big 4 firms, such as what’s required of large pharmaceutical companies like his own. Based on his observations, “I don’t believe they have the robust global quality systems in place to ensure the same level of consistency from country to country,” Hanish says. Unless a firm has a system for uniform quality assurance, he says, offshoring “could be a recipe for disaster.”
Daugherty and Dickins say the nature of the work being offshored tends to focus on administrative, computational tasks requiring little or no auditor judgment. U.S. engagement teams select parameters and apply judgments, and then rely on the overseas help to do the work, Daugherty explains.
He gives the example of a large company with tens of thousands of accounts receivable balances that need to be confirmed. The audit firm will establish parameters for selecting which balances to verify, and then send that information to the offshore office to be culled and selected for confirmation. The offshore audit team would “have the confirmations typed up on the client’s letterhead and send them back to the United States for the client to sign,” he says.
Hirth
Bob Hirth, executive vice president at the consulting firm Protiviti, and Mritunjay Kapur, managing director at Protiviti India, say the Big 4’s practice of offshoring external audit work is common knowledge in the auditing profession. “They’re not experimenting with moving work around the world,” Hirth says. “They’ve been doing it for some time.”
Kapur
Kapur says tasks sent to India typically include calculating debt depreciation on fixed assets or checking of formulae on spreadsheets to assure they work. “Bank reconciliations are being actively done out of India, for large financial institutions and Fortune 500 companies,” he says.
Gramling agrees that audit quality, monitoring, and training are concerns audit firms must address if they plan to expand their use of offshoring. “When you get into the international arena, I worry whether the same level of quality is actually in place in other countries,” she says. “A client in the United States can work face-to-face with the audit team and can see if they’re competent. When it’s offshored, they can’t get that sense of whether they’re competent.”
At the AAA meeting Gramling attended, the firms acknowledged the practice and provided some brief remarks, she says, but she also worries whether the firms are being completely transparent. “This is certainly a question that audit committee members should ask their audit firms,” she says. “Hopefully the firms have not adopted a ‘don't ask, don’t tell’ rule with respect to whether aspects of the audit engagement are offshored.”
Dickins says a host of audit and privacy rules could come into play regarding how audit firms manage such work, and how much information they should disclose to their clients about it. But it’s not immediately clear how any of those rules apply to the exact circumstances, she says.
“If this becomes more common or people start doing it as a general practice, clearly there will be regulations that come,” she says.
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