space shuttle The all four are competing for success


This article was first published in the October 2019 UK edition of 
Accounting and Business magazine.

Amid the myriad changes affecting the audit market of the UK’s largest listed companies, it is becoming clear that costs are set to increase, as the Big Four firms report overruns and renegotiate fees.

Today, companies in the FTSE 350 (all but eight of which have Big Four auditors) pay more than £900m collectively to have their businesses audited. This compares with just over £676m in audit fees paid by those same companies (excluding those that were not in the FTSE 350 at the time) five years ago. And those fees are set to rise even further after it emerged that the Big Four underbudgeted the cost of the audit in a significant number of cases – and now see little reason not to ask for more money.

At the same time, the value of non-audit fees charged to audit clients has fallen considerably over the past five years. Figures compiled for Accounting and Business show that this year FTSE 350 companies paid £146m to their auditors for non-audit services. Five years ago, the equivalent figure for those same businesses stood at £219m. The figures do not include audit-related fees, which have risen from £107m five years ago to £129m today.

But there is still concern that auditors will swallow certain costs in order to keep their clients. As a result, the Big Four firms have been under significant pressure to account for their cost overruns, amid fears that they use audit work as a loss leader for more lucrative consultancy work.

Renegotiation

Earlier this year, following their appearance before the business select committee of the House of Commons, the Big Four firms were required to provide details about the number of FTSE 350 companies they audited where costs were at least 10% more than originally budgeted.

Deloitte reported that, out of a sample of its FTSE 350 audit clients, 50% had cost overruns of more than 10%. While 80% of cost overrun clients had made an additional payment, only 24% had paid the full overrun cost.

EY admitted to similar overruns at 32% of its FTSE 350 clients in 2018. In half those cases, it took up the issue with the clients’ audit committees, all of which agreed to a renegotiation of the fees.

At KPMG, a sample of FTSE 350 audits over the past five years revealed 10%+ overruns at 16%. The firm renegotiated the fees at 83% of these companies.
And PwC saw overruns at 43% of its FTSE 350 audit clients. Fees were renegotiated at nearly two-thirds (62%).

In his letter to the business select committee chair Rachel Reeves, KPMG’s senior partner Bill Michael explained: ‘Typically, when we price our audits, we estimate the amount of work and mix of partners/staff required to meet our objective in terms of audit quality. We then discuss that estimate with the audit committee and seek to agree a fee which is both competitive and makes a positive contribution to profit.

‘We recognise that the outcome cost is unlikely to be exactly as we estimated, but as it is often the case that the assumptions on which we have made our estimate are reasonably borne out, the outcome is usually within an expected and appropriate range of profitability.’

He added: ‘It is our experience that, where additional work is validly required, audit committees are receptive to additional fees being billed. Where this is not the case, we consider the appropriateness of continuing as auditor for the subsequent year, although such instances are very rare.’

The amount an auditor charges its listed clients is, of course, a matter of public record, as indeed are the fees charged for non-audit work. It is therefore not particularly surprising that when a client replaces its auditor, the audit fee can remain broadly similar. The situation is an evolving one, though – there have been some significant increases in audit fees recorded when a new audit firm is appointed. For instance, BT Group’s audit fee jumped from £11.3m to £14.2m when it moved from PwC to KPMG earlier this year.

Such increases should not come as a surprise, especially given reports that Hywel Ball, EY’s head of audit in the UK, has written to his firm’s audit clients saying that they should expect to see their audit fees increase in the future. The price inflation has been put down to increased costs and investment in technology, as well as greater regulatory burdens. Reports also indicate that the firms are reviewing their audit client portfolios with a view to ditching those they consider to be high risk.

Low-balling

However, it is clear that, given the Big Four’s responses to the business select committee, there is a growing pressure to recoup cost overruns to avoid accusations of low-balling – the practice of charging a reduced audit fee in the hope of securing more valuable consultancy work.

KPMG’s response to the business select committee outlined the risk of undercharging that occurs when an audit firm takes on a new client. The firm said: ‘Although we spend a significant amount of time understanding a company during an audit tender, it is inevitable that we have a lower level of understanding of such a company’s systems, processes, people and control environment than we would have for a company that we have audited for a number of years.

‘There is therefore a higher risk that we underestimate the effort required to deliver a high-quality audit to a company where we have recently won a competitive tender.

‘Looking back at first-year audits of the 21 FTSE 350 trading companies where we tendered and were appointed over the last three years, on around half of these audits the amount billed in respect of the first-year audit included additional fees to reflect costs exceeding budget, though in many cases the level of cost overrun was less than 10%.’

Philip Smith, journalist