10TH ANNUAL AUDIT FEE SURVEY

REPORT

SPONSORED BY

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Where are we now?

Chan

gin

g FASB Standards (66%)

AVERAGE AUDIT FEES

4.25% INCREASE

2017 $2,220,251

2018$2,314,703

EXECUTIVE SUMMARYAs businesses continue to face ongoing disruptive forces, they must keep evolving. As they adapt, their processes and controls become increasingly complex. Accounting standards and other regulations are a source of constant change, too. All of these elements combine with inflation to cause upward pressure on audit fees.

CHANGING FASB

STANDARDS

(66%)

YES

NO

To obtain an auditor’s report on the financial statements, has the volume of annual audit work performed by your external auditors changed?

PUBLIC PRIVATE NONPROFIT

What’s driving audit fees? THE LEADING CAUSE OF AUDIT FEE MOVEMENT

Based on examining the universe of filings with the SEC and the PCAOB.

73%

27%

27%

73%

22%

78%

Yes and no. Public companies are reporting more change in the amount of annual audit work carried out by external auditors pursuant to obtaining an auditor’s report on the financial statements, than are their private and nonprofit counterparts.

About the MethodologyThe Financial Education & Research Foundation (FERF) surveyed its more than 10,000 members regarding audit and associated fees paid during the 2018 calendar year, the latest period where data was available, and received 347 responses. Separately, FERF partnered with research provider Idaciti to pull fees paid by publicly listed companies during the same period based on U.S. Securities and Exchange Commission and Public Company Accounting Standards Board filings.

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AUDIT FEES TEN YEARS ON:The ten-year period during which FERF has conducted its annual Audit Fee Survey can only be described as Dickensian. That is, we have gone from one of the most devastating economic downturns to the longest-lasting halcyonic expansion (extending back to June 2009).

In an interview with FERF, Dr. Robert Knechel – an expert in audit fee research from the Warrington College of Business – explained that “Fees increased right after Sarbanes-Oxley through the beginning of the financial crisis, during which audit fees decreased.… The decrease during this period is at least partially attributable to the pressure to share the pain of the economic downturn. If everyone else was taking a cut, auditors were asked to take one as well. Since then, audit fees seem to have stabilized.”

The extent to which audit fees lowered on an hourly basis relative to what they are now is depicted in the average hourly audit fees from the FERF surveys included in the 2009 and 2019 report(s). Beyond average hourly audit fees, the largest public companies seem to have seen outsized increases in audit fees, while their smaller counterparts have seen stable (or even decreasing) audit fees.

The Difference a Decade Makes – Audit Fees by Revenue Classification

THE POLAR NATURE OF AVERAGE HOURLY AUDIT FEES FROM 2009 TO 2019

2009

2019

2009

2019

LESS THAN 25 MILLIO

N

$2

55,8

00

$1

76,6

00

$7

03,5

00

$4

17,2

00

$7

18,5

00

$1

,020

,500

$1

,332

,800

$1

,646

,500

$3

,228

,800

$3

,057

,200

$3

,417

,700

$6

,491

,100

$5,9

00,0

00

$1

1,22

2,00

0

$17,

848,

800

$21,

850,

100

25 TO 100 MILLIO

N

100 TO 500 MILLIO

N

500 MILLIO

N TO 1 BILLION

1 TO 5 BILLION

5 TO 15 BILLION

15 TO 25 BILLION

MORE THAN 25 BILLION

$216

$283

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SECTION 1: THE AUDIT FEE MARKETPLACE Audit Fees by Filing Status

2017 2018

Average Median Filers Average Median Filers

Large Accelerated Filer $5,117,302.29 $2,540,146.00 2,022 $5,133,952.65 $2,496,449.00 2,205

Accelerated Filer $919,438.09 $571,873.50 1,244 $1,056,748.55 $720,000.00 1,265

Non-accelerated Filer $1,600,660.88 $535,168.00 461 $484,550.77 $109,090.00 1,927

Smaller Reporting Company $160,316.38 $84,000.00 1,750 $209,541.61 $112,200.00 159

Smaller Reporting Accelerated Filer $744,346.92 $678,598.00 13 $740,782.27 $557,000.00 15

Analysis: The numbers indicate significant downward pressure on audit fees for non-accelerated filers, which is caused by the exodus of small reporting companies into this filing type. This movement came as a result of an amendment to the definition of small reporting companies by the U.S. Securities and Exchange Commission (SEC). While the audit fees have increased on average for large accelerated filers, the median audit fee has decreased; this is attributable to the large number of filers moving into this type for classification purposes.

• Data is based on publicly available filings from the SEC and the Public Company Accounting Oversight Board (PCAOB).

• On June 28, 2018 the SEC announced amendments to the definition of “smaller reporting company.”

• In order to maximize comparability between 2017 and 2018, the charts below omit all 40-F filers for both years, as well as companies that did not file in both the years displayed. Additionally, all null values were omitted when calculating the average, median, and counts for the respective years.

What’s in a Name? Of the companies that filed in both 2017 and 2018, just over 37% changed filing type in 2018. While differences in filing status may appear to be purely taxonomical, changing filing type can have a major impact on audit fees. For example, in 2018 companies changing their filing type to large accelerated filer paid $323,136 more in audit fees on average than they did in 2017; whereas, those that switched from large accelerated filer to one of the other filing types saved $274,153 on average.

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2018 Spending Beyond Audit Fees Fees reported by filing status as a percentage of total spend outside of audit fees.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Accelerated Filer $59,474.92 $67,689.44

Large Accelerated Filer $609,567.62 $622,932.67

Non-accelerated Filer $14,703 $74,103.18 $34,598.36

Smaller Reporting Accelerated Filer $18,192.00 $22,505

Smaller Reporting Company $2,447 $5,081 $11,517.34

Average of Non-Audit and Tax Fees Average of Audit-Related Fees Average of Tax Fees

• Data is based on publicly available filings from the U.S. SEC and the PCAOB.• Table is based on a sample universe of 6,352 companies that reported 2018 fees.

Audit Fee Averages by Industry

Number of Filers

Average of 2018 Audit

Fees

Average of 2017 Audit

FeesAverage Fee

Change

Business Services 653 $1,883,998.32 $1,794,599.00 4.98%

Chemical & Allied Products 813 $1,700,641.66 $1,699,859.00 0.05%

Communications 138 $4,825,283.53 $3,991,208.00 20.90%

Depository Institutions 465 $3,462,188.34 $2,816,208.00 22.94%

Health Services 77 $1,666,027.60 $1,597,242.00 4.31%

Insurance Carriers 133 $6,745,097.11 $7,127,019.00 -5.36%

Miscellaneous Manufacturing Industries 35 $1,056,192.77 $1,175,419.00 -10.14%

Miscellaneous Retail 97 $1,686,101.90 $1,493,841.00 12.87%

Oil & Gas 258 $1,596,649.27 $1,634,890.00 -2.34%

Security & Commodity Brokers 151 $3,838,137.19 $3,339,129.00 14.94%

• Data is based on publicly available filings from the U.S. SEC and the PCAOB.• Table is based on the universe of companies that reported in both years in the same

filing category. • Percentage change does not take into account a possible change in filing status that

may greatly impact YoY considerations.

FIGURE 13 - 2018 SPENDING BEYOND AUDIT FEES/DATA

Fees reported by filing status as a percentage of total spend outside of audit fees.

Average of Audit-related Fees

Average of Tax Fees

Average of Non-Audit and Tax Fees

Accelerated Filer $59,474.92 $67,689.44 $15,248.10

Large Accelerated Filer $609,567.62 $622,932.67 $139,637.31

Non-accelerated Filer $74,103.18 $34,598.36 $14,703.26

Smaller Reporting Accelerated Filer $18,192.00 $22,504.93 $191.33

Smaller Reporting Company $5,080.51 $11,517.34 $2,446.92

Percentages

Accelerated Filer 41.76% 47.53% 10.71%

Large Accelerated Filer 44.42% 45.40% 10.18%

Non-accelerated Filer 60.05% 28.04% 11.91%

Smaller Reporting Accelerated Filer 44.49% 55.04% 0.47%

Smaller Reporting Company 26.68% 60.48% 12.85%

- Data based on publicly available findings from the U.S. SEC and the PCAOB

- Table is based on a sample universe of 6352 companies that reported 2018 fees.

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Primary Audit Firm Firm Name 2018 Clients 2017 Clients 2016 Clients

EY 962 905 835

PwC 757 640 607

Deloitte 697 600 540

KPMG 672 649 589

BDO USA, LLP 278 278 233

Grant Thornton LLP 215 216 193

Marcum LLP 134 107 96

RSM US LLP 125 122 100

Moss Adams LLP 96 89 60

Crowe Horwarth LLP 96 74 79

1000

0

EY PwC Deloitte KPMG #5-#10

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2017

HOURS

RATE

MEDIAN $62,000

AVERAGE $202,182

MEDIAN AVERAGE MEDIAN AVERAGE

AVERAGE $112,813

23% CHANGE

AVERAGE $91,619

HOURS

RATE

$190 $168

762395

$194 $191

1,7542,475

MEDIAN $45,250

NO CHANGE

MEDIAN $45,000

The Audit Fee Marketplace for Private Companies and Nonprofit Organizations

Private Companies Median and Average Fees (FERF Survey)

Median and Average Hourly Rate (FERF Survey)

Nonprofits Median and Average Fees Changes (FERF Survey)

2018

MEDIAN $67,000

8% CHANGE

AVERAGE $228,080

13% CHANGE

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SECTION 2: WHY ARE FEES CHANGING? Interview excerpt - Dr. Robert Knechel, the Frederick E. Fisher Eminent Scholar in Accounting and Director of the International Accounting and Auditing Center on what drives audit fees

“We know a lot about what drives audit fees; it’s probably the most heavily researched area in academia when it comes to audits, because data is available. We’ve had publicly available data on audit fees since roughly year 2000, and now we’re looking at close to 20 years of data regarding the fees that are paid by every listed company in the United States ... we’ve seen a number of clear patterns emerge.

Clearly, the biggest driver of audit fee movement is size (i.e., large companies take more work to audit than small companies). This explains around 70% of variances before considering other factors. Aside from size, there’s complexity. Complexity often stems from the number of subsidiaries to whether the organization has international operations. As a general rule, the greater the quantity of distinct product lines a company has, the more complex the audit. With this complexity come more hours and higher fees. Another category receiving less attention relates to what the client expects from the audit. Audit committees have sought more robust audits, as the quality of an audit reflects on them. So, the audit committee wants more out of their auditors.

Additionally, internal control and reporting requirements under SOX 404 have driven increases in audit fees. When Sarbanes-Oxley went into effect, there was a new mandate placed on the audit profession. By asking auditors to perform something completely different, we saw a doubling in audit fees from 2004 to 2006. The market for audit fees corrected as people began to understand the requirements and how to meet them more efficiently. Looking back at it, audit fees probably increased too much from 2004 to 2006…. The things that cause audit fee volatility are shocks to the system. If there is another downturn on the horizon, you’ll see fees adjust. The other wild card is driven on a more localized basis. Auditing tends to be a local market effect, meaning an audit in Chicago is not the same as one in Miami or New York, so the level of competition and bidding for clients tends to be more localized – with some being more industry-specific. Thus, if I’m an audit firm in Houston, I have a large interest in oil and gas companies. If one of my competitors has a dominant share of oil and gas clients, the only way for me to get into that market is to undercut those other audit firms, potentially stealing some clients.

The final factor to consider is that audit selections are fairly sticky. While there is some regulatory pressure to switch auditors, it’s not a requirement in the United States to get new auditors. When firms switch auditors, there’s three to six other audit firms who could potentially take over. They all want the engagement, because an audit is like an annuity. If you get the audit today, you’re not going to get replaced next year. Markets don’t like when auditors are replaced too frequently, so if you bring in an engagement – you’re looking at six to seven years minimum. It’s like an annuity because you get the fee every year and you do your job and keep going until the company decides they want to change again.”

What’s Driving Audit Fees in 2019? FEI Daily

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FEI Members Respond to What’s Driving Audit Fees for Their OrganizationsWith ASC 606 becoming effective for public companies with calendar year-ends at the beginning of January 2018 and ASC 842 becoming effective this year, the increased frequency with which public companies are naming new FASB standards and focus on revenue recognition as primary contributors to audit fee changes (relative to their peers at private and nonprofit organizations) is unsurprising. An additional key differentiation between public and private/nonprofit organizations is found to the degree that inflation impacts audit fees. Fewer than 10 percent of public companies responded that inflation was a key driver in audit fee changes, while 27 percent of private companies and 24 percent of nonprofits noted that inflation was a driver.

Please indicate the primary factors that contributed to an increase or decrease in your audit fees. (multiple responses permitted)

FERF Survey

80

70

60

50

40

30

20

10

0

NONPROFIT ORGANIZATIONS

PRIVATE COMPANIES

PUBLIC COMPANIES

For Public Companies: ■ New FASB Standards 66% ■ M&A Activity 36% ■ Focus on Revenue Recognition 34%

For Private Companies: ■ Inflation 27% ■ Negotiation with Primary Auditor 23% ■ M&A Activity 20%

For Nonprofit Organizations: ■ Inflation 24% ■ Negotiation with Primary Auditor 20% ■ New FASB Standards 15%

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New Accounting Standards

“In the year of the change, you expect fees to go up. Of course, the change in audit fees is dependent on the overall magnitude of the change,” Dr. Knechel explains. With ASC 606 and ASC 842 being the most impactful among other recent changes to U.S. GAAP, unanimity of effort toward implementation is expected. What’s more, 60 percent of companies are reporting that they’re engaging with their external audit firms in implementing new accounting standards underscores the impact of the recent changes. As part of her organization’s ASC 606 adoption, Christine Russell, CFO at PDF Solutions, and her team employed an accountancy firm to assist with the transition, which included writing white papers to justify changing their revenue recognition method.

In our conversations with members on the topic of audit fees, they articulated that changing accounting standards impact finance teams in a big way. One FEI member commented, “Every time there’s a new standard, it increases the amount of work we have to do and the audit fee. You have new controls and, particularly in the first year, the auditors have to dig in and make sure we implement them correctly. Even if it’s all done very, very efficiently, it obviously has an incremental cost.”

Beyond the cost of implementing new standards, Dr. Knechel explains their impact on audit fees, saying, “These [changes] raise some tricky questions and the reality is that not everybody knows how to implement the new standards, so there is a learning curve. This learning curve suggests less efficient audits – i.e. higher fees. Audit fees potentially increase during the period of transition, but they don’t stay higher.”

In order to lessen the potential disruption from changes to U.S. GAAP, Ana Bowman, Controller at Omeros Corporation, and her team “try to proactively identify the accounting standard within the context of their business.” From there, Bowman focuses on quantifying the impact. With that understanding in place, she communicates what they’re dealing with currently and what is coming down the pipeline. After those informal meetings, Bowman’s team formally presents what happened, what they did, and their evidence to their auditor.

How much effort are you putting towards implementation of new accounting standards?

Are you engaging your external audit firm in these efforts?

Substantial Effort

62%

Some Effort

38% 60%

YES

40%

NO

“Every time there’s a new standard, it increases the amount of work we have to do and the audit fee. You have new controls and, particularly in the first year, the auditors have to dig in and make sure we implement them correctly. Even if it’s all done very, very efficiently, it obviously has an incremental cost.”

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PCAOB

If your audit firm was subject to PCAOB oversight review, were these comments shared with you?

Has your auditor requested that you make changes to your controls as a result of PCAOB requirements or inspection feedback?

Has your auditor requested that you make changes to your controls documentation as a result of PCAOB requirements or inspection feedback?

Although the PCAOB’s role is primarily overseeing auditors, its impact on the preparer community continues to be felt with 56 percent of respondents indicating that they have been required to make changes due to PCAOB requirements or inspection feedback and 64 percent having to make changes to their internal controls documentation.

Like all changes, these require significant investment, which could be deployed in furthering other objectives related to the finance function. In interviews on the subject of audits and mitigating audit fees, FEI members indicated that they use these disruptions as opportunities to rethink and improve the quality of their processes. One FEI member speaking anonymously noted, “Every time they [auditor] make us do something because of the PCAOB, we roll our eyes. We don’t like it because we already have other stuff going on. We discuss the materiality of certain things, if we can ignore other things that are immaterial. We have those conversations, but I think that a lot of the PCAOB things make a lot of sense, if you don’t take them too far.”

Our conversation with senior-level financial executives revealed a pragmatic approach to managing the impact of PCAOB requirements or inspection feedback, on which one FEI member noted, “We’ve done a pretty good job of negotiating with our auditors. We say, ‘Okay. We get that you have to do something. We’re on board to do some things, but we’re not sure that what we have in mind is as big as you think it needs to be.’ Generally, auditors are going to take a very conservative position, until you make it easy for them not to do that. It’s something that a lot of companies don’t do.”

70%

YES

56%

YES

64%

YES

30%

NO

44%

NO

36%

NO

The PCAOB’s Impact:

FERF Survey

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INTERNAL AUDIT, SOX 404 & Internal Controls Internal Audit

On bringing internal and external auditors together, Jason Valmore, VP of Corporate Internal Audit at Johnson & Johnson, noted, “A lot of it, I think, is around setting up a regular communication rhythm to discuss sharing risk, the cost-benefit of formal reliance versus informal reliance, opportunities to leverage work, and walking through phases of our audit for entities that are in our external auditor’s scope to coordinate those efforts so that they begin when the external auditor is available.”

Does your internal audit function provide direct assistance to your external auditors?

How is your internal audit function performed?

To what extent does your external auditor rely on internal audit’s work?

If your company has increased investment in internal audit, has that reduced external audit costs?

SEPARATE DEPARTMENT

60%

SOME RELIANCE

60%

SUBSTANTIAL RELIANCE

21%

NONE

19%

NO INTERNAL AUDIT

FUNCTION

6%

OUTSOURCED RESOURCES

13%

MIX OF INTERNAL AND OUTSOURCED

RESOURCES

21%

30%

68%

YES

63%

YES

32%

NO

37%

NO

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SOX 404

Has your company experienced an increase or a decrease in its cost of compliance with Sarbanes-Oxley Section 404 within the past three years?

Top 4 Reasons Why SOX 404 Compliance Has Increased Over the Last Three Years 1. PCAOB INSPECTION FINDINGS/RELATED ISSUES 2. IMPLEMENTED A NEW IT SYSTEM 3. ORGANIZATIONAL GROWTH 4. REGULATORY REQUIREMENTS

Jason Valmore on Modernizing SOX Compliance at Johnson & Johnson “At Johnson & Johnson, we are investing in an initiative to modernize the way we think about Sarbanes-Oxley compliance. It’s been many years since we’ve really taken a topside view on that, and so through a number of different work streams, such as audit scoping, audit risk assessment, testing automation governance, standardizing the internal control framework, we’re optimizing what we call our ‘continuous control review process.”

“The goal has three ends:

1. become more efficient in executing the certifications we need to do at the end of the year;

2. maintain a strong internal control environment; and

3. free up organizational capacity within internal audit to spend more of our time focusing on strategic, operating, and compliance risks – as opposed to just internal control over financial reporting.”

DECREASE

7%

INCREASE

39%NO CHANGE

54%

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Who Performs Your SOX 404 Testing?

INTERNAL AUDIT

42%

FINANCE/ CONTROLLERS

RESOURCES

27%

OUTSOURCED

22%

MANAGEMENT

9%

Christine Russell, CFO at PDF Solutions, on Working with Outsourced Internal Audit

“We are not the type of company that can afford to maintain an internal audit department. Instead we are using a firm for our SOX 404 testing. It’s wonderful, you only have their services as needed. They provide the test results to the auditors, who can choose if they wish to rely on the results. The auditors don’t care whether it’s a third party or your own internal group, they have to determine to what extent they are going to rely on the tests.

“One cautionary note I would give to other CFOs, it is very important to monitor your SOX 404 consultants and how well they are working with the audit firm. If you get a mismatch, the audit firm can’t get information from your consultants in a timely manner.”

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Do you expect these efforts to help reduce audit fees?

In commenting on the impact of the robustness of internal controls on audit fees, Dr. Knechel notes, “A well-run organization with good controls and no warning signs going off suggests a slightly easier audit, because it’s a less risky audit; however, a company that has poor internal controls, has ineffective management, that has badly designed processes – these are harder to audit because there are so many things that could go wrong. That increase in risk without adequate internal controls suggests that the auditor’s job is going to be harder and require more work, more money, and more time. So, over the last five years (actually going back longer than that) I think internal controls across the board have gotten better.”

INTERNAL CONTROLS

To what extent are you working to improve your controls environment?

PUBLIC

PRIVATE

NONPROFIT

■ Some Effort ■ Not Much Activity ■ Not a Current Focus

Greg Heinlein, CFO at SeaWolf Water, Gives the Private Company Perspective on Internal Controls

“We’re a private company, and we’re not fully tested on internal controls. It’s a practice we follow, but it’s not foolproof because of our small size. My controller and I worked at public companies, so we’re trying to apply the best practices without overkill.”

PUBLIC

PRIVATE

NONPROFIT

■ Expected Reductions ■ Not Much Or No Impact

38%

89%

12%

66%

12%

80%

62%

4% 6%

88%

17%

12%

18%

88%

7%

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Many respondents have noted that while they are working to improve their internal control environment (89 percent of public companies, 66 percent of private companies, and 80 percent of nonprofits), they do not expect these efforts to reduce audit fees (38 percent public companies, 12 percent for both private companies and nonprofits). This is likely due to the fact that companies have already done so much to improve their control environment. Thus, any subsequent improvements are unlikely to materially reduce the amount of work involved in a given audit.

The increased disassociation between improving a company’s internal control environment and reduced audit fees among financial executives at private and nonprofit organizations (both 88 percent) relative to their counterparts at public organizations (62 percent) is explainable by the increased frequency with which private and nonprofit organizations are audited under fixed-fee arrangements, where more efficient audits do not become less expensive. For these organizations, negotiating for reduced audit fees attains increased importance.

In conversations with senior-level financial executives on the topic of the relationship between internal controls and audit fees, one consistent theme emerged: many improvements aren’t made with the intent of decreasing audit fees; one FEI member speaks to this, asking, “Are they [organizations] aligning them [internal control improvements] to save audit fees, or are they attacking the control improvements for a different reason?” He continues, “If you are attacking control improvements for a different reason, you may or may not get the reduction in audit hours. Then there’s the bigger issue where management might not make a great case to say, ‘Okay, last year, you told me that you spent this much time on the audit because of these issues. Now, we’ll fix these issues. Show me that you’re taking that time back out of the audit.’ If you don’t do both sides of the equation, you’re probably not going to get the savings.”

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SECTION 3: MITIGATION STRATEGIESMost Frequently Used Audit Fee Mitigation Strategies

All Public Private Nonprofit

Responses 47 121 41

Reviewed our current audit focus areas to identify areas for improvement 45% 33% 15%

Improved our internal controls 28% 33% 27%

Centralized our audit footprint 36% 8% 2%

Increased automation 28% 24% 22%

Increased staff's audit skillset 9% 23% 29%

Increased our audit preparedness 40% 62% 54%

Reviewed our audit hours and fees, and negotiated with auditors 68% 40% 24%

Reviewed Audit Hours and Fees then negotiated with auditors

In the world of fixed-fee arrangements, commonly favored among nonprofit and some private organizations, many financial executives feel that the time to negotiate is before the contract is signed. Rich Adelman at Trilogy, Inc. (a nonprofit) comments, “I don’t know that you get to negotiate a lot on pricing, but if there’s ever a point where you do, it’s before you’ve signed. It’s definitely not going to be as effective later on. If we want to control audit fees going forward, we have to have an active discussion with the auditors about who’s doing what portion of the work and if we’re offloading too much. If we do more of the prep work and give them what they’ve asked for, their review process goes more smoothly, so it can reduce the time and – therefore – the audit fees.”

Dr. Robert Knechel on the Auditor’s Side of the EquationThe audit firm is trying to staff its people, right? Because they’ve got multiple engagements going on simultaneously. So, they must ensure that each engagement gets covered by people when they’re actually needed; this leads to an interesting scheduling problem from the accounting firm’s point of view. When you’re post year-end, things get even more hectic for accounting firms, because they have numerous, simultaneous audits for a given office – with personnel assigned to multiple engagements who are trying to be in more places than possible. Thus, scheduling becomes really critical, and I suspect that a lot of it has something to do with when the client wants an auditor around and what the client’s own filing deadlines are. Sometimes clients want to put out earnings releases before the end of the, you know, before the filing date, so that accelerates things even more.”

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Among larger companies, fixed-fee arrangements are significantly less common, therefore financial executives at these firms feel that they have greater leverage at the negotiating table and enhanced ability to control their destiny. In his experience going to the negotiating table, one FEI member advises that “You have to make it fact-based. We look at audit fee surveys and benchmark. We come to the audit firm with the view of what we think our fees should be in comparison to our peers.” In addition to benchmarking, one senior-level financial executive notes that you have to be willing to help facilitate the audit, expressing “You go to them, saying, ‘Here’s why we need this audit fee to be lower. We are willing to help.’ We turn it around to the audit firm by saying, ‘How can we help you be more efficient?’”

In looking for ways to make the audit more efficient, Bowman notes that financial executives need to keep a close eye on the audit approach, commenting, “It starts with keeping a close eye on the audit approach. What are they doing? Why? You have to be informed.” Through understanding the approach, financial executives are better able to make the negotiation based on comparatives. She notes that this is important when meeting at various stages of the audit, when it’s important to discuss the original budget and discuss variances based on their cause. At this point Bowman advises financial executives to ask the auditors to justify their hours, where they will explain ‘we did this, and it caused ‘x’ number of additional hours.” Then Bowman asks the auditors to highlight things that they can control (firm initiated) and can’t control (PCAOB initiated). She explains, “We are a little more aggressive with the firm-related items. Tracking the audit process with an emphasis on the way that your hours are going to be different because of mandates versus your own firm’s way of doing things is a big aspect of the audit.”

Pre-Mortem and Post-Mortem

Looking at the coming years’ audit focus, enables a finance team to conduct an audit post-mortem, which enables them to anticipate potential audit inefficiencies. Russell at PDF Solutions discusses this process, relaying, “It’s very important to be very candid at the start with your audit kick-off meeting. You need to share the financial results with any accompanying explanations with the auditors, so they have a high-level view of what they’re looking at. Then you need to provide explanations of anything that’s a little bit different from normal. We also ask the auditors to include a timeline, so that we can adhere to their timeline and that’s the way we start everything.” After starting off on the right path, Russell notes the need for a member of the finance team to monitor the timeline to ensure that everything is happening in good time and that PBCs [prepared by the client] are being delivered to the auditor and that the auditors are delivering what they need to the company.

Observation on Using an Audit Post-Mortem from an FEI Member The two things you’ve really got to think about are did we manage the process properly and did we get information requested in time? The big frustration generally is around fire drills that didn’t need to be fire drills. So, you start asking questions like, “Why are you asking me this in January, when I gave you the information in July?” That’s probably our biggest complaint, and we tell them, “That was a great question in July when we gave you the information. I don’t really think I’m going to answer that for you in January, because you should’ve managed it better.”

Then, we try to look at ourselves and say, “What could we have done better?” A lot of that falls again into two buckets. How did we perform the audit? Did we do our things in good time? Then we look back and ask, “Where are we at from a control perspective?” Year after year, is our control environment deteriorating? Is it getting better? Is it sort of steady state? Are there areas where we have concentrations of greater levels of deficiencies or even just challenges getting through the audit? And then, what should we do about that?

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Looking back on the audit enables financial executives to find areas to improve efficiency moving forward. When evaluating a recently finished audit, one FEI member advises asking two critical, reflective questions:

1. Did we manage the process correctly?

2. Did we get information requested in a timely manner?

These questions enable financial executives to promote accountability for shortcomings related to the audit and open up dialogue related to how they will avoid these shortcomings moving forward. Bowman at Omeros Corporation performs a similar post-mortem, which she uses to inform a training between her team and the auditors. This training enables her team to discuss why certain items were requested, when they felt like they weren’t the most applicable; they can expand this conversation to determine whether they could have asked for something better or different.

Preparing

That comparatively few public companies (40 percent of 47 respondents) view increasing audit preparedness as a fee mitigation strategy relative to private (62 percent of 121 respondents) and nonprofit (54 percent of 41 respondents) organizations is indicative of the fact that public companies have already invested heavily in preparing for audits, thus any incremental preparation is subject to significant diminishing returns.

As private and nonprofit organizations typically expend fewer resources preparing for audits, this is viewed as a viable option for mitigating future audit fee increases. To this end, Heinlein advises these organizations – although small – to act like public companies as much as possible. In similar vein, Winston Asai, Chief Financial Officer at Columbia Machine, Inc., instructs his team to do all the audit schedules they can ahead of time before the auditors are on-site.

Taking a longer-term view of audit preparation can lead to system and process improvements optimized to lead to more efficient audits. Heinlein discusses this, saying, “A lot of times, audits are around documentation and supporting documentation.” He notes that understanding this has helped his team be “very disciplined in our implementation of our ERP, in that we attach anything and everything associated with a transaction, a vendor setup, or a customer setup. When we do a transaction - whether an invoice or a vendor invoice coming in – we post all of that as an attachment to its vendor record. So, anytime that an auditor asks a question about a vendor, customer, or transaction – we have all the supporting documentation readily available. It’s all tied together and that makes the audit so much easier.”

Emerging Tech: A Year Away from Being a Year Away

Although relatively few (28 percent of public, 24 percent of private and 22 percent of nonprofit) organizations view increased automation as a viable tool for mitigating audit fees, the proportion of companies increased by 5 percent among public companies and 8 percent among private companies in comparison to the 2018 Audit Fee Benchmarking Survey Report. This trend indicates that many organizations are still waiting for emerging technologies to catch up with the hype. As these emerging technologies are increasingly adopted, the proportion of organizations viewing their adoption as a means to mitigating audit fees is likely to increase.

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SECTION 4: WHAT’S ON THEIR MINDIt Takes Two

In discussions with financial executives, a number of interviewees commented on the importance of fit. Christine Russell, CFO at PDF Solutions, describes her company’s journey from a good fit to the perfect fit, saying, “We recently made the decision to move on from our Big 4 auditor. They were wonderful, but we were at the very low end for them. They were nice and continued to audit us, but I felt that there was a mismatch. They have such a tremendous amount of overhead to pay for, and they have to pass that along to the client. We determined that we could find a better fit with a mid-size firm or regional firm. The firm we ended up choosing was very cognizant of our business and accounting methodologies – we were able to get the top partner at the new firm. Throughout the process, our Big 4 auditor was very cooperative and – frankly – they got to deploy their partners and staff to larger companies.” In looking for a suitable match, Russell notes that financial executives need to look at “how they [auditor] fit with regard to industry, your company size, geographic location, or any other characteristics relevant to your company.”

Diminishing Disruption

In interviews with senior-level financial executives, one consistent theme emerged: beyond fees, financial teams want less disruption from financial audits. Audits exist to solve the principal-agent informational asymmetry problem – in that a firm’s owners or creditors (principal) are unable to monitor management’s (agent) stewardship over an organization’s day-to-day operations. To ameliorate this asymmetry, an independent third party is brought in to provide assurance that management’s (agent) reports of stewardship (financial statements) are fairly represented in all material aspects.

Unfortunately, the third party is similarly beset by this informational asymmetry. Dr. Knechel comments on the impact of this knowledge disparity, saying, “A CFO sitting at the top of their own job sees everything (at least in theory) going on in the company and they have formed their own opinion as to what’s necessary. The auditor’s perspective is more limited; they come in without all of that advance information, and they have to form their own independent opinion.”

On Resolving Disagreements“Resolving disagreements requires a mutual understanding of where each side is coming from and as much accurate information as possible. The thing about financial statements is that most numbers are estimates. Most of the key numbers are estimates, and they’re based on the future. Whether you’re talking about valuing assets, or whether it be tier three assets or things like bad debts, or warranty or pension liabilities, these things all involve future estimates. Nobody has the right answer because no one has the crystal ball,” says Dr. Robert Knechel.

He continues, “I think there’s one thing that’s very important for the CFO to monitor closely – if a dialogue with the auditors is progressing towards possibly becoming a formal disagreement; because, if you have a formal disagreement with auditors, that is a reportable topic. For instance, if I said, ‘We think our revenue recognition should be $10,000,000 for this customer and here’s our reasoning, ’the auditors might look at it and say ‘No, we think it should be zero and here’s our reasoning.’ You can end up in a standoff if you don’t learn how to manage the dialogue properly. The auditors aren’t going to tell you how to book your numbers – that’s management’s decision – but they will report to the SEC if they have a formal disagreement with how management has booked the numbers. You never want to get in that position. You certainly can have a very robust dialogue, you can document everything that you believe is correct that supports your point of view, but at a certain point you need to have the discussion with your audit committee and probably back down from your position.”

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In order to bridge the knowledge gap, Dr. Knechel notes that “Audits require a high degree of interaction between audit and client personnel,” i.e. Disruption.

A number of FEI members expressed the imperative for auditors and preparers to come together and clarify expectations, noting “It feels like they don’t really know what they’re looking for, and they figure the more stuff they can throw in the workpapers, the less likely they are to be challenged. I want them to tell me exactly what they want and give us sufficient time to collect the information.” In addition to clarifying expectations, Dr. Knechel notes that companies and their auditors need to make efficient use of the calendar, saying “You must make sure that everybody is on the same page regarding when all this is going to happen. Obviously, there are filing deadlines that are going to influence some things, particularly towards the end of the year. As far as the preliminary work goes, which could be done six months before the end of the year, there’s a fair amount of flexibility.” In better cooperating with a company’s auditor, a financial executive can allay the burden placed on their team through scheduling preliminary work when teams are traditionally less busy.

Capitalizing on Continuity

Helping auditors understand a preparer’s business processes, accounting policies, and internal controls requires a substantial investment of time. Over the years, this investment is decreased as the audit firm’s professionals move along the learning curve. However, the turnover among auditors does limit the benefits of experience from prior years. As long as senior members of the engagement team and the preparer’s staff remain in place, the transferability of knowledge from year to year is maintained, along with communication channels.

Adelman discusses the difficulty which can arise from turnover on the preparer side, saying, “My predecessor was here just shy of two years before exiting. That instability at the senior level on the finance team caused uncertainty among the audit firm regarding to whom they were supposed to communicate issues. That caused them to retreat a little bit. Some things, they only shared with the CFO, who ended up leaving. The board felt left out of the dialogue. In my time here, we’ve tried to improve and say, ‘This is an open book, the board needs to know what I know, and I’m not the last step in your conversation.’ It reinforced what they knew all along but maybe lost sight of momentarily.”

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Interviewees

Jason Valmore – VP Corporate Internal Audit at Johnson & Johnson

Christine Russell – Chief Financial Officer at PDF Solutions, Inc.

Winston Asai - Chief Financial Officer at Columbia Machine, Inc.

Ana Bowman – Controller at Omeros Corporation

Greg Heinlein – Chief Financial Officer at Seawolf Water

Rich Adelman – Chief Financial Officer at Trilogy, Inc.

Dr. Robert Knechel, the Frederick E. Fisher Eminent Scholar in Accounting and Director of the International Accounting and Auditing Center

One general auditor at a large financial services organization speaking anonymously

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FERF SUPPORTERSThe Financial Education & Research Foundation (FERF) gratefully acknowledges the following companies for their support and generosity.

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Dillon Papenfuss is a research analyst at Financial Executives International. In addition to research, he writes for FEI Daily (FEI’s daily newsletter covering financial, business, and management news, trends, and strategies) and FEI Forward (FEI’s Sunday newsletter providing the ideas and information financial executives need to consider for the week ahead).

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