RSM Resources

Audit firm change - will it do your company good?

Accounting scandals in the public-company environment — and audit committee best practices that promote taking “a fresh look” at financial reporting procedures — are having an impact on audit firm turnover. Many organizations, for a variety of reasons, are looking for new CPA firms. 

So, who’s making the switch and why?

According to The CPA Journal article, “An Inside Look at Auditor Changes,” a total of 1,609 public organizations replaced auditors from 2003 to 2004 — up from 905 the previous year (this excludes transition of Arthur Andersen clients). Other findings include:

• Big Four firms had a net loss of 400 audits, while second-tier (middle market) firms had a net gain of 117.
• Big Four firms continued to drop smaller companies from their client lists and ceased auditing a net of 280 companies with less than $100 million in revenue.
• The client-retention rate for Big Four firms went from 64 percent in 2003 to 38 percent in 2004.
• Among organizations that registered auditor change:
• Fifty-five mentioned fee reductions as their motive. Of these companies, 40 percent had revenue under $25 million.
• Two-hundred seven (of 238 with revenue exceeding $100 million) dropped Big Four firms, and 13 dropped second-tier firms. Thirty companies with less than $25 million in revenue restated financial statements in 2004 — more than double the previous year (more than half cited internal control weaknesses).

Internal control concerns
According to some Big Four firms, risk associated with middle market companies is due to lack of effective internal controls. Organizations reporting internal control problems increased by 76 percent from 2003 to 2004. This may be due, in part, to more intense scrutiny of auditors’ opinions, as well as heightened reporting requirements.

Reported internal control problems by revenue segment breaks down as follows:

• Under $25 million: 48 percent reported problems — a 43 percent increase from the prior year.
• Between $25 million and $100 million: 29 percent — nearly twice the number reporting problems the prior year.
• Businesses between $100 million and $500 million: Far fewer reported problems than in the prior year. Larger companies typically have more financial resources to implement and maintain effective internal controls. 

Most internal control weaknesses were related to personnel, including lack of qualified accounting staff, insufficient segregation of duties, and lack of proper training and supervision. Inadequacies in companies’ accounting information systems were also linked to many internal control weaknesses.

Until middle-market companies are able to identify and remediate internal control gaps, they will likely continue to operate with higher levels of risk than larger companies. Therefore, it may be fair to say that the non-Big Four firms take on increased risk with their client base.

Fee reductions
Of the 55 companies that disclosed they changed auditors due to fee reductions:

• 60 percent were previously audited by a Big Four firm
• 16 percent were previously audited by a second-tier firm
• 24 percent were previously audited by a small accounting firm

Of these organizations, 9 percent ended up choosing a Big Four firm, 42 percent a second-tier firm and 45 percent a smaller firm.

Public company investors are being advised monitor audit-fee fluctuations — and watch for fees that simply seem too low — to gauge potential negative impact on quality. The goal should be to get the best price without a sacrifice to audit quality. And in the current an environment, an effective audit is relatively inexpensive.

Additional reasons
Other rationale firms have cited for changing auditors include:

• Proximity of auditor to operations
• Auditor more suited to company size and operations
• Audit partner leaving to join different firm
• Change in company control or management
• CPA firm merger
• Auditor leaving for inability to rely on management
• Independence impaired
• Resource constraints
• Fee discrepancy or cost reductions

What to look for in your next audit firm
Factors to consider when looking for a new CPA firm should include commitment to companies your size, as well as the following:

• Level of experience
• Successful transitions in the past
• Global experience and resources
• Potential disruption to your current internal control and audit procedures
• Is tax and consulting in question?

In choosing to “go out to bid,” it’s important to keep in mind the priorities of your organization, what you want and don’t want, and prospective audit firms’ potential to meet your needs

Janette D. Burke is a managing director with RSM McGladrey. For more information, contact her at janette.burke@rsmi.com.