Audit fees could be going up

CFOs have gotten used to inflation affecting nearly every aspect of business: salaries, supplies, equipment, and more. But one aspect of business seems to have eluded the pull toward higher prices: audits. For now.

So can CFOs expect an audit price increase as inflation catches up? The answer could be yes, in a big way, but not necessarily just because of inflation, which may only drive a portion of the increase, Dennis McGowan, vice president of professional practice and anti-fraud initiatives at the Center for Audit Quality, told CFO Brew.

Instead, proposed PCAOB standards that require auditors to more thoroughly identify clients’ non-compliance with laws and regulations (NOCLAR) will expand the scope and scale of the auditor’s role and “could increase audit costs by more than five times,” McGowan estimates.

“I’m not hearing that a big bill is coming” because of inflation, McGowan said, adding that “a change in scope, new standards, [and] changes in the business” will drive increased audit costs.

Here’s what CFOs need to know concerning both how much audit costs might go up and the underlying reasons why in order to manage costs and ensure compliance.

More work, more money. An annual study of audit fees by the Financial Executives International sponsored by the CAQ showed a YoY bump in audit fees of 2.5% in 2022—a period in which headline inflation was closer to 7%. And instead of inflation-related line items like cost of labor, essentially all of that increased audit cost was attributed to changes in the work required by clients, according to the study. More than half of the change was attributed to an increase in scope, such as a client engaging in an acquisition.

Former SEC general counsel and founding PCAOB board member Dan Goelzer wrote an extensive blog post in which he asserted that the existing standard “only requires auditors to detect and report misstatements resulting from illegal acts that have a direct effect on the determination of financial statement amounts, e.g., violations of laws and regulations that relate to financial statement content and presentation or tax liabilities.”

Changing standards to require reporting on a much wider range of potential illegality or regulatory noncompliance could be significant, Goelzer wrote. Auditors would have to monitor all the ways a company’s actions are potentially intertwined with any laws and regulations, such that noncompliance “could reasonably have a material effect on the financial statements,” according to the PCAOB.

How much could the auditing bill go up as a result? While acknowledging that his 500% estimation is “a back-of-the-envelope calculation,” McGowan noted that the idea of a three-digit percentage increase has recent precedent: “Audit fees doubled when [Sarbanes-Oxley] was implemented.”

Two sides. It’s with the potential for large fee increases in mind that McGowan thinks more study is needed to understand the best approach.

“[Among] the auditors I talk to, I think there’s an acknowledgement that certainly auditors could go further than those things that directly impact the financial statements,” McGowan said. Nonetheless, “I think boiling the ocean to everything [that the broader NOCLAR proposal includes] is just too expansive.”

The PCAOB’s position on NOCLAR is clear; “We have observed and empirical evidence has shown that companies’ noncompliance with laws and regulations may lead to sanctions, fines, and civil settlements, resulting in substantial financial damage to investors, especially when such noncompliance goes undetected for longer periods of time,” the organization wrote in its proposal.

The PCAOB points to an affect on stock prices when violations do surface, as well as a reputational concern for auditors amid the scandals they don’t uncover: “Highly publicized matters have drawn attention to the role of the auditor in detecting violations of laws and regulations, including consumer, environmental, or other laws and regulations.”

Regardless of how much audit fees increase, McGowan notes that the question of who the consumer of these services actually is can define how much fees rise. He said he doesn’t see a lot of interest in expanding audits from within corporate leadership, but outside of that cohort, investors are “ultimately the buyers of all audit services…and I think some of them do have a desire for the auditor to be doing more than they have historically.”

And with CFOs responsible for both acquiring audit services and relaying their findings to boards and investors, keeping in mind where costs will go and the reasons for that shift will help in both areas.