Loss-leader or Client-feeder?

The margins in auditing are not marginal.

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The margins in auditing are not marginal. Public accounting firms may poor-mouth, but “the audit practice is not a loss-leader,” says Lynn Turner, chief accountant of the Securities and Exchange Commission. Not only can the accounting profession balance its books when it comes to auditing, he says, it also must take the blame for perpetuating the myth of auditing as a loss-leader. Turner did not speculate in much depth about the motive for the low-margin myth in his “20th Century Myths” speech at New York University, but one possible motive is that the public accounting firms use the perception to leverage other, higher-margin business from companies. Or, possibly, it serves as an excuse for less-than- stellar work.

When pressed, the accountants are quick to admit that their assurance practices make money. And if there is a negative perception about auditing, it’s not the industry’s fault. Notes Mike Ascolese, a spokesperson for Pricewaterhouse-Coopers: “Our auditing practice is growing at double digits; it’s profitable; it’s not a loss-leader; and it will continue to see increased growth due to such factors as E-business.”

Joseph Berardino, a managing partner and head of Arthur Andersen’s Assurance and Business Advisory Group in North America, concurs. “There’s a myth that auditing is not a profitable [area], and that’s just not correct. Within our firm, we measure the profitability of our four business segments, and Assurance and Business Advisory [which includes auditing] is doing just fine.”

However, a couple of CFOs who have come up through the Big Five accounting world say the myth is actually not far from reality, especially when public accounting firms bid for new business.

The auditing process has become commoditized, observes William Kline, CFO of WildCard Systems Inc., based in Sunrise, Fla. Kline boasted a long career with KPMG, ending as partner in charge of the company’s financial services practice in South Florida before moving to the $10 million producer of electronic stored value cards.

“Companies view the audit as something they will price shop, because they don’t see a lot of difference among them [Big Five accountants],” says Kline. “It’s very hard anymore for the accounting firms to distinguish themselves, one from the other, so companies tend to look at the service based on price.”

Auditing is often used as the entry point, notes Ross Weintraub, CFO of Braintree, Mass.- based Aztec Technology Partners Inc., who also spent many years with KPMG. “There is a lot of margin pressure and competition to get a foot in the door,” he says. “So they can bring in the other services, whether it is tax consulting or strategic planning.”

Accounting firms themselves often slash prices to win contracts, as if their services were blue-light specials. Kline says he is currently looking for an accounting firm to do auditing for his company, and is down to two finalists. “The price competition was incredible,” he recalls, “and both of them came back to me and said, ‘If you get a better deal from the other guy, we will discount the business.'”

E&Y Settlement Adds a Chill

“A good fraud will beat a good audit anytime.” That comment, by Arthur W. Bowman, editor of Atlanta-based Bowman’s Accounting Report, may sum up the quandary Ernst & Young LLP found itself in when Cendant Corp. discovered “irregular accounting practices” at CUC International, a company it acquired in 1998. The ensuing lawsuits resulted in E&Y, CUC’s auditor, agreeing in December to pay $335 million to Cendant shareholders.

This settlement will have a major impact on the auditing profession, predicts Bowman. “It wasn’t just this event, although this settlement brought a lot of current problems to attention,” he says.

It’s not only the threat of litigation that hangs over auditors. The Securities and Exchange Commission continues to put a lot of pressure on the accounting profession to improve its independence, says Bowman. Many auditing clients are also consulting-practice clients, and this involves millions of dollars in fees.

The American Institute of Certified Public Accountants issued new standards, which significantly raised the bar regarding an auditor’s responsibility to detect fraud, notes Arleen Thomas, vice president of Professional Standards & Services at the AICPA.

“We don’t want to react to one or two failures [such as CUC International],” explains Thomas, “which is why we are always evaluating the environment.”

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