Audit Costs Not Affected by Big Four’s Stronghold: GAO

A new report goes against the belief that there should be more competition among the largest accounting firms.

Since the collapse of Arthur Andersen six years ago, large publicly traded companies have felt stuck. They have grumbled about their lack of choices for accounting firms and have partly blamed that for the recent rise of auditing fees.

But they don’t have the support of the U.S. government’s own auditor, the Government Accountability Office. In a recent report, the GAO acknowledges the tight quarters among the Big Four but disputes that it has had an enormous effect on rising audit fee levels.

And anyway, the GAO notes, no one has come forward with a great idea on how to introduce more Big Four-like choices into the marketplace. “Concentration in the audit market for large public companies is likely to continue,” the GAO predicts.

The GAO admits that another exit from the Big Four a la Arthur Andersen could present problems and push costs up even further. Still, the new report attributes recent fee increases to regulatory changes, such as the Sarbanes-Oxley Act, as well as more complex financial transactions and higher demand for accountants, rather than on the auditor oligopoly that currently exists.

For now, the GAO concludes that there is “no compelling need” to interfere with the auditing industry at this time. That may not fare well among the 60 percent of large companies that told the GAO the number of choices is inadequate. Because of their reputation and global, industry-specific, and technical expertise, the Big Four firms are these companies’ only practical options. Indeed, 94 percent of all public companies’ audit fees went to either Deloitte & Touche, Ernst & Young, KPMG, or PricewaterhouseCoopers in 2006.

While the agency’s findings — based on surveys of companies and auditors of all sizes, as well as academics and regulators — don’t present good news for large companies, the opposite is true for smaller-cap businesses. In fact, 75 percent of the smallest public companies — those with annual revenue of less than $100 million — believe their choices in audit firms are sufficient. From 2002 to 2006, the proportion of smallest public companies that used a Big Four auditor fell by half (in the same time period, the proportion of large companies using one of the largest firms hasn’t budged).

And those auditors fulfilling the needs of small and mid-market companies are also satisfied with the state of the industry. More than 70 percent of midsize and smaller accounting firms aren’t trying to grab large companies’ business, according to the GAO.

Since the Big Four have designed their methodologies around the Fortune1000, smaller companies often find a better match with a smaller auditor, says William Hancock, national practice leader of accounting firm Mayer Hoffman McCann, which specializes in mid-market companies. “For smaller and medium-size companies, there are a lot of choices,” he told CFO.com. “We see competition for that business.”

There’s also a widespread belief that the industry could change in the next five years if some of the larger firms outside the Big Four merge or begin offering more technical services.

Advocates for change in auditor competition have proposed mandatory rotations of firms, better disclosures of auditing fees by the accounting firms, or breaking up the Big Four firms. The GAO characterized all these ideas as ineffective.

In recent years, the four so-called second-tier firms have been gaining on the Big Four in terms of revenue and number of SEC registrants as clients. However, there is still a ways to go. For example, KPMG, the fourth largest firm KPMG reported $4.4 billion in revenue last year, nearly four times the revenue posted by the next largest firm, RSM McGladrey.

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