BDO chief predicts 25% hike in audit fees by 2022

Audit fees could increase by up to 25% over the next three years as auditors come under regulatory pressure to provide higher quality audit to listed companies, warns Paul Eagland, BDO managing partner. Sara White reports

The warning comes from Paul Eagland, managing partner of mid-tier firm BDO, who predicts a hike in audit fees by 2022, following the imminent, radical overhaul of the audit market. This will result in a tougher regulatory environment, updated auditing standards and increased scrutiny of the audit market. It is also a reflection of the fallout from serious audit failures ranging from BHS to Connaught, HBOS to Carillion, in recent years.

Eagland said: ‘A few years ago firms were all tendering for new audits and reducing prices to win the business. They would not increase prices but they are under pressure to now. Who could possibly think reducing prices could enhance quality? It didn’t make any sense.

‘My prediction is if you roll forward the next three years you will see a very significant increase in audit fees, I would guestimate 25% on average. I just think it is going to happen.’

It is three years since the Audit Regulation & Directive (ARD) was introduced in the UK requiring listed companies to end decades-long audit contracts and put their business out to tender. The immediate impact was low balling on prices by the Big Four audit firms, a situation which could not last. 

At the same time, audit is no longer viewed as a lost leader now that losses cannot be offset by lucrative contracts for consulting, transactional and and advisory work.

The tendency to under-price the audit in year one is reflected in the fee analysis in the annual Accountancy Daily FTSE 350 surveys, which show that the majority of audits increase in price in years two and three.

In its annual results for year end 2019, BDO reported that audit income across the firm, which merged with Moore Stephens in February, was up 25% to £200m [2018: £164.6m] on the previous year, helped by growth in AIM-listed audits and the impact of the merger.

‘Even without the merger impact, underlying [audit] organic growth was 15% and then 10% through the merger,’ Eagland said. ‘We’re expecting 15% growth in the next few years. Part of that is increasing market share, part is price increases in the audit market, and there will be more price increasing.’

BDO has benefited from the changes to the rules on non-audit services (NAS) - the 30% cap on the fees audit firms can charge for tax compliance, consulting and restructuring business, for example, which could cause conflict with the statutory auditor position.

The cap has seen BDO grow its share of non-audit service business from the larger listed companies.

Eagland said: ‘At the upper end, once a large limited entity has appointed a statutory auditor, it is very common that they will not buy other services from that firm, therefore we are on the list for non-audit services, including tax. We probably provide tax and other advisory services to about 40% of the FTSE 350.

‘It is just going to continue to grow for all sorts of reasons. One of the challenges with the limited number of firms in the market is that choice is very limited, which brings you back to the CMA [Competition and Markets Authority] review, then once a Big Four has been appointed then choice is very limited.’

Selective tendering

Despite tendering for an increasing number of audits, Eagland is realistic about the firm’s ability to handle the largest audits. ‘There are 40 businesses within the FTSE 100 where it just would not make sense to tender for those audits.

‘When you drop below the top 40, there are plenty of entities where we do have the capabilities to tender. And there is always a by-product of engaging with those companies as you get to know these organisations.

‘We would apply a number of filters before we moved into a formal tender. We don’t want to pitch for an audit where we always come second. We just want to be open and transparent – there is lots of business out there.

‘There is always the by-product of engaging in that you still get to know these organisations. ‘

Risk is hampering the profession though as the Big Four have tripped up over major listed audits, facing multimillion fines from the audit regulator, the Financial Reporting Council (FRC).

‘All firms in the audit area are completely evaluating the risk/reward of providing statutory audit. The moment there’s a corporate failure, you automatically expect that your last three audits will be forensically reviewed,’ said Eagland.

‘Most people think that living in a capitalist economy is healthy; they accept there will be corporate failures but what they don’t like is the LTIPs, the huge dividend payments and the pension holes.’

Auditors and boards

‘There is an interesting stratification in the audit market; if you just go macro, there are 5.7m registered businesses in the UK and something like 5.5m of these are micro businesses employing less than nine people. This leaves around 200,000 businesses and only 2,500 top public interest entities (PIEs).

There are signs that the relationship between company boards and auditors is changing with a gradual realisation that the audit is not simply a box-ticking exercise.

 ‘I think they [PIEs] have now completely recalibrated their understanding of the need to have a very thorough audit which results in an opinion they can rely on and other stakeholders can rely on, and they know that the quality of their systems and controls is directly correlated to the quality of the audit.

‘In that population you can see a lot of change and businesses are bolstering their financial teams and systems. There is much better management information.

‘When you drop down into the larger privately-owned companies, some of them feel quite squeezed by all of this as their stakeholders are different. Quite often the shareholders are the management themselves; you don’t have the public interest. But with audit standards cascading all the way through business they feel quite concerned, especially if the audit reforms result in even more regulation affecting their part of the market, without thinking through who the stakeholders are and without thinking through the outcome.

‘All stakeholders accept that once they’ve got a public interest, there’s an obligation on all of those stakeholders to have better systems, information, for us all to be much more responsible.’

Audit wins

BDO won three FTSE 250 audit tenders over the last 12 months, including investment manager AJ Bell and car parts retailer Halfords from KPMG, and property company Galliford Try from PwC. This illustrates how FTSE 250 companies are now prepared to look at non-Big Four firms as their auditor at a time of intense scrutiny of the audit market. These three audits alone were worth an estimated £1.1m to the firm based on previous year’s fees.

It also has a long-standing audit contract with mining conglomerate, Randgold Resources, listed on the FTSE 100, worth £750,000 in audit fees in 2018. The firm’s audit strength lies in AIM market, where it is also much more active in terms of audit tenders.

The mid-tier firm has avoided regulatory sanctions, only being linked by default to the £825,000 fine for MSR Partners (formerly Moore Stephens LLP) over a historic Laura Ashley audit investigation which pre-dated the merger with BDO. The FRC fine was handed out in May 2019 and was paid out of a legacy MSR account rather than merged BDO accounts.

By Sara White   

 

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