Big Four report cost overruns in over 50% of FTSE 350 audits

The  Big Four firms have revealed they are failing to charge some audit clients for the full cost of the auditing work they carry out, fuelling concerns that they may be using audit work as a ‘loss leader’ on key accounts, according to information provided to the business, energy and industrial strategy (BEIS) committee which suggests there are cost overruns in as many as half of all engagements

The chair of the BEIS committee wrote to the heads of the Big Four, asking for more details of budget overruns with audit clients and entertainment expenditure relating to their FTSE 350 clients, as part of its inquiry into the future of audit.

Deloitte’s analysis of its FTSE 350 audits over the last five years showed that just 20% did not result in an additional payment. Half of audits had overruns of more than 10% of the original budget, and of these 80% resulted in an additional payment (24% receiving payment for the overrun in full and 56% receiving payment in part).

EY provided details for each financial year, which show cost overruns on a quarter of FTSE 350 audits in FY14 (25%) and FY15(26%), increasing to 31% in FY16 and 44% in FY17.  The estimate for FY18 is 32%.

KPMG said it compared the outturn global costs for 483 audits of FTSE 350 companies completed over the last five years. Of these, after excluding the effects of foreign exchange rate changes and scope changes due to changes in circumstances 75 (16%) had costs 10% or more in excess of the amount budgeted.

In its letter, KPMG said cost overruns were more common on newly acquired audits. Of the 21 FTSE 350 trading companies won by the firm over the last three years, on around half of these audits the amount billed in respect of the first year audit included additional fees to reflect costs exceeding budget, though in many cases the level of cost overrun was less than 10%.

PwC cited other reasons for audit budgets being breached, including changes in the scope of work as a consequence of acquisitions or disposals or new accounting guidance, or where the auditor identifies issues requiring further work, or where inefficiencies arise in the audit process.

The firm said analysis of a sample of FTSE 350 audits over the past five years suggested costs were significantly more than budget for 55% of audits in 2013/14, 60% in 2014/15, 55% in 2015/16, 37% in 2016/17, and 43% in 2017/18.  In most cases (between 58% and 83% of the time), PwC recovered the additional costs.

The BEIS committee also asked the Big Four for details of their entertainment spending with audit clients.

Deloitte said its records show that in 2017 an average of £1,352 was spent on hospitality for each FTSE 350 company audited (a total of £120,321), and an average of £1,106 spent in 2018 (a total of £96,179).

Over 2017 and 2018, £120,368 was spent on hospitality involving FTSE 350 companies Deloitte was subsequently appointed as auditor to (an average of £2,561 per company).

EY broke down its figures for each of the preceding five years, with £141,849 spent on 448 events for FTSE 350 clients in FY14; £218,097 on 452 events in FY15; £193,989 on 492 events in FY16; £116,442 on 434 events in FY 17; and £98,213 on 340 event in FY18.

The letter indicates EY’s hospitality spending for non-audit clients who subsequently became audit clients has dropped substantially, down from £158,000 on 575 events in FY14 to £666 on six events last year.

PwC reported spending around £48,000 annually for about 100 FTSE 350 clients, with its spending on non-audit clients who go on to become audit clients also falling sharply, from £73,000 five years ago to £3,000 currently.

KPMG, which also supplied an annual breakdown, said its policy had been tightened in recent years, given the heightened public interest in audits of listed companies. The only entertaining permitted is business dinners or lunches, with the cost of the meal is limited to £60 a head and the cost of wine to £25 a head. Once the firm receives an invitation to tender for an audit, it applies the more restricted entertaining policies that would be applicable if the company were already audited by KPMG.

All the Big Four said their entertainment policies had been updated in response to new ethical standards in 2016. The Financial Reporting Council (FRC) told the committee that since that date, two of the firms have reported a total of 35 breaches (24 and 11 respectively) in relation to gifts and hospitality. Of these breaches, 27 were identified earlier as a result of the annual audit quality reviews, with one firm required to perform additional training in this area and a second asked to revise its policies.

The BEIS committee is expected to release its full report on the future of audit shortly.

Deloitte letter  

EY letter 

KPMG letter 

PwC letter 

FRC letter on hospitality 

Report by Pat Sweet

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