‘Loss-leading’ Big Four claims don’t tell full story

Originally published in The Scotsman 03 June 2019

Andrew Bone, former Big Four chartered accountant and co-founder of tech firm Airts, draws back the curtain on auditors’ controversial budget overruns.

If a company had huge budget overruns, year after year, you would expect their accountants to identify this as a cause for concern. But, what if the firms in question are accountancy firms, and the biggest ones in the country at that – the so-called Big Four?

In recent letters to parliament, gathered as part of a Commons Business, Energy and Industrial Strategy (BEIS) select committee report, the Big Four accountancy firms disclosed that a large proportion of their audit work goes over budget, and has done for many years.

The disclosure that up to 50 per cent of audits go over their original budget was seized upon by industry critics as evidence that audit work was being treated as a “loss-leader” to win more lucrative business and undercut competition from rival firms.

But this would appear to be a specious argument that ignores a multitude of other factors. What is actually at play here is the result of ever-increasing complexities in the operations of an audit practice, and the inherent and growing risks of getting it wrong.

An audit budget is in fact a detailed project plan, including the staff who will perform the audit, the expected hours they will spend completing the work, and the associated fee.

Each audit requires a unique mix of staff with critical skills, qualifications and availability – the latter both in terms of time and geographical location. This plan is usually created around six to 12 months before work is due to start, when many details regarding a client’s accounts or commercial situation are unknown.

In addition, audit work is increasingly delivered internationally, creating a further layer of complexity. Considering these factors, it is little surprise to me that audit budgets often turn out to be inaccurate, despite the substantial effort that the Big Four invest in planning and budgeting processes.

It’s worth noting that when audit firms go through their planning cycles, tens of thousands of budgets are scheduled for the coming year, involving the juggling of thousands of staff.

While planners may be fully competent, the von Moltke adage applies that “no plan survives contact with the enemy”, and no single planner, or even multiple planners, could effectively adapt plans in real-time to meet the needs of a firm’s myriad clients across multiple projects…and stick to original budgets.

The audit fee is an easy target for corporates on a cost cutting drive. Rightly or wrongly, it is often viewed as a commodity service. Inside the Big Four, that pressure frequently translates into pressure on the people creating the budgets to reduce hours and fees. The evidence shows that those budgets are often excessively ambitious, and rely on “best case” assumptions rather than the reality of dynamic project conditions.

Yet the claim by some industry critics that audits are being deliberately run as “loss leaders” fails to take into account the significant difference between costs (the true cost of the salaries, offices, equipment, and so forth) and budgets (the amount being charged to the client based on hourly billing rates).

Crucially, budgets already include a profit margin, so the evidence of overrunning budgets merely indicates lower profitability, and there is little evidence of losses in the Big Four’s own financial results.

Budget overruns of course have a financial impact, but there is a far more concerning human impact, which is very real and often overlooked.

Without real-time adjustments to plans, and the ability to re-assign staff to meet deadlines on the fly, inevitably auditors themselves bear the brunt of the additional work effort. This puts a strain not only on work/life balance and productivity, but also on the retention of highly qualified staff, and potentially even the quality of audits themselves – impacting the auditing industry as a whole.

– Andrew Bone, a former Big Four chartered accountant, is co-founder and chief executive of Edinburgh-based Airts which has developed Braid, an artificial intelligence powered resource planning and engagement management tool. It aims to help professional services firms maintain profit margins, deliver a first class client service, and improve employee happiness.

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