Are contingent fees allowed for audit engagement?
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In December 2010, a revision was announced to the APB Ethical Standards which took effect from 30 April 2011. Show
One of the revisions was a widening of the circumstances in which tax services cannot be provided by an audit firm to the entities they audit, on a contingent fee basis. The prohibition now extends to circumstances in which the outcome is dependent on an uncertain, or as yet undetermined, tax law interpretation (APB Ethical Standard 5, paragraph 95). The concern in this case is that the audit judgment as to the appropriateness of an accounting treatment might be swayed by the potential effect on the outcome of the tax service. As a number of existing non-audit service contracts with audited entities involved lengthy tax cases with the UK and European authorities, APB agreed to an extended transitional period, provided safeguards were applied: '…services contracted before 31 December 2010 may continue to be provided until the earlier of either:
The Financial Reporting Council press release has confirmed that it does not intend to extend the transitional relief further. Accordingly, any contracts with audited entities which would now be prohibited under ES5, but which continued in line with the transitional relief, will have to be terminated, amended to remove the contingent fee element, or the audit firm will need to take other appropriate action. Given the fact that we have managed to find money that our clients are owed in 95% of the audit assignments undertaken on their behalf, you may be puzzled to know why we don’t work on a contingent fee basis, and even more so when it isn’t uncommon for us to find that our clients are owed in excess of £100k…There are many reasons why we have taken this stance. In this article, I explain in a little more depth why we have taken this seemingly uncommercial position.1. Our status as a firm of Chartered Accountants gives you confidence that we will do a proper jobWe are proud of our status as independent auditors from a chartered accountancy practice. Our supervisory body, The Institute of Chartered Accountants in England and Wales, which also oversees the activities of the Big 4 (PwC, KPMG, E&Y and Deloitte) in the UK, requires us to follow accounting and auditing standards. In the Auditing Practices Board’s Ethical Standard 4, which relates to audits of financial statements in both the private and public sectors, it states that: 10. An audit shall not be undertaken on a contingent fee basis. 11. A contingent fee basis is any arrangement made under which a fee is calculated on a pre-determined basis relating to the outcome or result of a transaction, or other event, or the result of the work performed. A fee that is established by a court or other public authority is not a contingent fee. 12. Contingent fee arrangements in respect of audit engagements create self-interest threats to the auditor’s objectivity and independence that are so significant that they cannot be eliminated or reduced to an acceptable level by the application of any safeguards.
We see our status as an independent firm of Chartered Accountants as an indicator of quality. It means that we are subject to the same professional and ethical standards as the Big 4. What it means for you is that you can rely on us to do a thorough job and report objectively on the facts of what has happened, rather than any opinion or conjecture. Although our contract compliance audits are not subject to exactly the same degree of regulatory oversight as audits of financial statements, we choose to hold ourselves up to the same standard when it comes to contingent fee arrangements. We believe strongly that being remunerated on this basis is simply inappropriate for compliance audits as the “self-interest threats to the auditor’s objectivity and independence are so significant”.
2. Building positive relationships with agencies is essential to our ability to do an excellent job for our clientsBe under no illusion, we always are working for our clients, brand owners, when we are doing an audit. It is important, however, for us to form a strong relationship with the agency based on mutual understanding and respect. After all, it is not uncommon for us to audit high profile agencies every 1-2 years for different clients. The stronger the relationship we have we an agency, the easier it is for us to do our job to time and budget. If the agency believes that an auditor is being remunerated on a contingent fee or share of savings basis, it will place a huge question mark in the agency’s mind about the auditor’s independence. That will be highly damaging to the auditor’s professional relationship with the agency right from the outset. In fact, many agency contracts specifically forbid an auditor to be engaged on a contingent fee basis for this very reason. In addition, it will also destroy trust in the relationship between the brand and the agency that would then, most likely, lead to a big relationship issue for the marketing team to manage. For what might seem at the outset to be a low-cost or attractive ‘buy now, pay later’ option, can you afford to irrevocably damage your important relationships with your agencies?
3. The value we bring is not just about the money side of things
As part of our audit work we speak to the Account Director to understand how the day-to-day business processes (including things like briefing by the client) are actually working. That conversation can highlight efficiency issues on both sides that the client inadvertently ends up paying for in fees (often without realising) that can then be addressed appropriately. As that kind of thing is not directly related to any financial transactions, an auditor being remunerated on a commission basis will choose to overlook it as they will not be paid for anything that is not directly related to a past financial transaction.
We provide a 70-point check of the existing contract, highlighting any gaps in key clauses against a best practice agency contract template. Our clients find that this exercise adds considerable value looking forward into the future, and even more so if the results are applied to their other agency contracts.
4. We set out to provide value to our clients in everything we doWe aim to provide our clients with the same comprehensive audit of their agency irrespective of whether we uncover £10,000 or £1 million in accounting errors. We are able to do this because we have been paid a fee based on an estimate of the actual time it will take to do a thorough, professional job. It is often possible to tell roughly how much money is owed back to the brand within the first 2 days of the on site audit work. Hence, if paid on a contingent fee basis, there is a very strong temptation for the auditor to scale back the work if they believe that the brand will be happy with the results already found and they are happy with the amount of money they’ll be paid for the effort expended to that point (maximum reward for minimum effort is often the name of the game). The same applies equally if the auditor believes that they will be paid nothing, or very little. There is often a commercial necessity to move on to another project with the minimum of effort expended on the current one. Hence, in either scenario, there could be money and/or important issues left untouched (for example process efficiency and contractual completeness as raised under point 3).
5. We want to become a trusted adviser to our clientsWe want to build long-term relationships with our clients and act as their trusted adviser.
From my perspective, being paid on a percentage of savings found is not a long-term business model for contract compliance audit work. If the auditor is doing their job properly and pointing out where all the issues lie the first time around, when it comes to auditing that agency a second time, under the contingent fee model they may decline to undertake the engagement or literally just go in to ‘kick the tyres’ for fear of not being paid anything. As a result, underlying issues that have developed since the last audit could easily be missed. Similarly, if the auditor believes there is an opportunity for repeat work, then they might not declare everything the first time around, so that there will be ‘new’ problems to find during the second audit!
6. A fixed fee results in far fewer surprises for the brand and procurement team
Clients can actually end up paying far more with a contingent fee arrangement than if there was a fixed fee in place. Let’s face it, many procurement teams have small or non-existent budgets to spend engaging third parties to help them manage their contracts. Every procurement professional I’ve ever met knows that contract management is important and yet it’s an area that is, in many organisations, underinvested in. It’s no one’s fault, it’s just the way it is. Working on a ‘share of savings’ basis therefore seems to kill two birds with one stone: it solves the budgetary issue as payment is being made solely on the outcome of the audit and, if successful, everybody wins by taking a pre-agreed slice of the pie. In reality, however, the outcome is often different. From the client’s perspective, if the auditor’s share of the savings uncovered is only a few thousand pounds/euros/dollars more than the fixed fee would have been, then a problem generally doesn’t arise. If it gets to two, three or even more times higher, however, then the procurement team will feel that it is paying over money that actually could be used more usefully to support the brand itself. After all, when we uncover monies owed on an audit, the first thought of the marketing team is the positive impact it can have on the brand (and the company’s P&L) by reinvesting it in additional activity that drives incremental sales. Having been a client myself, albeit seeing it in other procurement categories or accounts payable recovery projects, if a big problem is uncovered and the consultant is being paid a commission based on what is found, when it actually comes to approving the invoice, the brand will absolutely resent paying over a very large amount of money for what is perceived to be relatively little work, no matter the depth of expertise that has been brought to bear. I’ve seen examples of where consultants have agreed a percentage somewhere between 15% and 50% of the findings that turn out to be substantial five or even six figure amounts for a few weeks of work. The client has then tried to renegotiate the deal as the amount appears excessive and months of negotiations ensue before the consultant is actually paid. It turns into a very painful process for both parties and they never work together again. This is completely contradictory to our aim of building long-term relationships with our clients as trusted advisers.
In summary
Carrying out contract compliance audit work on a contingent fee basis poses a threat to the independence and objectivity of an auditor, which means that the findings presented to you may not cover all the key areas or be in the best interests of your brand (because they have been driven by the auditor’s self-interest). Here at Financial Progression, we only work on a fixed fee basis, thus enabling us to deliver thorough and comprehensive compliance audits of your agency contracts time after time. Can you charge a contingent fee for a non audit service to an audit client?The estimation of the effect on the audited financial statements will be assessed on a prudent basis taking account of the relevant circumstances. Any arrangement with the auditor that includes contingent fee arrangements is not permitted.
Are contingent fees allowed by SEC?A contingent fee is viewed by the SEC staff as a direct financial interest that creates an impermissible mutuality of interests between the audit client and the auditor.
Which fees are permitted to be charged to an SEC audit client?Under the SEC rules, which of these fees are permitted to be charged to an SEC audit client? Both are permitted if immaterial Contingent fees are prohibited, and success fees are permitted Success fees are prohibited, and contingent fees.
Are contingency fees legal in the US?United States
Some jurisdictions, however do allow contingent fees in criminal cases. It depends on the attorney, the type of case and the fee agreement. In the United States, contingency fees are the standard in personal injury cases and are less common in other types of litigation.
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