Part 3: How public sector audit fees are set
What are the legal requirements for setting audit fees in the public sector?
The Act gives the Auditor-General (or the Auditor-General’s appointed auditors) power to charge audit fees to public entities. Section 42 of the Act requires that the fees must be reasonable, given:
- the nature and extent of the services provided;
- the requirements of auditing standards published by the Auditor-General;
- the necessary qualifications and experience of the people who provide the services; and
- any other matters that the Auditor-General thinks fit.
What is the process for setting public sector audit fees?
The first step in setting audit fees is that the Auditor-General’s appointed auditor prepares a draft audit fee proposal for negotiation with the public entity. This fee proposal usually covers three years of audits. In certain circumstances (for example, when a public entity is new or being disestablished), it may cover only one or two years.
The OAG reviews each draft fee proposal before the appointed auditor presents it to the public entity. The OAG also provides feedback to the appointed auditor about the reasonableness of the proposed fees.
In practice, most audit fees are then agreed by negotiation between each public entity and the appointed auditor. Most negotiations reach a successful conclusion without intervention by the OAG.
Whenever the appointed auditor and the public entity fail to agree on fees, the Auditor-General encourages the involvement of other parties in the negotiations. Either party is free to invite:
- a senior manager, such as a managing partner, from the audit service provider to review the proposal;
- a peer of the appointed auditor (such as another senior person in the audit service provider) to review the proposal;
- a relevant OAG manager to bring additional knowledge to the negotiation;
- the OAG’s Director – Auditor Appointments to compare the proposed fees with those for other public entities and to use other information where appropriate (for example, the number of employees, revenue, and assets, which may help provide an understanding of the relative size and complexity of the audit); and
- the Auditor-General to bring other resources into the negotiation as appropriate.
A negotiated fee is the Auditor-General’s preferred option. In the vast majority of instances, this is achieved.
As a last resort, when the parties cannot agree on a fee, the Auditor-General can set the fee directly. That fee-setting is subject to arbitration if one of the parties requests it. The Auditor-General usually sets the fee only after being satisfied that a negotiated settlement between the parties is not possible.
The Auditor-General has directly set the fee three times in the past 10 years. One of those three cases proceeded to arbitration, with the arbitrator finding that the fee set by the Auditor-General was reasonable. Figure 2 summarises the fees-setting process.
Figure 2
Process for setting public sector audit fees
How are reasonable audit fees determined?
The OAG’s role is to ensure that negotiated fees are fair and reasonable to both parties (that is, fair to the public entity, and provide a fair return to the appointed auditor). There is always some subjectivity in determining a reasonable fee for the audit service provided to a public entity. However, in general, fees for each public entity should be in keeping with the size, complexity, and risks of the audit.
Several factors legitimately affect the cost of the audit, the time required to do it, and the staff mix needed. These factors include:
- the complexity of the public entity;
- the structure and/or scale of operations of the public entity (including any subsidiary entities);
- the nature of issues affecting its operation;
- political, operational, or financial risk associated with the public entity and the sector; and
- whether the public entity is prepared for the audit in all respects.
In general, the OAG expects that audits of similar complexity and with similar risks will require a similar mix of audit staff.
What is the “OAG overhead charge” included in the audit fee?
Parliament expects public entities to fully fund the cost of their annual audits, including related costs incurred by the OAG. Therefore, a levy calculated on the proposed audit hours of each annual audit, known as an “OAG overhead charge” or “OAG contribution”, is added to each audit fee to recover the OAG costs. Those costs cover:
- developing and maintaining auditing standards;
- providing technical support for auditors;
- training auditors on specific public sector issues;
- preparing sector briefs to ensure a consistent approach to annual audits;
- developing and maintaining strategic sector plans; and
- performing quality assurance reviews of all appointed auditors every three years.
Can appointed auditors charge additional fees after a fee proposal has been agreed?
The OAG sometimes allows an auditor to negotiate fees additional to those agreed through the fee-setting process. However, this is only under specific circumstances, after the appointed auditor has satisfactorily explained those circumstances to the OAG and asked for its consent. After that, the appointed auditor can negotiate with the public entity in the same way as during the original fee negotiations.
The specific circumstances vary. They include where:
- the public entity has significantly changed the nature of its activity or operations;
- the public entity has failed to meet agreed deadlines and/or produce financial statements or a statement of service performance of readily auditable quality, and that failure has directly resulted in unavoidable increases in the costs for the appointed auditor above the level of the agreed audit fee for that audit period; and/or
- there are significant changes to the nature of the financial statements, statement of service performance, or other documents that the public entity is required to have audited.
The audit fee proposal states specifically what the appointed auditor expects the public entity to provide for the audit. If these expectations are not met, the appointed auditor may ask the Auditor-General to allow additional fees to be negotiated.
Although the appointed auditor is not expected to start negotiations with the public entity about additional fees until the OAG has authorised them to do so, they should tell the entity as soon as possible when any of the factors listed significantly affect audit efficiency.
What factors have affected audit fees recently?
In recent years, the audit environment has changed significantly, largely because of international factors such as the regulatory response to the major international corporate collapses of the early 2000s and, more recently (since 2005/06), major changes to international accounting and auditing standards. Also, new laws passed in 2011 will require auditors of “issuers” in New Zealand to be licensed, and their firms registered.
In recent years, as audits have become bigger and broader, demand for auditors has grown and audit fees have increased. That has put upward pressure on the audit hours for most audits and on auditor salaries, both of which affect fees. The difficult economic conditions resulting from the 2008 global financial crisis blunted auditor salary increases, but possibly only temporarily.
Today’s difficult economic environment and the resulting government budget deficits have forced public entities to constrain spending. As a result, auditors and public entities must seek to make audits more efficient, where possible.
The OAG monitors fees to ensure that fee negotiations are open and factual, and that improvements and efficiencies are sought regularly. Public entities have an important part to play in that process, and need to fully engage in negotiations.
The auditing environment will keep changing, with much of the change resulting from the desire of regulators to improve the quality of reporting by public entities and the level of assurance provided to stakeholders through audit reports.
What will affect future audit fees?
The Auditor-General expects continuing upward pressure on public sector audit fees. Some factors likely to affect audit fees include:
- greater costs associated with regulating auditors;
- a change in financial reporting standards – a transition to standards based on International Public Sector Accounting Standards (although not as major as the transition to International Financial Reporting Standards);
- likely gradual salary-driven pressure on audit charge-out rates as the global financial crisis subsides and auditors pursue other opportunities in New Zealand and overseas (but the timing and extent of this is not yet clear);
- increased focus on the quality of non-financial performance information; and
- auditors seeking to “right size” audit fees that have not yet been put on to a sustainable footing.
How does the OAG ensure that audit fees are reasonable?
The OAG monitors and moderates fees to assure the Auditor-General that appointed auditors propose reasonable audit fees to public entities. The OAG’s monitoring supplements the processes that audit service providers use to set fees, while recognising the need for negotiation between the appointed auditor and the public entity.
The OAG monitors fees by:
- reviewing historical audit hours for a given audit (hours quoted and actual hours spent) to gauge the historical pattern of over-recoveries or under-recoveries on the audit;
- reviewing proposed audit hours for a given audit compared with audit hours (quoted hours or actual hours) for audits of similar public entities in the same sector;
- comparing aspects such as revenue, number of full-time equivalent staff, and asset value with other audits as appropriate;
- reviewing the proposed audit team mix for a given audit; and
- reviewing the average charge-out rate that the appointed auditor proposes, in the context of the proposed audit team mix.
When monitoring fees, the OAG tries to ensure that:
- fees are based on realistic audit hours (that is, the hours reflect the nature and extent of work required);
- the audit team mix is appropriate, given the nature of the audit and risk profile; and
- charge-out rates are in line with market rates (when compared with the rates of other audit service providers carrying out public sector audits).
Audit New Zealand provides the Auditor-General with an important benchmark in terms of average charge-out rates, because Audit New Zealand does not seek profit. Other audit service providers seek profit.
Each year, an independent reviewer examines how the OAG monitors fees and allocates audits. The Auditor-General’s annual report includes the independent reviewer’s report. The reviewer has consistently concluded that fees have been set objectively and with probity. This gives the Auditor-General significant assurance about those processes.
How can public entities influence the number of audit hours that auditors propose?
The time it takes to conduct an audit significantly affects audit fees.
Appointed auditors determine the size and scope of audits in accordance with the Auditor-General’s auditing standards, with special attention to known areas of risk. The public entity cannot directly affect that by deciding what it wants its auditor to do. But it can:
- engage fully in negotiating fees by:
- ensuring that the audit proposal clearly and fully describes the facts and the reasons for any fee increases; and
- ensuring that negotiations with the appointed auditor are objective, based on facts, and focused.
- control the factors that will affect the amount of audit work required by ensuring that:
- the governance framework and internal controls operate effectively;
- there is a clear reason for the existence of any separate entities within the group, so that compliance costs are minimised;
- the appointed auditor can rely on any relevant work by the public entity’s internal auditor; and
- the appointed auditor and the public entity communicate regularly about issues that could affect the audit, to minimise surprises.
- prepare well for the audit by:
- minimising changes to the pre-agreed arrangements between the appointed auditor and the public entity, giving as much advance notice as possible of unavoidable changes;
- providing the appointed auditor with all the information required to conduct the audit on time;
- ensuring that the annual report (including financial statements and, where relevant, the statement of service performance) is subject to internal quality review before being submitted for audit;
- ensuring that the financial statements and, where relevant, statement of service performance are complete, include all relevant disclosures, and do not need to be changed significantly during the audit; and
- ensuring that staff help the audit team appropriately during the audit.
What are appointed auditors expected to do to ensure that audits are as efficient as possible?
The Auditor-General expects appointed auditors to maximise the efficiency of audits by:
- planning well, managing the audit team well, and carrying out the audit as planned;
- ensuring enough continuity of audit team members between and during audits;
- ensuring that the audit team is well briefed and knowledgeable about the public entity being audited; and
- ensuring that the appointed auditor and the public entity communicate regularly.