The appropriate cost of an audit

With increasing price pressure on SMSF audits,  Jo Heighway examines the role of cost versus value for this critical service.

The question of how much an SMSF audit should cost has become a hot topic as competition among auditors looking to build large-scale specialist audit firms heats up.

Audit fee pressures have never been greater, to the point I’m sure many auditors feel like they are involved in a limbo contest accompanied by the chant: “How low can you go?”

However, I am also seeing a change of attitude, where more professionals are realising it’s not just all about finding the cheapest deal. At some point cheap is just too cheap.

Spending $200 on an SMSF audit is highly likely a waste of $200. If what you are paying for isn’t worth the paper it’s written on, the price you paid for it will always feel too high.

For auditors, the greatest challenge we have today is demonstrating our value. If we fail to demonstrate value, it won’t matter how low audit fees go as we will simply become redundant.

Don’t worry, it’s not all doom and gloom. Once an auditor demonstrates their value, audit price fast becomes a non-issue and the reward is loyalty and a long-term client.

Do audit fee levels reflect the level of audit quality?

The audit fee is not of itself a true enough indicator to make a judgment as to audit quality. It is one indicator, and an important one, but it is impossible to judge quality on price alone.

Poor audits can be found at all price levels, high and low. It’s equally true high-quality audits can be found at all price levels.

The reason for this is simple. It is not even close to reality to assume each SMSF auditor in the market has the same running costs. There are auditors working internally in accounting firms, externally in specialist firms, part-time, full-time, from home, from skyscrapers, online, in person, in Australia and overseas, as sole practitioners, within large audit teams, who use technology well, use technology poorly and auditors who use no technology at all.

A simple fee comparison between two auditors is rarely a fair comparison of audit quality. The biggest concern should be that auditors properly price their work for longevity in the industry.

The auditors who don’t properly understand their own individual cost structure simply won’t survive, whereas an auditor who can explain their fee structure and business model clearly and confidently, and has a strong track record in the industry, is likely to be a great choice.

The negative perception of audit value

Almost without exception, when I am quoted in articles online in relation to the future of SMSF audit in Australia, the response will be comments like these:

“Just what information does the trustee want or need that the auditor provides?”

“Seriously, most audit contraventions are resolved by the accountant before the auditor identifies the issue.”

“For the vast majority of SMSFs audit is irrelevant. You are correctly seen as a ‘low-value statutory requirement’ because for the vast majority that is what you are – an expense imposed that may or may not be needed, but have to have. How you do it is irrelevant, so long as it is cheap.”

I don’t believe for a second this is a majority-held view. The SMSF audit profession has consistently received significant support from the regulators, professional bodies and the majority of SMSF specialists who view auditors as vital to the integrity of the SMSF system.

But in the face of pressure to reduce the costs of running an SMSF, it is more important than ever auditors ensure they remain relevant, provide value for money and continue educating non-auditors on what it is they actually do.

Many of the objections to audit fees arise due to the following negative experiences and stereotypes:

• all the auditor does is a quick tick and flick (checklist focus),
• the auditor’s file looks the same as the accounting file with a checklist stuck in it,
• the auditor doesn’t have any contact with the trustees, ever,
• the auditor has never issued an auditor contravention report (ACR), qualified audit report or even management letter,
• the accountant has to educate the auditor, who isn’t experienced enough,
• the auditor reports breaches that aren’t breaches, and/or misses actual breaches, and
• the auditor doesn’t understand technology and insists on paper and inefficient processes.

These all equate to the same complaint – these auditors are not providing value for money.

Independence

Without auditor independence there is no audit value.

I repeat: without auditor independence there is no audit value.

This can be a touchy topic for many as there are definitely challenges in objectively assessing audit independence when you are a business owner facing so many commercial pressures to survive. Independence is subjective and self-assessed and I’ve never met anyone who likes being told they aren’t allowed to do something.

However, the very nature of auditing means that, without independence, an audit is a waste of time and money.

What the trustees are paying for is an independent opinion. If that is not what they are getting, there is no point to the exercise.

Quality matters

It has long been recognised asset allocation, not security selection, is the key driver of long-term investment results. One of the most powerful insights of modern portfolio theory is the finding that allocating capital across risky assets can actually reduce overall portfolio risk, due to the benefits of diversification.

A good-quality audit will provide trustees with value for money where:

• the auditor is completely independent,
• the auditor conducts their audit using a high level of professional judgment combined with good audit technology,
• the audit approach is customised for the specific risks relevant to that fund,
• the audit report is accurate and reports all relevant issues,
• the audit is completed as soon as possible after year end,
• the auditor provides a detailed management letter that not only notifies the trustees of their findings, but contains recommendations for any rectification action that is necessary,
• the trustees are provided with the opportunity to undertake an online education program on becoming a first-time trustee or prior to lodgment of any ACR with the ATO, and
• the trustees have the ability to contact the auditor at any time.

Auditors add significant value to the SMSF system

The reality is that breaches and errors happen regularly.

In real life, people make honest mistakes and also poor decisions. Not all trustees belong in an SMSF. Not all trustees use advisers and not all trustees follow the advice they receive.

Not all advisers are SMSF experts. Not all advisers do the right thing. Not all accountants prepare perfect accounts.

Trustees benefit from our compulsory annual reporting whether they realise it or not. An independent audit report provides significant comfort to an SMSF trustee that should anything go wrong, should any advice they receive be wrong or even illegal, they will be the first to know about it.

In addition, auditors regularly save SMSFs money by identifying accounting and disclosure errors that have slipped through the cracks during fund administration.

Auditors are regularly the first point of call for accountants and financial advisers when something goes wrong or something big is about to happen. They provide a safety net to ensure nothing is missed as well as an experienced hand to ensure breaches are reported and rectified as painlessly as possible. A good auditor enhances a professional’s business brand.

The naysayers online seem to have come to the conclusion the ATO has all the information it needs to audit every fund itself thanks to the annual return.

To those people I would point out:

• being audited by the ATO is a very different experience to being audited by an SMSF auditor who works for the trustees as their client,,
• the average SMSF audit takes two to three hours to complete,
• the SMSF annual return contains very little information for forming an audit opinion,
• there are few ATO personnel with the qualifications and experience of an Australian Securities and Investments Commission-registered SMSF auditor, and
• auditors enable trustees to be fully informed of breaches before the ATO, giving them a huge head start.

In a keynote address in September last year, former ATO assistant deputy commissioner of superannuation Stuart Forsyth said: “We decided that the high-value intelligence we were obtaining from auditors needed to be treated with more priority. We therefore simplified our program and put ACRs at the centre.”

The ATO’s shift to focus more heavily on ACRs resulted in significant improvements in the targeting of ATO education and audit activity. It also reduced the tax office’s reaction time from up to 18 months to within eight weeks. Thanks to the auditors, the ATO was able to complete:

• 4500 finalised letters for low-risk-rated SMSFs,
• 1800 outbound calls for medium-risk-rated SMSFs, and
• 1800 comprehensive audits for high-risk-rated SMSFs.

SMSFs now represent a significant share of the retirement savings in this country. The fact SMSFs are audited annually gives our community confidence the tax benefits SMSFs enjoy today are fair and will benefit us all in the future.

Without annual independent audits, the integrity of SMSFs will be lost and without integrity there is no doubt many of the great features of SMSFs will be taken away for good.

The future of SMSF audit fees

Auditors have clearly identified the need to ensure they deliver exactly what the industry wants at a price that does not negatively impact on the ability of SMSF members to save for their retirement. There are a number of specialist SMSF audit businesses that are taking action to deliver future audit fee reductions by:

• investments in technology that integrate with administration technology to reduce rekeying/data entry and non-value-add audit steps,
• hiring remote workers such as highly skilled auditors who work from home (in Australia and overseas),
• educating accountants on producing a better quality pre-audit file,
• increasing the scale of business operations, including lower margins with much higher revenues,
• using data analytics tools to automate audit testing, and
• shifting audit techniques to ensure the audits take into account the changing technology at the investment and administration level.ration level.

With increasing consolidation in the SMSF administration space, and the ever-increasing number of SMSFs being established, larger-scale audit engagements are becoming commonplace. A smaller number of auditors doing a larger number of audits will deliver much improved economies of scale to the benefit of the entire SMSF industry. In the near future it is highly likely SMSF auditors will move away from a fee per fund model.  With increasing scale, fee per fund becomes less relevant and auditors are more likely to engage their clients on a value-priced retainer basis. This represents a fundamental shift in the way audit fee arrangements are currently structured, but is a vital component of the future of SMSF audit as it delivers:

•  regular cash flow for both the adviser and the auditor that is consistent with the actual timing of audit activity,
• a reduced focus on the fee per fund comparative rate that currently encourages shopping around and a race to the bottom on fees,
• a greater nexus between audit value and pricing,
• security and stability in the SMSF audit sector, with specialised businesses being able to demonstrate legitimate goodwill,
• the ability for administrators to ensure a fairer distribution of audit fees between simpler and more complex SMSFs – simple funds should pay less and more complicated funds pay more.