Print Edition
      April 2012

Unlocking the value, II

By Phil Cowperthwaite
Illustration: Blair Kelly

After you’ve added value to your micro-entity audit clients’ efforts, reap rewards by making the audits more efficient

Consistently making an acceptable return on audits of your micro-entity clients is surprisingly simple. All you need to do is quote a fixed fee that recognizes both your expertise and intellectual capital — then audit as efficiently as possible. It’s not rocket science, but it works.

Problems with the 20th-century pricing model
Some professionals gauge their success by the total hours charged. The more hours charged and billed, the more they are rewarded. But does this classic model of audit pricing really make sense in today’s world of rapid change? This model builds in a bias for inefficiency as it implies that the more hours you work, the more you will be remunerated for your efforts.

The model does not reward you for working smarter — that is, working more efficiently and spending less time to achieve high-quality results. Under the traditional model — a firm estimates the costs of a practice, including partners’ profit and chargeable hours, and calculates a rate per hour for each category of staff to attain the desired goal. Since rates are fixed for a period (i.e., a year), the only way to increase revenue is to increase the hours billed — if you work more efficiently, you will make less money unless you raise your hourly rate. But today’s reality includes advances in technology, helping you to maximize efficiencies and this reality makes the traditional pricing model obsolete.
So how can you leverage today’s advances while maintaining appropriate revenues?

Entering the 21st century and recognizing the value of intellectual capital
Today, the world values intellectual capital far more than it did a generation ago. The information technology sector has blown the lid off traditional pricing models as intellectual capital is worth what people are willing to pay for it.

However, once a product becomes commoditized, pricing is dictated by production costs and the supplier with the lowest price wins the day. But if you offer a service that is not seen as a commodity, then you should be able to maintain your fee regardless of how much time you spend. The key is to add value to your micro-entity audit client’s endeavours (see CAmagazine, March, “Unlocking the value”). Once you’ve accomplished this, you can begin to reap more rewards by making your audits more efficient.

Step 1 — Negotiate a fixed fee up front for micro-entity audits
In many audits, last year’s fee acts as a benchmark for this year’s bill. However, if you are auditing a micro-entity for the first time, you cannot rely on last year’s fee as a guide. Either negotiate a price that is based on your estimate of time and a per-hour rate or use local or industry norms to set your initial price.

By negotiating a set fee in advance, any efficiency introduced will benefit you by giving you more time to increase your client load, invest in making your audits more efficient, or enabling you to work fewer hours without a reduction in revenue. It is a given of course that quality work always come first. A fixed-fee engagement builds in the incentive to invest in audit efficiencies to reduce time spent and increase your bottom line.

Quote a fixed price for an audit. This comes with the proviso that if an unexpected problem occurs requiring significantly more time (a rare occurrence), then either the client will fix the underlying problem or the fee must be renegotiated before doing the unexpected work.

As a result, the client is reassured there is a fixed ceiling for the audit fee, and you have a guaranteed recovery before you start. Any savings generated will accrue to the firm. This does not benefit just the auditor; clients appreciate efficient audits. Inefficient audits are painful for all concerned.

Step 2 — Make audits of micro-entities as efficient as possible
Make your micro-entity audits efficient and earn an excellent return on your intellectual capital with the following strategies:

  • Ensure the engagement is one you want before you start  Whether it is for a new or a long-standing client, ensure that the client fits your firm’s risk profile and management is  able and willing to participate in making the audit as efficient as possible. Talk to the client before you start to test the waters.
  • Know your professional standards This will allow you to tailor your audit procedures so you do only necessary work. This is critical in a micro-entity audit where even a few unnecessary procedures can add a significant percentage to the total time required to complete the engagement. Time invested in reading and applying professional standards effectively is time well spent, regardless of what field you practise in.
  • Specialize Doing audits of 20 clients in the same sector is much more efficient than doing audits of 20 clients in 20 different sectors. Specialization gives you the leverage needed to minimize the time required to do an audit and limits your audit risk. If you are about to set off into unfamiliar territory, consider whether the return on the time you need to learn about the new area is worth the investment.
  • Automate your audit engagement as much as possible For example, you can automate file roll forwards, importing the client’s year-end trial balance, documentation, analytical review, checklists, financial-statement drafting, correspondence and many other steps. While you have to be determined to automate and invest some time and money up front, the end payoff is significant.
  • Get the right staffing mix Generally, micro-entity audits are more efficient when senior staff members are in charge. They make communication much more direct and less time-consuming. The often minimal time needed to review senior staff’s work on low-risk engagements can also create an efficiency gain. To train students on micro-entity engagements, ensure they are closely supervised by seniors in order to minimize costs. Consider the engagement inefficiency resulting from using junior staff on micro-entity audits as a cost of training.
  • Do your fieldwork at your client’s place of business You can connect directly with your clients, improve the quality of your audit evidence and reduce time on the engagement through focused work. Find a quiet space where distractions are minimal. Consider turning off your smartphone and limiting your time on the Internet while there.

Step 3 — Compare audit engagement profitability
To gauge the profitability of a micro-audit engagement when your goal is no longer to maximize the number of hours spent, calculate your estimated gross margin on each engagement. The estimated gross margin is an estimate of fees collected, less your variable costs — assumed to be largely direct staff costs.  (Variable costs will mainly be the cost of all staff resources per hour. This is not in reference to a notional billing rate applied to staff, but the direct out-of-pocket cost of staff to the firm. The cost of partner time could be measured notionally as the minimum required take-home drawings divided by a partner’s expected billable hours for the year.) Using this measure lets you compare the profitability of different audit engagements and styles.

Here are two staffing models for one engagement: spend 12 hours on an audit of a micro-entity yourself or have staff spend 24 hours on the engagement and spend three hours reviewing its work.

If you have agreed on a fixed fee, you now have a way of comparing the profitability of the different approaches by calculating the cost of personnel for each approach. This measure is not the only factor in your decision to accept an engagement or not, but it does gauge relative profitability.

Pulling it all together
Maximizing your return on micro-entity audits starts with illustrating the value the audit adds to a client’s operations, followed by negotiating a fixed fee in advance that recognizes the intellectual capital you bring to every engagement. This leaves you to focus on reducing your engagement costs wherever possible, enabling you to unlock the value of an audit for both you and your micro-entity clients.

Phil Cowperthwaite, FCA, is a partner of Toronto CA firm Cowperthwaite Mehta and a member of the IFAC’s Small and Medium Practices Committee

Technical editor: Ron Salole, vice-president, Standards, CICA

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