CAI Hao-feng, YANG Xin-kai

(Rutgers University, NewBrunswick, US, NJ, 08854)

Abstract： Factors influencing audit efficiency and effectiveness have been widely discussed, but few studies examine the connection between audit fee and audit efficiency and effectiveness. Because of the lack of previous research on the issue, the article attempts to study how fixed audit fee influences audit efficiency and effectiveness. We present a theoretical analysis and the result shows that fixed audit fee promotes audit firm management and improves auditors’ professional competence, initiative and independence which eventually is more beneficial to improve efficiency and effectiveness than hourly fee. In addition, the constraints of institution and engagement letter force auditors to make professional judgments enhancing the beneficial effect of fixed audit fee.

Key words： fixed fee audit engagement; audit effectiveness; audit efficiency

How fixed-fee engagements affect efficiency of the audit: comparing to other basis for billing, fixed-fee engagements can be beneficial to the efficiency of an audit in many ways[注]Whittington O Ray, Kurt Pany. Principle of auditing & other assurance services, twentieth edition 2 penn plaza, New York, NY 10121. Copyright 2016 by McGraw-Hill Education.[注]Whittington O Ray, Kurt Pany. Principle of auditing & other assurance services twentieth edition, Copyright 2016 by McGraw-Hill Education. Edited by ECW CPA.. Due to the nature of a fixed-fee engagement where the auditing fee is fixed regardless of the actual hours spent on the engagement, the audit labor cost for the hours worked beyond the budgeted time will be assumed by the auditing firm. Because the client does not pay for the additional hours worked, the auditing firm will have to afford more planning and preparation for the audit engagement, including communication with the client and its predecessor auditor, exercising more caution in sending optimal number of auditors and enhance the control over the auditors’ time reporting and the number of auditors sent to certain engagement. Specifically, to obtain more accurate estimate of the auditors’ hours that are required to complete an audit, the management of the audit firm may be inclined to take actions and monitor, analyze, and optimize the length of time and staffing spent on an engagement, which to some extent prevent slacking-off of the auditors on the engagement[1]. For example, under fixed-fee basis, to exhaust the potential of an auditor and his time, the auditing firm is more incentivized to find the best match of the auditors’ area of experience and expertise to the clients’ nature of business and their respective industries. This way an auditor, equipped with understanding of how a business is usually run and which type of risk is more common in that specific industry, would know where a material misstatement commonly hides[2-3]. Moreover, when working independently from the constraints of time and from the influence of potentially frugal clients who tend to put pressure on the time and resource necessary, he will have higher level of confidence in deciding where to apply substantive procedures after the risk assessments and control tests. Other actions that an accounting firm may take to keep in check the usage of resources, used to be reimbursed by the client, may include providing trainings that are more intensive and potentially more industry-specialized, all of which can be helpful for using the available resources more efficiently and conducive to producing quality audit. However, the incentive for the management to use the resources efficiently could backfire and possibly result in audits of unsatisfactory quality. When an auditor faces more stringent time and resource control from his management, it entails considerable professional ethics, good faith in completing the audit to his best effort, independence, courage to confront unreasonable estimate in time and resources allocated, and willingness to take time and conduct examinations carefully regardless of the pressure, failure to meet any of which is likely to lead to higher audit risks. Both the auditors and the management of the audit firm ought to pay special attention to this concern, should they consider switching from the time basis to fixed-fee basis. Nevertheless, even when taking into considerations of the potential pitfalls with implementing fixed-fee billing, it is still favorable over time basis in regards to efficiency. As the laws and regulations regarding audit practice grow and mature with safeguards that keep the threats in check, the cases where auditors’ violation goes unnoticed and uncorrected should diminish[4], all the more reason to adopt fixed-fee basis for billing auditing fee.

How fixed-fee engagements affect effectiveness of the audit: as discussed in length above, accounting firms are incentivized to plan the audit better, employ better training and dispatch auditors with more experience and specialized expertise in the respective industry, if the firm wish to adopt fixed-fee billing for certain attestation engagement. These steps, initially designed to improve the auditing efficiency, are beneficial to higher effectiveness, as well. In particular, auditors with specialized knowledge or experience in certain industry are supposed to have better insight in the entity, and to have a better grasp of the impact of industry, regulation, and factors that might affect the presentation and disclosure of financial information, all of which are likely to lead to more accurate assessment of control risk, helping the auditor determine the appropriate amount of substantive procedures to perform in further testing. As noted in the textbook, insufficient substantive procedures are detrimental to the effectiveness and excessive substantive procedures to the efficiency[5]. The actions that the auditors and the auditing firm would take under fixed-fee basis keep both aforementioned issues in check. There are, nevertheless, cases where the auditor has to use his judgment, such as the level of professional skepticism to exercise, the sample size of audit evidence when the auditor decides to employ non-statistical sampling, which can be subjective and easily justified, under the pressure from the management in terms of the time consumed on the fixed-fee based engagement, the auditor may choose to curtail the procedures or reduce the sample size to test, to the extent that won’t materially affect the overall effectiveness of the audit yet still forego the opportunity to spot misstatement. Nonetheless, besides the abundance of laws and regulations that supervise and hold the quality of audit and ethics of the auditors to an acceptable standard, the engagement letter agreed upon between the client and the auditing firm provides effective prescription in regard to the obligation of an auditor on the engagement and to what is expected out of the audit engagement that would be considered satisfactory and effective[6]. The auditor, on behalf of his employer, ought to fulfill the responsibility to the fullest extent as spelt out on the engagement letter. After all, no matter which billing basis the accounting firm adopts eventually, the amount of substantive procedures to perform and the scope thereof should be dependent on the result from the risk assessment procedures and tests of control, rather than on other extraneous considerations, be it the billing basis or the profitability of the auditing firm from certain engagement. On the client’s end, on the other hand, because under fixed-fee basis, the client’s expense on the audit engagement no longer depends on the hours spent on the engagement. The client would be less incentivized to exert undue influence to the audit to curtail the time and staff necessary for the engagement. This way the auditors can perform his job without unnecessary pressure while maintain independence in mind, and produce unbiased, well crafted, quality audit report. We’ve been discussing situations where the auditor is familiar with the industry and there’s no major change in the quality of financial statements. For clients with a history of lacking sufficient internal control and ineffective financial statement disclosure, the auditing firm needs to take special caution to budget the audit time and staff needed[7-8]. Implementing fixed-fee auditing before obtaining solid understanding of the client can be risky and may lead to underallocation of the budget to compensate the actual time that the auditor spends on the engagement and harm the morale of the auditor as well as his professional ethics, both of which are fatal to an audit engagement.

In conclusion, when based mainly on the perspective of efficiency, fixed-fee will be more favorable than the time-based billing; the advantage of fixed-fee billing outweighs the disadvantages, which can easily be brought to an acceptable level with proper internal control and thorough compliance to rules, regulation, and Code of Professional Conduct over attestation services.