There is a problem with the structure of the Big Four auditing firms and their market. Their resources are geared mainly to satisfying the demands of multinational corporations, which are their main source of revenue. But this means that the Big Four offer smaller companies the same kind of service, even though this may not be appropriate.
A one-size-fits-all solution is inappropriate when you are, say, providing annual financial information to shareholders. This is only one example, but if you consider how that information is derived you can immediately understand why the costs are excessive for smaller companies: the method used is too elaborate and follows the same processes used for multinationals.
Of the regular information that shareholders receive, usually the most interesting--and the most costly to produce--is the audited financial information for the company (including subsidiaries and/or associated companies if it is a group) with the notes to the accounts. To provide group financial information such as the P&L account, balance sheet etc, the chief executive appoints an audit firm for both the parent company and its subsidiaries. The auditor is usually one of the major firms, since generally only they will have representatives in each of the nations where the client has subsidiaries.
These local entities are audited by the local offices of the audit firm. As a separate exercise, the auditor performs and audits the consolidation based on the accounts that its local firms have audited. This process is the same irrespective of the client's size, so the cost is relatively high for smaller clients. In my experience this is unlikely to cost less than $250,000 for a company with only one or two overseas subsidiaries. So why pay this much? Perhaps because we are blinded by the idea that if it's good enough for multinationals, it's good enough for smaller companies.
This is why I conducted a pilot study with the help of a medium-sized auditor to find an alternative solution for smaller companies. Our goal was to test whether a cheaper solution could be found for a consolidated company that would still give its shareholders an acceptable level of information and reassurance.
We worked with a small group in the technology industry. It had a holding company that owned patents and trademarks, released new software updates, developed new applications and technologies where economically sensible and licensed them for use in its operating subsidiaries. The Swiss-based CEO managed the group, communicating with the operating entities and visiting them as necessary.
The company had sales operations in the Netherlands, the UK and the US. These licensed and distributed technology to customers and provided support and consulting services. The group established private limited companies in these countries, retaining full ownership. It established arm's-length distribution agreements that were tax efficient but complied with local taxation rules. The group's revenues were about $5m a year and growing quickly. The costs of establishing and maintaining the structure were modest.
The system we came up with featured the following measures:
* Appointing local medium-sized audit firms in each country of operation. These charged modest fees and had the resources and structure suitable for clients of this size.
* Auditing each entity separately so that results could be presented individually. (If a large audit firm had produced the consolidated accounts using the traditional method, these individual audited results would have to be disregarded and the individual entities audited anew by the local partnership of the big international audit firm.)
* Appointing a compiling (consolidating) auditor. Although this could be an audit firm not used by any of the operating entities, we thought it sensible to appoint one of the auditors of the operating entities--preferably the most complex one--since this would reduce the volume of information to be shared. …