Adam_Schwartz

I am doing an accounting project where I am a consultant giving advice to an auditor (called U&H) about a particular job they are bidding on in Baton Rouge. It is basically a series of questions that I have to answer and support with accounting documents and studies.

I wanted to get some thoughts on one of the questions from any of the accouting gurus here. I am not looking for anyone to do my project, just for some added insight. The question is:

What if U & H had billed the client for less than the total expenses expected to be incurred so that the firm could establish a foothold in Baton Rouge? How would the firm account for and report the out-of-pocket expenses in excess of the fees received? What implications would this arrangement have for future years’ engagements (i.e. Does “low-balling” hinder auditor independence? Is it illegal and/or relevant under the Sarbanes-Oxley Act? Is it unethical?)?

I am more concerned with thoughts on the low-balling portion of the question. I could not find anything in the Sarbanes Oxley act that says low balling is illegal. The thing that I found in the S-O act is that auditors cannot offer certain non-auditing services. Before the S-O act, auditors would low-ball to get business so they could generate more revenue from non-auditing consulting services. But I do not see it as illegal to low-ball in order to get business. Some argue that low-balling can affect independence, but some think it does not affect auditor independence.

Also, I would say that low balling is unethical, but not illegal. Besides the issue of low balling to sell non-auditing services is the idea that once an auditor has a company's business, it could jack up prices in subsequent years. Companies do not like to just change out auditors every few years, so an auditor could take advantage of this by low balling to get market share.

Adam_Schwartz

BTW, thanks in advance for any thoughts you guys and gals can share.

phinthesky

Well, would the firm have a contra-asset called something like "BR Promotional Expense"? They would fund this account and then draw out of it as they incurr out of pocket expenses. Future implications could mean that the auditors would have to increase fees in order to cover their earlier losses. They would in effect be overbilling their client for services received. Like you said this may not be illegal if the auditor is not trying to bill in other services that are not related to auditing.......

ViperrepiV

I'd put some sort of asset on the balance sheet, but then again, i'm not an accountant

Adam_Schwartz

Interesting - I thought that the losses would essentially be an operating expense, similar to what you said. But this would make more sense. My father in law said that the expenses could be construed as start-up costs since they are trying to gain market share in a new area.

So what you are saying is that they would establish a promotional expense account ahead of time, perhaps when the company was formed, and then draw from that as they try to gain market share in certain areas by low balling?

Also, I don't think this would be illegal AS LONG AS they are not trying to charge for other non-audit services. But that is where the S-O act comes in, so it might make low-balling an acceptable practice of gaining market share.

Thanks for the insight man.

lokman

As with many things in accounting, there's no one right answer. While my interpretation of SOX is that low-balling does not affect auditor independence, it does create other issues such as cutting corners to get the work done because you won't be able to recover it. That is not necessarily illegal, but it's probably not completely right either, much as you already concluded.

If the client is public, then I believe there are requirements to disclose the fees being charged by the auditor, and I guess someone could see that the fees might be abnormally low and call that and auditor independence into question. While not in the scope of your question, there might also be reporting requirements to the PCAOB as well.

I haven't looked at SOX in a while, so take what I've said at your own risk, but hope it helps.