March 26, 2009

AUDIT FEES NEED TO BE ESCROWED

Given the significant number of audit failures in recent years and now the meltdown of the financial industry in the United States the issue of auditor independence, audit fees and audit quality needs to be addressed. The relationship between auditors and their clients is a fee-based relationship that creates an inherent conflict of interest that can have significant influence over an auditor’s judgment and decisions, whether consciously or subconsciously, as a debtor-creditor relationship is created. In many of the recent audit failures I find they very often have happened due to flawed estimates and judgments. It is my belief that this inherent conflict of interest could be substantially mitigated or avoided altogether by escrowing the audit fees at the start of the audit engagement. This would remove the risk of not getting paid and lessen a clients ability to hold the fee hostage subject to the ultimate audit results.

Audit fees need to be escrowed with a third party in advance of the performance of work. This would minimize any negotiation of audit and accounting standards resulting in more independent and objective audits. There could even be oversight by a third party to make sure the audit has been completed in accordance with Generally Accepted Auditing Standards (GAAS) prior to the disbursement of the final fee to weed out those auditing firms that are not performing their audits in accordance with GAAS. This step alone would have been a real deterrent in some of the recently discovered Ponzi schemes and maybe could have saved investors millions if not billions of dollars.

What the public needs from the public accounting profession is increased accountability. Separate the decisions about money from the audit results and watch the quality of audits improve dramatically. The accounting profession needs to pass a standard that requires that audit fees be placed in escrow before the start of fieldwork. This would also have a positive impact on firm profitability.

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