Client Acceptance Newburg Company is in an industry in the early development stage, where there are minimal barriers to entry to the client's business model. Newburg Company's audit committee decided to put their 2014 audit out for bids. One of the Big

Question

Four CPA firms had performed their audits from 2011-2013, and although happy with the previous auditor, the audit committee believed they should rotate to another firm. On the last audit, the Big Four's audit fees were $500,000 . Barnaby, CPAs, came in as the low bidder, making a proposal to Newburg Company regarding audit fees for 2014 . Their proposed audit fee was $250,000. Required: (1) Based on this scenario, describe the ethical decisions that an auditor must make during portfolio management decisions such as the client acceptance and client continuance decision. What is the relationship between ethics and high audit quality? (2) What issues should the client's audit committee consider before going with the lowest bid?

Answer 1

(1) The ethical decisions that come into play during client acceptance and client continuance decisions concern the trade-off between audit fees, resulting audit effort, and the ability to conduct a quality audit. Given the fee data, one has to wonder whether Barnaby is going to do a quality audit in the year of the transition. Is it possible to do a similar quality audit with half the resources? Perhaps the cost structure of Barnaby is much different than that of the Big Four firm. If Barnaby has lower fixed and overhead costs, and lower litigation reserves, then perhaps they can still earn the same relative profit on the engagement that the Big Four firm did. Perhaps, the first year is considered a loss leader, as they gain experience with this new client. If not, then one must call into question whether the audit effort applied by the two audit firms was roughly equivalent. Since audit hours are not publicly disclosed, it is difficult to make a final determination. Ultimately, the ethical question is this: can an audit firm do a quality job with the audit fee that they are charging? And do they have the relative expertise necessary to make good audit judgments? If the answers to these questions is no, then there may be ethical problems in the acceptance or continuance of a relationship with a client.
(2) The quality of an audit helps ensure the financial integrity of the company's financial health and protects assets, creditors and investors. Therefore, the audit committee should not approach this situation lightly. The decision regarding an audit firms with a strong culture of quality places greater emphasis on developing, maintaining, and monitoring systems of internal control that yield good decisions in this regard. The cheapest deal may not always be the best deal, particularly in the area of quality.