Lowballing

13 May 2007 |

‘Lowballing’ is the ‘loss-leading’ practice in which auditors compete for clients by reducing their fees for statutory audits. Lower audit fees are then compensated by the auditor carrying out more lucrative non-audit work (e.g. consultancy and tax advice). Audits may even be offered for free. Such ‘predatory pricing’ may undercut an incumbent auditor to secure an appointment into which higher price consultancy services may be sold.

Ethical risks

There is a risk of incompetence if the non-audit work does not materialise and the lowballing firm comes under pressure to cut corners or resort to irregular practices (e.g. the falsification of audit working papers) in order to ‘keep within budget’. However, a lack of audit quality may only be discovered if the situation arises that the company collapses and the auditors
are charged with negligence.

If, rather than comprise the quality of the audit, an audit firm substantially increases audit fees, a fee dispute could arise. In this case the client might refuse to pay the higher fee. It could be difficult then for the firm to take the matter to arbitration if the client was misled. Thus an advocacy threat may arise. Financial dependence is a direct incentive that threatens independence. A self-interest threat therefore arises when, having secured the audit, the audit firm needs the client to retain its services in order to recoup any losses initially incurred. The provision of many other services gives rise to a self-review threat (as well as a self-interest threat).


Sufficiency of current ethical guidance

In current ethical guidance, the fact that an accountancy firm quotes a lower fee than other tendering firms is not improper, providing that the prospective client is not misled about:

– the precise range of services that the quoted fee is intended to cover; and
– the likely level of fees for any other work undertaken.

This is clearly insufficient to prevent the practice of lowballing.

Legal prohibitions on the provision of many non-audit services (e.g. bookkeeping, financial information systems design and implementation, valuation services, actuarial services, internal audit (outsourced), human resource services for executive positions, investment and legal services) should make lowballing a riskier pricing strategy. This may curb the tendency to lowball.

Lowballing could be eliminated if, for example, auditors were required to act ‘exclusively as auditors’. Although regulatory environments have moved towards this there is not a total prohibition on non-audit services.

Source:

ACCA 2006 answer paper

Highballing and Lowballing in Audit Pricing: the Impact of Audit Error

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