Introduction
Auditing is the process of examination of financial practices that is necessary for the maintenance of sound governance levels of a company. This tool of financial control allows ensuring that an organization follows accounting principles and does not engage in misappropriation of assets. The aim of this paper is to analyze proxy statements and annual reports of two American, publicly-held companies: Walgreens and CVS Health. Walgreens is the largest pharmacy retailer in the U.S. with 13, 200 stores in 25 countries and more than 400, 000 employees (Walgreens). CVS Health is the second largest retail pharmacy in the U.S. with 9, 709 stores and 32, 000 pharmacists (CVS Health).
Key Characteristics
In order to better understand factors that influence the determination of external audit fees for Walgreens and CVS Health it is necessary to consider key characteristics of the companies (see table 1).
Table 1: Comparison of Audit Fees and Financial Statements for Walgreens and CVS Health.
Discussion
External audit is a tool for ensuring accountability in management that helps to achieve and maintain good governance levels. The remuneration payable to external auditors is of high interest to both companies receiving audit services and companies rendering them (Kikhia 42; Kimeli 23). Companies that enter into negations regarding the provision of professional audit services want to ensure that they pay reasonable fees.
Auditors are also cautious during such negotiations because they need the remuneration to be high enough to “perform the engagement in accordance with applicable technical and professional standards for that price” (Kimeli 23). Shareholders who are interested in auditors being independent and objective also have to be concerned with the reasonableness of audit fees (Yousef and Naser 14). Furthermore, the public in general and professional accounting bodies are also interested in the level of audit fees because they have to be in line with the ethical standards of the audit profession.
The following factors related to a client’s company characteristics might enter into the determination of fees paid for external audit services: industry, a size of a company, profitability, risks, the complexity of services, and report lag among others (Castro et al. 264). A large body of academic literature indicates that the following attributes of an audit firm influence an amount of audit fees: audit firm profile, independence of audit committee, experience, competition, industry specialization, and the Big 4 factor among others (Yousef and Naser 14).
Taking into consideration the fact that Deloitte & Touche LLP and Ernst & Young LLP provided the audit services to the publically traded companies under discussion, it is necessary to start the discussion of the level of audit fees from exploring the role of the Big 4 factor in fee determination. The Big 4 companies charge premium fees for their services because they have “higher quality teams and they apply better procedures” (Castro et al. 264) allowing to effectively determine errors. 2016 proxy statements of Walgreens and CVS Health show that the amount of audit fees paid by the companies was fairly substantial—$13, 393, 800 and $12, 910, 811, respectively (CVS Health; Walgreens). It can be argued that audit fees levels are partially attributed to the Big 4 factor.
The difference in audit costs of the companies is $482, 989, which is not a considerable variation (CVS Health; Walgreens). Walgreens and CVS Health are companies of a large corporate size; therefore, they are subject to a high level of audit fees. The auditees size can be measured by “total assets, revenues, sales and number of employees” (El-Gammal 137). Large companies disclose more information in order to reduce agency and political risks, thereby increasing the level of audit effort that needs to be exerted by external auditors. According to Yousef and Naser, total assets and market capitalization are the most common measures used for assessing corporate size (15). In 2016, total assets of Walgreens and CVS Health were $72, 688B and $94, 462B, respectively (CVS Health; Walgreens). 2016 proxy statements of the companies show that market capitalization figures of Walgreens and CVS were $92, 151B and $84, 153B, respectively (CVS Health; Walgreens).
Even though CVS Health has more assets than Walgreens, the amount of audit fees it paid in 2016 was lower than that for its competitor (CVS Health; Walgreens). The discrepancy between the numbers can be attributed to the fact that there is a substantial difference in complexity of the auditees. Walgreens is the largest pharmacy retailer in the world with 13, 200 stores in 25 countries and more than 400, 000 employees (Walgreens). CVS Health, on the other hand, has only 9, 709 stores and 32, 000 pharmacists (CVS Health). There is ample evidence suggesting the existence of a positive relationship between the diversification of subsidiaries and operations of a company and audit fees it pays (El-Gammal 137). Walgreens has foreign subsidiaries that are subject to numerous legislative requirements for disclosure. It means that audit process of the pharmacy retailer requires additional time and manpower, which can explain the differences in the audit fees paid by the two companies.
Another important characteristic that can explain the discrepancy between the audit fees is client risk. In 2016, current ratios of Walgreens and CVS Health were 1.52 and 1.18, respectively (CVS Health; Walgreens). Even though the companies’ assets were greater than their liabilities, the current ratios indicate that financial health Walgreens was better than that of CVS Health. It means that CVS Health was less likely to honor its debts than its competitor. Also, in 2016, equity to debt ratio of CVS Health was 0.75, whereas equity to debt ratio of Walgreens was 0.64 (CVS Health; Walgreens). The fact that the audit fees paid by the companies differed only by $482, 989, which is unusual since there is a substantial difference in the complexity, can be explained by the discrepancy in risk levels.
Conclusion
The analysis of proxy statements and annual reports of two American, publicly-held companies—Walgreens and CVS Health—has shown that discrepancy in the audit fees can be attributed to the following factors: size, complexity, risk, and profitability.
Works Cited
Castro, Walther et al. “Determinants of Audit Fees: A Study in the Companies Listed on the BM&FBOVESPA, Brazil.” Revista Contabilidade & Financas, vol. 26, n. 69, 2015, pp. 261-273.
CVS Health. “Notice of Annual Meeting of Stockholders.” Investors.cvshealth.
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Kimeli, Elkana. “Determinants of Audit Fees Pricing: Evidence from Nairobi Securities Exchange (NSE).” International Journal of Research in Business Studies and Management, vol. 3, no. 1, 2016, pp. 23-35.
Walgreens. “Notice of 2017 Annual Meeting of Stockholders and Proxy Statement.” Shareholder.
Yousef, Hassan, and Kamal Naser. “Determinants of Audit Fees: Evidence from an Emerging Economy.” International Business Research, vol. 6, no. 8, 2013, pp. 13-25.