Low balling

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Low Balling is a model from the field of auditing . It is a model for describing the development of examination fees, first described by Linda Elizabeth DeAngelo in 1981 .

background

With low-balling, an auditor does not settle the full costs of the order when the client is checked for the first time. The value of an examination depends, among other things, on the likelihood that the examiner will discover errors. If the auditor is economically dependent on his client over the long term, the likelihood of the auditor making the errors public decreases. Therefore, auditors whose aim is to disclose errors are considered independent and thus the value of their audits for the capital market increases. The demand for high quality audit services with low own costs has led to increased competition in the market for initial audit mandates. The model is based on the assumption that the auditors have identical judgment and a similar competence. In addition, it is based on costs for the conclusion of the respective contracts as part of the initial test, some of which are omitted for follow-up tests, so that the selected auditor has an advantage over his competitors.

During the completion of their mandates , auditors receive fees that exceed their costs. Due to the increasing competitive pressure, the examiners try to undercut each other by reducing the examination fees in order to obtain new mandates. In some cases, these examination fees barely cover your own expenses. In anticipation of a later profit situation due to the order for an initial test and subsequent follow-up tests, they try to reduce this fee further. The inquiring company would incur costs again if they had to change the auditor. This possible profit is used to reduce the examination fee for the first period even further and to achieve a total of 0 over both periods. The drastic lowering of the exam fee is known as low balling .

This assumption applies to a 2-period model. The auditor chosen in the first period benefits from the limitation of the entire mandate term. However, in Germany the term of the mandate is - at least so far - basically unlimited.

In the case of further periods, the current auditor has the problem that from the second period onwards, possible other auditors also apply for a two-period or multi-period model and also charge a fee that is below their profit to be generated in the following period. The consequence is that actual profits for the auditor can only arise in the last period of a mandate, because there new auditors could no longer expect profit from a subsequent period. The condition here is that there are no technical differences between the auditors and that the service life of the company is finite.

Fee cutting can also occur over the course of the periods . This is understood to mean the (further) lowering of the examination fees that comes from the client. Arguments for this can be offers from other auditors or references to mandate experience available after 1-2 years, which should lead to an increase in efficiency for the auditor.

In Germany, however , Low Balling has to be brought into line with the auditor regulations and the required economic independence of the statutory auditor on a case-by-case basis.

Low balling effect

Because the auditors are undercut by competing auditors when new mandates are tendered, the final audits are often not cost-covering because audit assignments are accepted with low fees. The “low balling effect” is used during the initial test as a door opener for hoped-for further cost-covering services that lead to disadvantages of the tests. The quality of the exam also suffers due to the drop in fees. The auditor endeavors to continue the existing business relationship in order to compensate for his initial losses. The clients share this interest because they want to avoid the transaction costs incurred when changing auditors. However, this can lead to mutual dependency. The examiner could try to enforce a higher fee while the client might try to influence the examination result.

literature

  • Linda Elizabeth DeAngelo: Auditor independence, 'low balling', and disclosure regulation . In: Journal of Accounting and Economics . tape 3 , no. 2 , 1981, p. 113-127 , doi : 10.1016 / 0165-4101 (81) 90009-4 .
  • Hansrudi Lenz: The low-balling effect and the independence of the statutory auditor. In: Economics Studies. (WiSt), 20th year 1991, pp. 181-184.
  • Chi-Wen J. Lee, Zhaoyang Gu: Low Balling, Legal Liability and Auditor Independence . In: The Accounting Review . tape 73 , no. 4 , January 1, 1998, pp. 533-556 , JSTOR : 248189 .
  • Ruth-Caroline Zimmermann: Econometric model on the influencing factors of examination fees . In: Auditors and accounting policies of clients . Gabler, 2008, ISBN 978-3-8349-1008-0 , pp. 130-174 , doi : 10.1007 / 978-3-8349-9790-6_7 .

Individual evidence

  1. ↑ Linda Elizabeth DeAngelo: Auditor independence, 'low balling', and disclosure regulation.
  2. ↑ Schedule of fees for auditors . In: WPK magazine . No. 1 , February 2012, p. 37-38 ( wpk.de [PDF]).
  3. ↑ Auditor in conflict of interest. Compatibility of auditing and advisory work against the background of the principle of independence. grin.com, accessed on November 14, 2016 (Section: 3.1 Explanatory approaches for incentives to give up independence ).