Rating of audit-consulting groups "Russian audit", 2006

Large scale at any cost

Larisa Krashchenko, Vartan Khanferian

Таблица 1. List of the largest Russian audit-consulting companies, 2006
Таблица 2. General audit
Таблица 3. Investment audit
Таблица 4. Audit of insurance companies
Таблица 5. Bank audit
Таблица 6. Strategic consulting
Таблица 7. Financial consulting
Таблица 8. Tax consulting
Таблица 9. IT-consulting - management consulting
Таблица 10. IT-consulting - development and system integration
Таблица 11. Legal consulting
Таблица 12. Estimation activity
Таблица 13. ACG revenues from servicing from IAS
Таблица 14. ACGs with experience of providing IAS services to different categories of clients

Expansion of large audit-consulting groups to the regions has gathered head. National networks, operating under international brands, fully determine the market trends.

Expert RA new study confirmed forecasts related to smaller auditors being pushed out by large audit-consulting groups (ACG) (ratings 2003, 2004, 2005 and 2006). For the first time in the eleven years’ history the list of the largest ACG practically remained unchanged. Only four companies (from Moscow) made their maiden appearance. There is nothing to say about arrivals from the regions. And quite recently the top-150 list was annually added by 20 new companies. Half of the newcomers represented regions.

Accordingly, the entry level to join the select club has grown up for the last three years. The annual entry level increase by 20% brought the figure to 400 000 USD. It is too difficult for regional companies to overcome the barrier without a well-known brand name.

Networks parade

Audit and consulting market has grown twofold within the last three years Aggregated revenues of the largest Russian ACG (without the “big four")

The market volume of 150 audit-consulting groups increased by 38.5% last year and amounted to 27 billion rubles (diagram 1). As in previous years, the market rapid development was determined by the rating top-10 groups (their share of the market is about 50%).

There is nothing new about the tendency of the market growth due to its leaders. Our studies made reference of the phenomena more than once. For instance, the market leaders entered the new millennium with dramatically effective results (2000-2002) and integrated into international networks, doing their best to amass their assets and improve their position in front of the colleagues from the West.

But this time the achievements exceeded all expectations. The growth was of an extensive nature, due to aggressive penetration into regions, acquisition of smaller structures and extension of personnel. Subsequently, within the last couple of years the top-10 proceeds doubled: from 6 to 13.3 billion rubles (annual average by 50%).

It is often said, that the top-10 does not reflect the whole market with several thousand audit companies. But now the criticism has completely lost its ground. Last year total number of organizations, belonging to networks or groups of companies, increased in our rating by 57%. Altogether the rating participants represent 1138 structures! It is interesting to note: each participant of the top-150 has about 7-8 companies in his group. And the 10 leaders of the list are accountable for 644 companies. It is three times more than a year ago. BKR-Intercom-Audit is an obvious leader in this respect – last year it increased its filial net from 137 to 427 structures. RSM Top Audit and PKF doubled the number of their affiliated structures, too. Rosekspertiza (MRI) also acquired some new elements.

Accordingly, the number of specialists in these companies doubled (from 3307 to 7336) with average market increment being only 26%. At present about 50% of all specialists at the market work in large ACGs.

Expanding their own filial and partner nets, companies pursue their commercial interests and perform outreach activities. Vitaly Semenikhin, BKR-Intercom-Audit deputy general director, says: “We decided to set our audit-consulting group, strange as it may sound, on the basis of outreach function, that we had taken upon ourselves. Regional audit companies operate in information vacuum with the gap growing wider and wider – and to preserve the audit system in Russia we decided to help them in all possible ways to improve technological aspects of their operations. The second reason was a fast-growing want of personnel. As a matter of fact, the most qualified staff in the regions is more responsible and – following traineeships – is quite competitive with staff from capital cities. And you cut your expenses by not paying more to such people. We have certain demands to companies joining our net: information openness, regular advanced training at our base and preliminary testing of their staff by our specialists. To work at full value in our net you have to show high quality”.

But explaining sweeping successes of the leaders, you have to take into consideration a couple of favorable factors.

First, it is general economic growth, inevitably pulling forward the market of services, — says Unicon general director, Andrey Doubinsky. — The Russian business strives to reach international capital markets. Hence increased demand for services to prepare international reporting and audit in keeping with international standards, prepare companies for initial public offering (IPO) and business assessment, check due diligence. Enlargement and restructuring of Russian companies brought about demand for servicing implementation of integrated information systems. International component of audit-consulting services has become costlier, the services getting more complicated and comprehensive”.

Second, it is “dynamic growth of medium size business and its desire to attract additional financial resources, unite and, consequently, be more transparent, — says Sergey Shapiguzov, PKF president. — That is why preparation and audit of reporting in keeping with IAS are so much demanded now”.

True, unique achievements cost a lot. Efficiency of large ACGs within the last couple of years has not gone up, rather it went down, considering inflation. Average revenue per person in 2006 was 1816 thousand rubles against 1835 thousand rubles in 2004. Two years ago we have already reported reduced growth of efficiency among big companies. But at that time the reason was transformation processes (large ACGs meticulously put things to order inside their structures before joining international networks), as a result rates of growth significantly slowed down to 13% per year (the rating of 2005).

Movement of large ACGs to regions resulted in increased revenues and influenced the market structure. Smaller companies lost big chunk of their orders and had to cut their personnel to stay afloat. The main rating table (table 1) demonstrates to what extent the process affected the rating participants, especially, in the regions. About one quarter of companies from the second half of the list showed negative growth of a number of specialists during the year. Our talks to companies confirmed our conclusions. Although some of them reported the tendency for specialists to move to industrial business or made references to business transformation internal structural processes.

Making stakes on audit

Within the year the market structure remained practically unchanged Structure of the market of audit-consulting services in 2006 (without the “big four”), %

Consequences of gaining new territories by large ACGs are obvious – their commercial calculations have been proved correct. But it is no secret that orders in the regions mostly relate to trivial auditing checks. That is why the last year revenues from audit services were at the top (for many years rates of growth in the consulting notably surpassed those in the audit). The audit sector in the general market structure has increased by 35%, with consulting annual increment being 39%). Altogether the audit-consulting services market structure remained unchanged (diagram 2).

As usual, the contribution of general audit was most significant. For instance BKR-Intercom-Audit and РСМ Top-Audit more than doubled their revenues in the sphere. Other leading companies showed a similar trend.

The sector of auditing investment companies has also demonstrated visibly increased revenues — 49% during the year. The demand was provoked by rapid development of the market of investment services in Russia.

Says Aleksey Rouf, general director of ROUFAUDIT (JPA International): “Investment climate in Russia has become more attractive both for foreign and Russian investors. Conditions of conducting business in Russia, its legal regulation and taxing have stabilized. Hence, the increased volume of investments. Real audit proved to be on demand – opinion of independent professionals about credibility of financial reporting, organizational efficiency and corporate governance”.

Audit services were also claimed by insurers. The share of auditing insurance companies has increased by 46.2% against 29.7% in 2005.

Aleksandr Kozlov, Rosekspertiza (MRI) general director, says: “Restructuring and consolidation in insurance business were reflected by growing demand for audit services. Orders for centralized audit of holdings and their internal units have been growing. One of our most interesting projects in the area of insurance audit is Rosgosstrakh insurance company – a holding with regional, inter-regional and other general insurance companies. Altogether the demand is dictated by the wish of the big corporation management to secure universal approach to quality and credibility of financial information”.

Sergey Kharitonov, Marillion general director, says: “Last year we felt growing demand for our services on the side of insurance companies. Strange as it may seem, but, to my mind, it is related to “screw tightening” policy, conducted by the state regulator in the area. Reporting of insurance companies has been more transparent, scheming was left in the past – under such circumstances insurers need auditors and consultants with experience and repute. Despite general decrease of a number of insurance companies in the country, the number of our clients-insurers went up. It is gratifying for Marillion to see largest foreign companies – newcomers in Russia – coming to us for services, considering us as a real alternative to the “big four”.

It is proper to forecast further rapid growth in the insurance sector. But audit will not be the only service on demand. Thus, Olga Goriacheva, Neksia Pacholi (Neksia CIS group) deputy general director, says: “The attitude of the Federal Service for Insurance Supervision in the area of strengthening financial stability of insurance companies resulted in about 70 insurers having lost their licenses in 2006. The tendency would continue – the decree No.149n of the Ministry of Finance, effective from July 1, 2007, “On approving demands to composition and structure of assets, accepted to cover insurer’s own funds”, would encourage growth of merger and acquisition deals (M&A). As a consequence, it will trigger further demand for complex audit-consulting services.

Finances are of paramount importance

Financial consulting in 2006 developed rapidly (Audit-consulting services, dynamics of growth)

Another peculiarity of 2006 is visible invigoration in the area of financial consulting. The segment revenues of the rating participants swung over by 51.4% against 13.1% in 2005 (diagram 3).

The acceleration may be pinned on two processes. First, it is one of the consequences of regional influx to large ACGs, since book-keeping services is a strong point of regional companies.

Second, it is reforming and consolidation in monopolies like RAO UES of Russia and RZhD, accompanied by appearance of new legal entities and affiliates. The process has been fostering increased demand for complex of services related to establishment of book-keeping, development and implementation of financial strategy and financial management system. Besides, large business has shown increased interest in services for preparing companies for IPO.

Consulting in the area of strategic planning and organization development was claimed, too. The increment of ACGs proceeds in the sector amounted to almost 34%. According to Tatyana Ivanova, EKFI group deputy general director, a number of clients in this particular sector of consulting increased by about half as much. In 2005 energy enterprises were the main company clients in the area of strategic planning and organization development, but last year we saw growing interest on the side of housing system enterprises. The demand may be explained by the Federal Law No.210 “On the foundations of regulating tariffs of the housing complex organizations”, coming into effect since 01.01.2006. The above law was used for the first time this year when tariffs for services of the housing complex organizations in the area of production and investment programs were approved.

Tax and legal consulting by volume of their services remain in the lead in the audit-consulting structure. The share of their services constitutes about 19% in the general market structure. But other types of consulting show more dynamic growth — about 26% a year. Thus, tax consulting, being a traditional kind of service, is required by companies building effective tax accounting system in keeping with current legislation. “Current consulting support and protection of interests during arguments with tax authorities are the most demanded services”, — says Natalya Malofeeva, deputy general director and partner of MKPTSN audit company. – The service is quite claimed at the market to make competition in the sector stronger than in any other part of the market. Accordingly, increase of prices and drastic growth of ACG proceedings can hardly be expected.

But the benign picture may be easily exploded by the authorities. More rigorous control and regulation procedures by the state are invariably followed by increased demand for tax and legal consulting on the side of enterprises. Vitaly Semenikhin continues: “Demand for tax consulting services hiked up by the end of 2006, due to adoption of enactments of the RF Supreme Court №64 dt. December, 2006 “On practices of court application of criminal law on responsibility for tax crimes”, and the RF Supreme Arbitration Court №53 dt. October 12, 2006 “On arbitration courts assessing arguments in support of tax profit received by taxpayers”. The thing is that significant part of deals turned risky and might be considered as a basis for launching criminal cases in the area of tax crimes. Employees of banks, audit, legal and consulting companies, formerly engaged in preparing so called “tax optimization schemes”, have now been considered as accomplices in tax crimes, therefore we face the growing demand for independent outside consultants to provide expert assessment of such schemes. The situation will only get worse to be accompanied by the growing demand. The main criteria for assessing efforts of tax consultants will be based on the level of protection of a client-taxing system, not on amount of money saved”.

Dream come true

The market of IAS-related services went up by 55.4% last year Share of IAS-related services

Reporting transformation services were the most claimed ones for the last two years (Dynamics of IAS-related services)

Active movement of large ACGs to regions is also dictated by perspective avalanche of orders from enterprises in need of IAS related services. The interest is quite understandable. So far regional structures are not too strong in the field (having no support from Western networks brands), there is a chance of getting a lucrative piece of the pie forever. And the piece is really big. The last year revenues of IAS-related service companies went up by 55.4% and amounted to 2.1 billion rubles (diagram 4). The share of the sector in the general audit-consulting services reached 8%.

The service would only be gaining popularity. Says Evgueny Samoilov, general director of Baker Tilly Rusaudit: “We think that increased demand for IAS services is conditioned by the financial market growth. Reporting in keeping with IAS is demanded by investors and creditors. Particularly, about 30% of the “third echelon” companies at the bond credit market prepare their reporting in line with IAS. We assume that this year the number of such companies would grow up. It is important to note: currently many companies are incapable of preparing their reports. They lack legally incorporated holding structure or legal model of tax optimization. Sometimes restructuring process may take two years – which creates pent-up demand to be realized only in 2008”.

As to IAS structure, the largest share is taken by services in the sphere of audit in line with international standards — 53.8%. Annual proceeds of companies in this segment have increased by 68.7% (diagram 5). 543 enterprises from industrial sectors have already turned to auditors for services.

Services to transform reporting have remained widely claimed as well. Annual increment in the sector amounted to 86.6%. A number of enterprises receiving such services have also gone up, from 366 to 483.

But the above services were mostly demanded by investment and insurance companies. The segment revenues in 2005 were nothing more than 3.6 million rubles, but the figure in the past year was 9 times more and reached 30 million rubles. The number of clients remained unchanged in practical terms (18 against 17).

IAS-related consulting and training services were also popular among investment and insurance companies. Annual revenue of ACGs in the sector increased by about 6 times – from 2.2 to 14.5 million rubles. It is easy to calculate the increase of prices for the two services. This is a classical example of growing prices due to increased demand.

Elena Troubnikova, Finexpertiza managing partner, says: “International standards are directed towards money. Demand for IAS-related services grows up together with investments, that is, very rapidly. Demand for transformation of reporting and for training grows faster than average level. The consultant duty under the circumstances has also been transformed from purely technological reporting service to organization of accounting. Companies have already understood the inevitability of IAS and made logical steps to resolve the problem in a systemic way”.

Long-standing quality worries

Regional expansion of large Moscow ACGs has gone outside purely commercial or enlightenment interests. The plans proved to be more sweeping and pragmatic. The issue at hand is to fight existing dumping and low quality of audit services.

Sergey Shapiguzov says: “Dumping rates are offered by those who sell pseudo-services instead of audit — like signing audit report without conducting necessary works. Clearly, prices for such services are minimal. If we do away with such companies, the amount of dumping would be less. Our clients should be able to see the difference in the quality of services. How can you fight “black auditors”? Probably, the best healer is time. But the audit laws should be constantly perfected, too”.

Evgueny Samoilov has his say on the topic: “The main reason for dumping at the market is absence of systemic quality control. Our clients do not see procedural part of auditor’s work, they get only an audit report with the auditor’s expressed opinion about credibility of accounting and reporting. The fullness and quality of the auditor’s work may be assessed only by another auditor – quality inspector. Only a normal system of quality control will allow to clear impostors away, otherwise nothing will change. Current situation drives professionals out of the business to further diminish quality standards and devalue the auditor status. At present the profession lacks unanimity of approach, for instance, there are several SROs paying priority attention to a “number of members”, not to quality of work”.

According to Andrey Doubinsky, lower quality of audit services can be objectively explained by reduced influx of qualified personnel to the audit sector in favor of the corporate sector, and by absence of legal demands related to responsibility of an auditor for poor quality of his work and to the size of mandatory insurance of professional liability. Many audit companies have not been ready for increased demand for their services and have to turn away new clients. New and mostly non-standard services pretty often are provided by specialists without necessary experience and proper training.

Market participants find the state partly responsible for lower quality of audit services. Aleksey Rouf: “Russian legislation should reintroduce the norm of necessary participation of auditors in authorized capital of audit organizations – it will bring to a necessary level the quality of work of all Russian auditors, in case of their SRO membership. Then we shall be able to locate 36.7 thousand auditor’s certificates, issued by the state regulator, and manage “quality of audit” instead of “audit risks”. The main thing is to make real contribution to improvement of quality and credibility of financial reports in Russian enterprises”.

Quick transformation to market relations in Russia may be another reason for poor quality, according to the market participants; one group of specialists was building business without time to study, others acquired theoretical knowledge having no time to accumulate practical experience and foster their knowledge. At present companies lack specialists capable of preparing business and structural elements – on the basis of historic factors – to satisfy expectations of current and potential owners and prove validity of their assumptions towards current situation and business prospects.

The quality problem is especially urgent in the sphere of compulsory audit – state unitary enterprises (SUE) are also liable to it. That is where the real fight is in store. State structures live their own life, and market participants themselves are sometimes incapable of reversing the trend of many years. The state support is required. Mutual activity of SRO, representing interests of auditors, and the state will determine the market fate.

Sergey Shapiguzov: “True, state unitary enterprises have no internal motivation for compulsory auditing. ОАО have external users interested in objective information of what is going on. SUEs mostly are not properly controlled by their owner and have no special structure to control auditor’s work. At best they are interested in accounting or tax consulting, at worst – only in a signed audit report for minimum pay. No doubt, you should not paint in black all SUEs, some of them show good attitude to normal audit. They need quality audit to attract investments and get a report, good enough to satisfy an external investor, who has no doubts about credibility of the presented information. But some of SUEs do not require such auditing. And, to my mind, “some” in this case means “majority”, therefore such SUEs prefer to deal with small audit companies”.

Andrey Doubinsky says: “A lot depends on the way the law “On audit activity” will be finally updated. If it contains amendments aimed at minimal satisfaction of the administrative reform in the area of handing some of supervision functions over to self-regulating organizations (SRO), the market of audit services would show consistent growth without any significant redistribution of market shares between its participants. But another option is also possible, related to radical reforming of the whole system of auditing, and the corporate governance sphere in particular. According to the draft developers, Russia has too many public structures liable to compulsory auditing. Besides, the goals of audit for enterprises of different scale with different types of owners are not always clear. The list of companies liable to compulsory auditing may be shortened by increasing threshold criteria by volumes of proceeds or size of assets”.

Darya Dolotenkova, chairman of the board of the Institute of Professional Auditors (IPA): “Audit is a natural instrument of controlling business. IPA’s main goal at the current self-regulating stage is to separate reliable audit companies from negligent ones and make a point of informing users. IPA publishes information about results of quality control and excluded companies. We increase demands for joining SRO, quality criteria to audit companies, professional requirements to controlling structures. To enhance the profession status we launch a project to train auditors at the best IPA companies and provide them with correspondent certificates. We regularly cooperate with users of audit services, state structures and public bodies”.