Sarbanes-Oxley a Boon for Auditors

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The New York Sun

Micros Systems Inc. is awash in accountants. Eleven auditors from PricewaterhouseCoopers LLP are scouring its books and 10 consultants from Deloitte & Touche LLP are examining its financial controls as the company tries to meet new federal rules by a November 15 deadline.


The Columbia, Md.-based maker of restaurant computer networks will spend as much as $4 million over two years to comply with the Sarbanes-Oxley Act of 2002.That’s almost triple Micros Systems’ original estimate and equal to 12% of its fiscal 2004 profit, said the controller, Cindy Russo.


Congress passed Sarbanes-Oxley to tighten financial reporting at public companies and police outside auditors after accounting fraud caused the collapse of Enron Corp. in 2001 and World-Com Inc. in 2002.The law has become a windfall for accounting firms that failed to stop the fraud and that fought passage of the bill. Audit bills have risen 50% in two years, according to the newsletter Public Accounting Report.


“It’s an open checkbook,” said Ms. Russo, 34. “It’s a tremendous hit to our bottom line.”


Corporate accounting costs are soaring as public companies approach the November deadline for meeting Section 404 of Sarbanes-Oxley. It requires companies to set up and test internal controls such as those for inventory and cash balances. Outside auditors then must check and approve those controls, the law says. That’s on top of the firms’ usual work of auditing clients’ books and providing tax advice.


All companies traded on American exchanges, including non-American ones, must comply with the law.


The result is more fees for accounting firms such as Deloitte, the largest by revenue of the four biggest firms, and PricewaterhouseCoopers, the third, as well as Ernst & Young LLP, the no. 2 firm, and KPMG LLP, no. 4.All are based in New York.


“The audit firms were not doing their jobs,” said Mark Lilling, 54, a Great Neck, N.Y.-based chartered accountant and CEO of Audit Committee Consulting Team LLC, which advises board audit committees. “Congress’s solution was to make the audit firms do more work.”


Audit costs rose in the previous two years as companies put new controls in place after the accounting scandals at Enron and WorldCom, as well as Tyco International Ltd. in 2002.The average cost of a public-company audit rose 15% to $650,504 in 2003 following a 30% jump in 2002, a compounded rise of 50%, according to an April survey by Public Accounting Report.


Just two years ago, the firms were fighting the law proposed by Maryland Senator Paul Sarbanes, a Democrat, and Ohio Congressman Michael Oxley, a Republican.


The proposed bill would be a “de facto government takeover of the accounting profession,” according to a June 2002 memo from the American Institute of Certified Public Accountants. “These provisions would needlessly raise costs to business and make it more difficult for companies to prosper and grow.”


In July 2002, WorldCom filed the largest Chapter 11 bankruptcy in American history after announcing it would have to restate $11 billion in earnings because the long-distance phone company had filed false financial statements. Sarbanes-Oxley passed both houses of Congress and was signed into law by the end of the month.


“The accounting firms were vehemently opposed and would have killed it if WorldCom hadn’t come along,” said the director of investor protection for the nonprofit advocacy group Consumer Federation of America, Barbara Roper, 48.


The law they opposed has brought the firms an avalanche of auditing assignments.


“We have more audit work than we’ve ever done before,” said the 49-year-old chief executive officer of Chicago-based Grant Thornton LLP, Edward Nusbaum. Revenue of the no. 6 accounting firm rose 25% to $459 mil lion last year and Grant Thornton forecasts an increase of 23% in 2004. “Everyone is looking for more accountants. We’ve added 27 partners this year and we’re still looking.”


At the four largest accounting firms, revenue from audit fees alone rose 15% in 2003 from the year before, according to Public Accounting Report.


“It’s like nothing I’ve ever seen, and I’ve been in the field 35 years,” said Leland Graul, 55, director of the audit practice at New York-based BDO Seidman LLP, the seventh-largest American accounting firm.


Section 404 alone will add 30% to 40% to his clients’ accounting bills in 2004, Mr. Graul said. BDO Seidman had $350 million in revenue last year.


More work hasn’t necessarily brought more profit to all the firms, which as private partnerships don’t disclose their net income. While Sarbanes-Oxley generated accounting fees, it also banned much of the firms’ most lucrative business – the consulting work for clients that eventually created conflicts of interest. The Internal Revenue Service has prohibited many tax shelters sold by the firms in the 1990s.


“Sarbanes-Oxley created more work with 404 reporting, but took some work away,” said the vice chairman of Ernst & Young, Robert Guido, 58.


The firms may no longer provide most consulting services, including bookkeeping, actuarial or investment work, or design computer systems. Consulting accounted for an average 35% of revenue for the four firms in 1999,according to Public Accounting Report.


For investors, the benefits of Sarbanes-Oxley are marginal and don’t merit the added expense, said James Halloran, who helps choose $33 billion in investments at National City Private Client Group in Cleveland.


“You’ve created a slightly better environment for investors, but it’s overkill,” said Mr. Halloran. “You’ve taken decent companies and caused them to incur an unnecessary expense to verify something that was already there.”


At Yellow Roadway Corp., the biggest American trucking company, the new rules meant adding 50 new auditing procedures to increase scrutiny in payroll, bank-account management, and billing, said the company’s general counsel, Dan Schuray.


Yellow Roadway, based in Overland Park, Kan., will pay about $4 million in auditing and consulting fees this year, compared with $1.8 million last year, said Mr. Schuray, 41.


“I question the expense and the effort,” he said.


If outside auditors find any “material weakness” in a company’s internal controls after November 15, they must send a letter to the company reporting it and file a copy with the Securities and Exchange Commission.


“No one wants to get that letter,” said Mr. Schuray.


Uncertainty over what constitutes a material weakness has spurred many companies to spend more than needed, just to be safe, said the vice president of finance at Edina, Minn.-based Regis Corporation, which owns Supercuts hair salons, Kyle Didier.


“You’re somewhat at the mercy of the auditor’s opinion,” said Mr. Didier, 38. “It’s a windfall for the accounting firms.”


On top of the audit fees, Sarbanes-Oxley compliance is burning up more employee time than forecast, companies say. Those in the Financial Executives survey estimated they would use an average 25,667 worker hours this year.


“The rules were a lot deeper and more detailed than expected,” said Mel Rothlisberger, corporate audit vice president of Dana Corp., the largest maker of light-truck axles. “I don’t think there was an understanding of how complex this would be.”


To ensure its inventory controls were working, Toledo, Ohio-based Dana dispatched internal auditors to 55 of the company’s 100 plants and warehouses where they checked the serial numbers of gaskets and axle parts against inventory controls. Dana is spending about 50% more than projected for Section 404 compliance, said Mr. Rothlisberger, 60.


The soaring costs are a sign that companies are fulfilling the goals of Sarbanes-Oxley, said the SEC’s chief accountant in Washington, Donald Nicolaisen.


“While I am sure it wasn’t Congress’s intent to pass an ‘accountants’ full employment act,’ these rules on internal controls are going to change financial reporting and make it much more transparent,” said Mr. Nicolaisen, 60.


More than just corporate bottom lines are at stake, said William McDonough, chairman of the Washingtonbased Public Company Accounting Oversight Board, the independent agency created under Sarbanes-Oxley to monitor the auditors.


“Section 404 is such an important part of restoring investor confidence that it is worth the cost,” Mr. McDonough, 70, said at an August press conference in Washington.


The board will audit the work of the biggest four accounting firms every year and examine the performance of smaller auditors on a rotating basis. That surveillance replaced a system of “peer review” in which the firms monitored one another. The law also gave board audit committees, instead of management, the power to hire and fire auditors.


“The law has put accounting in a spotlight,” said Charles Niemeier, a member of the oversight board.


For companies, the higher audit costs show no signs of going away, says Gordon Parnell, chief financial officer of Microchip Technology Inc. The Chandler, Arizona-based maker of semiconductors has added five financial managers to track transactions at a cost of about $200,000 and expects to spend 60 percent more in audit fees this year than last, he says.


“A significant portion of it will be ongoing,” Parnell says, because companies will have to prove each year that their controls meet Sarbanes-Oxley standards.


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