So where’s the relief?
Public companies expected a spike in audit costs in 2004 as they moved to become compliant with rules under Sarbanes-Oxley accounting reform.
The requirements for setting up internal controls were particularly costly. They included new documentation procedures and more oversight for managers.
2004 was the ramp-up year, but the hope was that 2005 would provide a big reprieve.
It didn’t happen.
Though overall accounting expenses decreased in 2005, audit fees rose nearly $300,000 for the average company to about $4.4 million. That’s up about 7%, according to a study by Chicago law firm Foley & Lardner LLP.
The increase might not seem like much, but audit fees already had shot up about 65% the previous year, and were thought to be on the way down.
“The point is there was not a dramatic change,” said Tom Hartman, the lawyer who authored the study for Foley & Lardner.
Accountants said regulators continued to demand more from the internal controls requirement laid out in Section 404 of the 2002 Sarbanes-Oxley Act.
2006 could shape up to be a better year for companies as the emphasis turns toward streamlining procedures to meet Section 404 requirements.
“We’ll continue to be more efficient,” said Rick Rayson, managing partner with Deloitte & Touche LLP in Costa Mesa.
The smaller the company, the bigger the proportional hit from audit fees last year, according to the Foley report.
Smaller companies with market values from about $300 million to $2 billion saw an increase of 22% in audit fees to $1.3 million in 2005, the study found. In 2004, costs had nearly doubled.
Midsized public companies saw an increase of 6% in audit fees last year. In 2004, audit costs at this crop of companies was up 92%.
The largest companies, which make up the S & P; 500 index, saw an increase in audit fees of 4% to $8.4 million in 2005. The costs were up 56% the previous year.
Some Good News
There was some positive news in the report. When companies listed all areas of accounting costs, including ones that are more intangible, overall expenses were down.
Companies with more than $1 billion in annual revenue saw accounting costs fall by 6%, the first cut since the study began four years ago. Companies with less than $1 billion in revenue saw a decline of 16% in overall accounting costs.
The biggest change came in the area of productivity,or the amount of time workers spent on Sarbanes-Oxley that they otherwise would have spent on different tasks.
For companies with more than $1 billion in annual revenue, lost productivity was $2.5 million last year, down from $2.9 million in 2004.
Companies with less than $1 billion in revenue saw a much bigger decline in lost productivity, down 46% to $563,000 in 2005.
Accounting costs fell in other areas: set-up costs for Sarbanes-Oxley and legal fees. Audit fees are different because they’re paid with cash, unlike lost productivity.
The rise in audit fees is a significant cost, especially to smaller companies, Hartman said.
One in five companies have considered going private, according to the report. One in 10 have pondered a sale. Both figures are in line with the previous year’s results.
More than four in five companies said corporate governance rules are too strict. And for the first time, no respondent to the survey said the rules were “not strict enough.”
Even the Securities and Exchange Commission admitted as much in a recent release, saying that while Section 404 has produced benefits, “its implementation has been unduly costly.”
Looking Back
Initially, the job of getting companies compliant with Section 404 was huge. Executives and managers scrambled in the wake of the Sarbanes-Oxley Act to find new ways to identify and document processes and general checks and balances.
Section 404 essentially was an effort to build enough internal controls in a company to prevent and detect financial reporting errors and fraud by employees and executives.
“The year one costs included internal costs, basically doing all the documents, many of which (were created) from scratch,” Rayson said.
Then in 2005, the Public Company Accounting Oversight Board and SEC stepped in and told accountants they needed to boost their focus on areas that were neglected in year one.
There was a call for more attention to tax provisions, anti-fraud programs and management override standards along with controls in some areas that covered complex financial transactions such as derivatives.
This required more audit work,and offset the gains in efficiencies that were gained after the initial setup of the accounting systems.
Now it looks like there might be some pullback, partly because of political pressure stemming from Section 404 complaints.
“Year three will be interesting,” Rayson said.
In May, the Public Company Accounting Oversight Board said it was considering lightening the audit load for public companies. A final decision is expected in the coming months.
“While preserving the principles of Auditing Standard No. 2, the board plans to consider amendments that would ensure that auditors’ primary focus during an integrated audit is on areas that pose higher risk of fraud or material error,” the group said.
Areas to be addressed include:
Clarifying the definitions of significant deficiency and material weakness in internal control.
Reconsidering “strong indicators of a material weakness” to allow for more judgment in determining whether a deficiency exists.
Guiding auditors to increase their use of the work of others where appropriate.
Allowing for and promoting auditors’ use of experience gained in previous years’ audits to focus and make most efficient the work in subsequent years.
“I think you’re going to see a change in the environment,” said John Poth, audit partner at Haskell LLP in Irvine.
Rayson said there could be “a slight decrease overall this year” in audit fees, though it would vary by company.
