Audit & Accounting

Regulators at the Public Company Accounting Oversight Board are wrestling with proposals to abandon the current "pass-fail" auditor reporting model for informing investors of the accuracy of corporate financial statements -- a move that could require independent accountants to provide considerably more information about the veracity of their clients' financial reports. But critics of the plan for requiring auditors to provide a more detailed discussion of their views of corporate financial statements are warning the PCAOB that such a shift in auditor reporting standards would create more confusion than enlightenment for most investors. Under the current ground rules, auditor reports filed with the Securities and Exchange Commission must include unqualified opinions "stating that the company's financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conforming with GAAP." Some members of the PCAOB's Standing Advisory Group however, have warned the board that this approach effectively establishes a pass/fail system under which investors are provided with no information to distinguish between companies with borderline financial statements and those with highly accurate statements. "The problem with the current (pass-fail) model is that if you have a company that is trying to push the line as far as they can get away with, the auditor's report would provide that company with essentially the same rating as one that does an excellent job of providing high quality financial information," Consumer Federation of America Investor Protection Director Barbara Roper told the PCAOB. At the Feb. 16 SAG meeting, Roper argued that a change in the auditor reporting model to allow accountants "to provide more insight into the audit report" would make it more difficult for companies to do the bare minimum to achieve a GAAP "passing" grade. Other SAG members disagreed, warning that providing anything more that the auditor's pass-or-fail rating might confuse investors. "The investing public should be able to read a financial statement and pretty much get out of it what's good and what's bad," Dallas CPA Wanda Lorenz told the board. Providing more detailed - but potentially more ambiguous -- information about the auditor's opinion may not be helpful to the average investor, she maintained. Those views were echoed by SAG member Lynn Turner, managing director at proxy researcher Glass-Lewis, who told the board that "because of the level of sophistication of the average investor, you have to keep in simple." In voicing concerns about a shift to more detailed auditor disclosures, Turner - a former Securities and Exchange Commission Chief Accountant - urged the PCAOB to be sensitive to the needs of investors who already find financial reports difficult to understand. "You have to keep it simple," he said. "You have to tell them whether the numbers are right or not right...in simple language."

High-profile Texas investor and entrepreneur Sam Wyly has filed an $80 million suit against Big Four firm Ernst & Young, charging that the firm's audits of troubled Computer Associates influenced his decision to sell his company, Sterling Software, to CA in a stock transaction. According to published reports, Wyly's suit, which was filed in Texas District Court here, said that he relied on E&Y audits for CA's fiscal 1999 to sell his company to the concern for stock. Roughly one month later CA's shares plunged some 12 percent when its earnings reports were delayed, and then fell further when the company failed to make its earnings forecast. Computer Associates replaced E&Y in 1999 with Big Four rival KPMG. "We believe the case is without merit," said an E&Y spokesman. Computer Associates ultimately became mired in a $2.2 billion accounting fraud, a scandal that led to the ouster of several members of its top management, including chief executive Sanjay Kumar. The company had been backdating purchase orders and keeping the books open past the period close. Recently, the company named former Dell executive Robert W. Davis as executive vice president and chief financial officer, replacing Ira Zar, who last year plead guilty to securities fraud. Last week, interim chief executive Kenneth D. Cron, who was picked to replace Kumar, stepped down, and president and CEO-elect, John Swainson assumed the reigns of the Islandia, N.Y.-based company. The suit marks the latest go-round for Wyly in his battles with CA and related parties. Four years ago, he led a proxy battle to unseat management, and later filed another suit in an attempt to have management return their bonuses.

A survey of 220 businesses revealed that while compliance costs associated with SOX Sections 404 and 302 are front-loaded, once companies are through the process, there is a great deal of proportional value. The poll, conducted jointly by International Data Corp. and RevenueRecognition.com, also noted that a compliance "chasm" exists and that companies that have crossed it have achieved more effective results at less cost. IDC asked respondents to rate the cost of six major Sarbanes-Oxley compliance tasks, and also to judge the effectiveness of those tasks for improving risk management. The cost and effectiveness ratings were roughly even for activities such as documenting accounting policies, certification and sign off on internal controls, certification of financial statements, and responding to external audit attestation processes. However, the cost of documenting internal controls was rated substantially higher than its effectiveness for improving risk management, and the cost of repairing any weaknesses was rated substantially lower than its effectiveness for improving risk management. The survey focused on costs for internal resources and outside consulting from both Big Four and non-Big Four audit firms. The resource requirements to support SOX increased in direct proportion to the size of organization based upon revenue. For public enterprises with more than $1 billion in revenue, the average amount of labor spent on compliance activities was more than 12 person-years. Companies in the $200 million to $1 billion revenue range averaged more than six-and-a-half person-years of effort. Furthermore, the cost of external auditing services increased 52 percent for public companies. Midsized companies with $200 million to $1 billion in revenue reported an 81 percent average increase.

In the wake of a number of national restaurant operators having to restate earnings due to lease accounting errors, the Securities and Exchange Commission advised restaurant companies to assess the impact of such errors in order to determine whether restatements are necessary, according to The Wall Street Journal. In a letter sent to the American Institute of CPAs, SEC chief accountant Don Nicolaisen wrote that restaurateurs who "determine their prior accounting to be in error should state that the restatement results from the correction of errors, or, if restatement was determined by management to be unnecessary, state that the errors were immaterial to prior periods." Operators such as Red Lobster and Olive Garden parent Darden Restaurants Inc.; Brinker International, operator of the Chili's and Macaroni Grill concepts; and Carl's Jr. parent company CKE Restaurants Inc., have all restated financials due to lease accounting errors.

As part of the 91 inspections of smaller audit firms performed over the course of 2004, the Public Company Accounting Oversight Board identified "significant" deficiencies in two of the firms, one finding of which was significant enough to question the firm's audit opinion. According to BNA, the two firms were identified as Dudley, Hopton-Jones, Sims & Freeman, of Birmingham, Ala., which had one Securities and Exchange Commission issuer client at time of the inspection, and Clyde Bailey PC, a sole practitioner in San Antonio with 17 publicly traded clients. With regard to Dudley Hopton-Jones, the oversight body unearthed deficiencies such as inadequate testing of the client's self-insurance reserve, and called into question the firm's audit opinion. The board's report on Clyde Bailey revealed a host of problems, including "inappropriate farming out of substantially all" audit work to another auditor and a number of departures from generally accepted accounting principles. Meanwhile, Dayton, Ohio-based Battelle & Battelle, with four public clients, received a clean audit inspection but did not get a sign-off on its quality control system. The PCAOB will make the quality controls findings public after one year should the firm fail to address them. The firms receiving clean inspection reviews were: Gelfond Hochstadt Pangburn, in Denver; Moore Stephens Frost, of Little Rock, Ark.; Ramirez International Financial & Accounting Services, in Irvine, Calif.; Richard Browne & Co., of Tampa, Fla.; and Saslow Lufkin & Buggy, in Avon, Conn.

AeA, a large trade association to the high technology sector, said that the impacts of the Section 404 requirements of Sarbanes-Oxley is "devastating" to small and midsized companies, and estimates its true implementation costs at $35 billion, compared to Congress' initial projection of $1.25 billion. In a report titled 'Sarbanes-Oxley Section 404: The 'Section' of Unintended Consequences and its Impact on Small Business,' the group makes a series of recommendations to the Securities and Exchange Commission, the Public Company Accounting Oversight Board and Congress, including suspending the 404 mandate for companies with annual revenues of under $1 billion and a proposal to allow companies to annually rotate the internal controls that are scheduled to be tested. "This is the quintessential example of the law of unintended consequences, and Section 404 of Sarbanes-Oxley is not meeting its objectives. It has been an unnecessary burden for small- and medium-sized companies throughout the United States, and while Section 404 is well intentioned, the tremendous increase in cost to smaller companies is out of control," said William T. Archey, president and chief executive of AeA. Alex Davern, chairman of AeA's Sarbanes-Oxley Advisory Committee and chief financial officer at National Instruments Corp., said, "Smaller companies neither require, nor can they afford, the same level of investment in internal controls as larger companies. Implementation of Section 404 needs to be reevaluated and modified to prevent permanent damage to the small- and medium-sized businesses that are the job growth engine of the U.S. economy." A copy of the report can be found at http://www.aea

A startling 90 percent of Americans are worried about their retirement savings, even prior to President Bush unveiling his sweeping second-term agenda, which includes a series of reform measures topped by revamping the Social Security system. Some 57 percent of consumers participating in a survey by banking and financial services conglomerate Wachovia Corp. said that they often worried or sometimes felt worried about how well they will be prepared for retirement, while 32 percent said that retirement savings was an occasional worry. Wachovia's survey -- conducted prior to the election -- included 2,100 consumers with household income or investments exceeding $75,000. It was conducted last fall, before Bush won re-election. 36 percent admitted that they weren't saving enough for retirement, while another 11 percent were worried but were confident that they were pursuing the right course of action. Just 16 percent of the survey participants expressed confidence that they would receive Social Security benefits when they retired. And 50 percent were skeptical of the president's plan for private accounts, saying it was too risky for their retirement savings.

Former Senators Connie Mack and John Breaux, chairman and vice-chairman of the President's Advisory Panel on Federal Tax Reform, have scheduled the panel's first meeting for Feb. 16, 2005. Witnesses will be Fred T. Goldberg, a partner at Skadden, Arps, Slate, Meagher & Flom LLP, and a former commissioner of the Internal Revenue Service; Louis Kaplow, a professor of law and economics at Harvard Law School; William G. Gale, co-director of the Urban-Brookings Tax Policy Center; and Stephen J. Entin, president and executive director at the Institute for Research on the Economics of Taxation. Treasury secretary John Snow will also appear before the panel. "The president has tasked our panel with developing reforms to make the tax code simpler, fairer and more growth-oriented," said Senator Mack. "I look forward to the opportunity to hear from Secretary Snow as well as this distinguished group of experts as we begin the process of examining the problem and formulating solutions." "The current tax system is an unfair burden on Americans," added Senator Breaux. "When it takes the average taxpayer 11 hours to fill out the short tax form, something is wrong. This is a unique opportunity to work in a bipartisan effort and find ways to make the tax system serve Americans better." The witnesses will provide the panel with a historical overview of the current tax system and an understanding of how it evolved and where it is today. The panel will also hear background about tax systems. In particular, the witnesses will explain the difference between a tax on income and a tax on consumption, how the different bases impact the overall functioning of the tax system, and the advantages and disadvantages of each one in terms of simplicity, fairness and economic growth.

Securities and Exchange Commission Chairman William Donaldson said that his agency would examine the possibility of modifying or rewriting some current rules, such as the ones requiring stricter internal controls, granting investors power to nominate board members, and governing the methods in which stocks are traded. In published reports, Donaldson said that, while the regulator might be considering any or all of the above-mentioned refinements, the SEC has not abandoned its plans to impose fines for both individual and company wrongdoers. Donaldson said that he hopes the watchdog will approve a measure that would give shareholders more power to elect board members of their choosing, but the rules in their present form may have to be rewritten. A host of business groups have lobbied against the shareholder-nominating proposal, claiming it would cater to special interest groups.

While the current Social Security system is not in crisis mode, it faces serious problems with regard to solvency and sustainability, according to the Government Accountability Office. The auditor general said that if nothing was changed with the 70-year-old program until 2042, "achieving an actuarial balance" would require a 30 percent reduction in benefits or a 43 percent increase in payroll taxes. The GAO also labeled Social Security's problems "a subset of our nation's overall fiscal challenge." Absent reform, the country would have to choose among escalating federal deficits and debt, gargantuan tax increases, or federal budget cuts. However, the GAO warned that when evaluating any reform measure, financial stability should not be the sole criteria. A equitable balance with regards to benefits, as well as administrative and operational issues, also require consideration. The auditor general added that any changes enacted with Social Security should be made "in the context of the broader challenges facing our nation," such as those concerning private pension systems, Medicare and Medicaid.