New Laws, New Challenges: Implications of Sarbanes-Oxley. (Financial Reporting)

By Felo, Andrew J.; Solieri, Steven A. | Strategic Finance, February 2003 | Go to article overview

New Laws, New Challenges: Implications of Sarbanes-Oxley. (Financial Reporting)


Felo, Andrew J., Solieri, Steven A., Strategic Finance


Amid recent corporate scandals, investors, regulators, and politicians have asked, "Where were the auditors?" The Sarbanes-Oxley Act of 2002 was designed to combat the perceived ineffectiveness of the external audit.

"This is the most fundamental, far-reaching legislation to affect the accounting profession since the 1930s," says Dana Hermanson, director of research at the Corporate Governance Center at Kennesaw State University and member of the National Association of Corporate Directors' (NACD) Blue Ribbon Committee on Audit Committees. "Its impact will be felt for years," he emphasizes.

Outspoken educator Dr. Abraham J. Briloff, Emanuel Saxe Distinguished Professor Emeritus at Baruch College in New York, applauds Congress for passing the law. But he adds that its success or failure will be in the detailed implementation and administration. "If political judgments prevail, instead of market and professional forces as were stated in the original objectives, I am afraid that we will inevitably be back at our original starting point, and we will be no better off for all our efforts," Briloff says.

Probably the Act's single most significant component is the creation of the Public Company Accounting Oversight Board (PCAOB). The Board will establish standards, perform quality reviews of auditing firms, and investigate and discipline firms and individuals. Since Congress believed that having an oversight board dominated by CPAs might be too close for comfort, only two of five members can be CPAs, even though some argue that this restricts accounting and auditing expertise. Board members are required to serve full-time, and they are prohibited from receiving payments (other than retirement payments) from public accounting firms.

The Act also requires public accounting firms to retain documents prepared to support their audit reports for at least seven years. That may make it easier for the Board to determine if audits were conducted improperly.

NEW INDEPENDENCE

Impaired auditor independence is commonly cited as a major factor in the recent scandals, based on the assumption that cozy relationships between auditors and clients increases the likelihood that auditors may "look the other way" or, worse, help falsify financial reports. Lead auditing or coordinating partners and reviewing partners must now rotate off an audit engagement every five years, and the General Accounting Office (GAO) will study the possibility of mandatory firm rotation.

At a roundtable on Sarbanes-Oxley hosted by the Technology Executives Roundtable in Atlanta, Tim Bentsen, partner-in-charge of KPMG's MidSouth Business Unit, noted that the law will change both the expectations and costs of auditing. "The cost of auditor rotation--the five-year requirement--that's an added cost in terms of bringing somebody back up to speed and having the right person with the right experience," Bentsen said.

Although more manageable than requiring companies to rotate audit firms on a predetermined schedule, the provision could result in executives (particularly CFOs) spending additional time on the annual audit in order to help audit firm personnel get up to speed. If having a "fresh set of eyes" involved in an audit improves auditor independence, however, this may be time well spent.

Another restriction is likely to have a significant impact on how companies fill key positions. A company is prohibited from hiring anyone who has worked for its audit firm during the one-year period preceding an audit. The affected positions are CEO, CFO, controller, chief accounting officer, and equivalent jobs. The prohibition isn't limited to the audit team; it covers any former employee of the audit firm.

When audit firms provide nonaudit services to clients, auditor independence appears to be impaired. Even if an auditor's judgments aren't clouded, the appearance of a conflict may be problematic. …

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