In what may be the era of scandal fatigue, there is no shortage of work for the accounting profession as it tries to fix a reputation tarnished by the blow-ups of Enron Corp., WorldCom Inc. and a host of other clients.
As Warren Buffett once said, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."
These days no one knows that better than auditors. "We need to keep in mind that no profession can take its position for granted," Bob Bunting, chairman of the American Institute of Certified Public Accountants, said in a recent speech.
Here are 10 hot topics with accountants:
1. The Power of Four
The surviving Big Four accounting firms are more powerful than ever.
The same scandals that brought down Arthur Andersen also gave rise to an avalanche of work generated by the stricter accounting and audit standards in the Sarbanes-Oxley corporate-governance bill. More work and fewer hands in turn have delivered greater leverage for demanding - and winning - higher fees at PricewaterhouseCoopers LLP, Deloitte & Touche LLP, Ernst & Young LLP and KPMG LLP. The Big Four are even rejecting jobs and leaving clients when the risks seem to outweigh the potential rewards - a stance they could rarely afford when the industry was more crowded.
Adding to demand for the Big Four's services: a requirement by Sarbanes-Oxley that public companies assign certain consulting and auditing work to different firms. Sun Microsystems Inc., for example, employs all of the Big Four for auditing, tax and internal-control work.
In a 2003 report, the Government Accountability Office reported that the Big Four audited more than 78% of all U.S. public companies' books. So pressed are the biggest firms to fill current corporate demands, some believe that if another Andersen-style implosion were to occur, public companies could have trouble securing as much auditing and accounting help as they need.
2. Where the Money Is
A few years back, the annual audit was one of the best bargains around. The accounting firms used it as a way to get their foot in the door and sell other services like information-technology consulting. But the accounting scandals of the past three years have persuaded many corporate audit committees that this isn't the place to skimp. Now audit committees want more, not less, in an audit, and they're willing to pay up.
According to AuditAnalytics.com, which tracks accounting issues, 2004 audit fees for companies in Standard & Poor's 500-stock index as of mid-December were running 25% higher than a year earlier; and in 2003, they climbed 18%. Fees for services other than audits, such as internal-financial-control reviews and consulting, were up 28% in 2004 over 2003.
"You might even expect higher increases in audit fees going forward," says Mark Cheffers, a spokesman for AuditAnalytics.com, a unit of the audit company Ives Inc. of Manchaug, Mass.
3. Tax-shelter Crackdown
Here's one service that Uncle Sam hopes accounting firms will sell less of in 2005: abusive tax shelters.
Such shelters, or transactions with no real business purpose other than to dodge taxes, cost the U.S. Treasury tens of billions of dollars over the past decade. In the past year, the Internal Revenue Service has cracked down on the structures, with mixed results.
One of the most scrutinized peddlers has been KPMG. Its past sales of shelters with names like "FLIP" and "OPIS" were highlighted in hearings of the Senate Permanent Subcommittee on Investigations, and they are the subject of an investigation by the U.S. attorney's office in New York. KPMG says it is cooperating with the IRS and prosecutors.
In October, President Bush signed legislation increasing the IRS's power to police the issue. And last month, the Public Company Accounting Oversight Board issued a proposal that would prevent accounting firms from auditing public companies to which they sold shelters that the IRS has since denied. The board, a nonprofit created by Sarbanes-Oxley to oversee auditing of public companies, is accepting comment on the proposal, which would go into effect in late 2005 if approved.
4. The Middle Gets Bigger
With the Big Four stretched thin, can midsize firms increase their share of business from public companies?
It is already happening. The eight midtier firms that had the most turnover in audit clients in the first eight months of 2004 took a total of 143 clients from the Big Four, according to the International Accounting Bulletin, a newsletter from the financial services intelligence firm VRL Publishing in London. Only 10 companies switched from a midtier firm to a Big Four auditor. In the same period of 2003, midtier firms gained 104 clients and lost 11 to the Big Four.
While the bulletin's editor, Marc Barber, questions whether the numbers signal any sort of sustainable trend, those in the middle have no doubt.
"In the past year and a half, second-tier firms have shown that they can handle companies once thought to be handled only by the Big Four," says Thomas J. Marino, chief executive of midtier accounting firm J.H. Cohn LLP in Roseland, N.J. Over the past seven years, J.H. Cohn has bought 14 smaller firms. The largest of the acquired firms had $22 million in annual revenue.
5. The Cost of Controls
Just say "404" to a corporate executive, and you're likely to hear a litany of complaints. The number refers to the section of Sarbanes-Oxley requiring public companies to report on the adequacy of their internal financial controls. For many companies, the rules took effect on Nov. 15. But the costs and hassles of compliance started earlier.
A report last August from Financial Executives International, a Florham Park, N.J., group that studies issues affecting top corporate officials, said that the total average cost of 404 compliance had soared 62% to $3.1 million from an estimated $1.9 million six months earlier. The group surveyed 224 companies with revenue averaging $2.5 billion.
"No one had any idea how big a task this was," says Colleen Sayther, president of Financial Executives International.
"If you look at something like Enron and WorldCom," Ms. Sayther adds, "even if they had full documents about their internal controls, it might not have made a lick of difference."
The Public Company Accounting Oversight Board stands by the requirements of 404, which it helped write. To be more accommodating, however, the Securities and Exchange Commission recently extended by 45 days the end-of-fiscal-year 404 reporting deadline for some smaller companies.
6. Adding Up Their Own Beans
Accountants have more beans to count - on the job and in their wallets.
Pay increases are occurring at both public accounting firms and corporate internal-audit departments. According to Robert Half International Inc., a financial recruiting service based in Menlo Park, Calif., average starting salaries for managers at large accounting firms are expected to rise 10% this year to between $68,000 and $92,000. Average starting salaries for internal audit managers at companies with more than $250 million in annual revenue are expected to rise 12.5% to between $69,500 and $90,000.
With bigger bucks dangling, many schools of accountancy are reporting increases in student enrollment, and the New York-based American Institute of Certified Public Accountants says more people are sitting for its CPA exams. The number of accounting degrees awarded nationwide in 2003 jumped 11% from the year before, according to the institute.
7. Stock-option Showdown
Barring intervention by Congress, most companies will begin expensing employee stock options in the third quarter of this year under the terms of a long-debated new rule of the Financial Accounting Standards Board, the Norwalk, Conn., accounting-standards setter. The House has passed a bill to block the proposal, but the rule's main opponents - mainly big tech companies from Silicon Valley - haven't yet been able to win over the Senate.
Requiring companies to declare options as an expense, like salaries and other compensation costs, will reduce profits. Bear Stearns Cos. says that if options had been expensed in 2003, the aggregate earnings of companies in the S&P 500 index would have been 8% lower. The impact is expected to be greatest at software and tech firms, where options - the right to buy a specific number of shares at a fixed price sometime in the future - tend to be a big part of compensation.
Not all companies have waited to be told to expense their options. Coca Cola Co. and Washington Post Co. started booking them several years ago when the debate began. Today, about 850 companies expense their options, including Microsoft Corp., Exxon Mobil Corp. and Wal-Mart Stores Inc.
8. A Fairer Fair Value
For the past decade, companies and auditors increasingly have sung the praises of "fair value" accounting for various assets and liabilities. Under the concept, assets are booked at their current worth in the marketplace, not the cost at which they were acquired.
The only problem is: What is "fair" fair value? When pinning fair value for complex balance-sheet items such as private-equity portfolios, mortgage-servicing rights and insurance loss reserves, a lot of estimates come into play.
Until recently, guidance has been all over the map. Last June, the FASB proposed a statement on fair value measurement and in September discussed it with some constituents at an open meeting. The FASB now is discussing issues raised by constituents and plans to finalize its proposal as early as this year.
"The rules are not trying to reduce estimates but make them more accurate," says Tim Ryan, an audit partner at PricewaterhouseCoopers, New York.
9. One World, One Set of Rules
It's been a long and winding road for the International Accounting Standards Board, the London-based panel that in 2001 began creating one set of accounting standards for European and other countries. As of Jan. 1, public companies in more than 90 countries now have the option or are required to use the new rules. In the European Union, more than 7,000 public companies will begin using the standards this year.
The rationale is to develop consistent financial reporting across countries, especially as companies register their stocks to trade in each other's markets. The U.S. will retain its own accounting standards, but the FASB and IASB are seeking common ground. "There's still a lot left to do," says IASB board member Mary Barth. "But I never would have dreamed we would have been working as closely with the FASB as we do today."
10. Hedging Bets
After much debate, the European Commission in November adopted what many have declared a watered-down accounting standard on the financial contracts known as derivatives. International Accounting Standard 39 concerns the reporting of derivatives such as foreign-currency risk hedges and risk associated with variable-rate debt. It is seen as a major victory for the banks that often employ the instruments, because it leaves them much discretion when reporting losses.
The issue is no less contentious in the U.S. The FASB's derivatives standard and related guidance fill more than 800 pages. Amid the complexity, the mortgage-finance giant Fannie Mae recently announced that it will restate billions of dollars in past earnings to recognize an estimated $9 billion of losses on derivatives used to hedge interest-rate risks. Fellow mortgage-purchaser Freddie Mac is one of many companies with a big restatement already behind it, due in part to misapplication of the rules.
The FASB is trying to clarify the rules. "There's a frustration level among everybody," says Marc Lackritz, a member of the FASB's advisory council and president of the New York- and Washington, D.C.-based Securities Industry Association. "We all yearn for simplicity but it's a very complicated issue."
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