Stricter Audit Rules Gain Traction

Accounting-standards setters, refusing to back down amid opposition from many corporate executives, stuck to their guns over new rules requiring auditors to take a stronger role in assessing financial-reporting processes.

The Public Company Accounting Oversight Board approved the rules detailing how auditors should evaluate internal controls at publicly traded companies. The rules, which require Securities and Exchange Commission approval, come as a result of the Sarbanes-Oxley Act, enacted by Congress in 2002 to improve corporate governance in the wake of accounting fraud at Enron Corp., WorldCom Inc. and elsewhere.

The legislation mandated that corporate managers must have tight internal controls and must evaluate their effectiveness, as well as pay their outside auditors for an independent assessment. Tuesday's rules give auditors guidance on how to make that assessment.

Regulators have faced resistance from public companies, both about the amount of work required and the cost. A recent study of 321 companies by the Financial Executives International, a professional group in Morristown, N.J., found that the nation's largest businesses expect to spend an average of $4.7 million each this year to implement requirements associated with the rules.

PUBLIC ACCOUNTABILITY New rules for auditors of public companies would, among other things, require that: • Auditors examine the controls that their clients have in place over corporate financial-reporting processes.   • Auditors attest to management's assessment of the adequacy of these controls.   • Auditors communicate any material weakness of a company's audit committee to the company's board of directors.   Source: Public Company Accounting Oversight Board

The oversight panel has received 193 comment letters since unveiling the proposed rules in October. Amid the opposition, the SEC, which oversees the accounting panel, delayed implementation by five months, with big companies now expected to comply by Nov. 15.

"As we heard from many public companies, these requirements are tough, and they will entail extra work and cost," said William McDonough, chairman of the oversight panel, in a speech Tuesday to government officials and employees in Washington. But the goal of obtaining "the best possible assurance that a company's financial statements are reliable" is "simply too important to demand any less."

Kayla Gillan, one of the oversight panel's other four members, said the additional work "will result in increased audit fees." But she warned accountants that the new procedures shouldn't be used as "an excuse to price-gouge," and she urged any company that believes it is being overcharged for such work to contact the oversight board.

Auditors will be required to look at the internal controls themselves, in some cases doing walk-throughs of key stages of certain processes. Internal controls include systems to ensure processes as varied as the correct recording of revenue to the proper authorization of transactions between parties that have a relationship with the client, such as management and members of their immediate families.

Historically, auditors had to report to a company's management and audit committee if they found material deficiencies in a client's internal controls. But regulators noted that many recent accounting frauds resulted from managers' ability to exploit weaknesses in the systems.

Raymond Bromark, head of a group of national technical-accounting experts at PricewaterhouseCoopers LLP, said companies are at different stages of readiness for the new requirements. "Some have been very aggressive in anticipating the final standard and some have been hoping it goes away."

The oversight board provided for more flexibility than originally proposed in letting outside auditing firms rely on work by internal auditors and others. But outside auditors must give more weight to work done by experts who are independent of management. Auditors also will have more leeway than envisioned in testing controls at small and midsize firms.

Colleen Sayther, Financial Executives International's chief executive, said compromises like these were "a step in the right direction" but didn't go far enough. For example, she said she believes auditors generally should be able to rely more heavily on work they did in prior years. By documenting procedures that are often already well-established, "it is a tremendous amount of work for not a lot of benefit."

Write to Cassell Bryan-Low at cassell.bryan-low@wsj.com

Updated March 10, 2004

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