By Carrie Johnson
Washington Post Staff Writer
Wednesday, December 20, 2006
Accounting industry overseers yesterday scrapped an audit rule targeted by businesses as expensive and burdensome, proposing looser guidelines that would direct accountants to focus on the integrity of corporate managers and the most risky aspects of a company's financial reports.
The proposal is designed to address the most contentious part of the 2002 Sarbanes-Oxley law, passed by Congress after problems at Enron and WorldCom tarnished the reputation of the accounting profession and rocked investor confidence.
The planned changes to a rule that requires auditors to review the financial controls of their client companies come after more than two years of complaints by businesses large and small. The overhaul marks one of the most significant concessions by regulators in a broad campaign by trade groups to make corporate rules and laws more flexible.
Criticism over the rule and charges that it is prompting fewer companies to list their shares on U.S. markets have gathered momentum in recent months, which was acknowledged by Mark W. Olson, chairman of the Public Company Accounting Oversight Board. The proposed change, which will be subject to more than two months of public comment, "will help transform the rule into a cornerstone accomplishment rather than a provision that continues to be associated with adverse market trends," Olson said.
At its core, the proposal cuts the current rule by one-third -- to 65 pages from 180. It is intended to eliminate unnecessary or duplicative work by the nation's largest accounting firms, which have posted steep profit gains for the past few years as a result of the rule and the reluctance of companies to push back against it in the post-Enron environment.
Members of the accounting board debated whether the plan would result in substantial cost savings, with at least one expressing a measure of skepticism. It may be two years or more before the economics become clear, said Bill Gradison, who urged "a strong need for patience."
Under the plan, which could be revised based on public feedback, auditors would be allowed to use the work of internal accountants and corporate managers as well as refer back to their own work in previous years. They would be given new instructions on such costly and resource-intensive issues as how many corporate offices they must visit. And they would be told that they no longer need to test controls that relate to "a large portion" of their clients' assets, language that was harshly criticized in comment letters from managers as too onerous.
The plan would require auditors to look for problems that have a "reasonable possibility" of producing a weakness in a company's finances. The current provision instructs auditors to consider issues with a "more than remote" chance of causing trouble.
Instead, auditors would be encouraged to examine how companies close out their books at the end of each quarter and to scrutinize managers' integrity and ability to overrule in-house accountants. Among the items auditors would be explicitly told to consider under the new proposal is whether corporate managers' compensation is tied to the financial performance of the company, an issue that affects the independence of the managers' judgment.
In a change that observers said would significantly reduce costs and the number of audit hours, the accounting board proposal would throw out a requirement that auditors assess how well management reviewed internal controls -- focusing instead on a single assessment of how the controls are working.
When working with companies with market capitalization of between $75 million and $787 million, accounting firms would be urged to focus on such issues as the number of people in the financial unit, the number of the company's business lines, and the complexity of the company's operations. Smaller companies would not automatically win less-intense reviews from auditors.
Charles D. Niemeier, a member of the accounting board, said the current rules work for small companies, noting that more than 18 percent of companies with market capitalization of less than $787 million had discovered control weaknesses during the first year of reviews. But that figure was halved during the second year -- evidence, he said, that rigorous reviews were uncovering mistakes that are important to investors.
Regulators had predicted that the changes could take effect as early as March or April, in time for next year's audit season. But disagreement between the accounting board and the Securities and Exchange Commission over the extent of the concessions hindered the process. Officials now say the new rule will likely be adopted next summer. Small businesses recently won another compliance extension and will not be required to adopt the proposal until the end of 2008, meaning that it could take until 2009 to determine how much the reviews will cost.
Rulemakers called the changes substantial but vigorously denied that they would lead to fewer protections for investors. "This proposal does not diminish or water down" the existing rule, said Kayla J. Gillan, another accounting board member.