The Public Company Accounting Oversight Board (PCAOB) got an earful of harsh criticism recently about its proposed standards for the work auditors should do before signing off on management assessments of companies' internal controls. Most of the 186 comment letters received by the chief auditing regulator were from finance executives, and their common theme was the likely cost the standards would impose on companies. "It's the addition of a costly independent audit attestation that people are objecting to," says Curtis Verschoor, professor of accounting at DePaul University. "That's where the battle lines are drawn."
Arguing that the PCAOB is misinterpreting Congress's intent in Section 404 of the Sarbanes-Oxley Act, the critics assert that Congress only meant for auditors to evaluate these internal assessments, not undertake the much bigger task of conducting their own audit of the underlying controls. Even worse, the proposed PCAOB standard calls for outside auditors to use their own work as the "principal evidence" in determining whether company controls are adequate, rather than relying on work done by internal corporate auditors.
Executives insist that the unnecessarily stringent requirements will add up to many more billable hours and significantly higher costs. In fact, according to Financial Executives International (FEI), companies expect audit fees to rise by as much as 30% to 50% as a result of the work required by the PCAOB's proposed standard. "We believe that the standard as currently drafted creates a situation where the costs far outweigh the benefits of implementation," FEI says. The "duplicative testing" that it requires by external auditors will mean many costly interruptions to business operations, it adds. The comment letters also argue that the PCAOB guidelines for how much testing auditors should do give insufficient weight to the auditors' judgment.
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But not all agree the PCAOB is asking too much. Therese Webb, a managing director at Chicago's Parson Consulting, argues that the work the standard requires of outside auditors may be a necessary catch-up after the 1990s, when outside auditors relied more and more on internal audit staff. Webb adds that in the first year under the new standard, "there's a tendency to do more rather than less just to be sure there aren't any gaps." She predicts, however, that both auditors and management will relax in subsequent years.
Parveen Gupta, a professor of accounting at Lehigh University, points out that auditors may insist on doing the extra work regardless of what the standard says. "Whenever you ask a professional to give an opinion, I'm going to do a lot more work before I open my mouth," Gupta says.
The PCAOB would not comment on the letters it received, but said it is reading them all as it considers changes to its proposals.
The American Institute of Certified Public Accountants says it is very difficult to estimate how much more work will be needed or how much more expense might be involved. Circumstances will differ from company to company, explains Chuck Landes, the AICPA's director of audit and attest standards. "Those companies that have their controls documented, have stronger controls, have done more work on their own assessments, the time will be less than for those organizations that have not done a very good job of putting strong controls in place [or] in documenting those controls," he says.
Regardless, Lehigh's Gupta says it still means higher costs for everyone. "The PCAOB standard is going to increase auditor liability, and whenever you increase liability, the fees go up and the [workload] goes up too," he concludes.
The PCAOB is also taking it on the chin for the standard's requirement that auditors consider the effectiveness of the company's audit committee as part of their 404 work. Since Sarbanes-Oxley gave audit committees the responsibility for hiring and firing outside auditors, executives cite the potential conflict of interest for an audit firm grading its direct boss. "This type of circular arrangement is the reason that Sarbanes-Oxley saw fit to take the engagement of the external auditor away from management," says Loretta Cangialosi, controller of Pfizer Inc. But DePaul's Verschoor says the audit committee plays such a critical role in the internal control structure that not considering it "would leave a huge gap in the evaluation process." He argues that the draft standards put too little emphasis on elements like the control environment and a code of ethics.
For now, the ball is back in the PCAOB's court, and companies are watching the clock. With Section 404 slated to take effect for companies with fiscal years ending after June 15, 2004, "it's pretty important that companies have a good feel for what the PCAOB is going to do," says Dennis R. Beresford, an accounting professor at the University of Georgia's Terry College of Business.
A PCAOB spokesman says the board is likely to approve a final standard in early 2004. The regulations then go to the Securities and Exchange Commission, where they will be put out for comment again before being made final. Some letters express concern about the time required for the entire process and suggest postponing the effective date for Section 404 for a second time.
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