Section 404: Worth the cost?

Three MACPA members recently debated the pros and cons of Sarbanes-Oxley's most famous — or infamous — provision

By Bill Sheridan
Statement Editor

It's wildly expensive and time-consuming, and it's impacting far more CPAs than anyone might have initially guessed.

Is Section 404 of the Sarbanes-Oxley Act worth the hassle?

It depends on whom you ask. Most everyone can agree that increasing the reliability of financial statements is a good idea. But in the debate over how to best accomplish that, corporate CPAs differ from CPAs in practice, who differ from CPAs at non-profits. Regulators have their own opinions as well.

Each of those views was presented at Loyola College recently as three MACPA members joined a representative of the Public Company Accounting Oversight Board to examine Section 404's impact. The debate touched on a number of issues — the costs involved, separation of services, internal audits, the role of non-profits. But each panelist agreed on one thing: There are as many questions as answers at this point.

"As long as there is a dialogue and everyone is talking to each other, I think we'll end up making progress," said Barry Benjamin, managing partner at PricewaterhouseCooper's Baltimore office. "But I don't think where we are today is necessarily where we'll end up being five years from now."

Cost vs. benefits

At publicly traded companies, Section 404's impact is most often measured in money and time. Ken Kelly, CPA, corporate vice president and controller for McCormick & Co., said his company has spent roughly $7 million on internal control work since 2003. "That's about a dollar per share that (complying with Section 404) has cost our shareholders," he said.

McCormick got an early start on its internal control process, and by the end of 2003 the company had completed about 80 percent of its documentation. Even so, Kelly said the company was struggling to complete the process by the end of its fiscal year, which fell on Nov. 30.

The next step, said Kelly, is to figure out a way to turn the initial implementation steps into a process that can be repeated each year. Ongoing costs won't be as steep as the initial implementation price tag, but neither will they be cheap.

"Sure, there are many benefits that are coming out of (Section 404)," said Kelly. "But in my opinion, the cost significantly outweighs the benefits. ... Enron and the other things that gave rise to this were caused by crooked, dishonest people. These provisions don't get rid of crooked, dishonest people."

So how, he wonders, will corporate America measure the success of its 404 efforts?

"I'm not sure there's a measure out there that you'll be able to use to determine that," he said. "It will be more of a feeling: Do we have more faith in our financial markets because of it?"

Firms weigh in

Firms that provide audit services for public companies also are struggling with how to measure the effectiveness of their 404 work.

"I'm convinced that we won't know if we got it right until after we go through (PCAOB) inspections," said PwC's Benjamin. "We're seeing it in the way firms are interpreting 404: How do you define what a deficiency is? What's significant and what's not? When do you have a true weakness in the control environment? We are struggling with all of these things with our clients (and) trying to reach some conclusions."

The good news, Benjamin said, is that firms are sharing ideas and information as they try to reach that consensus. The PCAOB has offered helpful suggestions as well.

"But again, it's a new area," he said. "There's likely to be a lot of change and more specific guidance in the next couple of years before we really get comfortable with living in this new 404 environment."

Firms like PwC are dealing with a number of other issues as well, including auditor independence, documentation and ethics. Each comes with its own new standard with which firms must comply. In turn, those standards are producing huge amounts of change, uncertainty and stress among firm staff.

Staff itself is another area of concern. The Washington D.C.-based PCAOB and SEC are hiring CPAs by the score as they try to implement and regulate new accounting reforms. That leaves a smaller pool of talent from which area firms can choose.

"That's our number one issue — being able to ensure our clients that, when they complete all the work they need to do, we'll have enough people to go through all of that work," Benjamin said. "I believe we're there, but it's a judgment that changes each day depending on turnover."

Should non-profits comply?

Though the Sarbanes-Oxley Act was meant to apply to public companies alone, some private companies and non-profit organizations are trying to head off the possibility of future regulation by implementing pieces of the act.

Among them is Johns Hopkins University. When Sarbanes-Oxley was signed into law, the huge non-profit (it has 25,000 employees and about $4 billion in assets) was pleased to find it was already in compliance with some provisions of the act — audit rotation and separation of services among them. But the university found other provisions too onerous for its decentralized environment to handle.

Section 404, meanwhile, is getting a long, hard look from JHU officials. Lynne Lochte, CPA, director of HopkinsOne (an initiative to replace all financial and administrative systems at JHU and Johns Hopkins Health System with SAP software), says JHU wants to consider adopting as much of Section 404 as possible, "so that if it comes down the pike later that non-profits are required to adopt it, we would be in compliance." But the costs involved make JHU officials wary of complying with Section 404 in its entirety.

That's a dilemma many non-profit organizations are facing. If donors see that the money they give to non-profits is being used to pay the costs of complying with accounting-reform regulations, they may be less likely to contribute.

Lochte says that's a big reason why JHU is lobbying to prevent reforms similar to Sarbanes-Oxley from impacting local, private organizations.

"There are costs associated with adopting Sarbanes-Oxley," Lochte said, "and if you put that burden on non-profits, you're going to be limiting the dollars that are available for the public good that these groups do."

Here to stay

The issues surrounding Section 404 will be haunting CPAs for years to come. A recent survey by AMR Research found that companies will spend an estimated $5.8 billion on Sarbanes-Oxley-related initiatives in 2005. Beyond that is anyone's guess.

"It's there and we can't change that. Now the question becomes, how can we bring the most value to it," Kelly said. "I don't know exactly what (Section 404) is going to cost us on an ongoing basis, but it will be an ongoing cost and we expect it will be less than the initial costs to set it up."

The benefits undoubtedly will surface as time goes on, too. In fact, Benjamin said one of them has already arrived.

"There has never been a better time to be a CPA," he said. "I grew in our firm as an auditor, and it's apparent to me that the real value of an audit has never been more clearly emphasized than it has during the past three years. How clients and audit committees use that value is up to them, but I think it is clear that there is a lot to take from an audit."

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