The right stuff: CFOs, auditors & audit committees reexamine their relationships - Sarbanes-Oxley Act of 2002

California CPA, Oct, 2002 by Sharon Ross

($427 billion) YEP, THAT'S RIGHT, A $427 BILLION LOSS. It's the estimated total loss in market value of WorldCom, Tyco, Qwest, Enron and Global Crossing. And it has been the impetus for a thorough reexamining of the client-auditor relationship.

Even before the unanimous passage of the Sarbanes-Oxley Act of 2002, CFOs, auditors and audit committees have been scrutinizing their relationships, looking for best practices that will quell investor fears, stabilize a volatile market and rebuild trust in the profession.

This reexamination has led some companies and accounting firms to take steps toward eliminating perceived conflicts of interest and improving the transparency of financial reporting and the auditing process.

Many public companies have scrutinized their decades-long relationships with their auditors and have determined it is time to select new ones. Others, such as Disney, backed away from giving their auditors consulting work. PricewaterhouseCoopers joined the ranks of KPMG and Ernst & Young and sold its consulting arm to IBM.

THE MARKET'S NOT CORNERED

But change hasn't been limited to public companies. Many privately held companies and nonprofit organizations have changed their financial reporting process.

For example, for the first time in its 92-year history, CalCPA modified the agenda of its annual meeting between its external auditor and audit committee to include an executive session. CalCPA management was excused, which allowed the auditor and audit committee to freely discuss any audit-related matters including internal controls.

This type of open meeting is based on a 1999 New York Stock Exchange Blue Ribbon Committee's guideline for audit committee practices. Even though many public companies did not start following the guidelines until last year, CalCPA felt it should proactively adopt the practice.

"In today's business environment, it's smart for both public and private companies to foster open, unrestricted communication between the auditor and audit committee," says Donna Lekosky, CalCPA director of finance.

In addition, Learning Tree and other public companies such as Rockwell International have gone a step further by including a clause in their audit committee charters about meeting separately with the external auditor without management present.

DIALOGUING WITH AUDITORS

"All companies should have an open, ongoing dialogue with their auditors, especially if there have been new professional pronouncements or changes in the company's business" says Lekosky. "No one wants surprises. I would encourage CFOs to stay in contact with their auditors throughout the year to ensure that everyone is on the same page."

CalCPA's auditor, Dave Ljung, a shareholder with Gilbert Associates, Inc. in Sacramento, agrees that meeting prior to the audit also can give companies a chance to handle problems in advance.

"Some of our clients are taking the initiative themselves and are calling to meet ahead of time," says Ljung. "We've done this historically with CalCPA and are suggesting to clients who have taken a real interest in the process in the past to meet prior to the audit.

"Small to mid-size companies usually meet only once after an audit," says Ljung, "but it makes sense to get the issues on the table early in the game. It's an opportunity for the audit committee to be involved in the planning and to provide input."

This is especially important, because now under Sec. 204 of the Sarbanes-Oxley Act, management must report to the audit committee all "critical accounting policies and practices to be used ... [and] all alternative treatments of financial information within [GAAP]."

It's up to the external auditor to counsel the audit committee on the appropriateness of such practices, because the audit committee is not equipped, nor is it expected to be able to guarantee the quality of the financial statements--that's the job of the professionals.

"For the most part, the audit committee is trying to be diligent in fulfilling its fiduciary duty, and they look to the auditor to inform them of what the issues are and familiarize them with the process in lay terms," says Ljung.

DON'T FORGET THE INTERNAL AUDITOR

Internal auditors may have difficulty in getting management to listen when they question potential accounting irregularities. To address this issue the NYSE Blue Ribbon Committee included "independent communication and information flow between the audit committee and internal auditor" in its best practices recommendations. If independent meetings were part of the routine, "independent dialogue between the audit committee and the internal auditor should lose its taboo nature and no longer imply treason against management," states the Blue Ribbon Committee.

Had this been the case for Sherrin Watkins at Enron and Cynthia Cooper at WorldCom, would the accounting scandals have been a blip on the radar screen? It's something the whistleblower provision in the Sarbanes-Oxley Act hopes to address.

ROOM FOR WHISTLEBLOWERS

Now internal accounting and administrative staff will have an outlet to report questionable accounting, thanks to the Sarbanes-Oxley Act whistleblower provision. Companies like Pinnacle Entertainment are setting up ethics hotlines to report questionable behavior. And Harrah's already has one in place.