Audit Prices Up For All

January 30, 2006
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GRAND RAPIDS — Over the past two years, there has been little argument that Sarbanes-Oxley Section 404 compliance has placed an expensive and cumbersome burden on public companies. Of greater concern in West Michigan, however, could be the cost of SOX for companies not currently governed by it.

Compliance costs related to Section 404 for large-cap companies averaged $4.36 million in 2004, according to New Jersey watchdog group Financial Executives International. Across the board, audit bills were up 50 percent, according to the newsletter Public Accounting Report.

At the local level, Herman Miller saw its bills from independent auditor Ernst & Young jump from $916,000 in fiscal 2003 to $1.3 million in fiscal 2005. Steelcase paid BDO Seidman $1.4 million in fiscal 2004 and $2.1 million in 2005. Universal Forest Products went from $468,477 to $744,045.

Then there are the banks. Already regulated by the FDIC, Section 404 compliance cost Ionia-based Independent Bank Corp. $600,000 in consulting fees and several thousand more in internal costs. Its audit cost alone jumped from $260,000 to $350,000.

Macatawa Bank saw its fees jump from $165,020 to $317,018.

"My opinion is that this didn't provide any value to our organization, at least internally," said Macatawa Bank CFO Jon Swets. "We've done a good job in our internal control system already. All this was just an exercise in documentation."

As an investor, Swets understood the need for the reform.

Many companies and auditors clearly needed to strengthen internal controls. Apart from Enron and related scandals, approximately 2,160 companies corrected errors in their financial statements from 1997 to 2004, according to San Francisco-based research firm Glass Lewis & Co.

"But knowing our internal controls are great already, I get frustrated," Swets said. "This was the old shotgun approach … it would have been nice to see them take a more rifle approach."

Meritage Hospitality Group Inc. has yet to reach Section 404 compliance, but its bills from auditor Plante & Moran have already doubled, from $65,000 to $135,000. Federal regulators postponed the deadline for public companies with market values below $75 million to complete Section 404's internal control assessments and testing.

The company has stated that, if faced with compliance, it may join the ranks of hundreds of publicly traded companies to "go private."

"It is so obvious that this act is much more onerous for the smaller public companies," said James Saalfeld, Meritage vice president and general counsel. "You can't just apply a set of compliance requirements across the board without taking into account that there will be a disproportionate effect for a $10 million company as a $200 billion one."

Recent articles and speeches, including that of Ohio Republican Michael Oxley himself, illustrate a desire to revise the act as it pertains to small companies. Saalfeld argues that investors recognize there is a greater risk involved with smaller companies; he believes the testing should reflect that risk.

Either way, audit fees now account for 8 percent of small public companies' expenses, compared to 1 percent of larger companies' expenses.

The rising costs of the noncompliant Meritage are a foil for the private sector. CFOs in companies not subject to the SEC will soon start to notice the impact of SOX as well, if they haven't already.

An estimated 70 percent of private companies subject their financial statements to audits each year, primarily to satisfy lenders, minority shareholders or other partners, such as bond and insurance companies, according to the American Institute of Certified Public Accountants. Audits are even more common among nonprofit organizations.

Here, costs have risen by an estimated 34 percent, according to a survey from law firm Foley & Lardner LLP.

Locally, that trend holds true for clients small (where one firm reported its bill for a small nonprofit had increased from $2,300 to $4,700 this year) and large (where the number of hours involved in a common private company audit at one regional firm is up 10 percent to 15 percent, another estimated 10 to 30 hours).

"There are a lot of new accounting rules and standards that have trickled down to private companies and nonprofits," said Bob Herr, Crowe Chizek managing partner. "There is a lot of pressure to do it different ways, to take a more skeptical approach."

The largest difference is relatively simple. In the past, Herr explained, auditors were expected only to report fraud and irregularities when discovered. The standards did not specify that auditors had to seek out fraudulent reporting. Now, the "Generally Accepted Accounting Principles," a combination of authoritative standards and commonly accepted ways of recording and reporting information, do just that.

"That's a big impact," Herr said. "Our clients feel it, and we feel it, but I think, whether it's executive directors, private business owners or public management, they all want to make sure affairs are in order, and that if there are problems in a certain area, they want to know about it."

Big Four firm Ernst & Young has taken that philosophy a step further.

"At the end of the day, no firm wants to maintain two methodologies," said Dave Hoogendoorn, managing partner of the West Michigan office. "We would eventually like an audit methodology that is consistently applied regardless of whether a company is public or private."

That would not include the level of reporting and testing associated with Section 404, but would maintain the same standards of internal controls.

However, convincing companies to absorb the extra costs might not be so straightforward.

"It's not our role to convince them this is good for them," Hoogendoorn said. "Every company has to evaluate its role in corporate governance and what standard they want to hold themselves accountable to."

Crowe Chizek has concentrated on a value proposition, finding that, as Herr said, "most clients are fine with it, it's just a matter of educating and explaining the benefits."

But in an atmosphere where West Michigan businesses are already frustrated with rising costs, assuming another one is not a welcome suggestion.

"It hasn't been an easy message to deliver, especially with clients that have had financial difficulties," said George Riddering, managing partner of Plante & Moran in Grand Rapids. "But when we have to do more work and more hours on our end, that's just how we go about pricing engagements. That's the reality, and you need to make sure the client understands that you're going to be fair with them."    

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