Nearly one of 10 companies that has changed auditors so far this year has also reported internal control issues.

That's according to an in-depth analysis conducted by Manchaug, Mass.-based AuditAnalytics.com, which found that 1,647 companies reported a change in auditors through Dec. 6. And 152, or more than 9 percent of the total, had disclosed internal control issues.

More than half of those 152 companies dismissed their auditors, while in 71 cases—or 47 percent of the cases—the auditor resigned, according to the study.

Disagreements A "Big Deal"

In general, over the past four years, 18 percent to 34 percent of all auditor changes have been resignations, suggesting that when there is an internal control issue, the auditor is increasingly likely to resign.

Joe Cyr of AuditAnalytics.com stresses that internal controls are flagged when an auditor change notification specifically identifies internal controls in its filings. He stresses that this does not mean that a lack of these controls, whether corrected or not, were the cause of the auditor change. It simply means that they were mentioned.

"It's a big deal whether or not a company or auditor disagrees whether there is an internal control weakness," explains Mark Cheffers, chief executive officer of AuditAnalytics.com. "The identified company must disclose and the auditor must explain it. There is a lot of judgment going into whether a control weakness is material."

Keep in mind that most of the companies that reported a control issue and saw a change in their auditor so far this year were smaller, non-Fortune 1000 companies.

In fact, at least 80 of the companies are not even considered accelerated filers under the SEC's classification; their revenues are under $75 million (AuditAnalytics.com does not provide the revenues for a number of the 1,647 companies).

Just eight companies had revenues that exceeded $1 billion: Global Crossing, Alaska Air Group, Symbol Technologies, Blyth, Building Materials Holding, Ardent Health Services, Foamex International, and Freds.

Just three of the companies have a market capitalization that exceeds $1 billion—Blyth, McAfee and Symbol. And Symbol is the only company that is included in the Standard & Poor's 500.

Two Examples

In Blyth's case, the maker of collectible and giftware products reported results for its Jan. 31, 2004 fiscal year on March 15. On March 23, it announced that it appointed Deloitte & Touche as its new independent auditor for the January 2005 fiscal year, replacing PricewaterhouseCoopers, which would still be used for tax consultation and other projects.

Then, on April 14, Blyth said in a press release that it learned that PwC believed that the company's current designation of two operating segments did not comply with certain accounting standards. The company said it wouldchange its designation of operating segments for fiscal 2004 and possibly restate prior results to reflect the change.

It also said it had begun extensive analyses to identify properly its operating segments, reporting segments and reporting units, and to assess potential impairments of goodwill for its redefined reporting units.

On Aug. 10, Alaska Air Group announced that it dismissed Deloitte & Touche and replaced it with KPMG. It also mentioned that Deloitte's report on Air Group's financial statements for each of the years ended Dec. 31, 2003 and Dec. 31, 2002 did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles.

However, Alaska Air did disclose in the same announcement that in connection with its audit of Air Group's financial statements for the year ended Dec. 31, 2003, Deloitte advised the audit committee of two matters related to its internal controls that Deloitte considered to be reportable conditions under standards established by the American Institute of Certified Public Accountants.

"First, Deloitte noted that although the company reconciles its balance sheet accounts regularly, and those reconciliations are reviewed by someone other than the preparer, the company should improve its process of analyzing the underlying account detail," Alaska Air stated in the filing. "Second, Deloitte noted that Horizon was not reconciling its inventory of expendable parts on a timely basis."

Among smaller companies, online betting company Youbet.com fired BDO Seidman in August as its independent auditor. It also said that BDO's reports for 2003 and 2002 "did not contain an adverse opinion or disclaimer of opinion, nor were such reports qualified or modified as to uncertainty, audit scope or accounting principles."

But, alas, it did concede that during the second quarter 2004 review process, BDO identified "a reportable condition" that, while not a material weakness, "involves internal controls over certain limited aspects of our quarterly closing process." The company said it addressed the item and hired Las Vegas-based Piercy Bowler Taylor & Kern as its new independent auditor for 2004.

Of course, there is no guarantee that in any of these cases, the next auditor will be more lenient. "Maybe stricter," Cheffers adds. "This is why you see many companies move from a Big Four firm to a smaller firm. They have a different perspective of what constitutes a material weakness."

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