SOX Costs Down; FASB News; More

Audit costs related to Sarbanes-Oxley compliance for public companies declined for the first time in 2007 as companies and auditors alike grew accustomed to the process, but the joy is muted by a slight increase in overall audit costs.

Audit costs related to Sarbanes-Oxley compliance for public companies declined for the first time in 2007 as companies and auditors alike grew accustomed to the process, but the joy is muted by a slight increase in overall audit costs.

A recent survey by the Financial Executives International polled 168 public companies with market capitalizations above $75 million and found their total cost for compliance with Sarbanes-Oxley’s Section 404 requirements averaged $1.7 million in 2007. Those same companies reported that overall audit costs—meaning the costs related not only to the internal control audit under Section 404, but also the financial statement audit—reached $3.6 million.

FEI says the Section 404 audit costs reflect a 5.4 percent decline from 2006 results, but at the same time the overall audit costs reflected a 1.8 percent increase from 2006.

Christine DiFabio, vice president of technical activities for FEI, says the survey doesn’t establish the cause for the overall increase in audit costs. The culprit could simply be inflation, or the experience of auditors on the engagement if firms are assigning more senior-level staff, she says.

The good news, she says, is the decline in Section 404 audit costs. “Companies that have been doing this for several years are building these processes into their daily processes, so the efficiencies there continue to increase,” she says. “Many companies were outsourcing their 404 work in the early years and now they’re bringing it in-house. Those are all good trends.”

According to the FEI survey, companies achieved a reduction in internal control compliance costs by reducing the number of hours internally and externally spent on compliance. Internally, companies reported an 8.6 percent decline in the amount of time devoted to Section 404. Externally the drop was even bigger, at 13.7 percent. The results also suggested that companies with centralized operations spend 30 percent less on compliance than companies with decentralized operations.

DiFabio says companies are showing increasing confidence in Section 404 requirements. The survey shows some incremental increases in respondents who agree that financial statements are more accurate, more reliable, and less susceptible to fraud than before Sarbanes-Oxley. “We continue to believe internal control is an important piece of good management,” she says. “We’re glad to see that the cost seems to be decreasing, but the total average cost at $1.7 million is still significant as an added cost for companies. We hope to continue to see efficiencies achieved in the future.”

FASB Resolves Issue With Intangible Assets

The Financial Accounting Standards Board has finally resolved a lingering conflict in Generally Accepted Accounting Principles regarding how companies can determine the useful life of renewable intangible assets.

The Board published Staff Position No. FAS 142-3, Determination of the Useful Life of Intangible Assets, to revise rules around what a company should consider in setting certain assumptions used to determine the useful life of renewable intangible assets. Such assets might include licensing agreements, servicing rights, trademark or software use, or other contractual provisions, among others.

The new guidance removes a provision originally contained in Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, that placed some limits on when an entity would consider a right to renew an intangible asset in establishing its value. Those limitations conflicted with FAS 141, Business Combinations, which instructs companies to take into account any renewal rights when valuing the same intangible assets.

The staff position says companies can consider their own historical experience in renewing similar arrangements when determining their valuation assumptions, says Stuart Moss, a partner at Deloitte & Touche. If they have no recorded experience of their own, they also can look to the market for setting assumptions, he adds. FAS 142 originally said companies should pay little heed to renewal rights when valuing the assets.

FASB first published a proposed solution to the conflict in 2006, creating a new category of intangible assets called “finite-lived renewal intangibles” and establishing a new method of amortizing them. The proposal was shot down by accounting firms and other constituents, who generally said it only added cost and complexity to the accounting without bringing any added benefit.

FASB’s initial reaction was to simply cancel the project and scrap the guidance, allowing preparers of financial statements and their auditors to sort it out themselves. But the market continued to press for a solution, and personnel changes at FASB led to the renewed effort to resolve the conflict, Moss says. “When they dropped the issue, there was a lot of pushback from constituents.”

Although the guidance was approved by six members of FASB, board member Donald Young dissented and published his view with the final guidance. He said the approach is conceptually flawed, failing to address the accounting treatment of costs to renew or extend the term of a recognized intangible asset and therefore not prohibiting capitalization of such costs. Young “believes that the outcome of this FSP will be a greater ability of preparers to avoid volatility in earnings, increased carrying amounts of assets of little value to investors, and less transparency in financial reporting.”

Moss says the new solution may result in longer useful lives for some renewable intangible assets because entities now have greater latitude to take renewal rights into account. It will only affect assets acquired after the guidance takes effect, he says, which is for reporting periods after Dec. 15, 2008.

FASB Finalizes Guidance Overruling Bankruptcy Rule

FASB has finished its revision of a long-standing bankruptcy accounting rule to change the way it applies to the adoption of emerging accounting standards.

The American Institute of Certified Public Accountants issued Statement of Position 90-7 in 1990 to establish a standard accounting method for companies in Chapter 11 bankruptcy proceedings. The statement requires entities adopting a fresh start to financial reporting following a Chapter-11 reorganization to adopt any changes in accounting standards within 12 months.

When the position was issued in 1990, it was common for companies to adopt new accounting pronouncements early or ahead of the required effective date, but FASB often prohibits early adoption to facilitate more comparability in financial reporting. The new staff position overrules SOP 90-7 in that regard, nullifying the requirement regarding changes in accounting principles.

FASB has said the early adoption requirements in SOP 90-7 have run into conflict with recently adopted accounting standards that prohibit early adoption, most notably FAS 141R, Business Combinations, which recently took effect.

Prior to SOP 90-7 there was a great deal of diversity among companies emerging from Chapter 11 in how they accounted for professional fees and other expenses related to the bankruptcy, according to the AICPA. One of the significant new provisions of FAS 141R is its requirement that all professional fees associated with a merger or acquisition be treated as expenses deducted directly from earnings, not as part of the acquisition cost to be capitalized over time.

PCAOB Brings Disciplinary Action for Audit Failures

The Public Company Accounting Oversight Board has slapped a disciplinary proceeding on another small audit firm, this time flagging the audit work around a Florida corporation that develops and sells insurance-related financial products.

The Board revoked the registration of Wieseneck, Andres & Co. and barred the firm’s 64-year-old “audit principal,” Thomas Andres, from associating with a PCAOB-registered firm. The PCAOB didn’t like the looks of audits performed by Wieseneck, Andres on the 2004 and 2005 financial statements of American Capital Holdings.

The Board said the audit firm didn’t do enough work on ACH’s 2004 assertions and valuation around goodwill, marketable securities, and intangible assets, which represented virtually all of the company’s reported assets, nor did it question the company’s failure to consolidate an entity in which it held a 90 percent interest. In 2005, the firm failed to flag departures from U.S. Generally Accepted Accounting Principles regarding error corrections and misclassification of declared dividends, according to the PCAOB.

The firm and Andres are eligible for reinstatement by the PCAOB after two years. It is one of a handful of enforcement actions the PCAOB has taken so far—only one of which has been leveled against a major firm. In late 2007, the board fined Deloitte & Touche $1 million in relation to a 2003 audit. Critics frequently say the PCAOB should be more aggressive in its police work.

FASB, China Reach Agreement on Convergence

Another Memorandum of Understanding has been struck on accounting standards—this one between the Financial Accounting Standards Board and the China Accounting Standards Committee—to pledge convergence to international accounting standards.

FASB has slaved away at reaching an MOU with the International Accounting Standards Board to put U.S. Generally Accepted Accounting Principles on an intercept path with International Financial Reporting Standards. Now FASB’s agreement with China says the two groups will keep tabs on one another’s work in moving toward international standards, exchanging opinions and technical expertise on convergence of accounting standards.

Herz

FASB Chairman Robert Herz said in a prepared statement the agreement is a precursor to increased or improved economic activity between the two countries.

“The Memorandum of Understanding … represents our shared interest in moving to a common set of high-quality, global accounting standards, a goal that will ultimately facilitate economic relations between the United States and China,” Herz said. “We look forward to continuing our dialogue with CASC and to working with our counterparts in China to make international convergence of accounting standards a reality.”