Corporate audit fees, which soared by punishing amounts in 2004 as companies struggled with their first year of Sarbanes-Oxley compliance, may be levelling off or even decreasing as executives and external auditors alike build on their second year of experience in 2005.
A Compliance Week analysis of audit and non-audit fees reported in recently filed 2005 proxies shows that many accelerated filers, who finished Year Two of compliance with SOX’ Section 404 in December, saw relief in 2005. While it’s too soon to tell exactly how pervasive the trend may be, the proxy statements are expected to provide some clues to the question that public companies of all sizes—along with regulators and investors—have been hoping to answer: What part did fees related to Year Two 404 costs play in audit fees overall?
Compliance Week examined the proxy statements of 47 large filers with Dec. 31 fiscal-year ends; those companies are among the first to have completed two full years of Sarbanes-Oxley compliance. Twenty-five companies saw outright declines in their audit and audit-related fees, and the median decline for the whole group was 2.4 percent. Total fees plunged 7.4 percent (subscribers can download the spreadsheet in the right hand column).
Some corporate executives who spoke with Compliance Week said a significant portion of the decrease in audit fees stemmed from a reduction in their second-year Section 404 costs. That is in line with previously published reports that predicted steep declines in Section 404 compliance costs once companies had a year of experience under their belts.
Atlanta-based BellSouth Corp. saw its audit fees fall from $5.8 million in 2004 to $4.3 million in 2005. Ray Winborne, the company’s chief accounting officer, said roughly $700,000 of the decrease was in SOX-related costs. (The other $800,000 was the result of the divestiture of a Latin American entity.)
Winborne
In an interview last week, Winborne described BellSouth’s first-year efforts in 2004 as “like we were training for a 26-mile marathon and we ran 35 miles because they kept moving the finish line.” In 2005, the $20.5 billion telecommunications company achieved a “significant reduction” in its internal controls testing work by simplifying its control documentation and “better scoping of the process of the controls,” he said.
Through its own effort and that of KPMG, which BellSouth hired to help with its controls documentation, Winborne said BellSouth slashed its number of key controls from about 2,000 in 2004 to about 300 in 2005. Standardizing its documentation also “streamlined it significantly,” he added; BellSouth’s Year One documentation “looked more like a novel.”
Still, Winborne noted that some of the company’s savings were offset by an increase in its external audit fees. He estimates that BellSouth ran up an extra $300,000 to $400,000 for additional testing outside of SOX, driven by changes in external auditors’ interpretations of rules from the Public Company Accounting Oversight Board.
BellSouth expects audit fees to be relatively flat for 2006. “Barring some major change in the rules from the PCAOB, 2006 will probably look like 2005,” Winborne said. “We got to a steady state in 2005.”
More Judgment Used
Audit fees at United Technologies Corp., an aerospace manufacturing giant in Hartford, Conn., fell from $31.9 million in 2004 to $25.8 million in 2005. Jay Haberland, vice president of business controls at $42.3 billion UTC, said the decrease comes almost entirely from reduced Section 404 fees. While nearly half of the company’s entire audit fee in 2004 was 404-related, he said, in 2005 UTC’s fees related to 404 were essentially cut in half.
Haberland said savings primarily came from integrating UTC’s financial statement and 404 audits during Year Two. “The first year, the 404 work was all additive to the normal financial statement audit work,” he explained. “In 2005, we saw substantial integration between the financial statement audit and the 404 internal controls audit.”
Haberland
A change in approach as a result of the PCAOB guidance also helped. “The rules were prescriptively interpreted and applied by the accounting firms the first year,” Haberland said. “We saw less of that and more judgment used in 2005.”
In particular, he said the company’s auditor, PricewaterhouseCoopers, relied more on UTC’s internal audit work in Year Two. “Everybody understood things better this year,” Haberland said. “We were more effective in our own testing and PwC was more effective in their work. The company also reduced the number of key controls it had to test.”
Haberland added that UTC will continue cost-reduction efforts and hopes “to see some improvement this year, though not as dramatic.”
EXAMPLES
Below are examples of companies that reported a decrease in SOX 404-related costs in their latest proxies:
AFLAC
Fees for SOX 404 reviews, attestation in 2005 were $1,924,551, down from $3,339,250 in 2004 (Auditor: KPMG).
American Electric Power
ICFR fees decreased from $6,321,000 in 2004 to $4,210,000 in 2005 (Auditor: Deloitte & Touche).
EMC Corp.
SOX 404 testing fees in 2005 were $1,271,399, down from $1,909,487 in 2004 (Auditor: PricewaterhouseCoopers).
Johnson & Johnson
SOX 404 fees were $4,400,000 in 2005, down from $5,855,000 in 2004 (Auditor: PricewaterhouseCoopers).
Marathon Oil
Audit fees included $4.0 million for the 404 assessment in 2005, down from $4.3 million in 2004 (Auditor: PricewaterhouseCoopers).
Source
Compliance Week: Audit And Non-Audit Fees For Sampling Of Large 12/31 Filers (Apr. 4, 2006)
One dynamic that could have affect audit fees is the PCAOB’s reports on the first round of internal controls audits, he added. “If the PCAOB auditors approach their work in a prescriptive and punitive fashion, we could see audit firms react and costs jump right back up.”
Haberland said UTC is focusing on total costs, not just on 404-related expenditures. “Our incremental non-audit costs, such as the use of other consultants and advisors, software and implementation, declined more significantly than our audit costs last year,” he said.
Meanwhile, audit fees were essentially flat at Schaumburg, Ill.-based Motorola Inc. It reported audit fees of $12 million in 2005, compared with $12.2 million in 2004. However, in its proxy filed March 10, Motorola noted that audit fees for Section 404 assistance, which accounted for $200,000 of audit related fees in 2004, were zero in 2005.
Motorola spokeswoman Juli Burda said the 404 audit-related fees were “associated with one-time advisory services” provided by the company’s auditor, KPMG, during its initial year of SOX compliance.
“We aren't expecting significant reductions in our audit fees in the near term,” Burda added. “We and our auditors have driven improvements in our respective internal processes and we will continue to do so.” However, she said those improvements have been offset by the growth of the company’s businesses, new regulatory requirements, and by increased staffing costs incurred by its auditor.
Bumps Ahead Still Remain
Still, observers caution that determining the true picture of 404 costs from proxy disclosures is difficult, since the data currently available is limited. In addition, while some companies voluntarily break out their 404-related audit costs in their proxies, most do not, masking how much of the audit fees were SOX-related.
Kueppers
Bob Kueppers, deputy chief executive officer at Deloitte & Touche, said one driver of the fee decreases is a less slavish devotion by companies to documenting and fixing every single control. But, he added, “external auditor fees for 404 are also coming down significantly in many cases.” He also cited recent surveys that have shown that total 404 costs have declined by more than 35 percent on average. Proxy audit fees show a “less dramatic impact,” he said, because they include both regular audit fees and 404 audit fees.
Ray Beier, partner and leader of National Technical Services at PricewaterhouseCoopers, also warned against drawing “overall conclusions” yet, since the current data is limited. Still, he continued, most companies that were stable—meaning that they didn’t have any acquisitions or any major systems changes during 2005 that would cause an increase in audit fees—are going to experience “meaningful declines” in their 404 costs.
Beier
“Our preliminary data is bearing that out, and we feel confident that the overall data will bear out that fact,” said Beier, who attributes the decrease to “efficiencies gained from Year One,” among other factors.
“The guidance that came out last May has been helpful, testing processes are more efficient, and the documentation effort of Year One hasn’t had to be repeated,” he said. “People simply understand better how to assess significant deficiencies and material weaknesses.”
Based on PwC’s calculations so far, Beier said approximately 100 companies that had material weakness disclosures last year have received clean auditor opinions this year, which he said “is clearly an improvement.”
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