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New Regulations: Preparing for the Unplanned Costs By Margaret A. Johnsson and Fran S. Wiechart January 2003 (Financial Executives International) CEOs and CFOs at $1 billion-plus companies are racing to comply with personal certification and other Sarbanes-Oxley requirements -- with little regard to implementation costs. At a recent global gathering of executives, the chairman and CEO of a corporation ranked among the world's 100 largest public companies confided that he had just signed off on the company's financials with great trepidation and less than full comprehension of every accounting policy he was approving.
Though few corporate executives may be as candid about their first experience with the new regulations, CEOs and CFOs in companies large and small are racing to better understand their financials in order to comply with Sarbanes-Oxley and a myriad of other new SEC and corporate governance requirements. To attest to the completeness and accuracy of corporate financial statements, non-financial disclosures, exhibits and footnotes, companies are beefing up internal processes, policies and analyses… with little regard to implementation costs.
The new regulatory environment takes the function of financial reporting to the next level of accountability. Everyone involved - boards of directors and audit committees, external and internal auditors, senior and multiple layers of management, financial staff, outside and in-house counsel - has a heightened awareness of the risks involved in filing their financial statements. This translates to more policies, more procedures, more risk assessment, more analysis, more scrutiny… and more expense.
Yet few companies are calculating the costs. In a recent informal poll of $1 billion-plus companies based in Chicago and New York, The Johnsson Group found that companies - ranging from pharmaceuticals to financial services - are finding the filings painful to complete and the regulations costly to meet. Many corporations have spent considerable time analyzing and adjusting their traditional close process, reporting and review schedules. Most of the companies said that more layers of management and their board's audit committees were reviewing the implications of accounting policies in an unprecedented way. Focused almost exclusively on the need to comply, none had examined the cost of implementing the new regulations.
In this new regulatory environment, companies will have to add financial staff and pay significantly higher auditing fees - projected at 20 percent to 200 percent over pre-Enron/Andersen fees. In some cases, independent auditors are being retained to audit the company's auditors. New risk ratings assigned companies by their auditors will require the lower-rated companies to pay higher audit fees, and new risk management consulting services will also add to the price tag. Accelerated re-porting deadlines, to be phased in over three years, compress the time in which to perform an audit, which will now require more people and further elevate costs. The new, more prudent practices of assigning two partners to an audit - one to oversee and one to observe - and rotating both partners every five years will also increase audit firms' fees.
Corporate governance costs are also on the rise. For example:
Costs of Compliance
To help clients with 2003 budgeting estimates, The Johnsson Group set out to get a handle on what a "typical" company might face in terms of one-time costs to meet initial deadlines, and ongoing costs for subsequent reporting periods. Costs were estimated for a Fortune 500 corporation with global operations and $3 billion in annual revenue. Cost estimates include: an in-house internal audit department, in-house legal counsel and significant disclosure requirements. Rough estimates, based on long corporate experience and an intimate knowledge of the financial reporting function, range from $4 million up to $9 million in tangible one-time costs and another $3 million to $8 million in recurring annual costs (see table). Naturally, actual costs will vary widely by company.
Equally significant are the intangible or opportunity costs involved for company directors and top management. With a larger share of time and resources directed at reporting financial activity, the company's leadership will have that much less time and resources available for forward thinking. Also, new products, new markets and new mergers or acquisitions may be realized more slowly as a result of the new regulatory environment.
Although much attention has been focused on the impact on large public companies, many privately held and smaller public companies are affected as well. Indeed, SEC Section 12 requires private companies with more than 500 security holders to file reports with the SEC and comply with Sarbanes-Oxley. Additionally, the SEC is requiring companies with a common equity public float of at least $75 million as of the end of 2002 to file 10-Qs and 10-Ks. For smaller companies, compliance costs can be disproportionately burdensome due to their size - an unexpected challenge in an already difficult economic environment.
Yet, despite the expense, some companies understand that this sharpened focus on financial reporting can have a positive net effect. "We voluntarily began certifying our financial statements six months early," explains Elisabeth DeMarse, CEO of Bankrate.com, an Internet consumer-banking marketplace. "As a smaller public company, our willingness to comply with Sarbanes-Oxley prior to our regulatory deadlines gives us a leg up in building credibility with our investors," she adds.
It's clear that in the aftermath of Enron, there is a heightened interest in solving operational problem areas that are either slowing the reporting process or management review of filings. Improvement projects on the back burner are rapidly moving to the front. As a result, expect to see faster external audits, increased expenditures in the finance operation to meet the new requirements and, eventually, improved internal controls and operations.
For example, costly software designed to consolidate financials or enable precise forecast processes might have seemed unnecessary in the past, but the need to close the books more quickly and forecast more precisely - under unprecedented scrutiny - is causing companies to recalculate costs versus benefits of such initiatives.
Focus on Key Skills
In addition to cost analysis, companies are beginning to focus on the types of personnel skill sets necessary to meet the ongoing requirements. Communications skills, combined with the ability to synthesize the numbers and present meaningful explanations, become increasingly important as many more questions arise from audit committees, management and auditors about various accounting procedures and results. Designating overt accountability is a major corporate culture shift that will produce an organization more deeply involved with tasks that have historically been the private domain of the auditors and senior management. With this heightened focus, public companies will move closer to the end game, which is to restore confidence in the quality of numbers and information provided to the public, employees, bankers, regulators and investors. Restored investor confidence will go hand-in-hand with more precision and transparency of the core financial processes and renewed credibility for corporations, which will come at a price the companies have no choice but to pay.
Recommendations For Streamlining the Reporting Process:
SEC Reporting and Disclosure Changes
Source: The Johnsson Group Inc.
MARGARET A. JOHNSSON is CEO and Founder of The Johnsson Group Inc. (www.thejohnssongroup.com), a financial consulting firm that is a wholly owned subsidiary of the Altran Technologies Network, with 18,000 consultants in 16 countries. She is a member of FEI's Chicago Chapter and serves on the Chapter's Board. Fran S. Wiechart is a Senior Financial Consultant at The Johnsson Group.
Subscribe to Financial Executive! The flagship publication of Financial Executives International (FEI), this premier magazine provides senior financial executives with financial, business and management news, trends and strategies to help them work better, faster and smarter. For more information about FEI, visit www.fei.org.
2003 Financial Executives International. Reprinted with permission.
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