SOX No Cure-All for Accounting's Ills

Accountants have been on high alert in the post-Enron work environment, but experts say that while accounting has improved, fundamental problems remain.

The Sarbanes-Oxley Act of 2002 has required tight internal controls over financial reporting, better documentation and in general, more accountability.

But some observers point out that, in effect, the fox is still watching the hen house. As long as the accounting firms are paid by the companies they audit, scandals will continue, New York Times columnist Joseph Nocera suggests. Some observers have proposed that audit fees be pooled and then distributed to the accounting firms by an independent body, such as the Securities and Exchange Commission or the New York Stock Exchange.

Another idea to change the relationship between companies and accountants comes from New York University accounting professor Joshua Ronen. He proposes inserting insurance companies into the process. The insurer would hire an independent firm to investigate the company and assess risk. "It would look at internal controls, internal auditing, management, past history of negative earnings surprises," Ronen said. The insurer would determine whether the company was insurance-worthy, the shareholders would vote on whether to buy the insurance, and the auditor would report directly to the insurer. The insurance could cover some legal costs and would presumably decrease the number of restatements.

But since companies are likely to continue hiring accounting firms directly - at least in the near future - the Public Company Accounting Oversight Board, put in place through the Sarbanes-Oxley corporate reform law, can do much to bring more independence to the process by auditing the auditors, Nocera writes.

The most-publicized result of SOX, the new internal controls requirements, have so far affected only large companies. But even these companies, with big finance departments and time-tested internal controls, are showing material weaknesses in internal controls over financial reporting, writes James Gentry, professor at the William Allen White School of Journalism and Mass Communications at the University of Kansas. Almost 10 percent of the 1,968 companies making regulatory filings this year had internal control compliance problems, Gentry wrote in BusinessJournalism.org. Compliance Week has reported that the failure rate for mid-sized and small companies is expected to be much higher.

Another issue is that many companies are still using inadequate financial systems to meet the requirements of SOX, accelerate closing and effectively report financial results. According to Ventana Research, many companies still rely on manual entries and spreadsheets that can introduce errors into the financial reporting process and poor systems that “do not do a good enough job providing people with information about their individual performance, or the performance of their business unit toward its objective.” Ventana surveyed 207 people from companies with more than 1,000 employees or $100 million in annual revenues, according to the Sarbanes-Oxley Compliance Journal.

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