Stricter Audit Rules Proposed

The government’s new accounting oversight body Tuesday proposed its first set of new audit standards, or guidelines for external auditors to check and affirm the effectiveness of companies’ internal anti-fraud controls.

The proposed new standards by the Public Company Accounting Oversight Board are meant to flesh out a section of 2002’s Sarbanes-Oxley corporate-reform law requiring public companies to perform a yearly assessment of their internal controls and publish the results in their annual reports to shareholders.

Enron Corp., WorldCom Inc. and other notorious accounting scandals were blamed in part on breakdowns in the firms’ internal controls, which are supposed to identify and correct problems before they result in serious misstatements of financial results.

An example of an internal control is a policy that prevents the same person who writes the company checks from reviewing the bank statements.

The proposed new standards, unanimously approved Tuesday by the five-member PCAOB, will be sent to the Securities and Exchange Commission for final approval after a 45-day comment period.

The PCAOB, created by Sarbanes-Oxley as the independent watchdog over the accounting industry, has taken over the development of new auditing standards to replace those that existed under the industry’s previous regime of self-regulation.

The board tried to strike a balance between tougher standards and unduly burdensome expense for companies, PCAOB Chairman William J. McDonough said Tuesday.

Rather than adopt a one-size-fits-all approach, the board proposed less rigorous standards for mid-sized and small firms.

For example, auditors will be required to field-test internal controls at large firms but not at smaller ones. Such field tests might involve questioning company employees who oversee internal controls, examining records and tracing certain transactions in detail. Auditors would report any deficiencies to the company’s audit committee.

In a new requirement, the auditors also would be asked to assess the effectiveness and independence of a client’s audit committee.

McDonough acknowledged that the new rules could add significantly to the cost of external audits, especially for firms whose controls are weak or whose recent audits weren’t too thorough.

“The degree of sticker shock will depend very much on how much companies were paying for their audits in the past,” he said.

Until Sarbanes-Oxley changed the rules, many accounting firms used audit business as a “loss leader” to land more lucrative consulting work from their audit clients, McDonough noted.

Companies that paid artificially low prices for their audits therefore can expect bigger cost increases now.

W. Steve Albrecht, associate dean of the Marriott School of Management at Brigham Young University, serves on several corporate audit committees. He said there has been some “pushback” from companies upset over the cost of documenting their internal controls, as required by new SEC guidelines.

However, in the aftermath of Enron and WorldCom, concerns about cost have taken second place to audit quality, Albrecht said.

Also Tuesday, the PCAOB gave unanimous approval to rules, first proposed in July, on inspection of accounting firms. Board employees will conduct annual inspections of the largest accounting firms. Smaller firms will be inspected every three years.