Print this article | Return to Article | Return to CFO.com
Can This Relationship Be Saved?
Auditors and CFOs aren't the friends they once were, but they are working out their differences.
Kate O'Sullivan, CFO Magazine
May 1, 2008
The healing has begun. It's been six years since the passage of the Sarbanes-Oxley Act, and four
years since companies faced their first Sarbox audits. After a painful start, compliance with the act has
become more or less routine for many businesses and their external auditors.
But what about the CFO-auditor relationship? Once close and collegial, it turned acrimonious at the
start of the post-Sarbox era, when auditors drew back from their clients in the name of objectivity.
Has the passage of time produced a détente, or are relations between the two parties still tense? What
effect have regulations passed in the wake of Sarbox had on the relationship — and, for that matter,
on audits? We decided to find out, through interviews with and surveys of finance chiefs and auditors.
(The CFO's perspective is presented here; for the auditors' side of the relationship, see the companion
story, "Auditor Angst.")
Let's start with some reasonably good news. In March, CFO magazine conducted a survey of 205
senior financial executives on the state of external audits (see the link to "What CFOs Have to Say
about Auditors" at the end of this article). Forty-two percent of those executives said they were very
satisfied with their audit firms, while 44 percent said they were somewhat satisfied. Anecdotally, CFOs
who have seen both audits and auditor relationships improve in recent years attribute much of the
change to greater familiarity with Sarbox.
"People have had a chance to digest Sarbanes-Oxley — to get used to it and work with it for a while,"
says Barbara Klein, CFO at CDW, a provider of technology products and devices that was recently
acquired by a private-equity firm. Finance chiefs say their departments are documenting controls and
accounting decisions more carefully and preparing more thoroughly for their audits; 27 percent have
added internal-audit employees in the past two years, according to CFO's survey.
Auditors have come up to speed, too, say finance chiefs. "I wouldn't go so far as to say that auditors
have loosened up, but they've developed a more standardized approach to working with [Sarbox],"
says Chris Johns, CFO of PG&E Corp., the holding company of the California utility giant. "They've
become more efficient."
At Johnson Controls, for example, auditors have developed a method for deciding when to refer issues
to the national office. "There's more of a system now," says Bruce McDonald, CFO of the $34 billion
diversified industrial company. "They set some parameters for people to exercise their local
judgment." By contrast, in the early years of Sarbox, it was "frustrating" when auditors started
passing questions on to the national office, says McDonald. "It extended the time frame on a lot of
decisions."
Stingy with Advice
Still, many auditors continue to be reluctant to provide advice — and many CFOs continue to chafe at
that reluctance. Forty-two percent of survey respondents who were dissatisfied with their auditors say
they don't provide enough guidance on accounting issues.
At a recent gathering of finance executives from around the country, grumbling about reticent auditors
was universal. One CFO complained that she was paying more for her audit but getting much less for
her money, because her auditors no longer provided accounting advice, which she considered the
most valuable component of audits past.
"They'll give you information, but they won't give you a recommendation," sums up Peter Kruse, CFO
of Nissan Forklift. (Ironically, information delivery is among the key complaints that auditors levy
against clients; see "Auditor Angst.")
PG&E is one of many companies that have engaged a third-party consulting firm to help address
complicated accounting questions. "By the time we go to our auditors with an accounting issue, we've
pretty much got it wrapped up," says Johns. "In the past there was a lot more willingness on the part
of our auditors to engage and talk about the accounting. Now they'll listen, but it's by no means
similar to the conversations we had before [Sarbox]."
Seventy percent of CFOs say they meet with their auditors ahead of time to determine the areas up
for review, a critical exercise in which CFOs point out the greatest risks and share the work internal
audit has already done. But these conversations are more guarded than they once were.
"The auditors leave a little bit in their back pocket," says Tom Ackerman, CFO at Charles River
Laboratories, a provider of research models and laboratory services to biotech and pharmaceutical
firms. "In earlier days they would lay out everything they were going to look at, but these days they
don't share their entire audit program with you. There's a little bit left unsaid."
Too Expensive
Although practically everyone complains about the dearth of auditor advice, that ranks as the numberthree gripe of finance chiefs. What's number one? Fees.
Audits in the post-Sarbox era are too expensive, according to nearly half of those who say they are
dissatisfied. Fees were widely expected to fall after the first year of Sarbox implementation, but in fact
they have continued to climb at most companies. Eighty-two percent of finance executives surveyed
reported an increase in fees from 2007 to 2008, although the majority of those say the increase was
slight — from 1 to 10 percent. Only 6 percent of companies saw fees fall. Seventy-three percent
expect fees to rise again next year.
Given the increased scope and complexity of audits, rising costs seem inevitable, says CDW's Klein.
"With the passage of Sarbanes-Oxley, there was more work, and if there's more work there's going to
be more cost," she says. "The fees have come down from the early years, but they're never going to
be at the levels they were pre-Sarbox."
CFOs bemoan the complexity of new accounting regulations and say they expect complicated rules to
drive audit costs even higher in the years to come. "If you look at something like derivatives
accounting, you have companies like Fannie Mae and the major banks, which have an awful lot of
smart people who go through the issues with their auditors, and they can't seem to get it right," says
McDonald of Johnson Controls. "The complexity of these standards is worrying, and documenting and
implementing them tend to drive up costs."
At the top of the list of future audit-cost drivers are fair-value issues, say CFOs: 37 percent of survey
respondents said fair-value accounting standards like FAS 157 and FAS 159 would be most likely to
raise the price of their company's audit in the next year. A short supply of audit staff and a possible
new format for financial statements also ranked as areas that will increase costs.
The Effect of AS5
One measure that many hoped would reduce costs significantly was Auditing Standard No. 5, issued in
July 2007 by the Public Company Accounting Oversight Board (PCAOB). AS5 instructs accounting firms
to take a more selective, risk-based approach to audits. But although the standard has helped matters
(along with a similar Securities and Exchange Commission interpretation), it has hardly been
revolutionary.
"AS5 hasn't resulted in the change a lot of us expected," says PG&E's Johns. In fact, a majority of
finance chiefs surveyed by CFO — 64 percent — say they have seen no audit changes at all as a result
of the new standard.
Still, a third of CFOs report that auditors have narrowed their scope at least somewhat thanks to AS5.
That's confirmed by Robert Kueppers, deputy CEO at Deloitte, who says AS5 has reduced Deloitte's
time on engagements and enabled the firm "to hold the line on audit costs."
At Johnson Controls, McDonald has been one of the lucky few to see a significant impact: "The
adoption of AS5 and the risk-based approach resulted in probably about a 20 percent reduction for us
in the cost of compliance with Section 404 [which mandates documentation and testing of internal
controls]. The auditors have been able to step back and look at something like our petty-cash controls
and say, 'That's not going to lead to a significant financial-reporting problem.'"
Ackerman of Charles River says he was skeptical about whether auditors would really take AS5 to
heart and scale back the scope of their audits. "It seemed like they might have a hard time moving
away from entrenched practices," he says. But Charles River has benefited from the new standard: its
audit fees came down more than 15 percent in 2007 from 2006. "Once AS5 was written down, it gave
audit firms something to lean on," says Ackerman. Auditors used to include 90 percent of the
company's global locations for either complete or limited testing, but last year fewer locations were
scrutinized. "The approach was more risk-based, taking into consideration the work we do at each of
the different locations," says Ackerman.
Jonathan Mason, CFO of specialty chemical maker Cabot Corp., views AS5 as "a step in the right
direction." He says the company's auditors are making a greater effort to identify significant controls
and examine those areas thoroughly. External auditors are also relying more on the internal auditors'
efforts, he adds. "The auditors are not going to write an opinion based on internal audit's work, but
they can get comfort on some of the less critical areas," says Mason. This marks a significant shift
from the early Sarbox days, when external auditors couldn't consider internal audit's work, because of
a mandate that external auditors conduct testing on all material items. Ackerman also notes that there
is now a greater reliance on testing done by the internal-audit staff than in the past, and says this has
been a major factor in reducing Charles River's audit costs.
With time and experience, auditors have gained a better understanding of the PCAOB's expectations.
"What you saw initially was a disconnect," says Mike Burke, a former KPMG partner who is now CFO at
Aecom Technology, a provider of technical- and management-support services. "The auditors focused
on the minutiae and companies focused on the biggest risk areas. Now we have a greater alignment
between the way auditors and companies look at the business."
The Way Ahead
Clearly, both companies and auditors have come a long way since the early days of Sarbox
implementation, when no one knew quite what regulators expected or what was required for a
"passing" grade on Section 404. "There was a lot of running around, chasing our tails, and learning
from month to month," recalls McDonald. Adds CDW's Klein, "Both companies and auditors probably
did more work than was required because we didn't know exactly what was required."
The lessons learned by auditors and finance staffers as they institutionalize the many changes
mandated by Sarbox have proved as important as the additional guidance from regulators in
improving the process. While the CFO-auditor relationship may not be as warm as before, it's still
evolving. One good sign: finance executives don't seem quite as angry as they were a few years ago.
Of course, there will continue to be struggles over fees and the amount of advice or information
auditors are willing to share, as well as how long it takes to get that information. But many CFOs see
things moving in the right direction. "We are moving much closer to a collaborative relationship," says
Mason. "Collaboration does not mean that the company doesn't have the primary responsibility for
making the accounting decisions and judgments. It just means that the auditor can add value."
Kate O'Sullivan is a senior writer at CFO.
Print this article | Return to Article | Return to CFO.com
Auditor Angst
Want faster, cheaper audits? Your auditor humbly suggests you avoid last-minute data dumps and other
less-than-helpful practices.
Alix Stuart, CFO Magazine
May 1, 2008
Want to drive your auditors crazy? Try this: First, meet with them ahead of the annual audit and agree
on a date when your work papers will be ready. Then, when they arrive for the audit, tell them you're
"almost ready" and hand over just enough material to keep them busy until lunch. Repeat as
necessary. Later, suddenly remember a contract or revenue-recognition problem that you haven't
previously discussed (the more complex, the better). Finally, as the deadline nears, demand a 24-hour
turnaround for the 10-K draft and complain loudly when the auditors tell you it can't be done.
This scenario may sound like a joke, but in fact auditors say it's exactly what many CFOs do every
year. Michael Deutchman, managing director at Los Angeles–based accounting firm Kabani & Co., says
he dreams of walking into a client company where "we can test the records and see right away that
they are what they're supposed to be."
But in reality, he laments, "there aren't a lot of CFOs who run companies that way." More often, says
Ben Neuhausen, national director of accounting for BDO Seidman, "the client takes forever to pull
together documentation, and then they present it three days before audited financials are due to their
lender, or a week before the 10-K has to be written. Somehow they think the auditor will work a
miracle."
The miracle is that despite the chronic unreadiness of auditees, the relationship between auditors and
their clients is actually improving. Most auditors — more than 60 percent of those recently surveyed
by CFO — say they have a better relationship with clients today compared with three years ago, when
the pain of Sarbanes-Oxley compliance was still raw. In part that's due to new interpretations from
the Securities and Exchange Commission that loosen the strictures of Sarbox, leading most auditors to
feel they can offer more guidance — "the fun stuff," in the words of one senior manager. New
guidance about how internal controls must be audited, in the form of Auditing Standard No. 5 (AS5)
from the Public Company Accounting Oversight Board (PCAOB), has also made things better.
Still, ask auditors what keeps them awake at night and client-related issues will top their replies. More
than half the nearly 100 auditors surveyed by CFO said that unprepared clients create high levels of
stress. One-third said the same of clients who are difficult to work with. The hassle from clients, in
fact, far outranked other strains, such as the pressure to generate more revenue.
No one expects a return to the cozy pre-Sarbox days, when auditors were practically an extension of
the finance team. But, auditors wouldn't mind a little more cooperation and appreciation. "The ideal
situation would be clients who understand their own accounting and make the time to get us what we
need," says Bruce Rosen, partner-in-charge of assurance services at New York–based auditing firm
Eisner. How often does that happen? By way of reply, Rosen laughs — and laughs some more.
Look Who's Not Talking
This is not to say that auditors are unsympathetic to their clients' problems. "Most clients want to be
ready, and they do the best they can," says Russ Wieman, national managing partner of audit and
advisory services at Grant Thornton. Still, there is plenty of room for improvement. Some 10 percent
of CFOs admit they are typically unprepared for audits, while another 37 percent are only sometimes
prepared (see "Can This Relationship Be Saved?"). A lack of qualified staff in corporate finance
departments is frequently to blame. "There's no question that many companies do not have the
accounting talent" to cope with increasingly complex accounting rules, says Wieman.
Unprepared clients mean longer audits, longer hours, and, sometimes, auditor burnout. "Some of our
toughest decisions are when one job hasn't wrapped and the next job is starting — what do we do?"
says Eisner's Rosen. Auditors have the option of leaving the audit unfinished and circling back when
time permits, something Eisner stipulates in many of its engagement letters. In reality, though, the
firm will bend that rule for clients with SEC or other filing deadlines, says Rosen, since few auditors
want to be known for making a client miss a deadline.
Another big problem, say auditors, is that CFOs fail to seek their input before making major
accounting decisions involving such matters as debt agreements, leases, or asset sales. More than half
the respondents to CFO's survey ranked this among the top three things clients do that reduce the
efficiency of an audit. "Tell the auditors [about major decisions] when you're in the planning stage,
and give them the agreements to look at," advises Neuhausen. "Don't present them at the end of the
year as a surprise."
Of course, clients claim that such cases are innocent omissions, and they often are. But Neuhausen
says that sometimes he "gets the sense that CFOs think if they just present it as a fait accompli, the
auditors will just go along with whatever they did and they can slip it by them."
Complexity Cuts Both Ways
As for longer engagements, auditors are quick to admit that clients aren't the only ones to blame.
Accounting complexity now throws up many hurdles, making it difficult for auditors to breeze through
assignments. More and more of their questions need to go to the national office, or at least to another
expert in the firm. "I've been an audit partner a long time, and 10 years ago I didn't consult that
much, because things weren't that complicated," says Wieman. Today he brings in subject-matter
experts far more frequently, thanks to complex pronouncements such as FASB Interpretation (FIN) 48
for income taxes. "There are a lot of things out there that individual auditors can't be expected to
know on their own," he says.
Fair value is another such issue. Both auditors and CFOs surveyed by CFO say that it is one of the top
factors that will add to audit costs in the coming year. That's mainly because it means extra work for
both the company and the auditors. "When we go to full fair value, I don't think there will be enough
experts around for everyone," says Wieman.
Many auditors say they try to work with a company in advance on fair-value issues so that the
numbers don't come as a surprise during the audit. Still, the amount of work involved in estimating
fair values is daunting. When it comes to valuing thinly traded securities, for example, a company
could once rely on a single broker quote. Now the accounting staff needs to either interview the broker
about how she or he arrived at the estimates, obtain multiple broker quotes, or supplement a single
quote with some modeling based on recent trades of similar securities.
Yet another reason auditors need more time is the PCAOB's Auditing Standard No. 3, which prescribes
general requirements for audit documentation. Before AS3, auditors used to have casual discussions
with clients about such topics as valuations and cash projections and then write a general memo. Now
they need to drill down much deeper and document each step along the way. "If you don't talk about
every assumption and how you tested it, you could be in trouble," says Wieman.
Judgment Days
What can be done to break the audit logjam? Regulators have been working on various measures to
ease external pressures on auditors. One, the recently implemented AS5, is already having an effect.
The standard allows auditors to focus on the riskiest areas of internal controls rather than probe all
controls in detail.
AS5 "was like taking a breath," says Robert Kueppers, deputy CEO of Deloitte. He says the standard
signaled a shift away from the PCAOB's pressure on auditors to "do more, do more, do more." So far,
it has reduced the time on engagements, albeit not dramatically so. "AS5 has at least allowed us to
hold the line on audit costs," says Kueppers.
But the real importance of AS5, adds Kueppers, is that "it gives renewed credibility to the use of
professional judgment — that you can make a reasonable assessment about what needs to be probed
and it will be respected." While the PCAOB has yet to inspect the first of the new, risk-based audits
(that will likely take place this summer), Kueppers is "confident" Deloitte's judgments will be affirmed.
Related to the emerging notion of allowing auditors to exercise more judgment, the SEC's Committee
on Improvements to Financial Reporting is mulling the creation of a judgment protocol, or list of
recommended steps, for both companies and auditors. By following the protocol, auditors would enjoy
a degree of protection from lawsuits if it turned out they were wrong about which transactions to test
or what accounting treatment was proper. Not surprisingly, auditors applaud the idea. "What we're
looking for is a framework to follow [that makes us feel we're] in good shape," rather than a safe
harbor that would inoculate them from any consequences, says Wieman.
The Treasury Department, meanwhile, is sponsoring a committee that is considering a range of
actions to encourage audit firms to grow their practices, including liability caps for auditors, a
redefinition of the auditor's responsibility to detect fraud, and a safety net to avoid the loss of a large
firm. Headed by former SEC chairman Arthur Levitt and former SEC chief accountant Don Nicolaisen,
Treasury's Advisory Committee on the Accounting Profession is due to release recommendations this
summer.
As for the audit firms, some are staffing up so that clients' foibles exact less of a toll. Moss Adams, for
one, says it schedules auditors for 50 to 55 hours per week during the busy season and generally
makes sure no one works more than 60 hours per week. The firm is also building extra "wrap-up" time
into its auditors' schedules for the two weeks following an engagement, so that the inevitable followon issues don't create extra scheduling pressures, says Kris Dunning, a partner in the firm's San
Francisco office. Moss Adams is trying to spread more of its work over the year and no longer requires
all auditors to come in on weekends during busy season. "This is the best busy season I can
remember," says Dunning, who has been with the firm 18 years.
PricewaterhouseCoopers (PwC) hopes that taking a more behavioral approach to engagements will
promote client cooperation. To that end the firm is stressing the importance of empathy and training
its auditors to better communicate the value of their work.
"You have to think about standing in [your clients'] shoes," says Robert Moritz, U.S. assurance leader
at PwC. "We make sure our people try to keep in mind that how you deliver the message is as
important as the message itself." So far, PwC surveys indicate that "client perceptions of the
relationship [have moved] in the right direction," says Moritz, although he concedes that "we've got a
lot of room to improve."
In the end, though, auditors can tolerate only so much annoyance. Most audit firms conduct an annual
"client continuance" assessment, and many are getting tougher about which clients they'll keep and
which they won't. UHY, for example, recently ended a five-year relationship with a client after the
company's CFO berated the audit staff. "You just can't have that stuff," says Larry Kaplan, managing
partner of the Boston office of UHY. "There's enough pressure in this profession without that."
Alix Stuart is a senior writer at CFO.
To see what auditors in our survey had to say about CFOs, click here.
Is Audit Quality Improving?
The Center for Audit Quality, a new industry group for accounting firms that perform public-company
audits, says that audit quality has improved over the past several years, according to its recent survey
of audit-committee members. More than 80 percent thought audits were better today than five years
ago. The auditors themselves seem somewhat less confident, according to a CFO survey. Just over
half — 54 percent — said they are more likely to detect fraud today compared with five years ago,
while only 4 percent said they were less likely to find fraud.
"There are things we do today that we rarely did five years ago," says Robert Kueppers, deputy CEO
at Deloitte. One, he says, is to bring in forensic accountants "to try to figure out, if someone wanted
to fiddle around with the books, where they would do that." The new focus on internal controls has
helped, too. "If your controls are good, it's just that much harder to circumvent them," Kueppers says.
CFOs, however, seem to be more skeptical. In a separate CFO survey (click here), only 23 percent of
finance chiefs said they thought auditors were more likely today to detect a fraud, and 11 percent
thought they were less likely to do so. — A.S.