Revenge Of The Bean Counters

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THOMAS REIS FOR TIME

There's a joke in the accounting trade that the difference between a wobbly grocery cart and a corporate auditor is that the cart has a mind of its own. Very funny, unless you had invested in MCI (formerly WorldCom), which recently announced that the pretax income it reported for 2000 and 2001 was just a tad off--$74.4 billion less than it had said, after writedowns and adjustments. Outside auditors have signed off on bogus earnings reports and balance sheets at companies from Rite Aid to Xerox. In some cases, auditors dealt with corporate brass intent on concealing thievery; WorldCom's ex-CFO, Scott Sullivan, recently pleaded guilty to fraud and conspiracy charges, for instance. In other cases, auditors simply lacked spine: again and again, they failed to police the books aggressively for fear of losing the client, along with consulting gigs that brought in higher profits than standard audit work.

The tables have turned. Strengthened and emboldened by the Sarbanes-Oxley Act, which overhauled accounting responsibilities, the bean counters have taken off their kid gloves and snapped on rubber ones. With their federally issued mandate to look for trouble, accountants no longer have to take a company's word that its audit policies are legit. The accountants have the power to challenge corporate ledgers with impunity — and they're raking in money doing so. "Auditors and audit committees are now in the catbird seat," says Harvard Business School professor Jay Lorsch. Companies no longer feel free to dump their auditors, for fear of sparking a public spat; no one wants to spook jittery investors, provoke shareholder lawsuits or another regulatory crackdown. "There's more respect for the auditor," says Julie Lindy, editor of Bowman's Accounting Report. "Companies no longer think the audit process is about creating the illusion that they're jumping through hoops."


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The change in the relationship is largely because of Sarbanes-Oxley, known in the trade as Sox or Sarbox. The 2002 law stiffens accountants' spines in part because it places them under a new federal watchdog agency that will soon start spot-checking their work. That agency, the Public Company Accounting Oversight Board, also has an industry moniker — Peek-a-Boo — and recently issued a stricter set of rules detailing how auditors should evaluate internal controls. Companies must test these controls regularly, and such tests must be conducted by a firm different from the company's outside auditor, to avoid conflicts of interest. The agency's chairman, former New York Federal Reserve Bank chief William McDonough, is close to finalizing joint supervision rules with the European Union — welcome news to U.S. investors after the collapse of Parmalat, the Italian firm that had concealed $18 billion in debt.

Bottom line: Be nice to your accountants — or else. Outside auditors answer to an audit committee made up of at least two independent board members; previously they might have dealt only with a chief financial officer, and "it would not have been unusual for CFOs ... to try to limit the scope of an audit," says Scott Green, head of compliance for the law firm Weil, Gotshal & Manges. Since the law bars accounting firms from selling certain consulting services to audit clients, including such lucrative ones as information-systems design, auditors face less pressure from their partners to pass cooked books.

The new measures have "put the fear of God" in corporate bosses and their employees "to make sure that auditors get accurate information," says Edward Nusbaum, CEO of Grant Thornton, the nation's sixth largest accounting firm. Gary Shamis, a managing partner at SS&G Financial Services in Cleveland, Ohio, says he recently met with the audit committee of a client "for the first time in 20 years." Because auditors are under greater scrutiny and because the law demands it, they must also document the process more meticulously.

And so the fee meter is running. The death of the Arthur Andersen firm, which dissolved after being found guilty of obstructing justice in the Enron case, reduced the Big Five accounting firms to the Final Four. That in part is why audit fees for FORTUNE 500 companies are expected to climb 38% this year, according to a survey by the Public Accounting Report. Top lines for accounting firms already look healthier. Ernst & Young booked a 17.4% revenue increase in its 2003 fiscal year, to $5.3 billion. Grant Thornton booked a 21% increase, to $485 million. The other winners? Smaller shops, which are absorbing business that the big audit firms are barred from providing, such as running tests of internal controls for clients. "The environment for these services is phenomenally good," says Stephen Giusto, CFO of Resources Connection, an accountancy and consulting company based in Costa Mesa, Calif., whose fiscal 2003 revenues rose 11%, to $202 million.

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