2003 Annual Review of Financial Reporting Matters
Huron Consulting Group is pleased
to present you with our 2003 Annual
Review of Financial Reporting Matters.

Restatement Results

                                      Introduction: Facts about the Database                In addit...
Overall Trends                                Restatements by Year Filed

Public companies that restated their
previously ...
Size                                          Restatements by Company’s Revenue Size (2003)

The number of 2003 restatemen...
Trends in Restated Annual                    Restated Annual Financial Statements
Financial Statements
Regulatory and Rulemaking Authorities

                                      SEC                                         ...
significant number of new staff. In 2004,             well as any profits realized on sales of
insight regarding the on-going results of             • Exclude SEC fraud judgments from
PCAOB                                                 (AICPA). Now responsible for auditing
FASB and IASB                                         • Three changes to the calculation of
Public Accounting Industry

                                          Competition: Do You Really Have                    ...
While these new requirements were                     market value assertions, and one from the
Industry Analysis

Consistent with prior years, we have                 Software Industry
tracked restatement issues by in...
Industry Analysis (cont.)                    Manufacturing Industry

Industry Analysis (cont.)             Finance, Insurance, and Real Estate Industry

Industry Analysis (cont.)         Transportation, Communications, Electric, Gas, and
About Huron Consulting Group

Huron Consulting Group delivers                                  Acknowledgment
financial, ...
Upcoming SlideShare
Loading in...5

2003 Annual Review of Financial Reporting Matters


Published on

  • Be the first to comment

  • Be the first to like this

No Downloads
Total Views
On Slideshare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

2003 Annual Review of Financial Reporting Matters

  1. 1. 2003 Annual Review of Financial Reporting Matters
  2. 2. Huron Consulting Group is pleased to present you with our 2003 Annual Review of Financial Reporting Matters. Sarbanes-Oxley and recent catastrophic restatements have Contents resulted in major changes in our financial reporting world. However, financial reporting problems continue to make headlines in the news, even though internal and external scrutiny Restatement Results 3 plus shareholder demands are working Overall Trends to improve the reporting process. Major Issues, with Definition Table Restatements by Company Size The 2003 Annual Review of Financial Restatements of 10 K’s Reporting Matters takes an in-depth Trends in Restated Annual Financial Statements look at the financial reporting world and addresses some of the major Regulatory and Rulemaking Authorities 7 events arising in 2003. SEC PCAOB Huron's report examines the actions FASB and IASB taken by the U.S. Securities and Exchange Commission (SEC), the Public Accounting Industry 12 Public Company Accounting Oversight Board (PCAOB) and the Financial Industry Analysis 14 Accounting Standards Board (FASB) Software Industry and includes our observations Manufacturing Industry regarding the public accounting Finance, Insurance, and Real Estate Industry industry. In addition, our report Transportation, Communications, Electric, Gas, and Sanitary Services Industry analyzes the leading causes and trends in financial restatements filed About Huron Consulting Group 18 with the SEC for the year ending Contact information December 31, 2003. We hope that you will find the 2003 Annual Review of Financial Reporting Matters informative and useful. We welcome your comments and feedback, especially as to what additional analysis you would find helpful. Please do not hesitate to contact us to discuss issues raised in the report. Huron Consulting Group LLC February 2004 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 2
  3. 3. Restatement Results Introduction: Facts about the Database In addition, we applied the following definitions and practices in compiling To identify common attributes and trends our analysis: in public company accounting errors, we analyzed filings for restated financial • Multiple amended filings by a single statements (10-K/A's and 10-Q/A's) during company for the same underlying the five-year period January 1, 1999 purpose were counted as one through December 31, 2003. restatement. If the period being restated included an annual period, the The purpose of our analysis was to gather restatement was recorded as a 10K data on the size and industry of the restatement, whereas if only quarterly "Given that we had a runaway registrants that experienced a restatement periods were being restated, it was problem and, ultimately, to review the recorded as a 10Q restatement. market in the 1990s, you just underlying accounting error that necessitated the restatement. We also • Restatements are recorded as of the don't change that type of culture summarized information on the type of year filed, not when announced. Thus, financial statement (annual or quarterly) to the extent that companies announced overnight. It takes a while to put involved in the restatement. the need to restate during 2003, but failed to file amended financial the brakes on that train. The procedures we employed in our statements by December 31, 2003, analysis included: these companies were not included in While it is slowing, investors our 2003 restatement database. • Performed a search of all 10K/A and Similarly, some companies announce sure as heck do not want to 10Q/A filings in the Edgar database via an 8-K or press release that the from 1999 through 2003 using the company is going to restate in the near stand in front of it yet." keywords "restate," "restated," future, but then ultimately do not file "restatement," "revise," and "revised." amended financial statements with the Lynn Turner, SEC (e.g., file for bankruptcy or are • Refined search to include only delisted), and therefore these Former SEC Chief Accountant "restatements" defined as a restatement companies are not included in our of financial statements that was the restatement database. result of an error, as defined in APB 20. Our report excludes restatements due to • Our process was limited to the changes in accounting principles and information contained in the public non-financial related restatements. filings and did not involve interaction with any of the companies in our • Prepared a database with relevant database. As such, the interpretation of information for each restatement the accounting changes has not been identified, including the following fields: verified with these companies. Company Name, SIC Code, Annual Revenues (from the most recent filing), Footnote Disclosure Describing the Restatement Issue, Classification of Restatement Issue, Restating 10K or 10Q, and Auditor of Record (limited to amended annual financial statements). 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 3
  4. 4. Overall Trends Restatements by Year Filed Public companies that restated their previously released financial statements due to accounting errors totaled 323 in 330 323 2003, a slight decline compared to the Number of Restatements 330 restatement filings identified in 2002, 270 and up from 270 in 2001 and 233 in 2000. These restatements have been filed in 233 216 both amended quarterly (10Q/A) and annual (10K/A) financial statements filed with the SEC. 1999 2000 2001 2002 2003 Major Issues, with Major Accounting Issues (1999 - 2003) Definition Table 14.0% Reserves and Contingencies Errors in accounting for reserves and 17.5% contingencies was the leading cause of restatements in 2003. This category Revenue Recognition 19.0% includes accounting errors related to 16.2% accounts receivable and inventory reserves, restructuring reserves, accruals, Equity 14.5% and other loss contingencies. 15.7% Restatements attributable to this category experienced a greater increase in 2003 8.7% Capitalization/Expense of Assets than any other accounting issue. 10.1% Reserves and contingencies may be the Inventory 5.4% most judgmental accounts in a company's 5.7% financial statements, because in many % of Total 5-year Average cases, they are subject to an estimation % of Total 2003 process. These restatements, however, do not simply reflect changes in estimates, but rather reflect flawed judgments due to oversight or misuse of Accounting Issue Explanation facts, fraud, or a misapplication of GAAP. Reserves and Contingencies This category includes errors involved in accounts receivable and inventory Revenue recognition was the second reserves, restructuring reserves, accruals, and other loss contingencies. leading cause of restatements in 2003. However, the 63 revenue recognition Revenue Recognition Those instances where the company improperly recognized revenue on related restatements identified in 2003 transactions. represent a 26 percent decrease from 2002 when revenue recognition Equity This category includes errors involving stock option accounting, EPS restatements reached an all time high. accounting, and accounting for warrants and other equity instruments. Capitalization / Instances where a company has improperly capitalized an expenditure Expense of Assets that should have been expensed under GAAP (or vice versa). Inventory This category includes inventory valuation issues, inventory quantity issues, as well as cost of sales adjustments. 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 4
  5. 5. Size Restatements by Company’s Revenue Size (2003) The number of 2003 restatements by Greater than $1 billion, 20% companies with annual revenues under $100 million rose to 158, or 49 percent of all restatements filed during the year. Under $100 million, 49% The percentage of restatements filed by companies with annual revenues greater $500 - $999 million, 6% than $1 billion decreased slightly in 2003, from 22 percent in 2002 to 20 percent in 2003. $250 - $499 million, 12% $100 - $249 million, 13% 10 K's Restatements by Year Filed (10-K/A’s vs 10-Q/As) In 2003, the number of filings containing restated audited annual financial statements rose to a record high of 206, 10 K/A's 206 representing 64 percent of total 10 Q/A's 183 restatements filed during the year. While Number of Restatements investors rely on both quarterly and annual financial statements of public 147 140 135 130 companies, there is a different level of procedures and responsibility assumed by 116 117 the auditors for each of these. Annual 100 98 financials require a higher level of effort and association because an audit opinion is rendered. 1999 2000 2001 2002 2003 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 5
  6. 6. Trends in Restated Annual Restated Annual Financial Statements Financial Statements 400 As described earlier, the number of 395 registrants filing 10K/A's rose in 2003 to 206. To identify the underlying number of 350 annual financial statements affected by these errors, we also tallied the gross number of restated annual financial 300 312 Number of Restatements statements included in these filings and observed a similar trend with 395 restated 250 audited annual statements being included in the 206 10K/A filings. 228 200 172 150 159 100 50 1999 2000 2001 2002 2003 Total Restated Annual Financial Statements 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 6
  7. 7. Regulatory and Rulemaking Authorities SEC more than form when reporting business transactions and events. In 2003, the SEC continued to undergo change. In the aftermath of Sarbanes- Jurisdictional Conflict and Concurrent Oxley, the SEC's powers and resources Proceedings have increased and have resulted in a very active year. Civil and criminal actions for misconduct "We must reduce the financial in the financial markets have been coming "Objectives-Oriented" Standards; more frequently from multiple sources, reporting system's reliance on SEC Provides FASB with Guidance including the SEC, federal prosecutors, state attorney generals, regulators, and rules and move towards an Under federal securities laws, the listing agencies. In 2003, this Commission is the ultimate authority on prosecutorial action caused tension objectives-oriented system." accounting standards for public registrants among those with the power of in the United States. In 2003, the SEC enforcement and also increased the Cynthia Glassman, staff recommended that future accounting complexity of defending registrants and standards be prepared on an "objectives- individuals accused of wrongdoing. SEC Commissioner oriented" approach. While many have debated the merits of "principle" versus The increasing pace of investigations and "rule" based financial reporting, the new heightened scrutiny of corporations "objectives-oriented" guidance seems to highlighted occasional differences in "The SEC staff released its report embrace the principle side of the approaches by the SEC, Justice discussion. Department and other governmental encouraging standards that are agencies. In particular, the SEC staff recommended more objectives-based and less that future accounting standards possess For instance, a 2003 SEC press release the following characteristics: criticized the Oklahoma Attorney General rules-based. I embrace the for not cooperating with federal officials • Be based on an improved and related to his prosecution of the observations of this study." consistently applied conceptual WorldCom matter, and thereby possibly framework; jeopardizing the federal criminal cases Donald Nicolaisen, being prosecuted against WorldCom. • Clearly state the accounting objective of SEC Chief Accountant the standard; Complications arising out of the multiple proceedings make the selection and • Provide sufficient detail and structure so expertise of defense counsel all the more that the standard can be operationalized important. "Active state enforcement is and applied on a consistent basis; Help Wanted; SEC Looks to Hire critically important because the • Minimize the use of exceptions from the standard; and The SEC's 2003 budget of $716 million SEC lacks the resources to is set to increase again in fiscal year • Avoid use of percentage tests ("bright- 2004 to $811.5 million. The 2004 budget uncover every lead and investigate lines") that allow financial engineers to is almost twice the size of the SEC's achieve technical compliance with the $423 million budget in 2001. The every allegation of misconduct – standard while evading the intent of the government mandate is clear: hire more standard. professionals both to preempt future even with our financial reporting calamities and to Although this recommendation specifically enforce the law against wrongdoers. recent budget increase." addresses prospective accounting standard setting, there also appears to be Along with this substantial increase in William Donaldson, SEC Chairman a strong message that substance matters funding, the SEC has been hiring a 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 7
  8. 8. significant number of new staff. In 2004, well as any profits realized on sales of the SEC expects to complete the hiring of securities of the registrant in the last twelve 842 additional positions it received months. approval for in 2003. "No legislature, no regulatory On Your Mark, Get Set, Go. Life in the This hiring process was aided by the Financial Reporting Function agency, and no oversight amendment of the civil service hiring rules for accountants. The Commission can As if the pressures of more disclosure and body can stamp out greed." now hire staff accountants under the transparency were not enough, starting same rules it applies to the hiring of December 15, 2004, annual financial Kayla Gillan, attorneys, reducing a hiring process that statements are due to the Commission 60 once took months down to weeks. days after fiscal year end. The filing PCAOB Board Member However, complicating this process is a deadline had previously been shortened current shortage of accountants. The Big to 75 days from 90 days as of December Four accounting firms and the PCAOB 15, 2003. Quarterly filing time periods both are also currently trying to recruit for have also been shortened in total by 10 their accounting staff. days to 35 days after period end (as of December 15, 2004). Sarbanes-Oxley Table 1 Penalties Invoked This change may have little impact on Tally of Enforcements by Level of Individual larger, well organized and well staffed In 2003, we had registrants. However, for some registrants Position of Individual Number of Number of Individuals Individuals Charged Charged with Fraud "firsts" and new this shortened period could be problematic, precedents set especially when considering the existence Chairmen 75 63 arising out of the of thinly staffed accounting departments and CEOs 111 99 landmark the dependence on key personnel. Proper Presidents 111 96 Sarbanes-Oxley assessments and planning by registrants is CFOs 105 79 legislation and its key to avoiding the reputational risks of COOs 21 19 new powers and seeking extensions for quarterly and annual CAOs 16 14 penalties. filings. Combined with the enhanced VP's of Finance 27 19 penalties of Sarbanes-Oxley, the motto General Counsel 11 8 The believed-to-be seems to be get it done quicker, but make Controllers 47 28 first criminal action sure it's right. under the section 302 certification Score Cards and Report Cards rules was Weston Table 2 Smith of For those who follow the actions of the Corporate Fraud Task Force Accomplishments HealthSouth. SEC, two notable reports came out in 2003. Criminal Prosecution Statistics, July 9, 2002 - May 31, 2003 While the SEC did In January, as mandated by Sarbanes- 250 Corporate Fraud Convictions utilize the Oxley Section 704, the Commission 320 Current Investigations temporary freeze released its enforcement activity report for 500 Individual Subjects under review authority granted to the five years ending July 30, 2002. 169 Currently filed cases it under section Included among the many notable items in 354 Subjects involved in pending cases 1103 of Sarbanes- the report was a tally of enforcement Oxley, the provision actions by level of individual (see Table 1). Civil/Regulatory Enforcement, Statistics through June 30, 2003 that appears still open to name a In July the Corporate Fraud Task Force, 443 SEC Civil Enforcement Actions filed "first" is Section which includes professionals from the 11 Companies suspended from trading 304. Under Section Commission as well as other governmental 30 Companies' assets frozen 304, in the event of investigative and prosecutorial offices, 124 Actions sought to bar Executives from practice within public companies a restatement by a issued its first anniversary report noting the registrant as a accomplishments during its twelve months result of in existence (see Table 2). misconduct, the CEO and CFO must reimburse the Over time, trends in these numbers will registrant for any bonus or other incentive- highlight the targets of prosecutorial and based or equity-based compensation, as regulatory attention and will provide 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 8
  9. 9. insight regarding the on-going results of • Exclude SEC fraud judgments from their enforcement activities. state law property exemptions, allowing additional assets to be recoverable by Client Advocate, But to a Limit the SEC. "It could drive a wedge between The new rules for attorneys that practice • Change civil enforcement provisions lawyers and clients. The system before the SEC have caught everyone's and increase maximum fine per attention in the legal profession. The rules violation. won't work, you will have were adopted by the SEC on January 23, 2003 and became effective August 5, • Allow access to grand jury information corporations that won't feel 2003. They require, among other things, when there is shown to be a that attorneys report evidence of a "substantial need in the public interest." they can consult lawyers." material violation "up-the-ladder," initially to the chief legal counsel or the chief • Increase the subpoena range related to M. Peter Moser, executive officer. If the attorney feels that civil actions brought by the SEC. an appropriate response has not been Chairman of American Bar provided in a reasonable amount of time, Most interesting are the proposed changes the attorney must report the material related to SEC access to privileged and Association (ABA) Task Force violation to either an independent work-product protected documents. Under committee of the board of directors or to the proposed legislation, registrants could the full board. voluntarily produce information to the SEC without waiving the privileges associated "This bill will not only act as a At the time these rules were adopted, the with produced documents. Should this SEC chose to extend the comment period legislation become law, a significant hurdle deterrent, but even more on the "noisy withdrawal" provisions that to registrant cooperation with the SEC were originally proposed. Additionally, the would be removed. importantly will help restore some Commission proposed an alternative solution whereby the issuer, not the This legislation shows that, in addition to faith in the process for investors attorney, would be required to publicly providing the SEC with greater financial disclose the withdrawal of the attorney. resources, Congress intends to continue its who have plenty of education in support by increasing its regulatory For years, auditors have dealt with Rule authority. the school of hard knocks." 10A of the Securities Exchange Act of 1934 and its requirement for auditors to On the Horizon Mike Oxley, Congressman, disclose illegal activities of registrants to the Commission under certain Section 404 of Sarbanes-Oxley requires Chairman of Financial circumstances. However, auditors are registrants to document and evaluate their independent of their clients and owe a internal controls over financial reporting, Services Committee duty to the investing public, while and it requires both the registrant as well attorneys are advocates for their clients. as the auditor to opine on these controls The sanctity of the attorney-client privilege annually. The SEC originally proposed also is a major difference from the duties that registrants comply with Section 404 and rules governing the auditor. beginning in September 2003. In August of 2003, the SEC deferred the original Congress Proposes New Legislation to compliance dates. At the time this report Strengthen SEC went to print, the current SEC rules will require certain registrants ("accelerated In May of 2003, U.S. Congressmen filers") to comply with Section 404 for Richard Baker (R-LA) and Michael Oxley fiscal years ending on or after June 15, (R-OH) introduced a bill to "strengthen the 2004. All remaining registrants will be SEC's enforcement powers and increase required to comply beginning with fiscal its ability to return funds to defrauded years ending on or after April 15, 2005. investors." The Securities Fraud Prior to the implementation date, Deterrence and Investor Restitution Act additional guidance will likely be provided was pending in the subcommittee at year- by the regulatory authorities. end. The proposed legislation would: 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 9
  10. 10. PCAOB (AICPA). Now responsible for auditing standards, the Board couldn't have picked a The Public Company Accounting better place to let the financial reporting Oversight Board ("PCAOB") or ("the world recognize its authority than by stating Board") was created by Sarbanes-Oxley its position directly in the auditor’s report. to oversee the auditors of public companies. In 2003, the PCAOB began Before publishers recall auditing its oversight work and adopted its first textbooks, there will likely be more auditing standard in December. changes to auditing standards forthcoming from the accounting oversight board. It's an .ORG not a .GOV Another GAAP Watchdog While ".org" versus ".gov" might be a subtle difference in terms of internet The peer review process that audit firms addresses, the fact that the accounting previously conducted for each other to oversight board is not a government monitor quality and compliance with "We're looking for really quality agency but rather a not-for-profit entity auditing standards is now a primary role creates significant distinctions. of the Board. people…To some extent we're also Possibly most significant is the battle for Many critics of the audit profession competing with the PCAOB and talent; the board is paying private sector didn't believe the peer review process competitive wages. This issue is probably adequately identified weaknesses and they can pay a lot more." most significant to the SEC. While the that, as an "intra-profession" review PCAOB and SEC compete for similar process, it lacked true independence. Donald Nicolaisen, accounting candidates, the SEC is The accounting oversight board certainly constrained by government pay levels changes that perception. SEC Chief Accountant from paying salaries similar to those offered by the PCAOB. Additionally, in its review of audit workpapers, the Board will have an It also means the Board's direct powers informative view into accounting policies "At the end of a Board (PCAOB) related to the accounting firms it monitors and judgments made by registrants in the are derived from contract law arising out financial reporting process. It appears the investigation, we will take of the firms' registration with the Board. Board will use this information to make The Board lacks subpoena and other referrals to the SEC with regard to any necessary action against prosecutorial powers without teaming potential financial reporting misstatements with, or referring back to, a ".gov." at registrants. the accountants. We will turn The First Auditing Standard Leaves No The communication process between the our findings regarding the Doubt as to Who is in Charge auditors and the registrants also raises many questions, including: company's financial reporting In December, the accounting oversight board issued its first auditing standard • Will auditors be allowed to inform a over to the SEC." marking a landmark change in the client when the client's audit has been language for future audit reports. Under the selected for review by the PCAOB Daniel Goezler, new standard, no longer will the report team? state "…conducted in accordance with PCAOB Board Member generally accepted auditing standards." • What if the PCAOB concludes an audit Instead the report will read "…conducted in was not performed in accordance with accordance with standards established by generally accepted auditing standards? the Public Company Accounting Oversight If so, when in the process is the Board." The standard must be approved by registrant informed there may be a the SEC before becoming effective. problem with the audit? Prior to the establishment of the Board, As of year-end, no official press release generally accepted auditing standards were of the PCAOB has addressed these the responsibility of the Auditing Standards questions. Board, a group organized by the American Institute of Certified Public Accountants 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 10
  11. 11. FASB and IASB • Three changes to the calculation of earnings per share; "Convergence" Movement Towards Uniformity in Global Standards • Asset exchanges that would require a gain or loss to be recognized on the Right now, Generally Accepted exchange of similar productive assets Accounting Principals (GAAP) varies on a based on the fair value of the exchange country-by-country basis and can involve unless the exchange lacks commercial different sets of rules. Reasons for these substance; and differences are as diverse as some of the "In order to realize the benefits of cultures in countries around the world. • Unusual ("abnormal") amounts of idle Business practices, structures and capacity and spoilage costs would be truly global financial reporting, we preferences vary globally and a natural excluded from the cost of inventory and consequence is that accounting standards expensed as incurred. need convergence in…accounting, may vary accordingly. Congratulations to the SFAS Class auditing, and disclosures." In a world where our economy is global of 2003 and the free flow and formation of capital Scott Taub, across borders is good for all, uniformity The FASB issued two new Statements of in accounting standards should be a high Financial Accounting Standards this year. SEC Deputy Chief Accountant priority. In furtherance of the goal, the FASB and the International Accounting Statement No.150 - Accounting for Certain Standards Committee ("IASB") have Financial Instruments with Characteristics begun to work formally together towards of both Liabilities and Equity "If the US Congress or political "convergence" of accounting rule making. Statement No. 149 - Amendment of authorities in other countries seek The IASB was formed several years ago Statement 133 on Derivative Instruments as a result of a restructuring of the and Hedging Activities to override the decisions of the International Accounting Standards Committee. Its purpose is to work toward View at www.fasb.org/st/summary/stsum competent professional standard the development of a "single set of high- 150.shtml and www.fasb.org/st/summary/ quality global standards," including stsum149.shtml setters… accounting standards consideration of US based accounting standards. Who Really Writes the Rules? will inevitably lose consistency, The IASB's pronouncements, known as The influence of user groups is substantial coherence and credibility," International Financial Reporting on the establishment of accounting rules Standards, will be mandatory in the in America today. In 2003 we continue to Paul A. Volcker, former Federal European Union in 2005. The SEC see Congress involve itself in the rule monitors the projects and proposals of the making process especially in some Reserve Board chairman and current IASB in a similar fashion to how it tracks historically controversial areas. Two FASB activities. pieces of legislation, the Broad-Based chairman of the foundation that Stock Options Plan Transparency Act of In 2002, the IASB and FASB began to 2003 and the Stock Option Accounting oversees the IASB work more closely together, sharing Reform Act of 2003, have attracted agendas and teaming on key issues. In considerable bipartisan support in December 2003, the FASB issued the first Congress. The Broad-Based Stock exposure drafts that resulted from these Options Plan Transparency Act of 2003, efforts. In a December 2003 news introduced in March, demands a study by release, the FASB explained the proposed the Securities and Exchange Commission new rules as follows: to assess the potential impact of broad- based stock-option plans on the economy. • Voluntary changes in accounting Additionally, the legislation would impose policies would be required to be applied a moratorium on new FASB rules related by retrospective application rather than to stock options. The proposed legislation by cumulative effect adjustment, as is currently pending in subcommittee in currently required; the U.S. House of Representatives. 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 11
  12. 12. Public Accounting Industry Competition: Do You Really Have • 86% of respondents said that they a Choice? would prefer a market with more than four big firms. The ranks of the major accounting firms have shrunk to the "Final Four," plus a • 67% of respondents said they would not couple smaller global firms that primarily suggest any actions such as serve mid-sized companies. In addition, government intervention to increase "If there's a shortcoming to when factoring in further limitations caused competition. by industry concentrations at specific firms, oversight, it's that the PCAOB as well as the "costs" to change auditors Some commentators still feel the financial (including the risk of disagreement over reporting world would benefit from more can't let another [big firm] fail. If prior accounting judgments) registrants choices among the major accounting seldom change auditors. firms. Unfortunately, the industry has firms get to a situation where they shown little ability to produce a new major To analyze the situation, Sarbanes-Oxley participant that the public markets accept know this, it could be a problem." mandated a study by the U.S. General or for whom registrants are willing to incur Accounting Office (GAO) on public the "costs" that change involves. Charles Mulford, accounting firm consolidation and competition, which was issued in July 2003. Tougher (Or Just New?) CPA License Professor of Accounting at the Requirements The GAO report states "we found no Georgia Institute of Technology empirical evidence that competition in the To become an attorney, one must audit services market has been impaired graduate law school, pass the bar exam, to date." It also reports that the "most and apply for admission on a state-by- observable impact of consolidation state basis. Other professions requiring "I worry, however, that they appears to be on the limited number of an admittance process or license auditor alternatives for large national and requirements have similar patterns. (colleges and universities) multinational companies that require firms with extensive staff-resources, industry- Becoming a CPA, and more importantly are not attracting enough of the specific and technical expertise, the type of license granted to a CPA, will geographic coverage and international now vary based on state rules and the best and brightest students... reputation." experience of the accountant under what most people refer to as the "150 hour We must all work together to find The July 2003 report was followed up by requirement." This requirement mandates a supplemental report in September 2003 that to be able to take the CPA exam, one ways to rejuvenate accounting that presented selective large public must have completed a fifth year of company views on accounting firm college education or its equivalent. as a chosen field of study." consolidation. Notable facts contained within the report included: Therefore, CPAs will now have a longer Kayla Gillan, educational term, generally in the form of • 50% of respondents used their current earning a masters degree. In addition, a PCAOB Board Member auditor for 10 years or more. form of restricted CPA licenses will be awarded to individuals who have no audit • Almost all respondents used their experience Their license will not allow auditor of record for a variety of them to certify financial statements. services besides audit and attest. These new rules are established state-by- • Company/Auditor Relationships state and vary significantly, including the averaged 19 years. dates when they take effect. Many states are now operating under the "150 hour • 88% of respondents said that they requirement" rule. would not consider using a non-Big 4 firm for audit or attest services. 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 12
  13. 13. While these new requirements were market value assertions, and one from the motivated by many good reasons, they auditor on balances for which it has taken come at a time when the demand for responsibility. accountants may be at its greatest level as "The goal is to strike a result of the previously discussed needs In a December speech, Doug Carmichael, of the Big Four, the SEC and the PCAOB. chief auditor at the PCAOB, discussed the the appropriate balance between need for valuation experts to assist in the SEC Issues New Independence Rules; delivery of the audit function, and loss of continuity and the need The People Side stressed that auditors need to understand valuation theory and practices. to have a 'fresh set of eyes' In January 2003 the Commission issued new independence rules for the public Many current accounting standards involved in the audit." accounting industry. Included in these new involve fair value accounting such as the rules was a requirement that firms rotate recently adopted standards for business Jackson Day, the lead audit partner every five years combinations and goodwill impairment. In beginning with fiscal years ended after the addition, a change in GAAP requiring the Former Acting SEC Chief Accountant May 6, 2003 effective date. The prior rules expensing of stock options would involve require rotation every seven years. a valuation exercise. With this increasing Accordingly, all lead audit partners in their reliance on fair value measurements, the fifth through seventh year of service on issue will become where will the auditors "A corporation's true economic public registrants will have to rotate off the responsibilities for the determination start client during 2004. As a result, there could and stop. financial condition cannot be seen be triple the number of normal audit partner rotations in the upcoming year. An Added Consequence of Class when assets are reported at their Actions; Auditor Requested The premise underlying changing the Investigations historical cost amounts. The only audit partner is to bring a new "independent" person to be responsible Several audit firms created or enhanced objective way that the true for conducting the audit. Shortening the their forensic accounting and investigative rotation period accelerates the frequency specialties in 2003. These changes were economic financial condition of a for enhancing "independence." This "fresh made not just to generate revenue for the set of eyes," coupled with the increased firm, but to play a major role in planning corporation can be portrayed is to regulatory oversight of the accounting and executing audit procedures for their profession, could result in increased clients. As important, these forensic mark to market all of the questioning of historical accounting accountants are assisting their respective practices of public companies. firms' response in assessing shareholder corporation's assets and liabilities" class action allegations made against the CPA: Certified Public Accountant or management of their audit clients. Walter Schuetze, "Appraiser" Management integrity is an essential Former SEC Chief Accountant Once again in 2003, the usefulness of our component to the audit process. As such, system of historical cost accounting and formal allegations impugning this trait the reliance on judgments and estimates must be taken seriously, even though in financial reporting was publicly debated. many may be unfounded. "Valuation expertise should In an October speech, Walter Schuetze, While the observance of special become part of the working former SEC Chief Accountant, challenged investigations and inquiries arising out of the effectiveness of auditing lawsuit allegations may be a growing trend, knowledge of auditors." management's judgments and estimates it is also likely a natural consequence of noting that "we have judgments by the the combination of (1) PLSRA of 1995, Douglas Carmichael, auditor piled on top of judgments by which requires shareholder complaints to management." Mr. Schuetze discussed an "state with particularity" and provide more PCAOB Chief Auditor alternative approach whereby financial detailed allegations, and (2) together with statements would be prepared based on the recently issued statement on Auditing the fair market values of assets and Standard No. 99, Consideration of Fraud liabilities. There would be numerous in a Financial Statement Audit, which "expert" opinions on the financial requires specific considerations in the statements – from the appraiser for all the planning of the audit, to detect fraud in financial statements. 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 13
  14. 14. Industry Analysis Consistent with prior years, we have Software Industry tracked restatement issues by industry. Over the past five years, the following four Restatements by Major Category (2003) industries have experienced the greatest number of restatements: Software, Taxes, 6% Manufacturing, Finance, Insurance and Investments/ Real Estate, and Transportation, Derivatives, 9% Communication, Electric, Gas and Sanitary Service. The following charts illustrate the breakdown of accounting issues underlying restatements in 2003, Inventory, 6% as well as the number of restatements in Revenue Recognition, 37% each industry over the last five years. Other, 12% Equity, 21% Acquisition Accounting, 9% Software Industry Restatements by Year Filed 48 Number of Restatements 40 38 34 30 1999 2000 2001 2002 2003 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 14
  15. 15. Industry Analysis (cont.) Manufacturing Industry Restatements by Major Accounting Issue (2003) Other, 23% Revenue Recognition, 18% Reserves/Contingencies, 11% Taxes, 11% Inventory, 7% Acquisition Accounting, 7% Equity, 23% Manufacturing Industry Restatements by Year Filed 64 60 60 52 49 Number of Restatements 1999 2000 2001 2002 2003 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 15
  16. 16. Industry Analysis (cont.) Finance, Insurance, and Real Estate Industry Restatements by Major Accounting Issue (2003) Reserves/Contingencies, 16% Other, 23% Capitalization/ Expense of Assets, 6% Taxes, 6% Revenue Recognition, 10% Discontinued Operations, 6% Equity Method, 6% Equity, 10% Investments/Derivatives, 17% Finance, Insurance, and Real Estate Industry Restatements by Year Filed 48 44 Number of Restatements 41 29 30 1999 2000 2001 2002 2003 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 16
  17. 17. Industry Analysis (cont.) Transportation, Communications, Electric, Gas, and Sanitary Services Industry Restatements by Major Accounting Issue (2003) Gain/Loss, 7% Other, 26% Equity, 15% Equity Method, 8% Impairment of Assets, 7% Revenue Recognition, 12% Capitalization/ Expense of Assets, 10% Reserves/Contingencies, 15% Transportation, Communications, Electric, Gas, and Sanitary Services Industry Restatements by Year Filed 48 42 Number of Restatements 33 21 22 1999 2000 2001 2002 2003 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 17
  18. 18. About Huron Consulting Group Huron Consulting Group delivers Acknowledgment financial, operational and economic consulting services to corporations, public We wish to gratefully acknowledge the outstanding contribution to this analysis by institutions, law firms, and lenders. Using Jeff Szafran, Lauren George, LeeAnn Asiaf and Rachel Trafford. an integrated approach and focusing on results, our experienced professionals Contact Information improve business performance by helping clients solve complex business problems, Joseph J. Floyd meet unexpected challenges, and 617 226 5510 capitalize on opportunities. Huron was jfloyd@huronconsultinggroup.com created on the belief that our people are our greatest asset and that our clients deserve the very best in terms of effort, care, and intellectual capacity. www.huronconsultinggroup.com 1-866-229-8700 BOSTON CHARLOTTE CHICAGO HOUSTON LOS ANGELES MIAMI NEW YORK PALO ALTO SAN FRANCISCO WASHINGTON DC © 2004 Huron Consulting Group LLC. All rights reserved. 022004 2003 Annual Review of Financial Reporting Matters | Huron Consulting Group 18