The Costs of Auditor Chaos
By Rebecca Byrne
Staff Reporter
TheStreet.com
03/15/2002
The mad dash to change auditors faced by Arthur Andersen's clients in the wake of the accounting firm's indictment could unsettle equity markets and prove costly both in terms of additional fees and lost productivity.
"There's going to be a massive scrambling to line up new auditors," noted Bruce Rosen, an auditing partner at accounting firm Richard A. Eisner & Co. "There'll be chaos for a while."
Andersen was indicted on an obstruction of justice charge for destroying "literally tons" of documents and purging electronic data related to Enron's bankruptcy, according to the Justice Department.
If convicted, the company's executives face $500,000 fines and five-year probation terms. Andersen could also be barred from conducting audits on publicly traded companies, which would have far-reaching implications for its 2,300 clients.
"A delay in earnings announcements almost seems inevitable," said Mark Bradshaw, assistant professor of accounting at Harvard Business School.
Extra Time
The Securities and Exchange Commission has said it will accept unaudited financial statements if companies are unable to meet existing deadlines, and the agency will give affected firms an extra 60 days to deliver fully audited results if necessary.
The grace period will address timing constraints that the affected issuers may face and should help minimize disruptions in the capital markets, according to the SEC.
Still, some analysts worry that 60 days may not be enough, and that the uncertainty caused by Andersen's collapse could prove to be very unsettling to the market.
"We were going to be weak heading into the preannouncement [season] , and the delays may extend that period of weakness," said Peter Canelo, formerly an investment strategist at Morgan Stanley, but now an independent strategist.
Double Taxation
Aside from the hit to credibility that Andersen's clients now face, they are also likely to encounter numerous costs associated with physically changing accountants. If Andersen is dismissed in the middle of an engagement, clients will be forced to pay fees both to Andersen and the new auditor.
"A normal switching of auditors is quite a costly process," said Bradshaw.
The exact cost varies depending on the size and complexity of the company, but accountants say the whole process tends to be expensive because it can take the new accountant hundreds of hours simply to learn how the business operates.
"Since they don't have the prior years' working papers to start from and often lack institutional knowledge and contacts, a first-time audit will cost much more than subsequent ones," said Jeff Brotman, adjunct professor of accounting at Pennsylvania Law School.
Initial audit fees can run as much as 25% to 30% more than recurring audits, although it is possible that a new auditor will waive those fees and consider them as a cost of acquiring the client.
The Devil You Knew
Even so, there's a reason why most companies engage the services of one accountant for decades at a time. When a firm hires a new auditor, valuable time and resources are spent on simply educating the accountant about the business, which can be a drag on efficiency.
"As they get up to speed, they're bothering the people who work there," Bradshaw noted. "I can't imagine the lost productivity consumed by company employees helping out the auditors. It's a messy process."
Of course, there is always a silver lining. The collapse of Andersen would reduce the number of major U.S. accounting firms to just four, which would heighten the competition among those that are left. "Thus, the audit fees may not go up by as much as they should," said Brotman.
Richard Molé, CPA and partner at Weisberg Molé Krantz & Goldfarb, believes that the death of Andersen could provide a "fresh start" to many of its clients.
"A new set of eyes could give some of these companies more perspective, or insight, into how they report," he said.
Me, Too
Brotman said he wouldn't be surprised to see companies that were not audited by Andersen also switch firms.
"If you were unhappy with your auditor but had been afraid of changing because of stigma, the chaos of massive changes all around might be great cover to make your move," he said.
In general, analysts expect earnings numbers to be much more credible from now on.
Of course, Andersen may yet survive the scandal. The company has said the action taken against it has been "a gross abuse of government power," and that the indictment is riddled with factual and legal errors. But many experts say the damage to the firm's reputation has already been done, and that it is only a matter of time before the 2,300 clients jump ship.
"It will be interesting to see how long it takes these companies to be squeezed through the cycle and how long it takes them to come out the other end," said Julia Grant, accounting professor at Weatherhead School of Management. |
