Thursday, April 19, 2007

Explosion of earnings restatements is due to...

the fact that companies weren't spending enough on internal and external auditing pre-Sarbanes-Oxley. says "An explosion in accounting errors — in part reflecting the difficulties of today's complex rules — has forced nearly a quarter of U.S. companies to learn the art of the restatement."

Later in the story, the author states "Reports showing the prevalence of errors due to equity accounting, followed by expense recognition, general "misclassification," acquisitions and investments, revenue recognition, and tax accounting, confirm for (Glass Lewis managing director Jonathan) Weil that companies weren't spending enough on internal and external auditing pre-Sarbanes-Oxley. That, as much as harsh rule-making, was at the root of many restatements. "Find me one major institutional investor who has ever complained about auditor fees," he says. "Glass Lewis doesn't like excessive costly duplicative regulation either. But the stronger regulation you have of internal controls, the lower the cost of capital should be for companies."

Well, the problem with that is CEO's generally want to spend as little as possible on the accounting function. They want quick and dirty ERP financial implementations, and don't want to hire enough staff to properly implement financial systems and then maintain those systems. At budget time, the accounting department is generally at the bottom of the priority list. The linked article quotes a Grant Thornton principal who agrees:

"Companies are in business to produce their product and sell it at a profit, and the reporting of the processes around that is a secondary goal," he says. "In some cases, it's become too secondary."

Further, the article states that "Generally, companies have tried to keep auditing fees at a minimum. Glass Lewis managing director Jonathan Weil, the editor of the San Francisco–based firm's financial research, suggests that restatements often stem from companies having spent at "ridiculously low levels" for their pre-Sarbanes-Oxley auditing."

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