Risk & Compliance

404 Costs to Drop, Big Four Maintain

After ''start-up and one-time factors'' are accounted for, say the firms, the total cost of complying with the thorny Sarbox provision should fall ...
Stephen TaubDecember 9, 2005

The cost of Section 404 of Sarbanes-Oxley, which governs internal controls over financial reporting, will drop “substantially” in a company’s second year of implementation, concludes a study by consultancy CRA International (formerly Charles River Associates) and commissioned by the Big Four accounting firms.

“The data suggests what many observers have said for some time — that a significant portion of first-year costs of implementation was the result of start-up and one-time factors that will diminish over time,” the accounting firms wrote in a letter to Securities and Exchange Commission chairman Christopher Cox.

According to CRA’s study, total Section 404 costs for the larger companies that were surveyed — 96 members of the Fortune 1,000 — are expected to decline an average of 42 percent in the second year, from $7.3 million to $4.3 million.

For smaller companies — 120 companies with a market capitalization between $75 million and $700 million — those costs are expected to fall 39 percent, from $1.5 million to $900,000.

In their letter, the accounting firms also asserted that audit fees related to 404 implementation play a only small role in total first-year costs. Audit fees accounted for just one-fourth of total 404 costs for the larger companies, the firms added, and about one-third of costs for smaller businesses.

Other components of total costs, according to the letter, included the cost of hours by company employees, fees to providers other than the auditor, and expenses for hiring and training new personnel, as well as buying and implementing new software.

The effect of audit fees on total costs may be further eased by an expected drop in the number of key controls that will be tested in year two.

For larger companies, auditors are expected to test an average of 540 key controls in the second year, down from 669, and the companies themselves are expected to test an average of 867 controls, down from 992.

For smaller businesses, the study forecasts that auditors will test an average 206 controls, down from 262, and the businesses themselves will test an average of 298, down from 359.

“The declines in costs and testing levels reflect the elimination of significant start-up factors, such as initial documentation that does not need to be repeated, the benefits of experience, and reduced remediation requirements,” wrote the accounting firms.

Asked to identify the top three drivers of year-two cost savings auditors most commonly cited reduced documentation because of work that need not be repeated in year two, increased efficiency because of progress on the learning curve, and remediation efforts that should not recur in the second year.

Another promising sign: Auditors also said they expect to rely more heavily on the work of others in the second year.