Deloitte and Economics and Policy

Running head: DELOITTE AND ECONOMICS AND POLICY 1

Following the American Psychological Association Style Guide

Professor DELOITTE AND ECONOMICS AND POLICY 2

Introduction/Third Party Consultants

“Typically, the third-party consultants come from the Big Four accountancies, second-tier firms like BDO Seidman and Grant Thornton, or business-process specialists such as Protiviti

Inc. or Paisley Consulting. And there appears to be no shortage of work, either. In a survey of public-company executives conducted by CFO magazine earlier this year nearly 60% of managers said they had hired third-party consultants to help with Section 404 certification”

(Banham, 2006).

Auditing Practices

Before the passage of SarbOx legislation, many auditors saw themselves as business advisors to companies. Auditors would offer advice on accounting transactions and new ventures; auditors really knew the core business of their clients because they were involved in operational processes. The nearly "real-time" advice that auditors gave to clients enabled organizations to consult with them regarding complex accounting transactions.

Contracting of third-party auditors is a trend that is likely to continue. Organizations and their respective external auditors feel better having an objective third party to test controls, advise on processes and documentation, and alleviate fears about auditor-client independence.

There is no question that organizations regard objective third-party advice to be valuable, and many are turning toward audit committees to provide oversight as well. DELOITTE AND ECONOMICS AND POLICY 3

Audit Committees

“In no small part, audit committees help to create the right environment for confident investing around the world. They do this by playing a substantial and growing role in matters of financial responsibility and accountability to shareholders, regulators and the business and government communities at large” (Lloyd, 2007).

Reasons for Increased Auditor Dependence

Meeting financial reporting, testing, and compliance in the post SarbOx era has been tough on CFOs. The following points illustrate why companies are so anxious to disperse compliance risk by seeking advice of third-party auditors and audit committees (Banham, 2006).

Even with the dire consequences of bungled compliance and reporting, many companies feel like they have SarbOx 404 compliance under control.

“With Sarbanes-Oxley Act Section 404 compliance processes widely in place, many audit committees are refocusing on the issues they view as critical to the integrity of the company’s financial reporting process. Oversight of internal controls remains a top issue, as does risk management. But many audit committees have identified accounting judgments and estimates as their top priority, and they’re looking to the CFO to help them better understand this increasingly complex area of oversight” (Daly, 2007). Because of the failures and extreme costs of Section 404, a 2011 article called for Congress to amend the section to require the opinions of

CEOs, CFOs, and external auditors on “the effectiveness of risk management processes” (Leech

& Leech, 2011). The authors argue that “this legislative change will result in significantly more DELOITTE AND ECONOMICS AND POLICY 4 reliable financial statements, [will] reduce long-term Section 404 compliance costs, [will] better align with the new global regulatory focus on risk management and risk oversight and, most importantly, [will] restore global confidence in US corporate governance and capital markets”

(Leech & Leech, 2011).

Auditor Responsibility

Audit committee members are increasingly under pressure from responsibilities that are cited under section 204 of SarbOx. Some of the responsibilities include the following (Daly,

2007):

Management Accountability

Because of their increased responsibilities, audit committees are demanding more accountability from management, especially the CFO and external auditors. Generally, audit committees are only somewhat satisfied that they are getting the information they need from management and auditors to fulfill their responsibilities. The rise in the number of financial restatements is driving audit committees to demand more and better information from management and external auditors.

As Daly reports, “Whatever the actual cause of restatements, the growing intolerance— by investors, regulators, and others—for management miscues has put a premium on `getting the numbers right’” (Daly, 2007). DELOITTE AND ECONOMICS AND POLICY 5

Committee members acknowledge that their responsibility is to take a “deep dive” into vital issues regarding accounting. Audit committees are relying most heavily on CFOs to provide a greater level of understanding of critical accounting issues. While there are many points that

CFOs can help audit committee members understand, the biggest opportunity is to increase the depth and frequency of communication between the CFO and the committee. It is critical that the

CFO and the audit committee speak the same language, understand critical issues, and devote appropriate time to discussion of key points.

Refocusing the Auditing Committee Agenda

As organizations work toward the creation of more diverse auditing committees, there should also be a focus on more enterprise risk management. An Ernst & Young survey from

2006 reported that respondents thought that compliance issue distracted audit committee members from "other" critical risk issues. The majority of respondents to the Ernst & Young survey reported that only 20% of the typical audit committee agenda was devoted to risk. Risk management is uncharted territory for most audit committees, and committee chairs are aware that the topic of enterprise risk management must play a much larger role on audit committee agendas.

Enterprise Risk Management

Lloyd states that “Whether scrutinizing financial statements or exploring the possible risk from a cross-border transaction, the work of audit committees is vital to the future success of the companies they serve, particularly as the competition for global market share intensifies” (Lloyd,

2007). DELOITTE AND ECONOMICS AND POLICY 6

The experience that many companies have in managing financial risk through SarbOx regulations can be transferred to other risk management areas. SarbOx disclosure has raised the expectations of stakeholders who want transparency in all areas of business reporting.

Stakeholders are paying attention to how companies conduct their businesses, and their perception of an organization is critical (Nabel, 2007).

Enterprise risk management (ERM) can be defined as an organization's planned efforts to identify the myriad risks that exist as an organization conducts its business operations. Some common business risks include credit risks, market risks, product risks, and risks to reputation or brand. Managing enterprise risk is not about eliminating all risks—an impossible task. Instead,

"Risk Intelligent Enterprises" (Deloitte, 2007) modify their overall strategic plans to include risks assessment and management.

Conclusion

Companies have been relying on external auditors to help meet Sarbanes-Oxley compliance mandates. Client-external auditor relationships are under scrutiny because of a renewed focus on objectivity and transparency in financial disclosure. Relationships with consulting (third-party) auditors provide companies with an additional set of objective

(nonbiased) eyes for assessing business processes and internal controls. Financial restatements

(reissuance of past financial statements) have become commonplace. Restatements can be costly for a company in terms of reputation and negative effects on stock prices. Company executives, DELOITTE AND ECONOMICS AND POLICY 7 anxious to avoid having to file a financial restatement, are relying on third-party auditors to serve as an additional line of defense in the process.

Auditing committees play an important role in managing relationships between independent auditors and management. They also provide objective oversight and guidance to an organization on a number of issues. The responsibilities of the audit committee continue to increase as accounting rules and regulations become more complex. Companies are reshaping the look of their audit committees by recruiting a younger and more diverse demographic mix.

Audit committee members are spending more time per year in their oversight duties and will benefit from company-sponsored training and education. Audit committees will shift their focus from financial compliance to overall risk management in organizations. Enterprise risk management will include financial oversight, but that is only one aspect of a company's overall risk. Enterprise risk management is most effective when integrated into an organization's strategic plan—the overall goal being to help the organization achieve business objectives and improve business performance while planning and managing company-wide risk. DELOITTE AND ECONOMICS AND POLICY 8

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