and ‘Segregation of Services’
Philip K. Kleckner and Craig Jackson
Note: Part 2 of a series
are retained by publicly held companies to “skeptically”
review operational results. Most service industries would
crumble if they didn’t support their customers, but
not so with accounting. Due in large part to the relationship
between Enron and Arthur Andersen, the Sarbanes-Oxley Act
has imposed measures to ensure that a company’s auditors
remain skeptical of their client’s financial reporting.
II of the Sarbanes-Oxley Act (“Auditor Independence”)
lists services that auditors can no longer provide to audit
clients. The justification for this prohibition is that
maintaining independence is critical during the process
of auditing financial statements. Our society would not
have the confidence to invest billions of dollars in the
stock market without the clean opinions of independent auditors.
provisions of the act aid in maintaining independence as
well as preventing conflicts of interest. The rules of the
act, issued on January 28, 2003, address the following areas:
services. Sarbanes-Oxley creates explicit
categories of nonaudit services that, if provided to an
audit client, are now deemed to impair the auditor’s
Bookkeeping or other services relating to the accounting
records or financial statements of the audit client
Financial information systems design and implementation
Appraisal or valuation services, fairness opinions, or
Internal audit outsourcing services
Human resource services
Broker/dealer, investment adviser, or investment banking
Expert services unrelated to the audit
Any other service that the Public Company Accounting Oversight
Board (PCAOB) determines by regulation to be impermissible.
requirements. Audit committees must preapprove
all services provided by their auditors.
rotation. Audit partners are prohibited from
providing service to the same audit client for five to seven
consecutive years, depending on the partner’s role
in the engagement.
reports to audit committees. Auditors now
must communicate certain matters to audit committees, including
accounting policies of the company.
of interest. An accounting firm is prohibited
from auditing the financial statements of a client if key
members of management were on the audit engagement team
within a one-year period.
financial disclosure. The act requires more
comprehensive disclosure in the financial statements, including
compensation. Sarbanes-Oxley indicates that
independence shall become impaired if the audit partner’s
compensation is based on selling nonaudit engagements to
the audit client.
authority. It is now unlawful for any registered
public accounting firm to prepare or issue any audit report
with respect to any issuer, if the firm engages in any activity
prohibited by any of the subsections (g) through (l) of
section 10A of the Securities Exchange Act of 1934.
provision that will have the greatest impact on the accounting
profession will be the loss of selling additional services
to current clients. During the 1990s and the early 2000s,
advanced technology and improved education enabled accounting
firms to provide many nonaudit services to their current
clients. A company’s external auditors seemed to be
the best candidates to perform these additional services
because they know the business. But this raised an issue:
How many services can a firm provide before losing its independence?
Arthur Andersen was providing so many services to Enron
that it was in effect auditing its own work.
companies may lack the resources to comply with many Sarbanes-Oxley
requirements, particularly those under section 404, which
requires public companies to attach an internal control
report to their annual filings indicating the following:
An acknowledgment that it is the responsibility of management
to establish and maintain adequate internal controls.
An assessment of the effectiveness of the internal control
structure and procedures for financial reporting.
An attestation by an external auditor on the assertions
made by management in its assessment of internal controls.
with more than $75 million in market capitalization have
to comply in 2004 if their fiscal year ends on or after
November 15, 2004. The PCAOB extended the deadline for small
companies to fiscal years ending on or after July 15, 2005.
consulting engagements that companies employ accountants
to provide go a long way with respect to discovering errors
and improving internal controls. Many observers fear that
outsiders will be unable to perform these services as well
as current auditors. This fear may be alleviated by the
skills that forensic accountants bring to the table.
segregation of duties has always been a critical component
of internal controls, the recent accounting failures have
necessitated that all aspects of financial reporting, including
oversight, be segregated. Not only will such segregation
be good for the public, it will ultimately be good for accountants,
by reinstilling confidence in a profession that has been
tarnished by several well-publicized audit failures.
K. Kleckner, CFE, CPA/ABV, is the director in charge
of the Business Crimes Group, and Craig Jackson
is an associate, both at RosenfarbWinters, LLC, in Roseland,