Accounting Practices in U.S. Public Companies
Has the Environment Changed?

By Linda M. Nichols

E-mail Story Print Story

The Sarbanes-Oxley Act of 2002 (SOX) has dramatically affected the accounting and auditing professions. SOX led to the creation of the Public Company Accounting Oversight Board (PCAOB), whose role is to oversee and inspect the audits and auditors of public companies. SOX also increases management’s responsibility for financial reporting by requiring the CEO and the CFO of public companies to certify the quarterly and annual statements submitted to the SEC. Criminal penalties may be imposed on anyone who knowingly falsely certifies the financial statements. Another major change is SOX’s requirement that all public companies issue a report on internal control, acknowledging management’s responsibility for maintaining controls and assessing the effectiveness of the company’s internal control structure and procedures.

Have new regulations, and the perception that financial reporting is under closer scrutiny, led the environment of accounting departments in public companies to really change? If changes have occurred, have they taken place at public companies of all sizes? To obtain insight into these questions, controllers from both large and small public companies were asked to complete a short survey, the results of which follow.

The Survey

The controllers of both large and small U.S. public companies were surveyed regarding the change in the accounting environment within their companies over the last five years. For the purposes of this study, large companies were defined as those with over $400 million in sales for 2003, and small companies were defined as those with less than $200 million in sales in 2003. Respondents were asked to compare 1999 to 2004 and state their level of agreement or disagreement with 15 statements based on a five-point Likert scale (1 = strongly disagree, 5 = strongly agree).

The surveys were mailed to the controllers of 100 U.S. public companies in the oil and gas industry; there was a 63% overall response rate, with 34 respondents from large companies and 29 from smaller companies. The results are presented in the Exhibit.

All respondents disagreed slightly with Statement 1, thus indicating that some changes have occurred in their accounting practices since 1999.
Both large- and small-company respondents agreed that their accounting practices have become more conservative over the past five years (Statement 2), with the highest level of agreement found in the respondents from smaller companies.

All respondents indicated a strong level of agreement with Statement 3, reflecting an overall increase in the quality of financial reporting since 1999.

The respondents were basically neutral regarding the question of whether the complexity of transactions has increased (Statement 4), although large-company respondents indicated some slight agreement that transactions have become more complex. Large companies probably deal more with complex issues, such as derivatives and special-purpose entities.

Respondents representing smaller companies strongly agreed with Statement 5, indicating that smaller companies have spent time evaluating their accounting practices. Respondents from large companies showed slight agreement with this statement. The difference in response between large and small companies may indicate that large companies did not feel a need to reevaluate their accounting practices, being more confident in what they had been doing in the past.

The respondents from small companies agreed with Statement 6 (consideration of proper GAAP has increased), while the respondents from large companies were about neutral. The same holds true for this statement as for the last. Management of large companies may not have felt a need to reevaluate their accounting practices and application of those practices, being more confident in what they had been doing in the past.

All respondents disagreed that pressure has increased to meet earnings goals (Statement 7), with respondents from smaller companies expressing a higher level of disagreement.

Respondents from large companies reported a higher level of agreement with Statement 8, regarding increased scrutiny of financial records, than did respondents from smaller companies. Most of these large companies are audited by the Big Four. While all audits have increased in scope post–Sarbanes-Oxley, the difference seems to be especially pronounced among the Big Four firms.

Large-company respondents agreed slightly that accounting staff members now feel more comfortable questioning accounting practices (Statement 9), while small-company respondents were neutral on the question. Large companies may have been more apt to instill internal whistleblowing procedures, in the wake of the Enron scandal.

All respondents strongly agreed that the workload for their accountants has increased (Statement 10). This may reflect the streamlining of American businesses in an attempt to operate more efficiently and cut costs.

All respondents were neutral with respect to Statement 11; the perceived level of job security in their accounting departments has not changed since 1999.

Respondents from both large and small companies agreed slightly that there has been an increase in technical training for their accountants (Statement 12). Small-company respondents had a slightly higher level of agreement than large-company respondents, indicating that training may have increased more noticeably in small companies.

The respondents from small companies disagreed with Statement 13, while large-company respondents were neutral. The results indicate that training on ethical issues has not increased since 1999.

All respondents strongly disagreed with Statement 14, indicating that turnover in accounting staff has not increased in the past five years.

Finally, all respondents very strongly agreed that GAAP is becoming increasingly complex and difficult to interpret (Statement 15).

Analysis of the Results

The results reveal that, in many areas, there has not been a great deal of perceived change in the accounting environment of oil and gas companies since the Enron collapse. Some areas, however, have seen changes. There was an overall level of disagreement with the statement that pressure to meet earnings goals has increased. This is not a surprising result in the wake of Enron and SOX. Now that both the CEO and the CFO have to sign off on the fairness and accuracy of financial statements, they must more carefully consider the possible consequences of manipulating numbers to meet earnings forecasts.

There was also overall disagreement that the turnover of accounting staff has increased. The job market in accounting is good, due in part to new employment opportunities created by SOX. For example, audit firms have increased their hiring levels of new accounting graduates. According to this survey, however, the turnover level of existing industry accounting staff has not significantly increased.

Although turnover has not increased, the survey results reveal that the workload per accountant in oil and gas companies has increased over the last five years. This could be attributed to cutbacks in accounting personnel as companies strive to trim costs. The tight job market might also mean that accountants are willing to work longer hours in order to keep their present employment.

The respondents agree that GAAP has become increasingly more difficult to interpret and apply. Following the Enron collapse, much criticism was voiced against U.S. GAAP because of the highly technical manner in which the standards are written. The standards are rules-based, and are often difficult to interpret and apply to transactions in varying situations. Many commentators have proposed that a principles-based set of accounting standards be developed for use in the United States. Under a principles-based system, standards would be more theoretical, providing guidelines but not consisting of highly technical and detailed rules. Judgment would need to be applied by managers and auditors in applying the guidelines to specific transactional situations. The survey’s finding implies support for the development of standards that would be easier to interpret and apply.

There is general agreement that outside auditors have increased their scrutiny of company financial records and reports. Public pressure exerted on the auditing profession after the Enron collapse, along with the provisions of SOX, has served to increase testing in the audit environment. Increased scrutiny in audits should result in more reliable financial statements and, ultimately, an increased level of confidence in American business.

Finally, and perhaps most important, the respondents indicated that the quality of financial reporting within their companies has increased. This likely results from accounting managers being increasingly concerned with fair and accurate reporting due to increased pressure and penalties from the SEC.

Although some slight differences were noted, the responses of large- and small-company controllers in the survey did not differ significantly. A more detailed analysis of the responses does not reveal any significant differences when the company size is broken down more finely. The results indicate that the post-Enron changes in the accounting environment have occurred at companies of all sizes.

Implications for Practitioners

While SOX was met with skepticism by the accounting profession, this survey indicates that it may have had a positive impact on the quality of financial reporting. All accountants need to be diligent in making sure that these benefits are not lost as the number of scandals and, therefore, the level of public scrutiny of the profession decrease. Newly implemented procedures should continue to be carried out with due diligence and toward the goal of fair and representative reporting.

An interesting finding that should be addressed by the profession is in the increasing workload for individual accountants. Both public accounting firms and corporate America are under pressure to reduce personnel costs. Reducing the number of accounting personnel too much, however, could result in increased, and sometimes unreasonable, workloads for accountants—a dangerous practice. If individual accountants are overworked, mistakes are more likely to occur as they try to rush through their duties and responsibilities. While balancing workload and personnel costs is a delicate matter, members of the profession in supervisory capacities must recognize that high-quality reporting and auditing requires that accountants and auditors be given reasonable workloads that allow time to critically assess situations and resolve reporting issues.

The collapse of Enron and the resulting demise of Arthur Andersen has led to a reassessment of the accounting and auditing professions. The result has been a regulatory environment reshaped by SOX. While accountants and auditors have struggled with the changes, their overall effect appears to be positive. As this survey indicates, controllers believe that the quality of financial reporting within their companies has increased. The reputation of the accounting and auditing professions has suffered greatly over the last few years. The positive changes resulting from increased public scrutiny should help restore public confidence in financial reporting and in the accounting and auditing professions. More important, an increase in reporting quality should serve to prevent major corporate collapses due to accounting scandals in the future.