Public Companies Find SarbOx Compliance Expensive

By Karen Schwartz  |  Posted 03-23-2005
Companies are spending much more than originally anticipated to comply with Section 404 of the Sarbanes-Oxley Act, according to a recent survey.

Section 404 of the Sarbanes-Oxley Act of 2002 requires all public companies to establish an ironclad method of developing and maintaining an internal control structure and procedures for financial reporting, as well as a way to assess the effectiveness of the structures and procedures.

Expected benefits from Section 404 compliance include more reliable and accurate financial reports, leading to greater investor confidence.

The survey of 217 public companies was conducted by FEI (Financial Executives International), an association of financial executives based in Florham Park, N.J. It found that in the first year of Section 404 compliance, costs averaged $4.36 million per company, 39 percent more than the $3.14 million companies expected to pay.

The increase was largely due to a significant rise in costs of consulting and software and fees charged by external auditors.

Click here to read more about how companies anticipated handling Sarbanes-Oxley compliance.

As executives delved more deeply into what it would take to fully comply with Section 404, estimates rose exponentially. The mean for estimates of internal costs to comply with Section 404 during Year One was $1.28 million last July, but rose to $1.34 this month when the survey was repeated.

Similarly, the mean for estimates of external costs necessary to comply with Section 404 during Year One was $1.04 million last July, compared to $1.7 million in the most recent survey.

Auditor fees also rose significantly. Respondents used an average of 8,340 external consultant, vendor and auditor hours.

Companies also devoted significant internal resources to comply with Section 404. On average, companies spent 26,758 hours, up 4 percent over previous estimates.

One reason costs are so much higher than originally predicted is because of the complexity of the process, said Bill Sinnett, FEI's manager of research.

Click here to access a tool to help calculate your own SarbOx expenses.

"Public companies have to identify every single business process and transaction, and then document how that business process or transaction is supposed to happen and what can go wrong if it isn't done correctly. And after they have done all of that documentation, they have to test all of the controls," he said. "I suspect that companies didn't realize just how much documentation was required, how much time and effort it would take to do all of the documentation, and the effort required in storing and categorizing it all."

The most recent survey was the third such survey FEI has undertaken since Section 404 became mandatory. The first survey was in January 2004, when company executives were just beginning to think about what might be involved in complying.

The big question, Sinnett said, is whether costs in Year Two will increase, decrease or stay the same.

According to the FEI survey, most companies expect costs to decrease by an average of nearly 40 percent, mainly because start-up costs incurred in Year One would not have to be repeated. Most companies also anticipate reduced fees in Year Two, as well as efficiency gained from lessons learned in the first year.

But given the fluctuation of costs in the first three surveys, Sinnett said FEI isn't ruling out a fourth survey next year.

"Originally, everyone thought they were going to go down, but nobody is quite so sure anymore," he said.