Accounting principles, generally

April 11, 2005
Rules arent only for punishing bad behavior; they should remind all of us to maintain and encourage good behavior.

A few weeks ago some colleagues and I heard a presentation on details of new financial reporting standards stipulated by the Sarbanes-Oxley Act, a 2002 law that aims to put new starch into the internal accounting practices of public companies. This is an important change that’s having considerable consequences, many of them unintended.

No doubt many readers know this first-hand. For those who don’t know, Sarbanes-Oxley was the legislative reaction to scandals at Enron, WorldCom, and other large corporations where executives conspired to hide their financial problems and misdeeds from investors and regulators. The law that took effect recently establishes a new agency (the Public Company Accounting Oversight Board) to monitor corporate auditors; sets rules to ensure auditors are independent of company executives; strengthens rules about financial reporting and auditing; increases corporate financial disclosures; and mandates “unbiased” research from analysts.

Also, Sarbanes-Oxley gives the Securities and Exchange Commission and federal courts enforcement power for the new rules; calls for reports on firms that provide accounting and financial services; sets the penalties for accounting fraud violations; increases penalties on individuals convicted of corporate fraud; calls for CEOs to sign corporate tax returns; and increases penalties for hindering corporate fraud investigations.

My financial responsibilities in this job are not too sophisticated, so at first I wondered what was the point of this presentation. Was someone intimidating me as a way to discharge their own accountability? On the other hand, I realized quickly that Sarbanes-Oxley is going to have an impact on metalcasters.

It’s pointless to criticize the intent of this law, but the application raises so many questions that its effect may be negligible. First, there is the sweep of these rules. For small and mid-sized companies, like many metalcasters, these regulations must seem like a bureaucratic parody. What might be a good way to shine a light on a multinational chemical company is just silly when applied to a gray iron foundry. I have reports of small and mid-sized companies investing heavily in money and employee hours to comply with the new rules. If problems are found and remedies must be made, that will lead to even more costs. At least one manufacturer moved from a net profit for 2004 to a net loss, because of the Sarbanes-Oxley compliance costs.

On the other hand, the law creates a windfall for law and accounting firms, as well as specialty software developers, all of whom can help with the compliance process — for a fee. Given a choice between higher earnings and crystal-clear financial statements, I suspect many investors would tolerate some vagaries.

And finally, since the subject underlying this issue is accountability, we may ask why the SEC or FASB, or even the IRS, were not monitoring public companies’ accounting standards.

So let’s agree that this is not a perfect law, that it lumps together too many organizations under a broad standard, and raises lots of new questions. Its message of accountability is still valuable, and vital. As I learned in that presentation, it’s important to be reminded of accountability standards, even if the regulations do not apply to us directly.

If someone wants to cook their books, they will find a way to do it. But, rules aren’t only for punishing bad behavior; they should remind all of us to maintain and encourage good behavior.

While I pondered the nature of accountability I realized this is my 12th column for FM&T, a full year in the book. To my frequent surprise, people assume I am in charge here, I suppose because my face shows up on this page every month. Not being in charge does not relieve us of accountability, however. All of us should acknowledge, frequently, that the work we do is an extension of who we are, and that we are accountable to our colleagues, our customers, and ourselves.