Coming: Auditor Cataclysm?

Industry watchers are predicting a massive shake-out in the accounting business over the next few years. This may not be great news for CFOs.

One smallish change: The cost of audits will go through the roof. “Audits may cost 40 percent more in 2002 than they did in 2001,” forecasts Hermanson.

That very large spike in the cost of filing audited annual and quarterly reports may convince managers at small, privately owned companies to avoid the public markets entirely. Likewise, it might sway executives at some small-cap public companies to take their businesses private.

The dustup in the audit industry itself will be equally dramatic — particularly for smaller accounting partnerships. Says Hermanson: “You’ll see some firms from the audit side that may conclude, ‘Hey, we only have two audit clients. Let’s get out of the business.’ ” Some of those firms may simply resort to providing ancillary accounting services, tax work, and compensation and benefits consulting.

In addition to a pending spike in overhead costs and shrinkage in the number of clients, some of the procedural changes under the Sarbanes-Oxley Act will also take their toll. Charles Elson, director of the Center for Corporate Governance at the University of Delaware, notes that “the rotation of partners required under Sarbanes-Oxley is going to force some consolidation.”

Indeed, many regional outfits simply don’t have enough partners to go around. Industry watchers say a fair number of those firms will have little choice but to jettison their auditing offerings and focus instead on ancillary accounting and bookkeeping services.

At the same time, observers believe that some national auditors will merge with other firms to gain the scale they’ll need to satisfy the constant stream of regulations coming out of Washington.

There’s Got to Be a Morning After

This is not to say it’s all fear and loathing in the auditing industry. Firms that emerge from the impending cataclysm will probably find it easier to make money off their audit services. “Auditing public companies had become a commodity business,” notes Elson. “But if there’s a rise in fees, there will be profits to be made again.”

Bolstering that trend: An increasing number of corporate clients now say they will no longer purchase consulting services from their independent auditors. Such a shift will make it far less likely that accounting firms will treat audit services as a loss leader. In the past, some firms have been willing to take a hit on audit contracts because the engagements gave them an entree to flog more-lucrative consulting services to clients.

In fact, Julia Grant, an accounting Professor at the Weatherhead School of Management at Case Western Reserve University, believes the new regulatory regime may reinvigorate the entire profession.

“It’s too soon to say that firms will quit doing the auditing work,” Grant insists. “It’s the auditing work that gives them such a rich, in-depth knowledge of the business. If you’re a general-purpose, all-service firm, you’ll still need to hang on to the audit services.”

Grant also points out that Sarbanes-Oxley was intended to purge the industry of auditors who had either let their skills erode — or engaged in unethical practices.

“From the standpoint of the auditing industry,” she says, “that’s a good thing.”

Just don’t tell that to the 800 or so auditing firms that will be getting out of the business in coming years.

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