New regulations: preparing for the unplanned costs. (Regulation).

CEOs and CFOs at $1 billion-plus companies are racing to comply with personal certification and other Sarbanes-Oxley requirements--with little regard to implementation costs.

At a recent global gathering of executives, the chairman and CEO of a corporation ranked among the world's 100 largest public companies confided that he had just signed off on the company's financials with great trepidation and less than full comprehension of every accounting policy he was approving.

Though few corporate executives may be as candid about their first experience with the new regulations, CEOs and CFOs in companies large and small are racing to better understand their financials in order to comply with Sarbanes-Oxley and a myriad of other new SEC and corporate governance requirements. To attest to the completeness and accuracy of corporate financial statements, non-financial disclosures, exhibits and footnotes, companies are beefing up internal processes, policies and analyses... with little regard to implementation costs.

The new regulatory environment takes the function of financial reporting to the next level of accountability. Everyone involved -- boards of directors and audit committees, external and internal auditors, senior and multiple layers of management, financial staff, outside and in-house counsel -- has a heightened awareness of the risks involved in filing their financial statements. This translates to more policies, more procedures, more risk assessment, more analysis, more scrutiny.., and more expense.

Yet few companies are calculating the costs. In a recent informal poll of $1 billion-plus companies based in Chicago and New York, The Johnsson Group found that companies -- ranging from pharmaceuticals to financial services -- are finding the filings painful to complete and the regulations costly to meet. Many corporations have spent considerable time analyzing and adjusting their traditional close process, reporting and review schedules. Most of the companies said that more layers of management and their board's audit committees were reviewing the implications of accounting policies in an unprecedented way. Focused almost exclusively on the need to comply, none had examined the cost of implementing the new regulations.

In this new regulatory environment, companies will, have to add financial staff and pay significantly higher auditing fees -- projected at 20 percent to 200 percent over pre-Enron/Andersen fees. In some cases, independent auditors' are being retained to audit the company's auditors. New risk ratings assigned companies by their auditors will require the lower-rated companies to pay higher audit fees, and new risk management consulting services will also add to the price tag. Accelerated reporting deadlines, to be phased in over three years, compress the time in which to perform an audit, which will now require more people and further elevate costs. The new, more prudent practices of assigning two partners to an audit -- one to oversee and one to observe -- and rotating both partners every five years will also increase audit firms' fees.

Corporate governance costs are also on the rise. For example:

Director and Officer (D&O) insurance premiums are soaring -- some as much as 500 percent to 1,000 percent over 2001 levels.

Board committee meetings are being scheduled more frequently and for longer duration, adding meeting fees to annual retainers for directors.

New Disclosure Committees are being formed to bolster the board's ability to scrutinize financial statements and increase investor confidence.

New board-level consultants are being engaged, from compensation experts to those who can provide financial training to non-financial directors.

Costs of Compliance

To help clients with 2003 budgeting estimates, The Johnsson Group set out to get a handle on what a "typical" company might face in terms of onetime costs to meet initial deadlines, and ongoing costs for subsequent reporting periods. Costs were estimated for a Fortune 500 corporation with global operations and $3 billion in annual revenue. Cost estimates include: an in-house internal audit department, in-house legal counsel and significant disclosure requirements. Rough estimates, based on long corporate experience and an intimate knowledge of the financial reporting function, range from $4 million up to $9 million in tangible onetime costs and another $3 million to $8 million in recurring annual costs (see table). Naturally, actual costs will vary widely by company.

Equally significant are the intangible or opportunity costs involved for company directors and top management. With a larger share of time and resources directed at reporting financial activity, the company's leadership will have that much less time and resources available for forward thinking. Also, new products, new markets and new mergers or acquisitions may be realized more slowly as a result of the new regulatory environment.

Although much attention has been focused on the impact on large public companies, many privately held and smaller public companies are affected as well. Indeed, SEC Section 12 requires private companies with more than 500 security holders to file reports with the SEC and comply with Sarbanes-Oxley. Additionally, the SEC is requiring companies with a common equity public float of at least $75 million as of the end of 2002 to file 10-Qs and 10-Ks. For smaller companies, compliance costs can be disproportionately burdensome due to their size--an unexpected challenge in an already difficult economic environment.

Yet, despite the expense, some companies understand that this sharpened focus on financial reporting can have a positive net effect. "We voluntarily began certifying our financial statements six months early," explains Elisabeth DeMarse, CEO of Bankrate.com, an Internet consumer-banking marketplace. "As a smaller public company, our willingness to comply with Sarbanes-Oxley prior to our regulatory deadlines gives us a leg up in building credibility with our investors," she adds.

It's clear that in the aftermath of Enron, there is a heightened interest in solving operational problem areas that are either slowing the reporting process or management review of filings. Improvement projects on the back burner are rapidly moving to the front. As a result, expect to see faster external audits, increased expenditures in the finance operation to meet the new requirements and, eventually, improved internal controls and operations.

For example, costly software designed to consolidate financials or enable precise forecast processes might have seemed unnecessary in the past, but the need to close the books more quickly and forecast more precisely--under unprecedented scrutiny--is causing companies to recalculate costs versus benefits of such initiatives.

Focus on Key Skills

In addition to cost analysis, companies are beginning to focus on the types of personnel skill sets necessary to meet the ongoing requirements. Communications skills, combined with the ability to synthesize the numbers and present meaningful explanations, become increasingly important as many more questions arise from audit committees, management and auditors about various accounting procedures and results. Designating overt accountability is a major corporate culture shift that will produce an organization more deeply involved with tasks that have historically been the private domain of the auditors and senior management.

With this heightened focus, public companies will move closer to the end game, which is to restore confidence in the quality of numbers and information provided to the public, employees, bankers, regulators and investors. Restored investor confidence will go hand-in-hand with more precision and transparency of the core financial processes and renewed credibility for corporations, which will come at a price the companies have no choice but to pay.

SEC Reporting and Disclosure Changes Summary of Estimated Impact
(Incremental Costs)

The added expenses as a result of increased regulatory requirements:
(Assumes a "typical" Fortune 500 company with $3 billion in sales,
global operations, an in-house internal audit function, in-house legal
counsel and signiticant disclosure requirements.)

                               One Time/Initial

Independent audit scope
changes and fee increases      $1,000,000 - $5,000,000
Internal audit expansion       $250,000 - $500,000
External legal fees increases  $800,000 - $1,500,000
Legal resources expansion      $150,000 - $250,000
Outside consulting services    $400,000 - $600,000
Corporate governance
change (BOD, D&O premiums)     $200,000 - $250,000
Finance/accounting/reporting
expansion                      $250,000 - $500,000
Required process improvements  $200,000 - $400,000
System enhancements            $250,000 - $500,000
Total incremental costs        $4,000,000 - $9,000,000

                               Ongoing/Annual

Independent audit scope
changes and fee increases      $1,000,000 - $5,000,000
Internal audit expansion       $200,000 - $300,000
External legal fees increases  $500,000 - $1,000,000
Legal resources expansion      $100,000 - $200,000
Outside consulting services    $250,000 - $300,000
Corporate governance
change (BOD, D&O premiums)     $200,000 - $400,000
Finance/accounting/reporting
expansion                      $250,000 - $300,000
Required process improvements  $100,000 - $200,000
System enhancements            $200,000 - $300,000
Total incremental costs        $3,000,000 - $8,000,000

Source: The Johnson Group Inc.

RELATED ARTICLE: Recommendations For Streamlining the Reporting Process:

* Improve precision of transaction processing.

* Bliminate system interfaces wherever possible.

* Accelerate the reporting and close process to give top management and the audit committee ample time to review and ask questions. (External auditors are resisting pressure to cut into their audit time, crting more extensive auditing requirements, which further compresses time for the internal processes)

* Closely review key balance sheet accounts (both existing balances and accrual procedures/policies) as many "standard practices" such as consistency and materiality are no longer the cornerstone of the audit.

* Since the Management Discussion & Analysis (MD&A) section of the annual report will be subjected to more intense scrutiny (to appropriately draw investor attention to significant issues), get business unit heads in the practice of drafting MD&A for their areas.

* Quantify the costs associated with these changes in order to plan for them and prioritize the expenditures

Margaret A. Johnsson is CEO and Founder of The Johnsson Group Inc. (www.thejohnssongroup.com), a financial consulting firm that is a wholly owned subsidiary of the Altran Technologies Network, with 18,000 consultants in 16 countries. She is a member of FEI's Chicago Chapter and serves on the Chapter's Board. Fran S. Wiechart is a senior financial consultant at The Johnsson Group.