Who's Flunking 404?

Despite major efforts, many companies still have work to do.

By Robert Kugel Courtesy of Intelligent Enterprise

As part of its preliminary year-end earnings announcement, Eastman Kodak indicated that it expected to receive an adverse opinion from its auditors, PricewaterhouseCoopers, citing "material weaknesses" in its internal financial controls. A material weakness is an inherent flaw in financial systems that is likely to result in a misstatement of financial results. Ventana Research continues to expect that 5-10% of public companies undergoing their initial audits under Sarbanes-Oxley Section 404 will be cited with having a material weakness, and another 15-20% will be deemed to have one or more "serious deficiencies" (which, despite the name, is a less serious flaw). Despite a substantial investment in achieving compliance over the past two years, these companies will need to invest even more time and effort in remediating the flaws found by their auditors.

Even if they receive a clean opinion, we advise companies to turn their efforts toward improving the efficiency of their compliance process. Our Audit and Control Study done in mid-2004 indicated that, on average, compliance would consume about 10% of the time of finance organizations. We advise companies to address the root causes of this loss of efficiency by redefining systems and processes to reflect the new compliance requirements. Sarbanes-Oxley fundamentally changed financial controls, requiring companies to implement formal, documented controls that prevent fraud from occurring, rather than relying on informal controls and after-the-fact audits. Corporations must limit or eliminate unnecessary manual entries, spreadsheets, and other process elements that are fundamentally difficult to control. They should implement software solutions to automate processes and administrative functions. These systems may already be in place and require little or no investment in new software or systems.