20091008 Cost Of SOX From Cost Advisors (C) 2009 All Rights Reserved

Study of the Sarbanes-Oxley Act of 2002 Section 404

Internal Control over Financial ReportingRequirements

SEC Office of Economic AnalysisSeptember 2009

Cost Advisors’ Background

Founded 10 years agoH b d i SOX i A ilHave been doing SOX since April 2003Managed numerous large SOXManaged numerous large SOX projectsDeveloped SarbOxPro® softwareDeveloped SarbOxPro® software www.sarboxpro.com

Bill Douglas’ BackgroundFounder of Cost Advisors, Inc. 30 years of experience

M t iti i A ti IT S tManagement positions in Accounting, IT SystemsCFO, IPO, 'Big 4' public accounting, business processes, recovery auditing, internal controls, fraud, internal auditing, Sarbanes-Oxley (SOX)Financial Project management at both large and small public companiesPublished SOX Illustrated – a 200-page book on SOX

Credentials:Credentials:Certified Fraud Examiner (CFE)Certified Public Accountant (CPA) Certified Internal Auditor (CIA)Certified Internal Auditor (CIA)Certified in Financial Forensics (CFF)Licensed Private Investigator (PI)

Instructor for Oregon Society of CPAs

g yFrequent speaker and writer about fraud and controls

AgendagBackgroundS M th d lSurvey MethodologySurvey Data

Cost of Section 404Benefits of Section 404Effects of AS#5Effects of AS#5

Interviews with External Users of FS and AuditorsAuditorsConclusions

BackgroundgCost of SOX has been highAS#5 SEC G id t t 2007AS#5, SEC Guidance to management = 2007 reformsB t d t f l d l t d iBest data from large and accelerated companies

Non-Accelerated extended on 404(b)General FindingsGeneral Findings

Small companies spent greater % Fixed costs not scalableFixed costs not scalable2007 reforms (AS#5) cut costs

Survey Methodologyy gyAnnounced February 2008Web Survey: December 2008 January 2009Web Survey: December 2008 – January 20098215 companies eligible to participate (25% response rate))Time blocks:

Before AS#5Aft AS#5After AS#5Next Year (year in progress at time of survey)

CEO, CFO, General Counsel (any could delegate), , ( y g )Phone survey of 30 users of financial statements

Lenders, security analysts, credit rating agencies, others

Survey Methodology3 Groups3 Groups

Market Cap(# Shares x Stock Price)

Large Accelerated Filer

(10K in 60 days) (10Q in 40 days)

Accelerated

$700M(10Q in 40 days)

Most Respondents404(a) and (b)

Filer(10K in 75 days) (10Q in 40 days)

$75MNon-Accelerated Filer

(10K in 90 days) (10Q i 45 d )

404(a) only

(10Q in 45 days)

Survey MethodologyD t C ll t dData Collected

1. Internal Labor Hours2. Audit Fees3. Outside Vendor Fees4. Non-labor Costs

Survey MethodologyTi f C ll t dTimeframe Collected

Current year in progressCurrent year in progressMost recent completed yearThe year prior to thatThe year prior to that

Survey MethodologyC tCaveats

Self-selection biasNot found in samplep

Response bias (no penalty for lying)Can’t test for most of this

Only 100 non-accelerated comply with 404(b)Only 100 non accelerated comply with 404(b)None of the costs were audited

Especially audit fees related to 404(b)Internal labor at $121 per hourInternal labor at $121 per hour

FEI had used $50Deferred maintenance of controls could be included in SOX

Controls already required by Section 13(b)(2) of the Exchange Act

Current Year estimates included

Cost of Section 404 I t l l b t $121/hInternal labor at $121/hr.

Overall SOX Cost

404(b) auditNon-Labor

Overall SOX Cost

( )27%

Outside vendorInternal

l b * vendor10%labor*

* Internal Labor at $121 per hour

Cost of Section 404 I t l L b t $50/hInternal Labor at $50/hr.

Non-labor

Overall SOX Cost

404(b) audit41%

Internal labor*35%

Non labor9%

Outside vendor

* Internal Labor at $50 per hour (Approx rate per FEI, Robert Half, Salary.com)

Cost of Section 404 - Trend

-30%-13%

$557$503

$138$126

ands Non-Labor

Internal labor*Outside vendor

$821 $652 $584

$311 $222Th 404(b) audit

$Pre AS#5 After AS#5 Next Year

Cost of Section 404 – Non Accelerated (<$75M) (N= 60-200)200)

$900 $56

$600$700$800$900

$400$500$600

$194$144

ands Non-Labor

$100$200$300

$311 $259$172

Th 404(b) audit

Pre AS#5 After AS#5 Next Year

Cost of Section 404 – 404(a) only companies (N= 534-938)

$400 $35

$36$37

$250 $258$205

ands Non-Labor

$96 $98 $82

Th 404(b) audit - None

Pre AS#5 After AS#5 Next Year

Cost of Section 404 – Accelerated ($75M-700M) (N= 600-970)

$1200 $90

$80 $79

$$489 $489

ands Non-Labor

$350 $281 $270

$216$167 $135Th 404(b) audit

Cost of Section 404 – Large >$700M (N= 600-960)

$208-26%

$4000$2765

$2351$2193

$208$195

ands Non-Labor

$1400 $1127 $1045

$696$480 $344

Th 404(b) audit

$1127 $1045

Total Next Year Cost (Labor Recalculated)( )

$2500 $2490

$200$429

$404 (a) only Non-

acceleratedAccelerated Large

Total $200 $429 $686 $2490Non-Labor $37 $42 $79 $195Internal labor* $81 $117 $202 $906Outside vendor $82 $99 $135 $344404(b) audit $ $172 $270 $1045( ) $ $ $ $

* Internal Labor at $50 per hour (Approx rate per FEI, Robert Half, Salary.com)

Predictors of SOX CostMarket capitalization (public float)Si f (t t l t )Size of company (total assets)# of years SOX experience

SOX Cost vs. Co. Size (Total Assets)( )

0.80%0 61%

0 58%s

0.70%0.61%

0.58%0.55% 0.59%

0.14%0 11%

0.33%0.27%

$700M+

$150- 700M

$50 - 150M

0.11%0.11%

Years of SOX Compliance

SOX Cost vs. Assets - $50 to 150M Float

870825 885

1200 790

580 550 590

150,000 400

395290 275 295

10,000

50,000

100,000

200 4029

7958 55 59

5,000 1 2 34+

Years of SOX ComplianceYears of SOX Compliance

N= 83-97

SOX Cost vs. Assets - $150 to 700M Float

29252475

39003300

1,000,000 2000

1525975

19501650

24752025

250,000

500,000

750,000

2000915

585495

975825

150,000 1 2 34+

N= 84-254

SOX Cost vs. Assets - > $700M Float

22000 22000

1400011000 11000

20,000,000 10000

15000 70005500 5500

110008000

1,000,000

5,000,000

10,000,000

5000 1050825 825

14001100 1100

750,000 1 2 34+

N= 82-453

Cost of Section 404(b) – excluding non-accelerated filersN 1331 1494 iN=1331 – 1494 companies

404(b) Audit Cost

35%40% 5 point decrease is 15%

20%25%30%

38% 35% 33%otal

404(b) audit*

5%10%15%

35% 33%

f To ( )

Pre AS#5 After AS#5 Next Year*38% 404(b) audit 62% traditional audit indicates audit fees increased by 61% (38/62)

38% 404(b) audit, 62% traditional audit, indicates audit fees increased by 61% (38/62). Researchers Kinney and Shepardson estimated first time 404(b) premium was about 100%.

Benefits of SOX (mostly for large companies)( y g p )

Investor Confidence

Other Co's Financials

Quality Financial Reporting

Anti-Fraud

Q lit f C t l

Audit Committee confidence

0% 10% 20% 30% 40% 50% 60% 70% 80%

Quality of Controls

Benefits of SOX Next Year - Optional Survey

-3 -2 -1 0 1 2 3Costs outweigh benefits Benefits outweigh costs

< $75M float

< $75M to

> $700M float

< $75M to700M float

Benefits of SOXConsider going private?

Benefits of SOXConsider delisting?

Effects of AS #5 (including 2007 SEC Guidance)

Relied on AS#5? AS#5 Useful?

Yes88%

Yes88% 94%

Effects of AS #5 (I l di 2007 SEC G id )(Including 2007 SEC Guidance)

Evaluation of deficienciess

R li t' i t ti

Reliance on self-assessments

Reliance on direct testing Good!

Number of controls tested

Nature, timing, and extent of evidence gathered

Reliance on management's interaction Good!

Number of locations tested

Level of documentation

Number of controls tested Good!

-40%-30%-20%-10% 0% 10% 20% 30% 40%

Number of risks subject to testing Good!

(Decreased) Increased

AS#5 – Internal Work Structured for Auditors (Next Year)(Next Year)

1 2 3Not at all A great deal

All iAll companies

Users of Financial StatementsPhone survey of 30 users of financial statements

P iti ff t th i fidPositive effect on their confidenceMaterial Weakness disclosures beneficialNo difference based on sizeNo difference based on size404(b) is necessary

Users of Financial StatementsAuditors Noted Improvements Over Time

R d ti i d t ti ff tReduction in documentation effortImproved communications between auditors and managementmanagementIncreased use of professional judgment in scoping and testingMore focus on higher risk areasStreamlining of audits subsequent to the first-time effort required by Section 404 complianceeffort required by Section 404 compliance

ConclusionsCosts vary based on size, experienceHi h % t i ll iHigher % costs in smaller companiesInternal Labor is most expensive, audit fee is

tnextBenefits of SOX:

Q lit t lQuality controlsAudit Committee confidence

QUESTIONS?

Bill DouglasBill Douglasbill.douglas@costadvisors.com

503-704-3719

www.sarboxpro.comwww.costadvisors.com

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