GE: How Much Are Auditors Paid? The financial report accompanying this letter is historic in that… 1 answer below »

GE: How Much Are Auditors Paid?

The financial report accompanying this letter is historic in that it is our first one covered by Section 404 of The Sarbanes-Oxley Act of 2002 (SOX). . . . But what does it mean to you? Is it a “check-thebox” bureaucracy based on an overreaction to the market scandals of yesterday? None of us likes more regulation, but I actually think SOX 404 is helpful. It takes the process control discipline we use in our factories and applies it to our financial statements. Implementing SOX 404 cost GE $33 million in 2004. But we think it is a good investment.

Jeffrey R. Immelt, Chairman of the Board and Chief Executive Officer, General Electric, in his Letter to Shareholders from the 2004 annual report


Since its required implementation in 2004, section 404 of Sarbanes-Oxley has generated a great deal of controversy. Its requirement that auditors assess the operating effectiveness of their clients’ internal controls over financial reporting and express opinions on the effectiveness of their clients’ internal controls over financial reporting and on management’s assessment of its internal control over financial reporting (this latter responsibility has since been rescinded) has imposed significant costs on accelerated filers. The costs of Sarbanes-Oxley have been cited as having significant impact on the U.S. capital markets. For example, a higher dollar amount of initial public offerings (IPOs) has been made on overseas exchanges since the implementation of section 404. Many companies cite the high costs of Sarbanes-Oxley compliance as a factor in their choice of stock market listing; in 2002 (prior to Sarbanes-Oxley), 9 of the top 20 IPOs were on U.S. stock exchanges compared with only 3 of the top 20 IPOs in 2006. In addition, during 2006, total IPO values on both the London/AIM and Hong Kong stock exchanges exceeded values on the New York Stock Exchange. 2

Among other reasons, the high costs of compliance with section 404 resulted in the issuance of Auditing Standard No. 5 (AS 5), which superseded Auditing Standard No. 2. Major changes under AS 5 include (1) eliminating the requirement for auditors to evaluate and opine on management’s assessment of internal control over financial reporting, (2) encouraging auditors to adopt a “topdown, risk-based” approach, resulting in more efficient audits, and (3) expanding the potential use of others’ work in the assessment of internal control over financial reporting. Then-SEC Chairman Christopher Cox noted that, as a result of the passage of AS 5, “the unduly high costs of implementing section 404 of the [Sarbanes-Oxley] act will come down” because companies “will be able to focus on the greatest risk of material misstatements in the financials.” 3 Some estimate that this reduction could be as much as 10 percent. 4

In addition to the provisions of section 404 related to internal control over financial reporting, Sarbanes-Oxley reduced auditors’ ability to provide nonaudit services to their clients. Section 201 prohibits two major types of services that had become significant revenue sources for accounting firms: (1) financial information systems design and implementation and (2) internal audit outsourcing. Not coincidentally, these were two areas in which Arthur Andersen provided extensive services to Enron prior to its failure. Furthermore, section 202 requires that the entity’s audit committee approve all nonaudit services (with the exception of those less than 5 percent of the total revenues paid to the accounting firm).


The preceding suggests that Sarbanes-Oxley could have a significant (yet indeterminable) effect on accounting firm revenues. On one hand, the internal control requirements of section 404 would presumably increase total revenues; however, the prohibition against providing financial information systems design and implementation and internal audit outsourcing services would likely reduce revenues. In addition, the requirement that the entity’s audit committee approve all nonaudit services would presumably heighten these individuals’ awareness of potential conflicts related to these services and reduce the likelihood that such services will be approved (or reduce the dollar level at which they are approved).

GE Exhibit 1 summarizes fees paid by General Electric to its auditors (KPMG, LLP) for various years both preceding and following the issuance of Sarbanes-Oxley; GE Exhibit 2 provides similar information for the average of Fortune 100 companies during these same years. 5 “Audit fees” are identified based on SEC rules and include fees paid for the (1) audit of the annual financial statements, (2) review of quarterly financial statements, (3) audit of the effectiveness of internal control over financial reporting, (4) attestation of management’s report on the effectiveness of internal control over financial reporting, and (5) other services provided in connection with statutory and regulatory filings and engagements. “Audit-related” fees include other fees that can be reasonably related to the preceding services as well as fees paid for due diligence and audit services on mergers and acquisitions and fees paid for audit services on employee benefit plans.


One additional phenomenon that may influence the fees reported by GE and the Fortune 100 companies in Exhibits GE 1 and 2 is the disclosure requirements implemented by the SEC. In November 2000, the SEC adopted requirements that registrants disclose the various types of fees paid to its financial statement auditors; under this initial guidance, audit fees included fees paid for the annual financial statement audit and those paid for the reviews of quarterly financial statements. Beginning in 2003, the SEC expanded the definition of audit fees to include services that “generally only the independent accountant can reasonably provide, such as comfort letters, statutory audits, attest services, consents and assistance with and review of documents filed with the [SEC].” 6 Some argued

that broadening the definition of audit fees would be misleading in terms of user perceptions of auditors’ independence. Barbara Roper, director of investor protection for the Consumer Federation of America, noted that “it’s absolutely industry’s water that’s being carried here. It makes it look like their audit fees are bigger, their nonaudit fees are smaller, and it masks the conflict of interest.” 7 Clearly, any comparison of fee breakdowns prior to and following Sarbanes-Oxley must consider the SEC’s revised definition of audit fees.


1. From a conceptual standpoint, how do the requirements of Sarbanes-Oxley related to nonaudit services affect perceptions of the auditors’ independence?

2. Assume that your firm was auditing General Electric in 2000 and was recommending an adjustment to its financial statements that reduced net income. Based on the fees paid to your firm in 2000, what incentive(s) might your firm consider in insisting upon this adjustment? How would your firm’s incentive(s) differ after 2004?

3. Compare General Electric’s fees prior to (2000) and following (2004, 2008, and 2012) the implementation of Sarbanes-Oxley. Based on the trends in these fees and various components of these fees, comment on the effect of Sarbanes-Oxley on General Electric’s fees.

4. Repeat question 3 for the Fortune 100 companies. Are the trends for these companies similar to those for General Electric?

5. For General Electric and the Fortune 100 companies, can you identify the increased costs of section 404 compliance cited in the press?

6. Comparing the fees in 2004 versus those in 2008 and 2012 for General Electric and Fortune 100 companies, does it appear that AS 5 has reduced costs of section 404 compliance?


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