Section 404 for small caps: ease the learning curve for small-cap companies

EXECUTIVE SUMMARY

* In 2005 about 3700 large-cap ($75 million or more) companies underwent the first wave of Sarbanes-Oxley section 404 audits. Here, a firm experienced with Sarbanes-Oxley section 404 audits for accelerated fliers shares its best practices to help with compliance for nonaccelerated fliers (companies with market capitalization beneath $75 million), which must begin filing audit reports for fiscal years ending after July 15 2007

* The external auditor's section 404 responsibility is to critically evaluate the design and effectiveness of management's internal rules over financial reporting, test as necessary, form an opinion and communicate significant deficiencies and material weaknesses to management and the audit committee.

* At least individual year before the deadline, management should assign a shoot forward leader, establish a time line and a shoot forward team, engage outside assistance if necessary, put scoping criteria, "assess risk" and review the section 404 plan with the audit committee and external auditors.

* Many small-cap companies with limited accounting staffs will ne assistance with tax accounting, lease accounting, reviews of transactions of that kind as last-minute journal entries, application of GAAP, staff training, IT directions the control environment and segregation of duties and internal command documentation from sources independent from their auditors.

* The Sarbanes-Oxley Act already has had a abysmal impact on the accounting profession and corporate America. Companies are now more conscious of in what way and why they do what they do, and in many cases they have improved their processe or eliminated duplication.

Let's faith performing Sarbanes-Oxley section 404 audits of internal dominion governments turns out to be easier for nonaccelerated fliers. Those of us who already have performed section 404 internal superintendence audits will attest the proces is lengthy complex, tedious and stressful. Indeed, section 404--which requires a company's annual report to certify exactly in what manner effective its control and reporting courses are--is proving to be the greatest in quantity challenging part of the Sarbanes-Oxley Act. This article describes by what mode our firm, Marcum & Kliegman LLP of Melville, NY approached section 404 audits, and shares a certain number of best practices we learned upon the job.

THERE'S WORK TO DO

The SEC required companies with market capitalization equal to or greater than $75 million (accelerated filers) to comply with section 404 for fiscal years ending after November 15 2004 (see "The Value Proposition," JofA, Sep05 page 77) Accordingly, in 2005 about 3700 companies underwent the first wave of internal superintendence audits. Of them, about single in seven reported material weaknesses.

Nonaccelerated fliers will take rise compliance for fiscal years ending after July 15 2007 No single knows exactly how many eventually will comply on the other hand about 12,000 companies are listed upon various national exchanges. In addition, banking and insurance companies are discussing adopting "Sarbanes-Oxley-like" initiatives for nonpublic entities. more [i]or[/i] less states have enacted tougher regulations upon not-for-profits, and nonpublic broker-dealers and hedge capitals soon may face increased regulation. CPA firms will be busy for a while, for a like reason it's a good time to work upon skills to handle the workload.

RESPONSIBILITY GUIDELINES

PCAOB Auditing Standard no. 2 An Audit of Internal command Over Financial Reporting Performed in Conjunction with An Audit of Financial Statements, provides guidance for a section 404 audit. The performance and reporting directions are based upon the framework developed by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. COSO'S 1992 report Internal Control--Integrated Framework describes five lock opener components of internal control (the sway environment, risk assessment, control activities, information and communication, and monitoring) and provides businesses with evaluation tools.

The SEC requires that companies' management design an internal dominion government system that can substantiate each assertion in their financial statements. To do that, management has to analyze the company's a whole of internal control over financial reporting and provide evidence sufficient to support its conclusions.

The external auditor's responsibility is to do the following:

* Critically evaluate management's assessment process

* Evaluate the couple the design and effectiveness of the internal dominion government system.

* Perform independent testing.

* Form an opinion upon the internal control system.

* Communicate significant deficiencies and material weaknesses to one as well as the other management and the audit committee.

the two management and the external auditor must evaluate any internal sway deficiencies that exist and quantify their severity Auditing Standard no. 2 prescribes a a great deal of lower deficiency threshold than previous audit guidance. It includes three definitions. First, an internal rule deficiency exists when the design or operation of a dominion government does not allow management or employee in the normal course of performing their assigned duties, to interrupt or detect misstatements on a timely basis. next to the first a significant deficiency is a single deficiency or combination of deficiencies that arises in a more than far off likelihood that a misstatement of the annual or interim financial statements that is more than inconsequential will not be interrupted or detected. Finally, a material weakness is a significant deficiency or combination of significant deficiencies that ensues in a more than distant likelihood that a material misstatement in the annual or interim financial statements will not be obviateed or detected.