How long before there is only one large accounting firm? The Big One?

After recent Enron events, the Big Five may become the Big Four. The current recession may spur even more consolidation in the accounting industry.

How will consolidation, Enron and other trends affect how businesses deal with accountants and vice versa?

Why is this important? The size, scope of services and geographic reach of Big Five accounting firms make them difficult to ignore. You would have to merge the 100 largest U.S. law firms to have a law firm comparable in size to a Big Five accounting firm. Their scope of services includes audit, tax, legal, investment banking, consulting and information services. They have global reach with offices in most major cities around the world.

What will further consolidation in the accounting profession bring? How high will fees go when the Big One or the Big Two is your only alternative?

What will happen to quality? Service may be slower, but less competition may mean accountants won't fear losing a client if they refuse to interpret accounting rules to promote management's goals. Financial statements may become more uniform, which will allow investors to compare companies better.

Further consolidation and Enron are also likely to increase regulatory control over the profession. The Big One may become a quasi-governmental organization, like a stock exchange. The SEC has already proposed creating a new regulatory body to discipline accountants and ensure quality control. Monopolies invite regulation.

The Enron scandal may also produce other changes. The most likely changes include:

• Document Retention. Expect more specific guidelines about what documents accountants must retain and for how long.
• Whistle Blower. There will be more pressure to require accountants to report questionable practices of their clients to the government.
• Independence. The SEC expressed concern in recent years accounting firms are not independent from their clients. A year ago, the SEC disciplined accountants whose families owned stock of their clients. The major concern now is about accounting firms providing consulting services to their audit clients. Does the possible loss of consulting work influence accountants in their audit work? Are audit services discounted to obtain large consulting fees? When a service is used as a loss leader, quality often suffers. Internal pressure builds to spend less time delivering the loss leader service. The best talent may go into the higher paid consulting field, which could adversely affect audit quality. Expect a major push to prohibit accounting firms providing consulting services to their audit clients. It's not likely the SEC will lead this charge. Harvey Pitt, the new SEC Chairman, opposes restricting services provided to audit clients. Until last year, Mr. Pitt was an attorney in private practice who represented Arthur Andersen. Two Big Five firm partners have recently become SEC Commissioners. The result is that three of the five SEC Commissioners have strong ties to accounting firms.
• Employee Hiring. Enron hired many employees from its accounting firm. To what extent does this enable a company to manipulate its accounting firm?
• Quarterly Financial Statements. Accountants audit the annual financial statements of companies, but they play a much smaller role in the quarterly financial statements of public companies. The fast stock price decreases of Enron and other companies shows many investors may be misled while waiting for the next annual audit to get an accurate picture. Investors rely on quarterly information as much as annual financial statements. Expect the role of auditors in quarterly financial statements to increase.
• Off-Balance Sheet Financing. The SEC recently released new guidelines about how to disclose off-balance sheet financing. Expect more on this in the near future.
• Pro Forma Financial Information. Companies that don't like their audited financial statements increasingly release to investors additional information not in accordance with GAAP, if it makes the company's performance look better. One common example is non-cash employee compensation expense required to be reported on financial statements when companies reprice stock options or grant options at below fair market value, which reduces profits. In addition to reporting what is required by GAAP, companies often report what their profits would have been had this non-cash employment expense not been included, which inflates profits. Expect an effort by regulators and plaintiffs' lawyers against the release of pro forma financial information.
• Audit Committees. Public companies have Director audit committees to oversee the relationship between the corporation and its auditors. This includes insulating the auditors from management coercion, assessing the independence and competence of the auditors and obtaining recommendations about how to improve accounting practices. Certainly, the world is wondering what the Enron audit committee (Messrs. Moe, Larry and Curley) were doing. Audit committees exist to remind the auditors they serve the corporation, and the Board of Directors (not management) is ultimately responsible for running the corporation. Although the SEC recently issued regulations designed to strengthen audit committees, expect even greater emphasis on audit committees in the future.
  
  Some of the possible changes discussed above will be beneficial. Others will have unintended adverse consequences. No one knows all the implications, but accountants certainly have the attention of the business, government and legal communities. Everyone has a stake in ensuring investors can rely on the financial information companies report. If they can't, it will be much more difficult to raise capital.