The Andersen-Enron scandal should serve as a wake-up call to builders: Ignoring the books could cost you a bundle. By Daniel Walker Guido
"If you are not in contact with your accountants in the wake of what has happened with Arthur Andersen and Enron, you are asleep at the switch," states Jack Haese, CFO of Porten Homes, which builds 200 units a year.
The Enron scandal prompted Haese to take a hard look at Porten's auditing firm. He didn't like what he found. "The company didn't have a lot of background working with home building companies," Haese says.
Knowing that the proper accounting expertise could potentially save the Rockville, Md.-based company thousands by preventing errors and helping it grow, Haese immediately searched for a new firm, finding one that had several other home building clients. "With Congress calling for all kinds of new regulations, it only makes sense to have accountants who know the home building industry if stiffer auditing regulations are imposed."
Haese is one of several home builder CFOs who are concerned that hearings on Capitol Hill could result in new regulations in the accounting industry as a result of the Enron and Global Crossing accounting scandals. Strict regulations could hurt all businesses in terms of how they must report their finances and how accounting firms audit them, these CFOs say. As regulations are imposed, such audits will become more time-consuming and expensive.
"Because of Enron, the Big Five accounting firms already want us to disclose more, to expand our footnotes," says Eugene Rowehl, CFO of Kimball Hill Homes in Rolling Meadows, Ill., "[They] are doing more due diligence in their audits; they all seem very worried that Congress will impose stiff restrictions and issue tough new guidelines," he adds.
"The difference," says Larry Sorsby, of K. Hovnanian Enterprises in Red Bank, N.J., "is that most auditors now will expand the footnotes that talk about any other sources of financing or partnerships not immediately seen in a company's financial reports."
Photo: Jonathan Barkat
Most big builders use the Big Five accounting firms and, for the most part, have considered such large auditing firms to be beyond reproach, Haese says. "That has not always proved correct. CFOs and/or the public home builder's audit committee need to be asking the accountants some pretty hard questions right about now," he insists. Play it safe
To start with, all builders should request that auditors give their companies an even harder going over now than they have in the past. "Ask them if they will actually get down to where the rubber meets the road and not just accept the final numbers. Ask to see the minutiae--the memos in which the expenditures were first discussed," Haese recommends.
Builders might be wise to insist their accountants separate their auditing business from their consulting business to avoid accusations of bias, says Jim Alexander, CFO of Houston-based David Weekley Homes. "You just don't need the headaches of reading about your accountants in the paper in yet another scandal," he says.
Pending legislation may solve this issue for builders. Legislation stipulating that an auditor can't create financial reporting systems for or perform the internal audits for a company it audits is currently being considered in Congress. This applies to auditors of public companies only, but the restrictions could filter down to auditors of private companies as well.
The irony of these changes is that they could cost builders money, says Steve Hays, a St. Louis-based accountant. "When you use your accountant for consulting services, you are getting the best value. He knows your business, and you don't have to bring in a company that is unfamiliar with what you do," he adds
|A series of articles on how builders can identify and mitigate hidden costs that decimate profits.|
But maybe it's worth the additional cost. Say you find that your accounting firm has become mired in a huge scandal. Changing firms, especially in the midst of an audit, is almost cost-prohibitive. "If you have to switch to a totally new and unfamiliar company, there would be a doubling up of costs," warns Hays. "That's why you need to do your homework," says David Weekley's Alexander. "Ask questions. Try to determine how likely it is that your auditor could get involved in such a scandal with some other firm, even one outside the industry." This is easier said than done, notes John M. Lacey, professor of accountancy at California State University, Long Beach: "I doubt that a year ago anyone could have predicted the problems that Andersen is having."
Andersen client, Jay Ryder, president of Ryder Homes, certainly never saw it coming. "When the Andersen scandal started, we questioned them, and they said, 'Nothing is wrong; we're big and strong. We'll be there for you.' But as the months went on, it became evident that something bad was happening. Then, the tax division for Andersen, which does our books, was sold to Deloitte and Touche."
Photo: Jonathan Barkat
Ryder quickly decided to follow the tax division since its employees knew Ryder's business so well. "We signed on with Deloitte and Touche, and the company agreed to honor contracts with Andersen," says Ryder. "So, fortunately, we haven't had to take a financial hit--so far." But he adds, the experience caused anxiety not only within his company, but also with some investor partners, who needed hand-holding until the Deloitte deal was inked.
Joel Rassman, CFO of Toll Brothers in Huntingdon Valley, Pa., says it is vital for builders to determine whether the audit manager and his or her associates have expertise in the home building business. "If you find that the people who are assigned to you don't have prior experience auditing home builders, find someone who has that type of background," he recommends. "Otherwise, your audit will take much more time, be more expensive, and yet not be as conclusive as it could be with an auditing team that has home building experience."
Lacey agrees: "A firm with experience in a particular industry knows the steps to add to its audit program for that industry. An auditor familiar with home builders would already know what to look for and how to disclose the home builder-specific information in the financial statements.
"And though it's true a firm that knows the industry may charge less," Lacey adds, "the principal benefit would be in better service, including operating and financing suggestions that could provide substantial cost savings."
Porten is a recipient of such suggestions, which have helped the company grow to a $100 million powerhouse that now has the attention of acquirers. "Say you want to go public; accountants help you decide what your plan is--what you want to look like in five years," says Haese. "They can tell you how to do things like build up land with less risk because they have experience with other builders in similar situations." Haese notes that this advice is essentially "free" consulting builders get as part of accounting services.
Once you're in a relationship with an accountant, you need to take steps to circumvent problems--or even the appearance of problems--down the road by including the accountant in your decision-making before you begin complex new transactions, Rassman suggests. "Don't pull any surprises on your auditors come audit time. Let them get involved from the get-go, and they will understand what you are doing and may have some very good suggestions."
The bottom line is that your financial statements must be transparent and easy for nonaccountants to read and comprehend, says Abba Blum, an accountant and home building industry auditor with Aronson and Co. of Rockville, Md.
"There is a natural tendency to get more creative with financing in a low-interest-rate market. But if you do that, make sure you spell out what you have done in a concise format that doesn't need a tax lawyer's interpretation to understand," Blum advises.
Because home building is a pretty straight-up business in which profits are made from building houses, Blum believes it might escape the scrutiny other industries will get from regulators. "This is not the time to panic. But it is the time to make sure you can account for every nickel spent and every dime earned."
"In some ways, the public builders could be very surprised to find the accounting scandal may have a silver lining for us," says Toll's Rassman. "Investors are going to be much more cautious and will ask more questions of companies who make profits in ways that are not easily understandable. They might decide in greater numbers that the often overlooked home building industry, with its easy-to-understand business practices, is a good place to invest."
Daniel Walker Guido is a former senior editor of BUILDER.