Public Company Accounting Reform

The Enactment of the Sarbanes-Oxley Act (SOX) of 2002

The enactment Sarbanes-Oxley Act (SOX) of 2002 used to be caused by the the monetary scandals in public companies such as Enron and WorldCom. The goal of SOX used to be to protect investor’s interest via improving the transparency, disclosure, reliability, timeliness, and accuracy of financial reporting. A alternate introduced was growing the responsibility of the management over inner controls and financial reporting. Managers are required to prepare an interior control report which establishes their accountability for maintaining adequate ICs as properly as evaluate their effectiveness. These changes have led to numerous views between managers and accountants; managers see them as costly while accountants as burdensome. Also, firms are required to establish an audit committee, and accounting firms are now difficulty to stricter regulations in performing their duties.

Costs and Implications of SOX Compliance for Managers

Management holds the view that the costs of complying with the new changes outweigh the benefits. A survey by Protiviti (2017) shows that the number of companies who spent at least $2 million on compliance activities increased. These costs are higher for the large and complex organizations. Also, these new changes have required the hiring of more staff, adopting more modern technology and IT infrastructure, and incurring consultancy and training costs to enhance compliance (Basile, Handy, & Fret, 2015, p.587). Managers also have a higher responsibility on the internal controls over financial reporting. The new changes require that managers must disclose material weaknesses and in such circumstances, they cannot pronounce that the firm’s internal controls are effective. With the new COSO internal control framework, managers also have to evaluate the firm’s reliance on IT as well as carry out more tests that enhance the identification of fraud.

Strengthening Corporate Governance through Audit Committees

A significant effect of these changes was the strengthening of corporation’s corporate governance by establishing independent audit committees. The audit committee members should be financial experts, and more importantly, the company must disclose whether they are independent. Its role is to monitor and review the risk management systems, internal controls, and the effectiveness of the internal audit activities. According to Basile et al. (2015), companies have gained more than a decade’s experience in SOX, and the compliance costs will continue declining over time, and they are now benefiting from improved internal controls and enhanced corporate governance.

Challenges Faced by Accountants and the Accounting Profession

On the other hand, accountants contend that they are spending more time on complying with the SOX internal control changes. The report by Protiviti (2017) reveals that two-thirds of organizations reported that they spent 10% more time on SOX compliance. The implication is that accountants face the burden of balancing between their daily activities and the documentation and reporting of the internal controls. Most public accountants also have the view that their roles have been reduced to that of policing organizations (Relter & Williams, 2012) and they argue that the continually changing regulatory framework makes it difficult for the accounting profession to adapt to the SOX.

Impact on Accounting Firms and Auditors

The SOX (Section 101-103) established the Public Company Accounting Oversight Board (PCAOB) which has enacted new rules for accounting firms. Auditors are required to attest to the management internal control assessment as well as perform an independent evaluation of the internal controls. The new SOX changes require that the external auditor attests to the management’s internal control assessment. Before the Act, auditors could offer consulting services to its clients and their independence would have been compromised. Maintaining auditor independence is a critical issue addressed by the SOX, and the new changes prohibit accounting firms from providing non-audit services to their clients.

Ensuring Compliance and Audit Quality

Under the new rules, accounting firms are to undergo regular inspections by the PCAOB where they undergo an assessment on their compliance with the auditing, independence, and quality control standards. Also, they are required to independently assess and supervise the corporation’s as they review the financial statements. Of importance is the mandatory audit rotation of both the partner as well as the firm, and the goal is to reduce the threats to independence.

Restoring Trust and Confidence

The SOX Act was in response to the corporate financial scandals in the publicly listed companies. The confidence of the investors and the public was significantly eroded, and the SEC aimed to restore trust and confidence. The strengthening of internal controls and audit committees has improved the accuracy and reliability of financial reporting. Increased transparency and disclosure reduces the likelihood of fraud, offering greater investor protection.

References

Basile, A., Handy, S., & Fret, F. N. (2015). A Retrospective Look at the Sarbanes-Oxley Act of 2002-Has it accomplished its original purpose?. Journal of Applied Business Research, 31(2), 585

Protiviti. (2017). Fine-Tuning SOX Costs, Hours and Controls: Assessing the Results of Protiviti’s 2017 Sarbanes-Oxley Compliance Survey. Protiviti. Retrieved from https://www.protiviti.com/sites/default/files/2017-sox-compliance-survey-protiviti_0.pdf

Reiter, S. A., & Williams, P. F. (2013). Sarbanes-Oxley and the accounting profession: Public interest implications. Open Journal of Accounting, 2(01), 8