Auditing: impact of Sarbanes Oxley Act

Introduction

Enron Company was among the United States top in fortune. However, it had a false account problem that led to its sudden bankruptcy raising the attention of not only the public but also the government and other stakeholders on the internal supervision and auditing systems of companies (Berger, 28). It is the impact of the scandal that proved to be making the public and other investors suspicious of the books of accounts of many businesses that led to the quick passing of the Sarbanes–Oxley Act of 2002 to avert the repeat of such a scandal in the future.  The Sarbanes–Oxley Act is also referred to as the "Public Company Accounting Reform and Investor Protection Act" in the Senate whereas in the house it is called the "Corporate and Auditing Accountability and Responsibility Act"  but is mostly referred to as the SOX Act (Berger, 30). SOX is an American federal law that set the new or even expanded the requirements placed on all the US public company boards, accounting firms and also management companies (Berger, 33). There are also some of the provision of the Act that had a direct effect on the private companies such as the intentional tampering with any evidence with the then motive of interfering with any form of Federal investigation. In reaction to the major scandals in corporate and accounting sectors such as the WorldCom and Enron, the bill has sections that cover the responsibilities of any given corporate board of directs while at the same time adding the penalties for certain misconduct. The Act further required the Securities and Exchange Commission (SEC) to institute some regulations that would refine the mode at which the public corporations would comply with the set laws (Berger, 30). The Sarbanes-Oxley Act of 2002 and PCAOB was institute to improve the auditing standards and also restore the public confidence in the governance of financial markets and the accounting profession as the overseers of sound financial reporting free of material mistakes and errors. In its role, the SOX Act has been subject to a variety of success and failures as is indicated in the below research. However, the SOX Act has been more successful than the failures it has faced (Turnbull, 30).

To be able to understand the impact of the SOX Act since its adoption, it is important to have a background of its initiation process and to pass through both houses to become law. Sarbanes,–Oxley Act, was named after is a sponsor who was a US Senator named Paul Sarbanes (D-MD) and U.S. Representative Michael G. Oxley (R-OH). Before the adoption of the SOX Act in 2002, several capital markets in the country had already been subject to a variety of financial scandals that led to several financial giants such as Enron and Tyco International admitting the existence of financial fraud and massive corruption (Asthana, Steven and Sungsoo, 34). The American public rose up in arms, and there was great uproar due to the trend that had begun shaping up in the country. The collapse of the companies came at a time that most Americans had become more vigilant in their security in every aspect especially because it was just after the 9/11 attacks that had increased the paranoia and scrutiny of the public on all the policies and also on the ongoing in the country. There were also some of the investors that also reacted to the issue by abandoning the companies they had invested in leading to increased bankruptcy among such entities. The fraudulent activities of such enterprises that had made up books by the unscrupulous management resulted in massive losses for the individual investors and also significantly affected and further threatened the economy of the country. It further led to the affecting of the capital markets in the nation (Asthana, Steven and Sungsoo, 35). However, it is the Enron scandal that resulted in the brewing of the massive storm since it was a major company in the country. It severed the capital markets and also affected the confidence of the public in a great way. Moreover, the Enron scandal further questions the integrity of the auditors since it led to the driving Arthur Anderson Company that was one of the World’s biggest audit firms into collapsing. Therefore, it is this that motivated and inspired the coming up and actuating of the Sarbanes-Oxley Act of 2002 with the sole purpose of protecting the investors through improving the reliability as well as the accuracy of the corporate and also to restore the confidence of the public in financial statements (Asthana, Steven and Sungsoo, 35). One of the major impacts of the Act is the increased regulations that it imposed on entities. During its debate and adopting the act was composed of sixty-six sections with some being long while others were short. Every part of the law was also mandated to dealing with given part of the reporting cycle of the organization with the sections contained in eleven titles that majorly death with internal controls of the companies. Each and every title within the Act resulted in its impact on the various areas of the financial reporting in any company (Turnbull, 34). It is this that made fraud even more difficult. The Act made it almost impossible to commit fraud since it would be both tedious and virtually impossible to influence any changes on all the eleven titles without causing any form of significant changes that may be noticeable. Furthermore, the SOX Act further made the regulations on companies financial reporting even stricter than any other rules ever imposed on entities in the history of the United States financial markets. As compared to some of the previous acts such as the Securities Act of 1933 and 1934 it was way stricter (Asthana, Steven and Sungsoo, 40).

It is the milestones attained by the Act that made it mandatory for the top management of any entity to certify the accuracy of any information that they may have presented from the consumption or use of the public regarding their company (Berger, 35). Moreover, the Act stiffened the penalties that result from any form of malpractice or inconsistency ion the part of the financial books of records. It further increased the oversight role played by the board of directors as well as further cemented and increased the autonomy and responsibilities of the outside auditors that act as the watchdogs to the public through reviewing and verifying the corporate financial records (Berger, 35).

The provision of the Act in section 101 to 103 led to the establishment of a significant and stable at monitoring the objectives of the public company executives, the accounting firms as well as the certified public accountants all to increase accountability (Lai, 41). The regulatory body is called the Public Company Accounting Oversight Board (PCAOB) consisting of five members who are financially literate of whom, two of them are CPAs with the rest not being accountants and are representing the public interests. It is the PCAOB that was mandated and accorded the power to register the public accounting forms, to enforce the compliance of the Act to the letter by the firms, manage the undertakings of the board of directors and also to conduct any necessary inspections (Lai, 41). Its independence was further reinforced by the fact that it does not provide any service as the US government department or agency ensuring that it is compromising or political interference as kept at minimal. PCAOB further had other responsibilities that included watching the companies, enacting and also adopting the professional accountant group’s auditing standards and other quality control and ethical principles required for the continued growth and thriving of the entities (Li, Pincus, and Rego, 10-11). The PCAOB was also regulated and monitored by the fact that it had to provide an annual report to the SEC. it further had to conduct annual inspections of the top public accounting firms. However, both SEC and PCAOB may conduct inspections at any random time making it even harder to fail to comply with the standards set.

The independence of the auditors was also increased and made it better for the operation of the auditors without any external infringement on their work. It is this that led to the growing scrutiny on the books of accounts, and the financial records have to have a sound and reliable vetting process hence increasing the accountability and the accuracy of the financial records released to the public.  Before the Act, the auditors faced a severe conflict of interest (Shakespeare, 333). It was because the primary ”watchdogs for the investors and the public, in general, were self-regulated and also conducted some major non-audit and consulting work for such companies still mandated to audit. As a result, the majority of the jobs were far more financially lucrative than the auditing jobs themselves, and it is this that brought about the possibility of compromise due to the vested interest in other areas. For example, for such an auditor, any form of challenging to the company’s accounting approach would subsequently lead to the damaging of the relationship with the client and hence may result in the loss of the bigger jobs or possible engagements (Turnbull, 26). The act protects the auditors through the banning of the accounting firms from providing any form of a list of banned non-auditing services for any particular clients. The audit and the review partners are also rotated at random every five years. According to the provision of the Act, if a company’s chief executive, accounting officer, financial officer and any other senior managers have worked with an accounting firm during the previous years, then the accounting firm is restricted from providing any legal audit services for such accompany and thus furthering the independence of the auditors (Shakespeare, 333).

The enactment of the SOX Act has also been imperative at enabling the investors the public and also the regulatory authorities to pinpoint or rather identify the boardroom failures (Kuschnik, 75). The board directors especially those who sit in the Audit committees are charged with the responsibility and also the mandate to act as oversight for the financial reporting of the US corporations all on behalf of the investors. The scandals that rocked the country indicated that the board members had failed at protecting the interests of the investors and also failed to protect the corporations from the subsequent financial meltdown and fraud. However, the establishment of the SOX Act was critical to the identification of the Board members who may either not exercise their responsibilities or those that are not fit to hold the positions due to their lack of expertise and skills to understand the complex the dynamics of business (Kuschnik, 80). It has been a crucial tool to put the board of directors in the limelight to ensure that they are well placed and also have the capacity to identify, stop and even act in case of an impending threat to the financial position of any corporation. It is this that has also led to the emergence of more informed and qualified boards of directors in the country resulting in the efficiency of the systems.

Before, the passing of the SOX Act, the funding received by Securities and Exchange Commission (SEC) mandated with the regulatory role was insufficient (Kuschnik, 65). The insufficiency in the funding affected its operations and hence its strained efficiency and in some cases led to the compromising of some of its structures due to the lack of funds to execute such endeavors. However, since the passing of the SOX Act, the funding of the entity has almost doubled. Sarbanes insisted on the need to ensure that such bodies are capable of executing their duties if at all their oversight role were to be met (Kuschnik, 67). Moreover, following the public outcry and the pressure that mounted on the government to address the financial issues that faced the country among the corporations, Congress and other budgetary allocation committees identified the need to invest more in the regulation of the capital markets. It also wanted to lead at safeguarding and protecting the investors and the public from any fraudulent activities from the companies and other involved stakeholders. The motivation to avert the 2000 crisis and also to maintain the public confidence in such corporation, the government have prioritized on making the SOX Act effective ad its proven efficiency over the past more than a decade of its existence is a major reason why every government prioritizes the making such bodies and SEC work (Kuschnik, 67).

The SOX Act has also been proven to result in a variety of benefits to firms and investors alike. SOX have been credited to the increased corporate transparency. Research documented by Turnbull (26-30), indicated that a comparison between the listed and the non-listed companies that are not subject to the SOX reported that the SOX compliant companies were far more transparent following the enactment of SOX. 6heir dispersion and also the accuracy of the analyst’s earnings forecasts were noticeable and significantly higher than that of those that are not compliant with the SOX regulations (Turnbull, 26). There was the reduction of the stock valuations of the majority of the firms which subsequently drive the share prices down to the advantage of the public that could now purchase them at affordable rates. There are also some indications pointing to the fact that the borrowing costs decreased for the entities that enhanced their internal controls. Moreover, the fact that corporations have increased their internal controls and their financial statements have also led to the change in perception by the shareholders and the public who began regaining the lost confidence in most corporations and began perceiving them as being more reliable (Turnbull, 26).

The Act further impacts the management’s responsibility in the financial reporting responsibility in a very major way while at the same time instituting grave consequences on any form of violation of the securities laws (Cosgrove and Niederjohn, 10).  The Act calls for the top management to take it upon them to ensure that the financial reports issued are accurate and up to date. The top managers are also mandated with the responsibility of verifying and certification of the financial report before they are released. However, there are severe consequences for any intentional falsification of the certification by any top manager. The manager found guilty of withholding information or interfering with the certification may face a sentence of up to 10 to 20 years in prison (Cosgrove and Niederjohn, 22). If the company, on the other hand, is required by law to make any form of a restatement due to the misconduct or defrauding by the top management, the senior managers may also be forced to give up their bonuses or even profits made upon the sale of the stocks of the company. Furthermore, the Act also stipulates that any individual, that is found guilty or convicted of the violation of the securities law; they may be prohibited from engaging in any service at the same role or position in the future. The law ensures that with the severe consequences instituted for any form of misconduct on the part of the management, they are personally held liable instead of leaving it upon the company shareholders to take the financial burden that comes with such defrauding of the public corporation.

 The SOX Act is not all flowery as one may be quick to imagine due to its numerous advantages. It has its shortcomings. The major weakness faced by the SOX Act is that it has resulted in increased cost of accounting fees due to having to comply with the provisions enacted by SOX Act. As a consequence of the increased accounting fees, there is a subsequent increase in the audit fees as well with some of the experts arguing that up to 74% increases the fees in the post-SOX period (Kleckner and Jackson, 13). The price increased due to the enactment of the SOX Act is directly attributed to the increased workload and also the growing liability on the auditors that came with the provisions of the Act. The Act allowed for increased efforts in the audit which further complicated the auditing engagements and also the requirement that the firms retain the audit papers for at least seven years to enhance the control of the public companies internal control structure which an effect on the cost has incurred in securing such documentations as well. The Act also requires that the communication between the auditor and the client be maintained for a while and as a result ensure that the efforts in accounting are even enhanced, and it m ay also lead to the increase in the amounts charged by such firms (Kleckner and Jackson, 13). The auditors’ legal liability also leads to the rise in the legal liability costs due to the increased risks. There could be the probability of misstatements that may include the inadequate or improper disclosures and also impropriate valuation, missed fraud or unnoticed fraud that may result from negligence and also the delays in completion of the audit exercise that could all lead to lawsuits and other expensive affairs.

Sarbanes-Oxley Act in Section 404 is one of the most expensive parts of the Act requiring the public companies to perform an extensive internal control test and also include an internal control report with the annual audits. The testing and also documentation of manual and automated controls involved in financial reporting requires the involvement of some external accountants and also in some cases some IT personnel (Kleckner and Jackson, 13). The cost of complying is also burdening for the majority of corporations that heavily rely on the manual controls. Sarbanes-Oxley Act encouraged companies to make their financial reporting efficient, automated and centralized.

Despite the fact that the SOX Act operated almost flawlessly and with increased advantages, it has faced unpredicted noncash costs that may be unforeseen, ignored or underestimated. There are indications that the unexpected costs may have risen in their millions of dollars higher than the original estimates while the noncash expenses such as the opportunity costs, excessive staff burden, and the lost investment opportunities may not have been considered during its initiation (Cosgrove and Niederjohn, 55). It may be difficult to identify explicitly measure and even quantify the noncash expenses that the businesses accrue as a result of the enactment of the law, but it is a factor that has led to the decision of many companies going private to avert the costs. The losing of investor opportunities is directly attributed to the implementation of the SOX Act with evidence pointing to the decisions made by large non-domestic public companies that withdrew from the US stock exchange. Various enterprises have announced their plan not to enlist with the US exchange due to the high costs implication that comes with compliance with the SOX. It is this that resulted in the decision of most of the companies to enlist with the London Stock Exchange which has fewer cost implications arising from the compliance with the regulatory authorities. There are also some major local companies in the United States that have taken the decision to enlist their IPO in other countries to avoid the massive compliance costs that come with the SOX (Cosgrove and Niederjohn, 53). Due to the enormous burden that comes with compliance with the SOX regulations, some companies spent a lot of time and their financial efforts at enlisting at the cost of the potential opportunities that could be presenting within their industry of operation. Several corporations lose out about the possibilities that may be demanding some capital outlay and therefore, resulting in leaving them to comply with the certifications and internal controls on financial reporting that may be a requirement by SOX (Koehn and Del Vecchio, 38).

In conclusion, the Sarbanes-Oxley Act passed in 2002 was put in place following a prolonged period of corporate scandals that involved the public companies from 2000 (Koehn and Del Vecchio, 40). There were several major companies such as that ended up being liquidated and going bankruptcy despite the robust and sound financial records that it had indicated over the years. The closure of some of the companies such as WorldCom and Enron raised tension and a sense of mistrust among the Investors in the United States and also to the public, and it is the pressure exerted by the public to enforce change that resulted in the enactment of the Sarbanes-Oxley Act in 2002 (Koehn and Del Vecchio, 38). The adoption of the act over the past over a decade led to tremendous achievements and milestones over the course of time. The Act has been the roadmap at restoring the investor’s confidence in the capital markets and also had been instrumental in closing the existing loopholes within the corporate that left room for potential defrauding of the investors. It has over time led to profound corporate governance changes in the United States (Koehn and Del Vecchio, 38). It requires that the companies strengthen their audit committees, engage in internal control tests, increase their transparency and disclosure and also set personal liabilities for the directors at ensuring accuracy and consistency of the financial statements. The Act has also led to the establishment of strict penalties for the securities fraud and also changes the public accounting firms that operate their businesses. It has, however, been attributed to massive direct and indirect costs. The direct costs result from the bulky nature of the work and the increased liability on the part of the auditing firms that has subsequently led to an increase in the costs charged by such companies. The indirect costs are mostly the noncash costs that may include the opportunity costs, the costs of investments lost and the expenses on the staff burden that resulted from the regulations that are hard to comply. As a result, some corporations opt to enlist in exchanges from other countries whole others have opted to go private to avoid the high compliance costs that come with the SOX Act. However, a cost-benefit analysis indicates a significant advantage of having the regulations as it has led to the streamlining of the sector and also resulted in returned confidence in the capital markets by both the public and the investors.