Analyzing the Sarbanes Oxley Act Efficiency - Essay Example

Sarbanes Oxley The Sarbanes Oxley Act or simply SOX was enacted in July, 2002 to check the accounting inconsistencies that are likely to happen in any enterprise. This act was meant to protect both the shareholders and the general public from any errors in the accounts. The Act was named after its major architects, Senator Paul Sarbanes and a Representative, Michael Oxley. The act sets out rules about which enterprise records should be stored. It also gives the specific length of time these records need to be stored (Holt, 2008). Also known as the Corporate and Auditing Accountability and Responsibility Act or the Public Company Accounting Reform and Investor Protection Act, SOX was enacted in the United States of America as a reaction to numerous major scandals that affected at least five companies. The high profile scandals in Peregrine Systems, Enron, Adelphia, Tyco International, and Worldcom were what led to the enactment of Sarbanes-Oxley. The scandals led to great losses on the side of investors as the companies’ share prices plunged and the public’s confidence in the country’s securities market steeply declined. This paper discusses the SOX act and its impact on internal control and accounting. Changes That Came as a Result Of Sox The legislation of SOX affected both the accounting and IT sectors. This is because the IT departments in most corporations are the ones charged with the duty of keeping certain electronic records. According to Cosgrove and Niederjohn (2006), SOX is clearly the most important piece of monetary legislation since the first legislation that was enacted to regulate the securities markets in the 30s. The act has an intense impact and has, in a dramatic way, changed financial reporting, the accounting industry, and in particular the auditing of companies owned by the public (Cosgrove and Niederjohn, 2006). Some of the changes that have happened due to this legislation are outlined below: There was the creation of the Public Company Accounting oversight board which was mandated to oversee and regulate the accounting industry. This body is also empowered to punish any organization or group of organizations that violate the regulations set out by SOX according to Cosgrove and Niederjohn (2006). With the enactment of SOX, company executives received more responsibilities. The legislation requires some high level company executive to verify that the company financial records and reports are 100% accurate. This means that if any inconsistencies are later found in the reports, the signatory executive will be answerable (Iliev, 2009). The Sarbanes-Oxley legislation came with a requirement for independent auditors to carry out audits periodically. In title two of the legislation, the standards for auditor independence have been drawn. This was done to decrease cases of conflicts of interest according to Holt (2008). Benefits of SOX There are many benefits that come as a result of the SOX legislation. Corporate governance is one of the areas that has been greatly improved by the legislation of SOX. The legislation requires the top executives to disclose the company’s financial records to shareholders. This enables people to discern whether or not there is a financial malfunction going on in the company’s accounting department. This serves to reduce corporate fraud and increase accountability (Iliev, 2009). With more accountability in many of the country’s public firms, investor confidence was restored. It can be said that the act was successful since restoration of investor confidence in public enterprises was its main aim. Another benefit was how the Act opened up financial system to management. Prior to the enactment, very few top executives understood what actually happened in the accounting department (Jahmani and Dowling, 2008). According to Jahmani and Dowling, SOX also enhances internal controls and management practices. Managers became more responsive to financial issues that arose in their companies. This lead to an increase in accountability and quality of services rendered. SOX legislation also encouraged public companies to come up with their own compliance process which enables them to solve their own issues according to their compliance policies. According to Cosgrove and Niederjohn (2006), the automation of financial reporting made it quite hard for fraudulent activities to happen within the organization. They say that the documentation and process management enables public companies to have some flexibility in their financial reporting capabilities. Downsides of SOX According to Jahmani and Dowling (2008), there has been a decline in IPOs (Initial Public Offers), especially from start up enterprises. They say that since the compliance process takes a heavy financial toll on small enterprises, the investor confidence in them is continuously diminishing. Jahmani and Dowling also claim that there was no clear guidance on how public companies were supposed to implement the enactment. Therefore most companies just came up with its own implementation measures which translated to the use of too much capital. Another significant disadvantage of the SOX legislation is the cost of implementation (Stephen and Schwartz, 2006). All public companies are supposed to implement the legislation their own way. There is no guideline for proper implementation and therefore there is much room for confusion and irregularities. Another con of SOX is that different auditors normally disagree on the best audit approach. This creates conflict and may lead to lack of proper financial reporting. The SOX compliance process is never ending, and this may make most companies go bankrupt since they have to use a lot of money in the implementation process. There is also the ever looming danger of a company falling in case of an international financial crisis according to Cosgrove and Niederjohn (2006). Conclusion Although a number of scholars have downplayed the role of SOX in running an accounting department in a company, I think that the legislation did a lot to bring a certain level of accountability to firms. The legislation not only defines what records need to be stored, it also shields the common individual and a firm’s shareholders against the damage that might occur in case of a financial misdeed (Cosgrove and Niederjohn, 2006). The issue of internal control has received more coverage in the press than it did before the enactment of the Sarbanes-Oxley Act. This because the compliance cost in internal control can be very costly for some companies, yet the enactment has done a lot to ensure that the financial situation in most companies remains intact even during the present tough economic times according to Stephen and Schwartz (2006). If there is to be any degree of integrity in our organizations, there should be no question about the effectiveness of SOX. Companies should to be held responsible for their financial misdeeds. This is because if something goes wrong in the company, it is not just the employees whoa re affected, the general public will also be affected as noted by Iliev (2009). If financial malfunctions go unnoticed and uncorrected, the ripple effects will be felt everywhere. For instance, the company will not have enough money to pay all of its employees, and when this happens, some of them are bound to be laid off. If the company is laying off employees, that means that there will be no new jobs for very many people who need them (Holt, 2008). If public companies do not feel like enacting SOX the legislation has given then the opportunity to go private. However, when a company becomes private, it cannot have its shares traded publicly anywhere as stated by Iliev (2009). The cost of SOX compliance might be high, but the end benefits outweigh any loss that the company might go through in the process of SOC implementation. References Cosgrove, S. and Niederjohn, S. (2006). The Effects of Sarbanes-Oxley on the Public Accounting Industry. Retrieved February 15, 2010 from: http://www.economics.neu.edu/activities/seminars/documents/cosgrove.pdf Holt, M. F. (2008). The Sarbanes-Oxley Act: Coasts, Benefits and Business Impact. Retrieved February 15, 2010 from: http://books.google.co.ke/books?id=Z1PasED8CIAC&dq=Sarbanes+Oxley+advantages&source=gbs_navlinks_s Iliev, P. (2009)The Effect of SOX Section 404: Costs, Earnings Quality and Stock Prices. Journal of Finance. Retrieved February 15, 2010 from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=983772 Jahmani, Y. and Dowling, W. (2008). The Impact Of Sarbanes-Oxley Act. Journal of Business and Economics Research. Retrieved February 16, 2010, from: http://www.cluteinstitute-onlinejournals.com/PDFs/1228.pdf Stephens, L. and Schwartz, R. G. (2006). The Chilling Effects of SARBANES-OXLEY: Myth or Reality? The CPA Journal. Retrieved February 16, 2010, from: http://www.nysscpa.org/cpajournal/2006/606/infocus/p14.htm Read More