Sarbanes-Oxley Act - Assignment Example

? Case study: A Primer on Sarbanes-Oxley Table of Contents Table of Contents 2 Problem ment 3 Answer 3 Issue Public Company Accounting Oversight Board) 3 Issue-2 (Independence of Auditor) 3 Issue-3 (Corporate Responsibility) 3 Issue 4 (Financial Disclosure) 4 Issue 5 (Conflict of Interest) 4 Issue 6 (Criminal Fraud Accountability) 4 Issue 7 (Penalty Enhancement) 4 Nortel Case 4 Criticism 5 Answer 2 5 Answer 3 6 References 8 Problem Statement Problems to be investigated in the study are 1- analyzing SOX from the view point of various stakeholders and measuring additional cost of new Sarbanes-Oxley Act passed in 2002 and 2- understanding various facets of government practices required by a company to maintain synchronization with Sarbanes-Oxley Act. Answer 1 Issue-1 (Public Company Accounting Oversight Board) Sarbanes-Oxley Act (SOX) has established Public Company Accounting Oversight Board (PCAOB) in order to measure three aspects (Examining the audit process of public company, establishing audit report standard and rules, inspecting regulation and registration of public accounting firm). This section is introduced in order to regain public trust on auditing process. Major stakeholders for auditing process are the company whose auditing is in the question, shareholders of the company and accountancy firm doing auditing for the company. Unethical business leaders try to avoid maintaining transparency in the auditing process in order to hide financial crisis of the company from shareholders. Issue-2 (Independence of Auditor) This section of SOX deals with regulatory issues for auditing firm. Regulatory norms on auditing firm can be explained in the following manner. The audit firm cannot perform accounting recording for the client company. They cannot design financial information system for client company. Audit firm cannot perform internal audit outsourcing service. They cannot provide investment banking service to client company. The audit firm cannot provide service other than auditing to client company The firm cannot do audit for client company for at least one year if it’s employee has served as part of senior management for client company PCAOB has used these auditing norms in order to prevent auditors from performing minor deficiencies in auditing. Above mentioned norms will help auditors to be more focused on providing service to clients and they will be able to monitor minor deviation in accounting system of the company from GAAP norms. Issue-3 (Corporate Responsibility) This section provides idea of structural design of auditing committee. In accordance to the rule members of auditing company needs to be member of board of directors of the company. In 1999, Core et al. has found that audit firms with feeble governance structures face more agency trouble than firms with strong and sustainable boards. Research scholars have established a converse relationship between sustainability of the board and characteristics of Chairman’s duality. In 2000, Beasley et al. reported a direct relationship between weak governance in auditing process to agency problem and financial poor performance of the client company (Webb, 2008, pp. 5-23). Issue 4 (Financial Disclosure) In accordance to 404 sections of SOX public auditing firms need to certify internal control process regarding to accounting system of the company and also need to maintain auditing process with minimum one financial expert. Issue 5 (Conflict of Interest) This section deals with establishing control over analysts. In accordance to this section investment bankers need to supervise activity of security analyst and restrict them from creating vague market research data which can hurt interest of the company. Issue 6 (Criminal Fraud Accountability) SOX have modified Corporate and Criminal Fraud Accountability Act of 2002 in accordance to situation. They have maneuvered harsh punishments in terms of monetary fine and imprisonment for officers committing the financial fraud. Issue 7 (Penalty Enhancement) Penalty in terms of monetary fine and imprisonment has introduced for unethical companies doing financial frauds. Imprisonment term has been raised to ten years for financial auditors certifying financial records and documents recklessly. Nortel Case The study will analyze Nortel financial fiasco in order to understand ethical perspective of the auditing process. The company practiced transaction process like bill-and-hold (Companies has the provision to customer’s orders in present quarter but can deliver the product in next financial quarter). Nortel used to record revenue in present quarter for future payments. The company encouraged transactions like bill-and-hold by providing unethical benefits like discounts, incentives, extended billing period for customers. The company used ambiguous and non transparent auditing report and used to show vague financial reports for investors. They have repeatedly reported over hiked market capitalization data to shareholders for many years. The company has channelized investment capital in a non transparent way. The company not only violated Generally Accepted Accounting Principles (GAAP) on a periodic basis but misrepresented financial health of the company to shareholders also. Board of directors influenced auditing firms to manipulate earning statements and balance sheet statement to earn grater incentives. Board members and respective auditing firm were the key people behind financial fiasco. Transient ownership of Nortel increased from 2.5 percent to 13 percent within three years spanning from 1997 to 2000. The rise of transient ownership can be termed as failure of both management and auditing firm. The organization used street earning method to calculate earnings per share (EPS). Street earning method excluded different items like extraordinary charges, unusual items, depreciation and Charges from mergers. The company used the method to show a higher EPS value and disguise poor financial performance. This case study reflects need of the SOX in order to restore shareholder’s confidence on public accounting process. SOX will prevent unethical business practice by establishing governing body like Public Company Accounting Oversight Board to monitor activity of management and auditing firm. Criticism In 2003, Schroeder has criticized SOX act for the following reasons. The act has given minimal importance on evaluating performance of board of directors The act has excluded shareholders from giving proxy to elect directors Overemphasizing on compliance might make management and boards vulnerable to risks No critical explanation about compensation of executives Whistleblowers cannot communicate directly to board members (Chan, 2009, pp. 1-18). SOX should give importance to above mentioned points in the issues in order to deliver a more sustainable and impregnable legal framework. Answer 2 This study will analyze additional cost resulted due to SOX in insurance industry. Implementing SOX for publicly traded companies is associated with certain cost elements. Research scholars have suggested that the reform has increased cost for companies. Although SOX has reduced the scope of accountancy fraud while skimming fee structure has became headache for companies. Cost elements can be explained in the following manner. After implementing SOX companies need to pay high fees to external auditors listed in accordance to schedule 14A mentioned by Securities and Exchange Commission (SEC). Additional hike in audit fees creating problem for small business organizations not having sufficient financial resources. Although large companies can afford to pay huge fees to auditor to conduct auditing while mid level and small level firms find it difficult to pay the fees to listed auditors and hence in many cases they continue to maintain faulty accounting system without consulting external auditors. Fee of auditor has increased by forty percent. This whole system is ultimately undoing the purpose of SOX (Millar & Bowen, 2011, p.p. 161-170). Cost of compliance factor is associated with SOX. The policy has created huge financial burden on the shoulder of small banks in contrast to large and mid sized banks. Increased compliance cost is making their business vulnerable to external business threats. A statistical survey conducted by KPMG suggests that twenty four percent of banks are expecting to spend more than or equal to $1 million while forty eight percent banks are expecting to spend more than or equal to $500 000 on SOX compliance. Another survey indicates compliance cost might be increased to more than sixty percent above the estimation made by banks. SOX has triggered hundred and nine percent rise in internal cost while external cost has increased by forty two percent. In 2004, Price water house Coopers has made statistical research on compliance cost and their study shows average compliance cost for banking industry is $4.4 million with a hike of more than thirty percent from previous year. This huge industry cost is complemented with increased compliance cost, increased fees of auditor, increased internal cost and increased external cost. Research conducted by KPMG, Deloitte and Grant Thornton shows that compliance cost is overshadowing benefits in recent years for banking industry. Compliance cost has increased by eighty seven percent during the four years time frame spanning from 2002 to 2006. Cost of compliance in accordance to SOX is huge in the initial stage. Research scholars argued that the cost will decrease after companies gained expertise and knowledge about compliance act. Survey conducted by Kenneth Janson shows companies with second year of SOX experience decrease in compliance cost. Many banks has reported more than two hundred percent increase in compliance cost in the first year of SOX and they have not experienced any significant decrease in compliance cost for first two years (Garneau & Shahid, 2009, pp. 285-299). Answer 3 Organizations need to focus on maintaining consistency of transactional data of various areas. They can use SOA (Service Oriented Architecture) system to consolidate data with SOX guidelines and also with SEC. Companies need to control existing ERP system in accordance to guideline given by SOX to maintain transactional data. Integrate system can reduce overall cost of operation. Integrating consolidation activity with business warehouse can be useful tool for companies and also for auditing firms. After consolidating data will flow from single system to multi variant system without involving any interface. EAI (Enterprise application integration) system will help companies to automate the whole transactional process from taking sales order to producing accountancy report. Automation will help companies to reduce the financial abnormalities in the report and chance of human error. Data related to profit/loss statement, balance sheet and journals can be listed by using ERP system. This integration is must requirement for companies to comply with sections like 404, 401 and 302 of SEC (Maurizio, Girolami & Jones, 2007, pp. 14-31). Companies need to follow Generally Accepted Accounting Principles (GAAP) to do business in USA and Canada. Unethical trade practices like (bid and hold, street earning) should not be encouraged by financial institutions. Financial authority needs to regulate equity overvaluation by any company. There should not be huge gap between share price and underlying value. Regulation is required in the process of calculating market capitalization. Punishment of the top level managers in terms of monetary fine, imprisonment are required to stop different type of financial scams. Punishment like ten years imprisonment can be applied in extreme cases. The regulating committee can put a ban on the company involved in financial fraud. References Chan, M. (2009). Business perspectives and current developments with respect to the Sarbanes-Oxley act. Journal of Leadership, Accountability and Ethics, 7. 3, 1-18. Garneau, V., & Shahid, A. (2009). The Sarbanes-Oxley Act of 2002 (SOX): A redundant regulation for the banking industry. Journal of Banking Regulation, 10. 4, 285-299. Maurizio, A., Girolami, L., & Jones, P. (2007). EAI and SOA: Factors and methods influencing the integration of multiple ERP systems (in an SAP environment) to comply with the Sarbanes-Oxley Act. Journal of Enterprise Information Management, 20. 1, 14-31. Millar, J. A & Bowen. B. W. (2011). Small and large ?rm regulatory costs: The case of the Sarbanes-Oxley Act. Corporate Governance, 11. 2, 161-170. Webb, E. (2008). Sarbanes-Oxley compliance and violation: An empirical study. Review of Accounting & Finance, 7.1, 5-23. Read More