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On the backdrop of high profile accounting frauds and misstatements, Sarbanes – Oxley Act (SOX) was introduced in 2002 with an intended goal to make corporate accounting more transparent. Security Exchange Commission (SEC) was handed the enforcement responsibility and a new oversight body was formed the Public Company Accounting Oversight Board (PCAOB) for implementation of different provisions of the act.
Since these provisions fall under various provisions like Section 302 – Disclosure of controls, Section 401 – Disclosures in periodic reports (Off-balance sheet items), Section 402 – Assessment of internal control and the others. So, for simplicity we can break it into the following to understanding the impact on financial reporting:
Public Company Accounting Oversight Board (PCAOB): The law led to the formation of PCAOB, which constitute of independent five members board. Their duties are to:
Standards: SOX mandate that corporations use Generally Accepted Accounting Principles (GAAP) in reporting their balance sheets to shareholders and Financial Accounting Standards Board (FASB) will set the official standards.
Disclosures: All off-balance sheet transactions like operating lease and other relationships with unconsolidated entities must be disclosed in a separate section of the notes. Internal controls: It requires the companies to conduct an assessment of the effectiveness of the organization’s internal controls, and a provide a statement identifying the framework used by management to evaluate the effectiveness of internal controls.
As per the act, all material changes in financial condition or operations must have a real-time disclosure e.g. all designated securities transactions done by directors, officers and 10% stockholders must disclose designated securities tractions within two business days.
The CEO and CFO of the company must certify the accuracy and fairness of the audited financial statements. An intentional violation here will attract a penalty of up to $5 million and 20 years of imprisonment. CEO and CFO must also certify that any significant deficiencies in internal controls, frauds etc. have been disclosed to the audit committee and the auditors.
Public accounting firms: A registered accounting firm is prohibited from providing any non-audit services (listed) to an audit client coexisting with the audit. This aimed at a minimalizing possible conflict of interest and compromises of integrity in the audit.
The audit committee: The act requires for setting up of an independent audit committee which helps in improving the governance by separating the functions of oversight from management.
The work papers from the audit engagement must be maintained for a period of five years and if the audit firm is registered under PCAOB then for seven years. Any act of destroying, altering with any sort of document with an intent to influence any investigation will attract up to 20 years of imprisonment.
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