PHASE II -- QUESTION 1
Through the Sarbanes-Oxley Act, Congress addressed certain problems, issues, and deficiencies that were facing the external auditors.
a. Prior to SOX, what problems, issues, or deficiencies were facing the external auditors? (Bloggers, tackle one per comment.)
a. Prior to SOX, what problems, issues, or deficiencies were facing the external auditors? (Bloggers, tackle one per comment.)
b. Post Sox, how does the Sarbanes-Oxley Act of 2002 fix or minimize the problems, issues, or deficiencies noted above in part a?
posted by Dr. Scott @ 9/20/2005 02:19:00 AM
23 comments
23 Comments:
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One of the problems auditors faced was the pressure from managers of companies. Before the Sarbanes-Oxley Act there was a shift from cash based executive compensation to stock option compensation. Since stock options rose from 5 percent to 15 percent of shares outstanding at major U.S. companies and managers were no longer required to hold their shares for 6 months due to the relaxed rules of the Securities Exchange Act of 1934 it meant that managers could boost stock price in short-term one day and sell these high priced shares the next. This, "perverse incentive" is one of the reasons managers were motivated to manipulate the market and in turn place a great deal of pressure onto the auditors go along with these short-term accounting strategies.
Cornell Law Review
Post SOX, the establishment of auditor independence has helped fix the problem of incredibility in regards to an auditors report. These reports would not credible and investors and creditors would have little to no confidence on them without auditors being trustworthy in both the information and appearance of the reports. Before, creditors were able to easily mislead and configure the reports, however post SOX, this establishment of auditor independence sort of fixes or at least reduces and minimizes incredibility on auditor reports.
Auditors dealt with another issue similar to Managers; similar in the way that it was, like Andrew said in question 3, a moral problem. Due to the Supreme Court's decision in 1991 in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, the Supreme Court's Decision in 1994 in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, the PSLRA, the SLUSA of 1998, and the fact that the SEC took its focus off of the Big Five accounting firms the legal risk for an auditor decreased. This made the decision to engage in the accounting policies of their clients a much easier decision to make.
The purpose of the SOX act was to make sure that businesses are able to see the risks of competing in the market. Concisely stated in an article on www.riscpa.com, "It is a law designed to reform corporate America and protect individual investors." The SOX Act requires that all brokers/dealers (public and private) must be audited by a public accounting firm that is registered with the Public Company Accounting Oversight Board. This means the SOX Act is putting up an invisible wall between the auditors and the accounting companies. While the second question is asking how the SOX Act fixes the problems mentioned in part a, upon reading an article on www.economist.com - the author creates a likely argument that the SOX Act will not end well. Because the SOX Act requires that companies use smaller auditing companies, those small companies are under a great deal of strain. Not only is the need for experienced auditing companies growing, there are hidden costs that have not been calculated in order to comply with the Act. According to the website, this unprecedented cost is leading many public companies to go private in order to avoid the costs involved. However, it does say that for sure, the SOX Act will most likely reduce the amount of frauds over time.
Prior to SOX, very few public companies anywhere in the world had formally assessed the strengths and weaknesses in all of their external financial disclosure systems . External auditors often chose to do very little disclosure control assessment and testing. Audited financial statements produced under prior to SOX regimes were less reliable than
those post SOX .
With the Sarbanes-Oxley Act of 2002, many companies and their external auditors are currently focusing 90% of their assessment efforts documenting, assessing and testing controls. Also, financial disclosures from US listed companies are significantly more reliable than other external auditors around the world.
www.paisleyconsulting.com/website/pcweb.nsf
SOX made changes but basically it only shifted focus, created some limitations, and codified the practices already being followed by most good companies and CPA firms.
For instance, internal control reviews were always part of the planning process. SOX increased the focus. Independence (and its documentation) was always required. SOX defined the limitation on consulting. Most companies already had audit committees. SOX defined the requirement.
I wonder if the purchasers of stock shouldn't be held at least partially responsible for the problems in the markets. What was the intrinsic value of some of these problem stocks before the devaluation?
Auditor independence is/was an issue for external auditors, just as Rickwood mentioned. Discuss the controvery surrounding non-audit services. First, identify the type of activities that are considered to be non-audit services. Then answer, why the controvery?
Did the SOX Act really require companies to use smaller auditing companies? Where does it say this is The ACT? Would large companies be served well if this was a requirement? Does it make economic sense? Why or why not?
Jdaiva stated that "external auditors often chose to do very little disclosure control assessment and testing". Is this really true?
I could not find any place in the SOX Act where it said companies were required to use smaller auditing companies. However, in Title Two it does go into detail of all the regulations of the Audit companies. If this was a requirement I think it would hurt the larger companies because I small audit business might not be equipped with the man power to handle a large corporation.
Dr. Scott said to find where it was stated to use smaller auditing companies. I have read over the act, briefly and have not found this statement.
It wouldn't be fair for the act to say this in my opinion because you cannot rule out those larger companies that are just as efficient as the small ones at what they do. This would be completely unfair for those larger companies.
Also, it doesn't make economic sense because you would be ruling out the fair competition. Not only that but would there be as much reliability? Would you chose to go with a company that you know will be around five, ten years from now and has been around for some time or would you chose to go with an auditing firm whose just started their company and hasn't worked out all the kinks yet. So not I do not think it would be make economic sense.
The SOX Act does not require companies to use smaller auditing firms for the reasons the previous posters have mentioned but I discovered an article that claims that SOX has created more opportunities for smaller firms. In the article Small Firms: Think Big! (http://www.aicpa.org/ pubs/jofa/jun2004/dennis.htm), it mentions a variety of ways in which smaller firms can provide services to companies that the larger firms either cannot do or do not feel like putting their resources towards. Because the act has created new requirements to comply to, their are many new services to be done. Larger firms trickle some of these services to middle sized firms, and they in turn give some to smaller firms. As far as services that the larger firms must hand off,the article states that because the act prevents auditors from helping their clients with most compliance work, second firms can perform internal control testing and review internal control.
In researching Dr. Scott's question whether Jdaiva's statement that "external auditors often chose to do very little disclosure control assessment and testing" was true, I discovered the source that makes this claim: http://www.globalriskregulator.com/archive/February2005-18.html. I have yet to find anything to rebuke the argument that prior to Sox this was true. The article actually states that in 2004, over 500 US listed companies disclosed serious external disclosure control deficiencies. Author, Tim Leech, feels that this number will grow into thousands in coming years but the fact that it is discovered will only help fix the problems and improve future reliability.
In response to Dr. Scott's question, of whether or not large companies would be served well if they had to use small auditing firms to do their work, I think that a rule like this could provide an avenue for large corporations to force the small auditing firms to do whatever they want. If the corporation did want to commit illegal acts a small auditing firm may be willing to work with them to do so because the auditing firm would be worried that if they do not comly then they could lose the corporation's account which would be very devistating to a small firm.
In response to Dr. Scott’s comment, non-auditing services include:
-bookkeeping or other accounting services
-financial information systems design
-appraisal or evaluation services
-actuarial services
-internal audit outsourcing services
-management functions
-broker/dealer/investment advisory
-legal services unrelated to audit
There is controversy because if an accounting firm performs any of these services, they are no longer external auditors- there is no more independence. The auditing service is now part of the company, helping them to invest, bookkeeping, etc. Because of this, in agreement with rickwood, auditors would not be credible if they are not independent from the company because they can more easily tweak financial statements to look how they want to. This is why the SOX made auditor independence mandatory.
http://accounting.smartpros.com/x35824.xml
and the Sarbanes Oxley Act
Let’s start by saying that size doesn’t matter. What matters is the integrity and ethics of the company doing the audit. Lack of integrity and ethical values, is in my opinion the greatest problem that auditors faced. They say that they felt threatened because their client would take their business elsewhere, which is preposterous! It is outraging to hear that argument. It is their job to tell the rest of the world about any wrongdoings, why would they feel threatened by their clients. That’s like a student telling the professor that he is going to change sections if he doesn’t get an A in the class. It all boils down to GREED… and it is very sad.
The auditing firm cannot accept management’s responsibility to reach conclusions on the effectiveness of the entity’s controls nor can management base its assertion about the controls design and operating effectiveness on the results of the auditor’s tests. Sox provides a better definition of the separation between auditor and client. Kind of like the separation of powers in our government or the separation of church and state.
Both the auditors and the boards need to take responsibility for their actions. They may have each had different motives but they both committed crimes. Neither party should be held 100 % guilty because for the fraud to occur they both need to have agreed to it.
In an article I read, Peter Chan talks about how even though the Sarbanes-Oxley Act has done a lot to improve financial statements, in the end the statements won’t be that much better off. I agree with him because Chan argues that there can never be a true “independent” auditor. This is because the companies being audited select and hire their own auditors. The “outside” auditors are only interested in money that they can gain from the company being audited. They also are only really interested in doing the bare minimum in accordance with GAAP while checking companies’ books for errors and mistakes according to Chan. This will never work because auditors are always only going to be looking out for themselves. He suggests an idea that I think would be a major step forward in the auditing world. Chan suggests that outside institutional investors and investor-hired auditors would be more prone to have actual interest in the integrity of financial statements and they would also actually be separate from the company. He says that people could do this via the Internet by using companies’ raw data online. I think that this is a great idea because it ACTUALLY separates the company from the auditors because investors would be the ones paying for auditors and they care a lot about the integrity of financial statements.
http://www.findarticles.com/p/articles/mi_qa4048/is_200401/ai_n9382791#continue
In response to Dave Conrad's comment, I do not understand why the purchasers of stocks should be held partly responsible. They most likely would not know if the people on the board and auditors are committing fraud.
Quick answer to Anna. During the 70s and 80s both the individuals and institutions that purchased stock changed focus from strong companies with a good capital base and a high PE ratio to stocks with good earnings in the current quarter and those whose speculative future might seem bright. No intrinsic value. It is much easier to fake a good quarter than years of capital accumulation.
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