Term Paper on "SOX 404"

Term Paper 17 pages (6206 words) Sources: 20 Style: APA

[EXCERPT] . . . .

Sarbanes-Oxley Act came at the wake of a lot of scandals and apprehension and there was a lot of media pressure in its enactment that was caused by the collapse of Enron. This act provides stiff punishments for those at the helm of companies and fines of over $5 million for violation of the laws. (Snedaker, 2006) the act is named after senator Sarbanes and Oxley who are the architects of the act. Sarbanes-Oxley Act was meant to introduce regulation to corporate governance and financial accounting. The act brought in mandatory rules regarding the internal financial controls. (Romano, 2005) the Sarbanes-Oxley act of 2002 was assented to by the President on 30th July 2002 and principally applies to the issues as stated in the securities act, that is public issues and companies with shares and securities subscribed by the public, and all companies with assets of over $10 million and all companies with over 500 security holders come under its purview. The public companies, investment and securities traders, foreign companies, and others that trade securities at the national securities exchange are bound by the law. (Sonnelitter, 2005) There was an opinion current even before passing of the act that auditing was performing at low standards in U.S. public companies, and following that there came the act to reform accounting which was the 'Investor Protection Act of 2002' and the 'Public Company Accounting Reform'. The impact of the Sarbanes-Oxley Act was more to form the Public Company Accounting Oversight Board -- PCAOB that would then enforce the earlier accounting act. The addition was the mandatory disclosure required. (Coates, 2007)

The act has long-term and far reaching consequences, not only in the governance of the public companies, but also in the nature of auditing and the functions of auditors and financial controllers. There are requirements of many skilled persons from the accounting, auditing and Information technology to combine in bringing about the compliance of this provision. The current problem with the regulations in this act is that the act on being passed had set mandates for compliance with its requirements and deadlines are set. (Romano, 2005) the provisions of section 404 which has mandated the change therefore will have to be studied in the light of all these requirements.

Section 404 of the Sarbanes-Oxley Act: Introduction

There are eleven titles to the Sarbanes-Oxley act and the orders for compliance fall under the sections 302, 302, 401, 404, 409, 802 and 906. Of these sections section 404 deals with an important aspect of internal controls in corporate structures. (Romano, 2005) Section 404 is found under title IV. (Sonnelitter, 2005) the provisions of corporate governance (404) SOX was not a point of detailed debate. However there is an accusation that SOX being made mandatory is wrong. (Romano, 2005) the section 404 makes it mandatory for the company to establish and maintain a system that can control the internal activities of the company and financial reporting. This comes as a directive for public companies. (Snedaker, 2006) the federal regulation of financial markets is always the result of market problems. There is a school of thought that maintains that the disclosures under the act could be made optional instead of mandatory. (Romano, 2005)

The new requirements thus effectively verify if there are corporate procedures that create financial accountability and prevent frauds of the type that was created at Enron. The need to make the financial transactions and the accountability of financial controls resulted in the act making it mandatory for the companies to publish information about its financial compliance. This new requirement is on the processes that go on inside the corporate entity and the process and controls in place, and evaluation is done with the financial performance and the compliance result. The law is a shift in the view process of corporate performance. Now there are more expertise involved from a lot of specialized agencies for creating the reporting and compliance reports and making it possible in the first place. This involves information technology, Risk managers, business analysts and many others. All these agencies will have contributions to make in the internal control and its evaluation. The act made changes to the financial reporting to include reports both at quarterly statements and annual statements regarding the perceived efficiency of the 'internal control' mechanism of the company in the realm of financial reporting. (Ramos, 2004)

Internal Controls Feature of section 404 of the Act:

The important features of section 404 of the SOX Act relate to the internal controls with regard to the structures of corporate firms. (Shanley, 2004) the internal control is defined in the act at rule 13 a- 15(f) as "the procedure which is being formulated by or based on the assessment of the said executive of the issuer and said financial officers/individuals having same responsibilities and the aim is to provide accurate financial reporting and financial statements for external issue. The act also says that the internal control ought to have proper records showing all of the transactions held as well as the issuer's assets and bring about required with regard to their veracity which pertains to the practice of general accounting, and to have a system so as to avoid the unauthorized disposal or funds acquisition on such lines so that it could have adverse impact on the funds of the company." (Chew, 1993) the term internal control thus has a very broad meaning and will thus cover all activities of the company. Section 404 makes it mandatory for the Chief Executives of the company and the financial officers to present a report after evaluating the internal control of the company with regard to financial reporting. This is to be filed in form 10K, which is to be submitted to the SEC on the annual date for submission. (Ramos, 2004)

The regulations and the methods of following the procedure of financial accounting responsibility were clearly laid down by the authorities' long back. The Committee of Sponsoring Organizations -- COSO issued regulations on internal controls as far back as in 1992. The internal control would have well laid policies, procedures and sets of rules that would be followed. This will be mandatory for the management and is expected to ensure that thee is a reliable financial reporting, and the operations of the company is efficient and resourceful. It will thus ensure that activities of the company are always lawful. This internal mechanism will it is hoped, affect and improve the methods of analysing and storing data and information and also achieve a method of financial reporting along with efficiency in the operation processes of the company's activities. The ignorance relating to internal controls and in the management model which is traditional, the absence of such type of internal control is considered to be the fundamental weak element. The auditing task could avoid the element of risk, which is considered to be one of the significant and important activity which would be the output relating to the entire process. The benefit of the section 404 is that the efficacy relating to internal controls with regard to the company's risk will become evident to the investor and will for a part of the financial report of the company. The enterprise reporting must thus be based on computing the risks of the enterprise. (Lin; Wu, 2006)

Companies are now obliged to create corporate procedures that create financial accountability and prevent frauds. The law has brought in more requirements in terms expertise involved from a lot of specialized agencies one of the most important and critical function that will be the outcome of the process. (Shanley, 2004) the public companies must comply with all the directives of the 'Public Company Accounting Oversight Board - PCAOB' and the SEC. There is a criminal liability in case of default. The risks of noncompliance are huge and can easily affect the company's financial and operational structure. (Lin; Wu, 2006) This rule was made applicable to all pubic companies except the issuers of asset-backed securities and the registered investment companies. Thus in the final form the guidelines state that the management of the company must provide a statement that shows the adequate internal control with regard to financial reporting, and the framework that is in place to assess the effect of the financial control with an assessment of the last financial year with a statement reflecting management to assess the efficacy of the internal control of the registrant with regard to reporting of financial statements. (Shanley, 2004)

The benefit of the section 404 is that the efficacy of internal controls pertaining to the company's risk will become evident in terms of the investor. Although the procedure is costly for the company the investor will stand to gain from the new act, because the management of the company must provide a statement that shows the adequate internal control with regard to financial reporting, and the framework that is in place to assess the effect of the financial control with an assessment… READ MORE

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