Leading Financial Conditions

Abstract

Since 2002, the Sarbanes-Oxley Act has been in place to not only raise awareness for employees and investors but also improve the management of internal controls in public corporations. Under the law, CEOs and CFOs are solely responsible for the accuracy of the financial reporting by their companies as well as the internal control structure to include fines and criminal prosecution if consciously falsified. The Sarbanes-Oxley Act was passed as a response to the Enron fiasco in an attempt to protect investors from corporate accounting fraud. The Act, which is officially known as Public Company Accounting Reform and Investor Protection Act of 2002, was developed by Congress to rebuild confidence in the market. The ultimate goal of the act was to ensure that someone could be held accountable during the repercussions of poor financial decisions.

Leading Financial Conditions

The Enron Corporation, the world's largest energy-trading company and the United States seventh largest corporation, filed for the largest bankruptcy in U.S. history on December 2, 2001. Enron's shareholders lost billions in stock investments due to earning inflation and fraudulent financial reporting. Along with Enron, Congress had to react to multiple corporate financial scandals to included Tyco and WorldCom. The "Big Three Scandals" was the cause of Congress and Arthur Anderson to pass to Sarbanes-Oxley Act (SOX) in 2002. Sarbanes-Oxley Act is also referred to as the Public Company Accounting Reform and Investor Protection Act in the Senate and Corporate and Auditing Accountability and Responsibility Act in the House.

Sarbanes-Oxley Act was named after Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH). The Act was established for the protection of the shareholders against fraudulent accounting practices in public companies. Public companies, along with the board and accounting firms were required to increase the transparency in accounting practices. Sarbanes-Oxley Act applies "to all companies (whether organized in the United States or elsewhere) that have equity or debt securities registered with the Securities and Exchange Commission (SEC) under the securities Exchange Act of 1934" (Peluso, 2004, p. 3). President George W. Bush signed the bill into law on July 30, 2002, stating:

My Administration pressed for greater corporate integrity. A united Congress has written it into law. And today I sign the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt. This new law sends very clear messages that all concerned must heed. This law says to every dishonest corporate leader: you will be exposed and punished; the era of low standards and false profits is over; [and] no boardroom in America is above or beyond the law. (Kahn & Blair, p. 1)

Sarbanes-Oxley Act required changes in how the corporate boards and their executives interacted with each other and the auditors by establishing rules of accountability for corporations with harsher penalties for misconduct.

Oversight and Accountability

Sarbanes-Oxley Act was developed out of necessity to prevent another scandal like Enron or the like. Additional guidelines were implemented for publically traded companies in references to corporate oversight regarding oversight and financial information and accountability to the results of such. "Most companies seeking to comply with Sarbanes-Oxley undertake a process that involves identifying significant financial statement accounts, examining the processes surrounding those accounts, and pinpointing the risks associated with those processes" (Kendall, 2007, p. 40). The basis for the implementation of additional review and requiring CEO or CFO accountability is to prevent the company officers from claiming ignorance to the problem at hand.

Based on the McKesson and Robbins, Inc. fraud in the 1930s, the SEC recommended in 1940 that publicly-held companies create audit committees to improve the integrity of corporate financial information; however, it was not until the 1960s and 1970s that audit committee oversight received widespread attention in the United States. (Hassan, Said, & Wolfe, 2007, p. 19)

The audit committee is responsible for detecting financial oversights as well as verifying that all appropriated parties have been involved in the review.

The oversight responsibilities for the auditing committee are as follows:

The accounting manager performs and documents a preliminary review of the month-end trial balance for unusual activity or balances. The accounting manager prepares an analytical review of the agency's income statement variances and balance sheet. As an additional control, the branch president reviews this analysis. Subsidiary accounting managers prepare a month-end checklist, which is then approved by the assistant controller. The month-end checklist documents that all journal entries have been reviewed and approved by the accounting manager, appropriate cutoff activities have been completed, and all required closing activities and reconciliations have been performed. Internal auditing tests the checklist for accuracy. At fiscal quarter-end, the branch president and accounting manager review a transaction report that shows transactions posted in the last 45 days of the quarter as well as those generating branch revenue above a certain threshold. Accounting performs monthly bank reconciliations, which are reviewed by the preparer's supervisor. The assistant controller reviews all journal entries, including supporting documentation. At month-end, the controller verifies that all journal entries have been reviewed and approved. (Kendall, 2007, p. 41-42)

The audit committee uses these steps to prevent oversight and further make the principle officers aware of all financial situations by requiring their involvement.

Accountability within corporations is imperative for protecting the shareholder and employees. Someone must be held accountable for mistakes or bad decisions in the event that financial records have been withheld or altered purposely and caused the company to suffer. In the past, before Sarbanes-Oxley Act, companies have issues with employees placing blame or outright denying any knowledge of the situation which in turn became the bigger problem that "everyone was innocent." When a situation where no one is to blame occurs the problem has the potential of happening again assuming it was not detrimental enough to extinguish the company. Due to Sarbanes-Oxley Act and the rules that require CEOs or CFO to maintain all knowledge of current financials there