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Financial Statement Audits, Reviews, Compilations

  1. Sarbanes Oxley
  2. Assurance
  3. Engagement Letter

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Sarbanes-Oxley (SOX) Act of 2002: Definition & Overview

Updated: April 14, 2023

There is a lot to consider when it comes to reporting financials for your business. These can include compiling the balance sheet, income statement, and profit and loss statement. It’s incredibly important to provide accurate and relevant information for financial reporting. 

But even though many businesses follow rules and regulations, there can sometimes still be companies that are not fully truthful. This is why the Sarbanes-Oxley Act (SOX) was passed by the United States Congress. Read on to learn everything you need to know about the SOX act.

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    KEY TAKEAWAYS

    • The Sarbanes-Oxley (SOX) Act of 2002 was passed after a series of corporate financial scandals that were highly publicized.
    • The Act includes a wide range of new penalties and punishments for those that violate  securities laws. 
    • New rules were established for corporate officers, auditors, and accountants, such as increased accountability of corporate leadership, regulation of auditors and their services, and severe criminal penalties for violators.

    What Is the Sarbanes-Oxley (SOX) Act?

    The Public Accounting Company Reform and Investor Protection Act of 2002, commonly called the Sarbanes-Oxley (SOX) Act, was passed by the United States Congress into law to improve the rules and regulations regarding publicly traded corporations and public accounting companies. The Act was passed on July 30 and its main intention is to protect investors.

    It’s regularly referred to as the SOX Act of 2002, and it includes strict reforms to previous securities and public accounting companies regulations. As a result of these reforms, lawbreakers were now subject to stricter and tougher penalties. 

    In the early 2000s, there were several financial scandals involving public traded companies. Some of the most notable companies are Tyco International plc, WorldCom, and Enron Corporation. 

    Once these scandals became public, they completely shook investor confidence which led to a distrust of some of the corporate financial statements in question. Ultimately, the high-profile frauds required an overhaul of the regulatory standards that had been in place for decades. 

    Collapse of Enron and the dismantling of the international public accounting firm Arthur Andersen called into question the credibility of publicly traded companies and the accounting profession itself. The Sarbanes-Oxley Act was passed to restore trustworthiness and investor’s confidence in the financial accounting process.

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    Benefits of the Sarbanes-Oxley Act 

    With investor confidence falling to an all-time low, there needed to be a complete reform of previous securities regulations. It was more apparent than ever that the regulations had become outdated and insufficient. 

    The Sarbanes-Oxley Act provided a series of amendments and changes to the existing laws that dealt with security regulation. This included the Securities Exchange Act of 1934, as well as a range of laws enforced by the Securities and Exchange Commission (SEC). 

    By taking on this reform, the new laws created the following benefits for financial securities: 

    • New protections 
    • Accounting regulation and internal accounting controls
    • Increased criminal punishment 
    • Corporate Governance and Responsibility 

     These changes introduced better, more accurate, and more reliable financial practices, which ultimately benefit companies and their stakeholders.

    Major Provisions of the Sarbanes-Oxley (SOX) Act

    Since the Sarbanes-Oxley Act is an incredibly complex  document that includes several key areas. However, it contains three key provisions referred to by their individual section numbers.

    They are Section 302, Section 404, and Section 802. Let’s take a closer look at each.

    Section 302 of the Sarbanes-Oxley Act

    This section mandates that all of the senior corporate officers must certify, personally and in writing, that the financial statements of the company comply with SEC disclosure requirements. 

    It also outlined that at the time of the financial report, it must present in all material the financial condition and results of operations of the issuer. 

    If a corporate officer knowingly signs off on fraudulent financial statements, they are subject to a range of severe criminal penalties, including a possibility of a prison term.

    Section 404 of the Sarbanes-Oxley Act

    This is the section that mandates the documentation and assessment of internal controls over financial reporting by the company management. It also requires auditors to express an opinion on whether the company has maintained effective controls over financial reporting.

    It’s been argued that the requirements of Section 404 may negatively impact public companies. This is because it can be an expensive process to create and maintain the required internal controls. However, as the efficiency of internal control audits increased, the associated costs decreased.

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    Section 802 of the Sarbanes-Oxley Act

    This section includes three distinct rules that relate to the importance of accurate record keeping. The first addresses the falsification and destruction of records. The second outlines how long records must be retained and stored. And the third describes and lists the types of business records a company must store, including electronic communications.

    The Sarbanes-Oxley Act Requirements 

    • The requirement for attorneys representing public companies before the SEC to report any security violations to the CEO of the company or the chief legal counsel. 
    • Prohibition of extending personal loans by a corporation to its executives and directors 
    • The requirement to disclose any transactions and relationships that are off-balance sheet in periodic reports if they impact the financial status 
    • Amendment of federal criminal law to establish a maximum 20-year prison sentence for tampering with a record or otherwise impeding an official proceeding. 

    Summary 

    The Sarbanes-Oxley Act of 2002 created a reform of financial and securities regulations. This reform came from highly publicized financial scandals in the corporate world, involving companies such as Enron Corporation and WorldCom. 

    The Act established new rules for public accountants, corporate officers, and auditors to increase accountability and ensure recordkeeping was more stringent and accurate. The SOX also imposed criminal penalties on violators, which include a possibility of imprisonment. 

    This federal legislation was enacted to provide tighter financial regulations for public accounting firms and publicly traded companies, provide protection to their stakeholders, and to make those that violate those laws face harsh penalties for noncompliance.

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    Sandra Habinger headshot

    Written by Sandra Habiger

    Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at https://www.sixfiguresaccounting.com/ .

    Sandra Habinger headshot

    Written by Sandra Habiger

    Sandra Habiger is a Certified Public Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Learn more about her work at https://www.sixfiguresaccounting.com/ .

    FAQs ABout Sarbanes Oxley

    What Was the Main Purpose of the Sarbanes-Oxley Act?

    The main purpose of the Sarbanes-Oxley Act was to reform laws and regulations regarding public accounting firms, auditing standards, internal controls over financial reporting of publicly traded corporations and provide protection to investors.

    Who Is Subject to Sarbanes-Oxley?

    Any and all public securities-issuing entities in the United States are subject to the Sarbanes-Oxley Act. Foreign companies that are publicly traded and conduct business in the United States are also subject to the provisions of the Act.

    What Is the Sarbanes-Oxley Audit?

    With the Sarbanes-Oxley Audit, the annual financial statements of public companies must be audited every year by independent auditors.

    Are Private Companies Subject to the Sarbanes-Oxley Act?

    Private companies become subject to Sarbanes-Oxley if they’re preparing for an IPO. That said, penalty and liability provisions in the Act apply to private companies.

    Financial Statement Audits, Reviews, Compilations

    1. Sarbanes Oxley
    2. Assurance
    3. Engagement Letter

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