Impact of the Sarbanes Oxley Act on Auditing

¶ … Sarbanes-Oxley act on auditing

Changes as a result of the 2002 Sarbanes-Oxley law

In the wake of numerous corporate accounting scandals, several of which involved the famed and trusted accounting firm of Arthur Anderson, the U.S. Congress instituted the 2002 Sarbanes-Oxley Act (SOA). The Act was designed to reduce the likelihood of "cooked books, exorbitant [undisclosed] salaries and loans to CEOs, conflicts of interest by auditors, and hyped-up stock reports by securities analysts at some of America's highest-flying companies and investment firms" (Has Sarbanes-Oxley made a dent in corporate America's armor, 2004, Knowledge @Wharton). One of the reforms of SOA was to demand "significantly higher responsibility from audit committees of publicly traded companies" while amending the Securities Exchange Act of 1934 "to make the audit committee of a reporting company an important participant in the financial reporting process of the company" (Pandit, Subrahmanyam, & Conway 2005). Audit committees have been required since 1990, when the SEC began to require listed companies to provide an audit committee report as part of the annual proxy statement. Now, SOA sections 202, 301, and 407 mandate new standards of independence for such committees (Pandit, Subrahmanyam, & Conway 2005).

All members of the committee must be independent of affiliations to the audited entity and at least one member must be a 'financial expert' as defined by the SEC. "The audit committee is directly responsible for the appointment, compensation, and oversight of the auditor, who in turn reports directly to the audit committee" and "all auditing services and most nonauditing services must be preapproved by the audit committee" (Pandit, Subrahmanyam, & Conway 2005). The audit committee also may seek out independent counsel and other advisors to carry out its role and "must establish procedures for the receipt, retention, treatment, and confidential handling of complaints regarding accounting- and auditing-related matters" (Pandit, Subrahmanyam, & Conway 2005). None of these stipulations were required pre-SOA.

This particular reform significantly improved the transparency and independence of the reporting process. A study of the contents of the audit committee reports from the 2003 and 2004 proxy statements of 100 randomly selected companies listed on the NYSE found significant improvements in terms of the "clear identification of the financial experts on the committee; a definitive conclusion about the independence of the auditor; and a disclosure about the policy regarding the preapproval of nonaudit services" (Pandit, Subrahmanyam, & Conway 2005).