Sarbanes-Oxley Creates a New Beginning for Accountants

By Phillip K. Kleckner and Craig Jackson

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JANUARY 2005 - This series has examined various aspects of the Sarbanes-Oxley Act (SOA), including the new whistle-blower provisions (June 2004), the services that public-company auditors can no longer provide (July 2004), and the new penalties imposed by SOA (September 2004).

A Profession Under Fire

The accounting profession has never experienced direct external oversight by a government-sponsored organization. The Public Company Accounting Oversight Board (PCAOB) finds itself with an unprecedented task in a profession under fire. Assuming this responsibility is the former president of the Federal Reserve Bank of New York, William J. McDonough. In August 2004, the PCAOB, under McDonough’s guidance, published its findings from the limited inspections performed during 2003. Those inspections, noted by McDonough during his testimony before the House Capital Markets Subcommittee in late June, found “significant audit and accounting issues.” In some cases, GAAP was not followed. Draft reports were given to the Big Four with instructions to respond within 30 days.

Not only will the accounting firms have to work hard to bring their operations up to accepted standards, but they may also have to totally change their approach to auditing financial statements. Historically, accountants have disclaimed their responsibility to detect fraud by stating that that was not the purpose of an audit of financial statements. Soon that disclaimer may not be valid. In the August 2004 issue of CFO Magazine, McDonough expressed his opinion about auditors’ insistence that it is not their job to detect fraud: “We have a very clear view that it is their job. If we see fraud that was not detected and should have been, we will be very tough …”

This is an extraordinary statement. The responsibility of auditors has traditionally been to verify that the financial statements are presented fairly in conformity with GAAP. Fraud can occur without misstating the financial statements, which is why accountants have always had this disclaimer. Changing this responsibility will drastically change how financial statements are audited.

The intention of SOA was not, however, to burden accountants. Many of SOA’s provisions give accountants the tools they need to be more critical of financial statements, and Part 1 in this series focused on the new whistle-blower provisions of SOA. Public companies are now required to have the means in place to receive anonymous reports of whistle-blowers. A company’s own employees have a vested interest in the success of a company and want to do their part to see the company succeed. Unfortunately, employees may be reluctant to come forward for fear of persecution from their coworkers or the public. Establishing a way for employees to present their concerns anonymously increases the likelihood that they will come forward with their concerns and that more scandalous activities will be exposed and investigated before an audit even begins.

The second article in this series focused on the nonaudit services that a company’s auditors can no longer provide. Title 2 of SOA prohibits auditors from performing bookkeeping, consulting, and advocacy services for their audit clients. Preventing auditors from auditing their own work or performing management functions will by default improve independence. In addition, because the auditors will no longer be able to provide these services, companies may look elsewhere for them, which will add another level of scrutiny to the financial statements.

The third article discussed the new penalties that will be assessed upon those that willfully conceal from auditors activities to distort or misstate the financial statements. SOA strengthens a number of criminal penalties involving fraudulent financial reporting. SOA clearly shifts additional responsibilities to the audit committees and institutes criminal penalties for CEOs and CFOs. Previous penalties were evidently an insufficient deterrent to prevent major failures at Enron, Global Crossing, and WorldCom. SOA also requires CEOs and CFOs to personally certify the accuracy of the financial statements. Should the financials require restatement, the CEO and the CFO will be required to forfeit any bonus or profit received based on that particular statement.

Getting to Work

SOA directly addresses many of the problems that led to the recent audit failures. The PCAOB has been given the tools to effectively oversee the largest auditing firms each year and smaller firms every three years. A lot of hard work will be needed from all parties involved: audit committees, auditors, and management. The new whistle-blower provisions require companies’ audit committees to provide for investigations of each anonymous report of fraud. Audit committees have the option to hire outside counsel and other financial experts, including forensic accountants, to investigate fraud reports.

For a free market system to be successful, the public must have faith in it. One can plainly see how the markets are influenced every time a new fraud or accounting malpractice appears in the Wall Street Journal. With McDonough’s new attitude toward auditors’ responsibilities to find fraud, the time has come for more extensive integration of forensic accounting into the audits of financial statements.

Philip K. Kleckner, CPA/ABV, CFE, is the director in charge of the Business Crimes Group, and Craig Jackson is an associate, both at RosenfarbWinters, LLC, in Roseland, N.J.
Editor’s Note: Last in a four-part series




















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