Presentation on theme: "Accounting, Auditing and Corporate Governance: Impact of Enron Accounting Scandal and Sarbanes-Oxley Act."— Presentation transcript:
1Accounting, Auditing and Corporate Governance: Impact of Enron Accounting Scandal and Sarbanes-Oxley Act
2Corporate Governance in the US Before Enron Accounting Scandal ShareholdersBoard of DirectorsAudit CommitteeCEO
3Pre-Enron Corporate Governance Standards Listed companies must have a minimum three-person audit committee composed solely of independent directors.Existing definition of “independence” precludes any relationship with the company that may interfere with the exercise of director's independence from management and the company.Three year cooling-off period for former employees of the company and business relationships.Requires all audit committee members to be financially literate and at least one must have accounting or related financial-management expertise.Audit committee charter must provide that audit committee and board of directors have “ultimate“ authority to retain and terminate independent auditorsRequires shareholder approval of equity compensation plans for directors, but broad-based plans are exemptRequires board of directors to adopt and approve a written charter for audit committee, which must be reviewed annually.
4Enron enters into gas marketing and begins energy trading Skilling becomes CEOCHEWCO formed to buy JEDI interests. Enron employee under CFO Fastow is the partner. Deal is all debt with Enron liable for paymentsFERC issues order 636 that requires all gas transmission companies to “open up” their pipelines to unowned gas.Enron enters into gas marketing and begins energy tradingAnalysts question Enron’s booksCEO Lay challenges managers to embrace deregulation and shift strategySkilling resignsSherron Watson warns that Enron could “implode”Enron restates books going back to 1997CalPERS and Enron enter into JEDI-I to invest in energy projectsJEDI-II is formed. Enron needs a buyer for CALPERS interest in JEDI-ILJM-1 and 2 formed to transfer unwanted assets and debt off Enron’s balance sheetNew Name Enron Adopted“Asset Light” strategy is adopted. Enron begins shedding hard assetsDynergy merger fails. Enron debt downgraded to junk status. Enron files for bankruptcy
5Anatomy of Enron Accounting Scandal Enron, like many other companies, used special purpose enterprises (SPEs) to access capital or hedge riskBy using SPEs such as limited partnerships with outside parties, a company is permitted to increase leverage and ROA without having to report debt on its balance sheetCompany contributes hard assets and related debt to an SPE in exchange for an interest in the partnership
6Anatomy of Enron Accounting Scandal SPE then borrows large sums of money from a financial institution to purchase assets or conduct other business without debt or assets showing up on the company‘s financial statementsCompany can also sell leveraged assets and book a profitTo avoid classification of SPE as a subsidiary (thereby forcing entity to include SPEs financial position and results of operation in its consolidated financial statements), FASB guidelines require that only 3% of SPE be owned by outside investor.
7Anatomy of Enron Accounting Scandal Enron took advantage of these guidelines.Transferred troubled assets that were falling in value to SPEsLosses on these assets would then be kept off Enron‘s financial statementsTo compensate partnership investors for downside risk, Enron promised issuance of additional Enron sharesAs value of transferred assets fell, Enron incurred larger and larger obligations to issue more of its shares
8Anatomy of Enron Accounting Scandal August 14, 2001Sherron Watkins, an Enron vice-president, CPA and auditor previously with Arthur Andersen for 8 years, sends letter to Enron Chairman Kenneth Lay outlining many of the misleading accounting treatments used by Enron.In this memo, Watkins describes her reservations about the lack of disclosure of the substance of related party transactions with SPEs run by the CFO of Enron, Andrew FastowShe states: “I realize that we have had a lot of smart people looking at this and a lot of accountants including AA & Co. (Andersen) have blessed the accounting treatment. None of that will protect Enron if these transactions are ever disclosed in the bright light of day.“
9Anatomy of Enron Accounting Scandal October 16, 2001Enron Corporation, one of largest corporationsin the world, announced the following:reduction in its after-tax net income by $544 millionreduction in its shareholders‘ equity by $1.2 billion
10Anatomy of Enron Accounting Scandal October 22, 2001Enron announced that SEC was looking into related party transactions between Enron and partnerships owned by its CFO, Andrew Fastow
11Anatomy of Enron Accounting Scandal November 8, 2001Enron announced restatement of its financial statements for 1997 thru 2000 to reflect consolidation of SPEs it had omitted as well as to book adjustments recommended by Arthur Andersen for those years, which Enron had previously “deemed immaterial”In addition to recognizing an additional $628 million in liabilities, these restatements reduced previously reported net income as follows:YearReportedRestatedDecline1997$105$2873%1998$703$13381%1999$893$24872%2000$979$9990%
12Anatomy of Enron Accounting Scandal December 2, 2001Enron filed for bankruptcy under Chapter 11 of US Bankruptcy CodeWith assets of $63.4 billion, largest US corporate bankruptcy in historyTexaco, Inc., which went bankrupt in April 1977 with assets of $35.9 billion was next largest
13Anatomy of Enron Accounting Scandal January 17, 2002Enron fires Arthur Andersen as its independent auditorCites document destruction and lack of guidance on accounting policy issues
14Anatomy of Enron Accounting Scandal Enron bankruptcy of particular interest forfollowing reasons:Transactions involving SPEs and related accounting issuesBreakdown in corporate governance in relationship between Board of Directors and Audit CommitteeParticipation of Enron‘s independent auditor, Arthur Andersen, in setting up SPEsReveals shortcomings of rule-based US GAAPGAAP override
15Anatomy of Enron Accounting Scandal Accounting IssuesNon-consolidation of SPEs that permitted Enron to hide losses and debt from investorsSales of investments to unconsolidated (though actually controlled) SPEs as if they were arms-length transactionsRecording as current income, fees for services rendered in future periodsFair-value restatements of investments that were not based on trustworthy numbersAccounting for Enron stock issued to and held by SPEsDisclosure of related party transactions and conflicts of interest, and their costs to stockholders
16Anatomy of Enron Accounting Scandal Breakdown of Corporate GovernanceMany of related party transactions were brought to attention of Enron‘s BOD and were discussed in some detail with members of Audit and Compliance CommitteeSEC requires that exchanges (NYSE, ASE, and NASDAQ) require financial literacy for all audit committee members and financial expertise for at least one memberAt least 4 of 6 members had financial expertiseRobert Jaedicke, Professor of Accounting at Stanford UniversityWendy Graham, PhD in Economics and former Chair of Commodity Futures Trading CommissionLord John Wakeham, CA and British Secy of State for EnergyPaola Ferraz Pereira, President of State Bank of Rio de Janerio
17Anatomy of Enron Accounting Scandal Breakdown of Corporate GovernanceEnron‘s BOD reviewed and approved creation of SPEs and assigned Audit Committee duty to review transactionsBOD waived company’s code of ethics for SPE transactionsAudit Committee failed to adequately understand, review, and monitor SPEs and Enron‘s accounting and reporting practices
18Anatomy of Enron Accounting Scandal Independence of External AuditorArthur Andersen audited and gave unqualified opinions on Enron‘s financial statements since 1985Enron was AA‘s second largest clientIn 2000, AA received $25 million in audit fees and $27 million in non-audit consulting fees from EnronIn 2000, AA had total worldwide revenues of $9 billionAA was not only Enron‘s external auditor, but also its internal auditor and kept staff on permanent assignment at Enron‘s officesMany of Enron‘s internal accountants, CFOs and controllers were former AA executives and employees
19Anatomy of Enron Accounting Scandal Independence of External AuditorAA was consulted on and participated in setting up SPEsIn conjunction with Enron employees, they set up the SPEs to conform to the letter of the US GAAP requirement that outside ownership, presumably independent, must be at least 3% of the SPE assetsAA admitted it destroyed thousands of documents and electronic files related to the Enron audits for 1997 thru 2000, in accordance with “firm policy,“ supposedly before SEC issued subpoena for themOn October 12, 2001, AA’s lawyers issued an internal memo reminding employees of the firm’s document retention and destruction policies
20Anatomy of an Accounting Scandal – Enron Corporation Shortcomings of Rule-Based US GAAPSEC has authority to establish GAAP and GAAS in US, review and disapprove as inadequate financial statements of registered companiesSEC has delegated that authority to establish GAAP to FASB, a non-governmental agencyMany believe that US GAAP, as structured and administered by SEC, the FASB, and the AICPA, are substantially responsible for Enron accounting scandalUS model of specifying accounting rules that must be followed appears to have allowed or required AA to accept procedures that were within the letter of rule, even though they violate basic objectives of US GAAPUS model allows corporate officers to view accounting requirements of US GAAP as if they were specified in a tax code
21Example of Rules-Based US GAAP by Lessee - SPAS 13 Lease AgreementCapitalLeaseIs there transferof ownership?YesIs there a bargainpurchase option?YesNoIs lease term equalto or greater than75% of economiclife ?YesNoIs present valueof paymentsequal to or morethan 90% FMV?YesNoOperatingLease
22Anatomy of an Accounting Scandal – Enron Corporation Shortcomings of Rule-Based US GAAPFair-value requirement of financial instruments adopted by FASB permitted Enron to increase its reported assets and net income and, thereby, hide lossesAA appears to have accepted these valuations because Enron was following specific US GAAP rules
23GAAP Override Are auditors in US allowed to override US GAAP? Auditors in other countries allowed to override GAAPInability of auditors in US to override US GAAP may have been contributing factor in Enron accounting scandalMany believe that principles-based IAS GAAP that requires “true and fair view” of an enterprises’ financial condition is preferable to highly specified rule-based US GAAP
24US Audit OpinionIn our opinion, the financial statements of XYZ Company present fairly the financial position and results of operations for the years ended December 31, 20X1 and 20X2 in accordance with generally accepted accounting principles applied on a basis consistent with the preceding year.
25True and Fair View Opinion In our opinion, the financial statements of XYZ Company present a true and fair view of the financial position and results of operations for the years ended December 31, 20X1 and 20X2.
28Aftermath of Enron Accounting Scandal Sarbanes-Oxley Act of 2002New NYSE Corporate Governance Listing StandardsNew Corporate Governance Rules adopted by SECNew Rules and Auditing Standards adopted or proposed by Public Company Accounting Oversight Board
29Importance of Sarbanes-Oxley Act of 2002 “Last year’s Sarbanes-Oxley Act brought the most sweeping changes in corporate governance and financial disclosure for 70 years” (Financial Times, December 1, 2003)“Sarbanes-Oxley will be judged as landmark legislation. It is one of the most sweeping reforms since the 1933 Securities Reform Legislation.” (Beth Brooke, Global Vice Chair, Ernst and Young, September 15, 2003)
31Sarbanes-Oxley Act of 2002 Signed into law on July 30, 2002 Applies to publicly held US companies and foreign private issuers and their audit firmsEstablishes Public Company Accounting Oversight Board (PCAOB) to regulate accounting professionals who audit financial statements of public companiesProvides for significant corporate governance reforms regardingaudit committees and their relationship with their auditorsfinancial reporting and auditing process
32Sarbanes-Oxley Act of 2002 Listing of Titles and Sections
33Public Company Accounting Oversight Board Section 101 Not a government agencyPrivate sector regulatory agency subject to direct and substantial SEC oversightpreviously under Public Oversight Board of AICPAConsists of five full-time members who willOversee and investigate audits and auditors of public companiesSanction both firms and individuals for violations of laws, regulations, and rules
34Public Company Accounting Oversight Board Section 101 Board CompositionTwo of five board members must be or have been CPAsRemaining three must not be and cannot have been CPAsChair of Board may be held by one of the CPAs, but he/she must not have practiced accounting during five years preceding his/her appointment
35Public Company Accounting Oversight Board Sections 102 and 109 Registration with BoardAccounting firms that audit public companies must register with PCAOB and pay registration and annual feesFunding of BoardPCAOB will be funded by public companies through these mandatory fees
36Public Company Accounting Oversight Board Section 103 Auditing Standard SettingBoard will have responsibility for establishing following standards necessary to protect the public interest:Auditing and related attestationQuality controlEthicsIndependenceFunction previously performed by Auditing Standards Board (ASB) of AICPA that establishes GAASBoard required to cooperate with designated professional groups of accountants in standard setting (eg, AICPA)Board, however, has authority to amend, modify, repeal or reject any standard suggested by professional groupsThus, board may, but is not required to, continue to allow ASB to establish these standards
37Public Company Accounting Oversight Board Sections 104 and 105 Inspection AuthorityEmpowered PCAOB to regularly inspect registered accounting firm‘s operationsInvestigative and Disciplinary AuthorityEmpowered PCAOB to investigate potential violations of:Securities lawsStandardsCompetency and conduct
38Public Company Accounting Oversight Board Section 106 International AuthorityForeign accounting firms that prepare or furnish an audit report involving US registrants will be subject to authority of PCAOBIf registered US accounting firm relies on opinion of foreign accounting firm, foreign firm‘s audit work papers must be supplied upon request to PCAOB or SEC
39Public Company Accounting Oversight Board Section 108 Accounting Standard Settingestablishes criteria that must be met in order for work product of an accounting standard-setting body to be recognized as “generally accepted”may recognize as "generally accepted" any accounting principles established by a standard setting body that:is organized as a private entity;has, for administrative and operational purposes, a board of trustees serving in the public interest, the majority of whom are not, concurrent with their service on such board, and have not been during the two-year period preceding such service, associated persons of any registered public accounting firm;is funded as provided in Section 109 of the Sarbanes-Oxley Act;has adopted procedures to ensure prompt consideration, by majority vote of its members, of changes to accounting principles necessary to reflect emerging accounting issues and changing business practices; andconsiders, in adopting accounting principles, the need to keep standards current in order to reflect changes in the business environment, the extent to which international convergence on high quality accounting standards is necessary or appropriate in the public interest and for the protection of investors.
40Public Company Accounting Oversight Board Section 108 Accounting Standard SettingSEC must conduct a study on the adoption by the United States financial reporting system of a principles-based accounting systemCommission must submit results of this study to Congress by July 30, 2003Study shall include:the extent to which principles-based accounting and financial reporting exists in the United Stateslength of time required for change from a rules-based to a principles-based financial reporting systemfeasibility of and proposed methods by which a principles-based system may be implemented
41Sarbanes-Oxley Act of 2002 Listing of Titles and Sections
42Auditor Independence Section 201 New Roles for Audit Committees and AuditorsNew law prohibits independent auditors from offering certain non-audit services to audit clientsProhibited services include:BookkeepingFinancial information systems design and implementationAppraisals or valuation servicesActuarial servicesInternal audit outsourcing servicesManagement and human resources servicesBroker/dealer and investment banking servicesLegal servicesExpert services unrelated to audit servicesOther non-audit services not banned are allowed if pre-approved by audit committee
43Auditor Independence Section 202 New Roles for Audit Committees and AuditorsAudit committee must pre-approve all services (both audit and non-audit not specifically prohibited) provided by its independent auditorsRequires disclosure, in annual report, of fees paid to independent accountants for:Audit servicesAudit-related servicesTax servicesOther services
44Auditor Independence Section 203 New Roles for Audit Committees and AuditorsSecond partner review and approval of audit reportsLead audit partner and audit review partner must be rotated every five years on public company engagementsAn accountant is not independent if, at any point during audit and professional engagement period, any audit partner earns or receives compensation based on that partner procuring engagements with audit client to provide any services other than audit, review or attest servicesfirms with fewer than five audit clients and fewer than ten partners may be exempt from partner rotation and compensation provisions, provided each engagement is subject to special review by PCAOB at least every three years
45Auditor Independence Sections 204 New Roles for Audit Committees and AuditorsIndependent auditors report to company‘s audit committee, not managementIndependent auditor must report new information to audit committee including:Critical accounting policies and practices to be usedAlternative treatments of financial information with GAAP that have been discussed with managementAccounting disagreements between auditor and managementOther relevant communications between auditor and management
46Auditor Independence Section 206 New Roles for Audit Committees and AuditorsAccounting firm will not be able to provide audit services to public company if one of that company‘s top officials (CEO, Controller, CFO, Chief Accounting Officer, etc) wasemployed by firm andworked on company‘s audit during previous year
47Sarbanes-Oxley Act of 2002 Listing of Titles and Sections
48Corporate Responsibility Section 301 Financial Reporting and Auditing ProcessSelf-Regulatory Organizations (SROs) (NYSE and NASDAQ) must adopt listing standards for audit committeesSROs must prohibit listing of any security whose issuer does not have audit committee comprised entirely of independent directors:For a director to be deemed "independent," the board must affirmatively determine the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company)Former employees of company or auditors of company – and their family members – may not be considered independent until five years after their employment ends.
49Corporate Responsibility Section 301 Financial Reporting and Auditing ProcessAudit committee members are prohibited from receiving any compensation other than directors’ compensation feesChair of audit committee to have accounting or related financial-management expertise.Audit committee must have sole authority to hire and fire independent auditor and approve any non-audit relationship with independent auditorAudit committee must establish procedures for receipt, retention and treatment of complaints regarding accounting, internal controls or auditing mattersIssuer must provide appropriate funding for audit committee
50Corporate Responsibility Section 301 Financial Reporting and Auditing Processseveral provisions included to address special circumstances of particular foreign issuersallow non-management employees to serve as audit committee members consistent with “co-determination” and similar requirements in some countriesallow foreign government shareholder representation on audit committees
51Corporate Responsibility Section 302 Financial Reporting and Auditing ProcessCEO and CFO of each issuer shall prepare statement to accompany the audit report to certify "appropriateness of the financial statements and disclosures contained in the periodic report, and that those financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the issuer." .
52Corporate Responsibility Section 303 Financial Reporting and Auditing ProcessProhibits officers and directors of an issuer or their representatives from taking actions to coerce, manipulate, or fraudulently influence the independent auditor of the financial statements if that person knew or should have known that such action, if successful, could result in rendering the financial statements materially misleading
53Corporate Responsibility Sections 304 and 306 Financial Reporting and Auditing ProcessManagement must return bonuses or profits from stock sales received within 12 months of a restatement of financial results caused by non-compliance with financial reporting requirements as a result of misconductCompany officers prohibited from trading shares during pension blackout periods
54Sarbanes-Oxley Act of 2002 Listing of Titles and Sections
55Enhanced Financial Disclosure Sections 401, 402 and 403 Requires registrant to:provide explanation of its off-balance sheet arrangements in separately captioned section of MD&A sectionProvide an overview of certain known contractual obligations in tabular formatProhibits companies from making loans to insidersRequires electronic filing of disclosures of insider transactions in company stock
56Enhanced Financial Disclosure Section 404 Annual report must contain a report from management on internal controls thatStates management’s responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reportingContains an assessment of the effectiveness of internal control related to financial reportingExternal auditor must attest to manage-ment’s assertion concerning its assessment of internal control as part of auditAudit report must contain opinion on assessment made by management of company‘s internal controls structures
58Enhanced Financial Disclosure Sections 406 and 407 Requires companies to disclose whether they have a code of ethics for CEO, CFO, and senior accounting personnelAny amendments or waivers of code of ethics for directors or executives must be disclosedRequires company to disclose:Whether it has at least one “financial expert” serving on its audit committeeThe name of the expert and whether the expert is independent of management
59Sarbanes-Oxley Act of 2002 Listing of Titles and Sections
60Corporate and Criminal Fraud Accountability White Collar Crime Penalty Criminal PenaltiesFailure to maintain work papersSEC will establish rule covering retention of audit recordsBoard will issue standards that compel auditors to keep other documentation for seven yearsDocument destructionFelony to destroy documents in federal or bankruptcy investigationUp to 20 years in prisonSecurities fraudPenalties increased to 25 years in prisonFraud discoveryStatutes of limitations extended to two years from date of discovery and five years after actPreviously one year and three years
61Ramifications of Provisions of Act Sarbanes-Oxley ActRamifications of Provisions of ActConsulting servicesOther non-audit services, including tax services, require pre-approval by audit committeeImplications for CPAs with tax practicesExpert services not defined in ActPossible that tax services viewed as “expert“ services and not permitted by any firm providing audit services for publicly held audit clientCascading effectConcern is that new legislation by US Congress may become template for parallel federal and state legislation or rules changes that directly affect both non-public companies that are subject to other regulations and the CPAs that provide services to themAdditional burdens for CPAs in business and industryCEOs and CFOs now required to certify company financial statementsHave greater duty to communicate and coordinate with corporate audit committees who now hire, compensate and oversee independent auditors
62Aftermath of Enron Accounting Scandal New NYSE Corporate Governance Listing StandardsOn February 13, 2002, Chairman of SEC asked NYSE to review its corporate governance listing standardsBOD of NYSE appointed Corporate Accountability and Listing Standards Committee to review current listing standards and make recommendationsOn June 6, 2002, Committee presented NYSE BOD with report recommending significant changes in how NYSE-listed companies are governedOn August 1, 2002, NYSE approved Committee‘s recommendationsOn August 16, 2002, NYSE sent recommendations to SEC for approvalOn November 4, 2003, SEC approved new rules
63Selected Final Recommendations of NYSE Corporate Accountability and Listing Standards Committee Comparison with Current RulesFinal RecommendationCurrent RuleIndependent directors must comprise a majority of board of directors.No existing requirement.Listed companies must have audit, compensation and nominating/corporate governance committees, each composed entirely of independent directors.Listed companies must have a minimum three-person audit committee composed solely of independent directors. No existing rules requiring compensation and nominating committeesNon-management directors must meet without management in regular executive sessions.
64Selected Final Recommendations of NYSE Corporate Accountability and Listing Standards Committee Comparison with Current RulesFinal RecommendationCurrent RuleFor a director to be deemed "independent," the board must affirmatively determine the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company).Existing definition precludes any relationship with the company that may interfere with the exercise of director's independence from management and the company.Prohibit audit committee members from receiving compensation other than directors’ compensation feesNo existing restrictions
65Selected Final Recommendations of NYSE Corporate Accountability and Listing Standards Committee Comparison with Current RulesFinal RecommendationCurrent RuleFormer employees of company or auditors of company – and their family members – may not be considered independent until five years after their employment ends.Three year cooling-off period for former employees of the company and business relationships.Every listed company must have an internal audit functionNo existing requirement.Require chair of audit committee to have accounting or related financial-management expertise.Requires all audit committee members to be financially literate and at least one must have accounting or related financial-management expertise.
66Selected Final Recommendations of NYSE Corporate Accountability and Listing Standards Committee Comparison with Current RulesFinal RecommendationCurrent RuleGrant audit committee sole authority to hire and fire independent auditor and approve any non-audit relationship with independent auditorAudit committee charter must provide that audit committee and board of directors have “ultimate“ authority to retain and terminate independent auditorsRequire shareholder approval of all equity compensation plans.Requires shareholder approval of equity compensation plans for directors, but broad-based plans are exempt
67Selected Final Recommendations of NYSE Corporate Accountability and Listing Standards Committee Comparison with Current RulesFinal RecommendationCurrent RuleRequire companies to adopt and disclose corporate governance guidelines, codes of business conduct, and charters for their audit, compensation and nominations committees.Requires board of directors to adopt and approve a written charter for audit committee, which must be reviewed annually. No existing rules requiring compensation and nominating committees, corporate governance guidelines, or codes of business conduct.Any waivers of codes of business conduct for directors or executives must be disclosed.No existing requirement.Require foreign private issuers to disclose any significant ways in which their corporate governance practices differ from NYSE rules.
68Selected Final Recommendations of NYSE Corporate Accountability and Listing Standards Committee Comparison with Current RulesFinal RecommendationCurrent RuleEach listed-company's CEO and CFO must certify annual financial statementsNo existing requirement .Each listed-company's CEO must certify annually that he/she is not aware of any violation by the company of NYSE corporate governance standards.NYSE may issue a public reprimand letter for violation of a corporate governance standard, in addition to the existing penalty of delisting.No current provision for a public reprimand.The NYSE urges every listed company to establish orientation program for new board members.No such recommendation has been made previously.
69Restoring Confidence in the Accounting Profession Summary of SEC Actions and SEC Related Provisions Pursuant to the Sarbanes-Oxley Act of 2002Restoring Confidence in the Accounting ProfessionThe Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB)Section 108(b) - On April 25, 2003, recognized the Financial Accounting Standards Board as the accounting standard setter Section 108(d) - On July 25, 2003, issued a study on principles-based accountingSection The Act established an independent funding source for the FASBTitle II (Sections 201, 202, etc.) - On January 22, 2003, adopted rules improving the independence of outside auditorsSection On April 24, 2003, adopted rules forbidding the improper influence on outside auditorsSection On January 22, 2003, adopted rules governing the retention of audit records by outside auditors
70Improving the "Tone at the Top" Summary of SEC Actions and SEC Related Provisions Pursuant to the Sarbanes-Oxley Act of 2002Improving the "Tone at the Top"Section On August 27, 2002, adopted rules requiring CEOs and CFOs to certify financial and other information in their companies' quarterly and annual reports. Section 304 – Adopted rule requiring management to return bonuses or profits from stock sales received within 12 months of a restatement resulting from material non-compliance with financial reporting requirements as a result of misconduct. Section On January 15, 2003, adopted rules prohibiting company officers from trading during pension fund blackout periods. Section 402 – Adopted rules prohibiting companies from making loans to insiders.Section On August 27, 2002, adopted rules that accelerated deadlines and mandated electronic filing of disclosures of insider transactions in company stock. Section On January 15, 2003, adopted rules requiring companies to disclose whether they have a code of ethics for their CEO, CFO and senior accounting personnel
71Improving Disclosure and Financial Reporting Summary of SEC Actions and SEC Related Provisions Pursuant to the Sarbanes-Oxley Act of 2002Improving Disclosure and Financial ReportingSection 401(a) - On January 22, 2003, adopted rules requiring disclosure of all material off-balance sheet transactions.Section 401(b) - On January 15, 2003, adopted Regulation G, governing the use of non-GAAP financial measures, including disclosure and reconciliation requirements.Section On May 27, 2003, adopted rules requiring an annual management report on and auditor attestation of a company's internal controls over financial reporting.
72Improving the Performance of "Gatekeepers" Summary of SEC Actions and SEC Related Provisions Pursuant to the Sarbanes-Oxley Act of 2002Improving the Performance of "Gatekeepers"Section On April 1, 2003, adopted rules directing the SROs to adopt listing standards for audit committees.On November 4, 2003, approved new rules proposed and adopted by NYSE and NASDAQ requiring strengthening of corporate governance statndards for listed companiesSection On January 15, 2003, adopted rules requiring the disclosure about financial experts on audit committees.Section On January 23, 2003, adopted rules governing standards of conduct for attorneys appearing and practicing before the Commission.Section On July 29, 2003, approved new SRO rules governing research analyst conflicts of interest.
73SEC Study on Principles-Based Accounting In enacting the Sarbanes-Oxley Act, Congress recognized that accounting standards that contain too many exceptions, interpretations and bright-line percentage tests might have contributed to efforts by managements and accountants to structure transactions that provide a desired accounting result and yet allow the company to avoid clear disclosure of the economic consequences of those transactions in its financial statements.On July 25, 2003, SEC staff released its study.Study found that standards reflecting only a stated principle of accounting ("principle-only standards") would present enforcement difficulties because they would provide little guidance or structure for exercising professional judgment in applying that principle.
74SEC Study on Principles-Based Accounting also found that accounting standards that are too detailed ("rules-based standards") often provide a vehicle for circumventing the intention of the standard.Study indicates that best approach would be to develop accounting standards that:Are based on a conceptual framework;Clearly state the accounting objective of the standard;Provide sufficient detail and structure so the standard may be applied on a consistent basis;Minimize exceptions from the standard; andAvoid the use of percentage tests that allow financial engineers to achieve technical compliance with the standard while evading the intent of the standard.study's recommendation is consistent with the approach currently being developed by the Financial Accounting Standards Board
75SEC Study on Principles-Based Accounting Study acknowledges that FASB has begun shift to objectives-oriented standard setting and is doing so on a prospective, project-by-project basis.study expects that the FASB will continue to move towards objectives-oriented standard setting on a transitional or evolutionary basis.According to study, operationalizing objectives-oriented approach to standard setting in U.S. requires that the following key steps be taken over time:Ensure newly-developed standards articulate accounting objectives and avoid scope exceptions, bright-lines and excessive detail;Address deficiencies and inconsistencies in the conceptual framework;Ensure new standards aligned with improved conceptual framework;Address current standards that are more rules-based;Redefine the GAAP hierarchy; andContinue efforts on convergence of U.S., foreign, and international accounting standards.
76New Rules Adopted by PCAOB On April 18, 2003, announced process PCAOB will use to establish auditing and other professional standards for registered public accounting firmsPursuant to Section 103 of Sarbanes-Oxley, new Professional Auditing Standards will be established by PCAOBPCAOB decided not to exercise its authority under Section 103 to designate or recognize any professional group of accountants to propose auditing and other professional standardsPCAOB would have its own standard setting process for auditing and other professional standardsRule 3700 would govern formation, composition and role of advisory group in standard setting process
77New Rules Adopted by PCAOB On April 18, 2003, established Interim Professional Auditing Standards (IPAS) concerning:Auditing (Rule 3200T)Attestation (Rule 3300T)Quality control (Rule 3400T)Ethics (Rule 3500T)Independence (Rule 3600T)PCAOB determined that generally accepted auditing standards (GAAS) proposed by AICPA and Auditing Standards Board (ASB) should be adopted as Interim Auditing StandardsThese GAAS will continue to have same authority they currently have unless and until they are superceded by standards promulgated by PCAOB
78New Rules Adopted by PCAOB Interim standards adopted on an initial, transitional basis in order to ensure continuity and certainty in standards that govern audits of public companiesInterim standards will remain in effect while PCAOB conducts review of standards applicable to registered public accounting firmsObjective of review will be to determine, on a standard by standard basis, whether the IPAS should become permanent Professional Auditing Standards, repealed, or modifiedAs review of each IPAS is completed, PCAOB will adopt that standard, with or without modification, repeal the standard, or take any other appropriate action regarding that standard
79New Rules Adopted by PCAOB On April 18, 2003, adopted rules, subject to approval by SEC, establishing accounting support fee required by Sarbanes-Oxley ActOn May 6, 2003, adopted, subject to approval by SEC, a registration system for public accounting firmsOn June 30, 2003, adopted, subject to approval by SEC, an Ethics Code for PCAOBOn June 30, 2003, adopted rule, subject to approval by SEC, that requires all registered public accounting firms to adhere to PCAOB’s auditing and related professional practice standards in connection with preparation or issuance of any audit report for an issuer and in their auditing and related attestation practices
80New Rules Adopted by PCAOB On September 29, 2003, adopted rules, subject to approval by SEC, on investigations of registered public accounting firmsOn September 29, 2003, adopted rules, subject to approval by SEC, on process by which registered public accounting firm can seek to withdraw from registrationOn October 7, 2003, adopted rules, subject to SEC approval, relating to inspections of registered public accounting firms
81New Rules Proposed by PCAOB On October 7, 2003, proposed new rule regarding the terminology PCAOB will use in its Auditing and Related Professional Practice Standards to describe the obligations those standards impose on registered public accounting firmsOn December 4, 2003, scheduled an open meeting to consider whether to propose and seek comment on rules related to inspections and investigations of non-U.S. public accounting that register with the PCAOB
82New Auditing Standards Proposed by PCAOB On October 7, 2003, proposed new auditing standard entitled “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements”Addresses both:work that is required to audit internal control over financial reporting andthe relationship of audit to the audit of the financial statements
83New Auditing Standards Proposed by PCAOB On November 12, 2003, proposed two new auditing standards:First proposed standard would establish general requirements for documentation the auditor should prepare and retain in connection with any public company audit.Second proposed standard would require registered public accounting firms to explicitly state in each public company audit report that the audit was conducted in accordance with the standards of the Public Company Accounting Oversight Board
84Professor J. Timothy Sale University of Cincinnati Contact InformationProfessor J. Timothy SaleUniversity of Cincinnati