The Sarbanes Oxley Act Quality and Reliability in Financial Reporting

Quality and Reliability in Financial Reporting
Publicly-traded companies have an obligation to provide accurate and reliable financial statements to current and potential investors. Investors and others users of financial statements depend on this information to make investment and business decisions (McEwen, 2009). The Sarbanes-Oxley Act (SOX) and the Securities and Exchange Commission (SEC) acknowledge the importance of truthful, material, and dependable financial reporting. Based on SOX provisions and SEC reporting requirements, this paper discusses the significance of ensuring quality and reliability in financial reporting. The paper specifically focuses on the role of the board of directors and the chief executive officers (CEO) in ensuring the reliability of financial statements, strategies a CEO can use to ensure quality and reliable financial reporting, and how corporate management can increase investor confidence in financial reporting. Attention is also paid to possible consequences to a publicly traded company due to unreliable financial reporting as well as the effectiveness of the Sarbanes-Oxley Act in ensuring quality and financial reporting.
The Sarbanes-Oxley Act was introduced in 2002 in an attempt to enhance corporate accountability. The legislation was enacted in the wake of the infamous Enron scandal, a scandal that revealed glaring shortcomings in corporate accounting (Holt, 2008). SOX offers comprehensive guidelines that publicly traded companies must comply with in financial reporting. Publicly quoted firms have a duty to protect the interests of shareholders and investors by reporting accurate and reliable financial information. Further financial reporting requirements are provided by SEC, which obligates publicly listed firms to periodically file financial reports with the commission. The commission requires public firms to implement strong internal controls to ensure quality and reliable accounting.
As per SOX and SEC guidelines, the board and the CEO of a publicly traded company have an instrumental role to play in ensuring quality and reliable financial reporting. More specifically, the board and the CEO are required to certify that financial reports are accurate and dependable (Holt, 2008). Investigations conducted following the Enron scandal revealed that financial malpractices occurred in large part due to governance and ethical failures on the part of leadership (Vallabhaneni, 2008). Accordingly, top decision makers in a firm have an obligation to create and maintain an ethical environment that ensures quality and reliable financial reporting. This specifically involves designing and implementing internal accounting controls. These controls relate to aspects such as data access and protection, auditing, risk management, accounting policies, provision of loans to senior officers, ethical codes of conduct, recruitment of executives, and regulation of executives (Holt, 2008). Strong corporate governance guidelines establish transparency and accountability, consequently ensuring ethical responsibility in the preparation and reporting of financial reports.
The CEO is particularly responsible for enforcing a climate of ethics within an organisation. As the person in charge of everyday operations of an organisation, the CEO must play a frontline role in creating an ethical environment: the CEO must maintain strong internal control (Vallabhaneni, 2008). Based on risks identified by the board in the overall risk plan, the CEO should undertake and communicate to the relevant internal stakeholders a string of control activities (guidelines, instructions, and procedures) aimed at ensuring accurate financial reporting. These activities ensure inconsistencies and inaccuracies are detected and rectified early enough. The reporting structure starts at the operational level (Bragg, 2009). A typical organisation has various functions or divisions handling different processes that ultimately contribute to the achievement of the organisation’s goals and objectives. Each function or division is headed by a manager or executive that reports to the CEO. The CEO should ensure each aspect of operations is monitored regularly to ensure all transactions are recorded in a complete and accurate manner. When transactions are monitored at the operational level, discrepancies can be easily detected and corrected, eventually ensuring quality accounting and accurate financial reporting.
It is not just enough for the CEO to implement control activities: evaluation should be done on a regular basis to ascertain the effectiveness of the controls (Bragg, 2009). Any strategy or technique aims to achieve a particular goal or objective. To determine whether the objective has been achieved, an evaluation is necessary. Internal accounting controls are aimed at discovering and correcting inconsistencies in the documentation of transactions. Accordingly, an effective internal control is one which facilitates the identification of those inconsistencies.
Strong corporate management is vital for increasing the confidence of investors and other users of financial statements (Vallabhaneni, 2008). It assures investors that performance forecasts and expected earnings will be realised. Strong corporate management means that all the financial information the organisation relays to investors is accurate, substantive, and dependable. Financial due diligence is one of the ways through which corporate management can build investor confidence in performance data (Monks & Minow, 2011). Investors evaluate organisations based on several factors such as earnings before interest. Accordingly, financial due diligence should pay attention to quality. Quality can be achieved by analysing understated assets or liabilities, unusual income or expenditure, employment of accounting principles, and so forth. Essentially, corporate management should ensure investors understand all assumptions utilised in generating performance forecasts.
Without quality in accounting and financial reporting, there could be severe consequences on an organisation (McEwen, 2009). The collapse of Enron is an ideal example of the catastrophic consequences poor quality accounting can create. Once a powerful organisation, Enron is no longer in existence, mostly due to accounting failures. The accounting scandal goes down memory lane as one of the most notorious accounting scandals. Other powerful firms have also collapsed as a result of financial malpractices. When there is no quality in financial accounting, an organisation can lose the confidence of important stakeholders such as investors and lenders (Vallabhaneni, 2008). For instance, poor financial reporting may cause banks to decline or be reluctant in offering credit to the organisation. For lenders, poor financial reporting could be an indication of default risk. Equally, poor financial reporting may cause potential investors to ignore an organisation. Any investor puts their money where they are guaranteed of a return on investment. It may be difficult to get a return on investment when financial reporting is weak. Other possible consequences on poor financial accounting include company undervaluation or overvaluation, high tax liability, as well as inability to attract business partners and acquirers (Bragg, 2009).
The Sarbanes-Oxley Act has without a doubt made immense contributions to improving the quality of financial reporting. Since the introduction of the legislation, corporate governance in publicly listed firms has been much stronger (Monks & Minow, 2011). Additionally, corporate management has improved significantly as CEOs and chief financial officers are now responsible for internal accounting controls and financial disclosures (Holt, 2008). Moreover, there has been far greater professionalism in financial reporting. Even so, there are some shortcomings. For instance, the 2008 financial crisis revealed that the legislation was not quite effective in enhancing financial reporting and protecting shareholders and potential investors. In spite of the supposedly strong financial reporting requirements, unimaginable accounting malpractices were discovered at large firms such as Lehman Brothers. Why did the legislation not prevent these malpractices? Why did it not deter events that created the crisis?
Overall, top decision makers in a publicly traded firm have responsibility to create an ethical climate that ensures quality and reliability in financial accounting and reporting. The board and the CEO must constantly ensure strong internal controls. Such controls are crucial for building the confidence of key stakeholders, especially investors and shareholders.


References
Bragg, S. (2009). Accounting control best practices. Hoboken: John Wiley & Sons.
Holt, M. (2008). The Sarbanes-Oxley Act: Costs, benefits and business impacts. New York: Elsevier.
McEwen, R. (2009). Transparency in financial reporting: A concise comparison of IFRS and US GAAP. Great Britain: Harriman House Limited.
Monks, R., & Minow, N. (2011). Corporate governance. 5th ed. Hoboken: John Wiley & Sons.
Vallabhaneni, S. (2008). Corporate management, governance, and ethics best practices. Hoboken: John Wiley & Sons.