Fraudulent Financial Reporting: The Government and Accounting Profession React
Latshaw, Craig A., Review of Business
The recent occurrences of fraud have resulted in two significant events that will greatly impact the accounting profession. The two events are the federal government's enactment of the Sarbanes-Oxley Act, and the AICPA's anti-fraud program, beginning with the issuance of SAS No. 99. These two events will hopefully reduce the incidence of fraud and restore public confidence in the accounting profession.
With recent business failures such as Enron, Global Crossing, WorldCom and many others, the question that continues to be raised is: "Where were the auditors?" This question has brought about drastic action on the part of the federal government in the form of the Sarbanes-Oxley Act, the most significant legislation affecting the accounting profession since the Securities Act of 1933. In addition, the accounting profession itself is implementing several initiatives in order to address the major issue of financial reporting fraud (management fraud).
Restrictions of the Sarbanes-Oxley Act
The Sarbanes-Oxley Act is a major disappointment for the accounting profession, which had self-regulated itself for more than 110 years. That right has now been lost. The Act creates a five-member Public Company Accounting Oversight Board (PCAOB), completely independent of the accounting profession, which is empowered to inspect the auditing operations of public accounting firms that audit publicly held companies. For firms with over 100 audit clients, the inspections will be done on an annual basis. For firms with less than 100 audit clients, the inspections will take place at least every three years. The Board also has the right to impose disciplinary actions for any violations of the Act, the rules of the Board, the Securities and Exchange Commission (SEC), professional standards, or a firm's own quality control policies. These sanctions could range from $100,000 for individual negligent conduct to $15 million for knowing or intentional conduct, including recklessness and repeated acts of negligence. In ad dition, any violations would be reported to the SEC and state accountancy boards.
The Sarbanes-Oxley Act has also given the Public Company Accounting Oversight Board authority over many other areas regarding the accounting profession. The Board has authority to set and enforce auditing, attestation, quality control and ethics standards for public company auditors. Although these are components of the Act, the overall effect on the auditing profession is still unclear. For example, in a meeting in June 2002, the SEC Chief Accountant, Bob Herdman, stated that he expects the setting of auditing standards to be outsourced to the American Institute of Certified Public Accountant's Auditing Standards Board for at least the foreseeable future, but they would be under the oversight of the PCAOB.
Certain Non-Audit Services are Prohibited.
The Act lists eight types of consulting services that are now unlawful when provided to publicly held audit clients:
* information systems design and implementation
* appraisals or valuations services
* actuarial services
* internal audits
* management and human resources services
* broker/dealer and investment banking services
* legal or expert services related to audit services
In addition, the Act includes a "catch-all" category authorizing the Board to prohibit any services it wishes for auditors of publicly held companies. Any non-audit services not prohibited must be pre-approved by the audit committee and disclosed to investors in periodic reports.
Additional Restrictions. Other provisions of the Act include the required rotation of lead audit partners and reviewing audit partners of an audit client every five years. The Act also extends the statute of limitations for the discovery of fraud to two years from the discovery (it had been one year), and five years after the fraud act (it had been three years). …