As a result of the scandals of Enron, Tyco and WorldCom, the Sarbanes-Oxley Act was passed through Congress. The purpose of this act was to prohibit several questionable activities like some insider trading, conflicts of interest involved with auditors, and all personal loans to executive officers and directors.
In addition, it augments the transparency of corporate financial reporting. More detailed disclosures are now required. Moreover, penalties were extended for any violations to the securities laws or for misrepresenting financial statements.
Accounting Standard No. 2 called “An Audit of internal Control over Financial Reporting Performed in Conjunction with an Audit of Financial Statements” implores publicly traded companies to add the following two new reports in their financial statements.
1. The company’s outside auditor’s opinion of management’s assessment of the internal control over financial reporting. In addition, they must give their own assessment of the internal control system. To adequately provide their opinion on management’s evaluation, auditors must consider the following:
- Has the management admitted they are ultimately responsible for internal controls and not the accountants?
- Does management admit any weaknesses in the system and any correction that were made the previous year?
- What type of framework was used to evaluate the internal controls system?
- Does management state their evaluation in an acceptable format?
2. Management’s assessment of the efficacy of the company’s internal control over financial reporting. This report is not for the purpose of public relations or marketing. Instead, it must contain direct and impartial conclusions regarding the internal controls effectiveness.
