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Sarbanes Oxley Act Of 2002 Accounting Essay

The purpose of this report is to present the Sarbanes-Oxley Act, starting from the history of self-regulation and its regulatory bodies, presenting the governance scandals which triggered the Act’s creation, emphasizing the requirements of Section 404 and concluding on recent crises.
The history of self-regulation in the United States is structured in two parts:
(1) Early Standards, including the Acts of 1933 and 1934, GAAS and GAAP, with short focus on peer review, and
After seventy years of self-regulation many accounting frauds, governance scandals and bankruptcies shacked the U.S. market. Due to their relevance and impact on regulatory standards the cases of Enron and WorldCom were chosen to be discussed.
After enacting the Sarbanes-Oxley Act of 2002, the U.S. Congress started a new era, by choosing to enforce a new independent body (PCAOB) to monitor the auditing companies. In relation with SOX the followings were considered:
(1) SOX’s summary, with its objectives and main sections,
(2) Public Company Accounting Oversight Board (PCAOB), with its mission and enforced authority.
Next, the analysis focused on the section 404 of SOX 2002 because is the provision which caused the most violent discussions from executives’ part. Due to the section impact on companies’ financial statements the report includes a short presentation of its rules with a larger analysis of implementation costs and benefits.
Still, even if the SOX and the SEC regulated the market in order to protect the investors and to avoid future corporate frauds, the financial crisis revealed new scandals, out of which in this report are mentioned:
(1) Bernard Madoff’s Ponzi scheme, and
(2) Bank of America Corporation’s lack of disclosure related to Merrill Lynch merger.
Taking into consideration these scandals, changes of regulations must be considered for the future and, maybe, reconsiderations of auditors’ role as management strategic advisors.
HISTORY OF SELF REGULATION IN USA I.1. Early Standards In the United States, at the beginning of the 20th century, the regulations for accounting and auditing were the same as United Kingdom regulations due to the fact that the major American corporations were branches of Britain companies (Benston G., et al., 2006). Still, the market experienced a low level of regulation (or almost absent), the succeeding events (stock market crash in 1929 and depression from 1930) indicating a strong need for regulating and disclosing policies to be established by the federal government.
Securities Act of 1933 and Securities Exchange Act of 1934. The historical foundation for regulations of financial disclosure by corporations is considered to be the moment when, immediately after the market crash from 1929, the U.S. Congress enacted two major laws, the Securities Act of 1933 and the Securities Exchange Act of 1934. For the first time in history, those two rules contained pragmatic provisions regarding corporate investors and financial disclosure:
“Companies publicly offering securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.
People who sell and trade securities – brokers, dealers, and exchanges – must treat investors fairly and honestly, putting investors’ interests first.” [1]
GAAS. Starting with 1939, the first generally accepted auditing standards (GAAS) were drafted and adopted by the American Institute of Accountants (currently AICPA), through its Auditing Standard Executive Committee (AudSEC) (currently Auditing Standards Board). Because GAAS refers to risks assessment and ways to mitigate them, three areas of provisions were defined (Benston G., et al., 2006):
(1) general standards – for determining the auditors’ personal traits;
(2) fieldwork standards – for setting the audit analysis, evaluation of internal controls and audit evidences;
(3) reporting standards – for assessing the disclosures of financial statements and the audit opinions, respectively the application of GAAS to GAAP.
GAAP. Starting with 1936-1938, the SEC entrusted the Committee on Accounting Procedure (part of AICPA) to issue a private-sector accounting standards in order to set-up an accounting system requested by the market needs. The first generally accepted accounting principles (GAAP) were developed in its initial form of Accounting Research Bulletins (ARB).
Peer Review. In the early 1960s, the major consulting accounting companies started to form peer reviews for a better quality of “accounting, auditing and attestation services performed by AICPA members” [2] . This means that every CPA firm must be reviewed by another CPA firm. The latest company must independent from the reviewed company and must have qualified experience.
The supervision of the peer review activities is assured by the Public Oversight Board (POB), an independent private sector body [3] , which, even if was created by SECPS members, is independent from the profession and the regulatory process.
I.2. Regulatory Bodies Securities and Exchange Commission (SEC). The US Congress, through Securities Exchange Act of 1934, established SEC as an independent agency, having as main duty to “define technical, trade, accounting, and other terms used” in securities market, in the United States. The Commission is responsible for (1) interpreting federal securities laws; (2) issuing new rules and revising existing rules; (3) supervising the examination of securities players (brokers, investments advisers, other agencies); (4) monitoring private regulatory organizations in the securities area; and (5) complying U.S. securities rules with other American and foreign authorities [4] .
Currently, the SEC is administrating the most important laws that standardize the securities industry, laws which are: (1) Securities Act of 1933, (2) Securities Exchange Act of 1934, (3) Trust Indenture Act of 1939, (4) Investment Company Act of 1940, (5) Investment Advisers Act of 1940, (6) Sarbanes-Oxley Act of 2002.
The authoritative power of SEC implies laws enforcement in cases of fraud, insider trading, and any other infringements done by the individuals and companies on the securities area.
American Institute of Certified Public Accountants (AICPA). If all preceding associations (like the American Association of Public Accountants, the Institute of Public Accountants, the American Institute of Accountants) are taken into consideration, than it can be stated that AICPA dates from 1887 [5] .
Associating all the certified public accountants (CPAs) in the U.S., the AICPA is the main non-government authoritative body in developing auditing standards (including technical rules and ethical codes) and other regulating services for CPAs. Furthermore, it has the authority to monitor and to enforce the law in cases of non-compliance with the standards.
Auditing Standards Board (ASB). Within AICPA, the ASB is assigned to be the committee in charge to actually issue the standards and the regulations for CPAs, for non-public company audits, next to the necessary guidelines and the interpretations of the laws.
Financial Accounting Standards Board (FASB). Over time, the mission to regulate the private sector by clear defined financial accounting standards passed from AICPA’s Committee on Accounting Procedure to the Accounting Principles Board. By the end of 1960s the market development triggered an increasing demand for accounting standards updated in the same rhythm as the economical growth. As a result, since 1973, the Financial Accounting Standards Board has been created as a private, non-profit institution, founded with the purpose to “establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.” [6]
CORPORATE GOVERNANCE: FAMOUS SCANDALS In 2002, Ribstein L. argues in the Journal of Corporation Law that the traditional approach of corporate governance in large corporation must be established by government regulation. This approach is based on assumption that the shareholders, in order to protect their ownership goals, lack of tools to control the management actions. On the other hand, acknowledging the shareholders’ weakness, the managers are predisposed to take advantage of the situation by acting on their own personal interests and power.
Companies’ financial statements are the mean through which the managers can show their contribution to the corporate overall growth. If in this judgment is included the fact that corporate management usually has had compensation formulae strongly related with companies’ financial performance (such as options on company’s shares), the management tendency to manipulate companies’ financial statements becomes obvious, or, in other words, the management is highly interested “to manage earnings” (Kaplan R., 2004).
After seventy years of corporate regulation, in 2001 and 2002 series of management frauds rocked the investors trust in the market. Scandals like Enron, WorldCom, Tyco, Adelphia, and Waste Management opened a new era of financial manipulation. What is essential to be mentioned is the fact that all these frauds were possible despite all the levels of supervision in place, such as executive directors, external auditors, accounting firms, debt rating agencies, or securities market analysts (Ribstein L., 2002).
The most resonant scandal was Enron, which, after being one of the world’s biggest power dealers, revealed in October 2001 losses higher than $70 billion in equity value. WorldCom, which played an important role on telecommunication market, disclosed in March 2002 that its revenues are overstated by capitalizing expenses, losing $180 billion in shareholder equity. Both cases will be discussed in the following section, emphasizing on fraudulent operations and corporations weaknesses.
II.1. Enron Short summary: Disclosure date October 2001
Charges False increased profits, hidden liabilities totaling over $1 billion by using off-the-books transactions.
Manipulation of the Californian energy market during the electricity crisis, recording “total profits of $2.7 billion from trading electricity and gas in western markets” (Markham J., 2006).
Extorting and gaming the power prices, as well as an overcharge of “$175 million for electricity generated by Enron wind farms” (Markham J., 2006).
Securities fraud, wire fraud, money laundering, insider trading, and filing false income tax returns (for Enron’s executives).
Auditing firm Arthur Anderson
With losses higher than $70 billion in equity value (Bryce R., 2002), Enron scandal is one of the biggest political scandals in American history.
In 1985, Enron started its business as an important trader on U.S. energy market, developing its operations within: transactions with natural gas, constructions of power facilities and pipelines, telecommunications services, buying/selling commodities. Its rapid growth offered to the public media a sensation of unstoppable revenues and solid financial stability. Before the public disclosure from 2001, the revenues and the incomes reported by Enron were impressive (Markham J., 2006):
in 1998 – $31 billion in revenue and $703 million in net income after expenses;
in 1999 – $40 billion in revenue and $893 million in net income after expenses;
in 2000 – $100 billion in revenue and $979 million in net income after expenses.
In fact, the revenues were not real, the financial image presented to the shareholders being an illusion. In order to hide its losses Enron stretched the limitations of accounting standards and took advantage of all the regulatory lacks.
Due to its business specificity, the accounting recording was challenging. First aspect regarded the long-term contracts for which the current accounting rules obliged the company to forecast the future revenues. In this case Enron’s income recognition was made at present (or fair) value, using mark-to-market accounting, regardless the prospective economic conditions. The second aspect was linked with Enron’s reliance on structured financial transactions and, implicitly, on special purpose entities (SPEs). In this area the accounting standards were questionable, being debated by practitioners because of the difference which could be created between real economic situation and companies’ financial indicators.
Behind this “glowing” image, Enron built a network of derivatives trading and transactions with SPEs, which generated substantial revenues not only for the company itself, but also for the company’s directors involved in the SPEs partnerships. The report of investigation of the Enron Special Investigative Committee (Powers W., et al., 2002) mentioned the amounts by which Enron’s employees were illicitly enriched: “…Fastow (i.e. Enron’s CFO) by at least $30 million, Kopper (i.e. Enron’s finance executive) by at least $10 million…”.
In October 2001 Enron had to recognize expenses of $1.01 billion after tax and two months later, Enron filed for bankruptcy. Enron’s failure is a clear example of corporate governance malfunction. Managers were compensated with stock options based on the company’s short-term performance with no other restrictions, compensation program that incentivized managers to increase the short-term performance regardless the long-term consequences. Next to Enron’s management, part of the blame is assigned to external auditors (Arthur Andersen) and to parties responsible for the company’s internal governance (see appendix 1 for a graphic representation of the links between Enron’s managers and investors).
Analyzing the implications of accounting rules over the Enron’s scandal one statement must be made. U.S. GAAP are very extensive and, even more, rigid in its provisions, inspiring financial professionals to find creative accounting solutions to avoid the rules.
II.2. WorldCom Short summary: Disclosure date March 2002
Charges “Use of undisclosed and improper accounting that materially overstated its income before income taxes and minority interests by approximately $3.055 billion in 2001 and $797 million during the first quarter of 2002” [7]
“WorldCom’s transfer of its costs to its capital accounts violated the established standards of generally accepted accounting principles” [8] resulting in $3.8 billion fraud.
“WorldCom violated the anti-fraud and reporting provisions of the federal securities laws” [9]
WorldCom’s CEO Bernard Ebbers received from the company off-the-books loans of $408 million.
Auditing firm Arthur Anderson
In 1995 LDDC (Long Distance Discount Company) became WorldCom, one of the biggest telecommunication company on the U.S. market. Its CEO, Bernie Embers, joined the company in its early starts, in 1985. During his administration, the company experienced a period of high growth, with revenues reaching billions of dollars. In 1996, after the acquisition of MFS Communication Inc., WorldCom became the fourth biggest telecommunication company (Markham J., 2006), looking forward to using the opportunities offered by the new breakthrough innovations, such as fiber-optics and Internet.
In October 1997 WorldCom announced the merger with MCI Communications for $30 billion. The company continued to grow, reporting earnings of $16 billion (Markham J., 2006) between 1996 and 2000, even if the SEC obstructed the company from considering deductible large amounts spend in research and development.
In the early 2000, the entire telecommunication industry started to slow down, and, also, the stock prices were declining. The same happened in WorldCom’s case. By the middle of 2000, the stock price was almost half its 1999 price. Even so, WorldCom announced surprising profits (Markham J., 2006): $1.4 billion for 2001 and $130 million for the first quarter of 2002 (when in fact the company recorded losses). In March 2002, after an internal audit engagement, WorldCom announced the restatement of its financials figures due to inappropriate accounting recordings of the revenues between beginning of 2001 and first quarter of 2002, revenues which were not in compliance with GGAP provisions.
In June 2002, the SEC charges WorldCom for $3.8 billion fraud [10] . As it was revealed by the SEC investigation, WorldCom used an accounting artifice to capitalize its “line costs” (e.g. fees paid by WorldCom to third party services providers) and, in this way, to keep company’s earnings at expected levels.
WorldCom filed for bankruptcy in July 2002, “wiping out $180 billion in shareholder equity” (Markham J., 2006). Ebbers was dismissed from the position of WorldCom’s CEO in April 2002 [11] after admitting that he borrowed money from WorldCom in its attempt to cover his losses from buying WorldCom shares [12] . In 2005 Ebbers was sentenced to 25 years in jail.
As presented by SEC’s WorldCom corporate monitor, Richard Breeden, in his report on the company’s measures to restore its governance, “WorldCom seemed to meet most of the governance standards of its time” (Breeden R., 2003). The company’s configuration included all the necessary structures required for corporate governance (such as audit committee, compensation committee etc.), with almost 80% of the directors fulfilling the independence requirements. But, in fact, most of these “independents” were very strong linked to Ebbers, through their incomes. So, corporate governance is not only accomplishing a checklist with requirements, but being deeply concerned about the independence impediments. In WorldCom’s case the management board failed to assess the company’s risks and to draw corrective risk procedures. In Enron’s case, the board allowed the CFO to participate in financial partnerships (e.g. SPEs), searching for his personal gain.
In both cases, Enron and WorldCom, the CFOs failed to supply accurate financial data. Their fraud involvement was a real obstacle for which the problems were discovered too late.
Hard interpretations of GAAP’s provisions regarding net income and future earnings as well as unrealistic cash flow statements were present also in both companies. Furthermore, lacking of an appropriate internal control system, the adjustments in the companies’ financial reports were easy to be made by the high level employees.
SARBANES-OXLEY ACT OF 2002 The scandals of accounting fraud, corporate misbehaviors, non-compliance with business ethics, and bankruptcies occurred in high-level companies like Enron and WorldCom revealed the market’s strong need for deeper reforms in corporate regulations.
In July 2002, the U.S. Congress ratified the Sarbanes-Oxley Act (known also as the Public Company Accounting Reform and Investors Protection Act of 2002) in response to the corporate crisis. One of the most important legislative action since the Acts of 1933 and 1934, Sarbanes-Oxley has as objectives to rebuild the investors’ trust in the market and to enhance the transparency and morality of public companies, avoiding future similar allegations. Through the Sarbanes-Oxley Act are addressed issues like management’s legal liability, increased independence rules for internal governance agents, mandatory internal control audits, and increased management’s responsibility for financial reporting. Furthermore, Sarbanes-Oxley “increases the SEC’s power to determine that an individual is unfit to serve as an officer or director of a publicly-traded company, even in the absence of a judicial finding of a violation of the federal securities laws” (Fisch J., 2004).
Source: Anand S., 2007, Essentials of Sarbanes-Oxley, John Wiley

A study of management accounting within McDonalds Corporations

McDonalds is the one of the largest food service retailer in the world, operating in 117 countries and serving more than 60 million people, it was owned more than 32,000 restaurants globally. Mc Donald operates its business in any of the three types Franchisee, Affiliate or as a Corporation.
Company was founded by Richard and Morris Mc Donald as a single restaurant in California in 1940 initially and soon adopted the technique of fast food concept by the end of 1948 and soon expanded their product range and started making many food items and by the year 1958 they opened 34 restaurants and surprisingly it was opened 67 new restaurants in one year 1959 and made it as the total 101 restaurants.
Soon the company started the phenomenon of advertisement and expanded its business rapidly by investing more and more on advertisements, in 1960’s and 1970’s. By the end of 1970 company started 1000 restaurants and also started social service concept by starting Home away from Home for homeless children
In the beginning of 1980’s company faced tough competition from its competitors Burger King and Wendy’s and started aggressive marketing campaigns and then it is known as burger war at that time. However it continued to improve its business despite of tough competition. Mc Donald took 33 years to start 10,000 Restaurants and later it took 8 years to reach 20,000 restaurants mark. And by the end of 1997 the volume of Restaurants had reached to 23,000 and continued to open 2000 restaurants each year.
In the early 2000 it started to create a new image to the company to overcome the drawbacks and owes faced by the company in 1990’s.
The Business Model of McDonald’s: Mc Donald’s earns revenues in many ways like as an investor, as a franchiser of restaurants, and as an Operator of Restaurants. Only 15% of its profit comes directly from its own operations and rest of the money comes from the franchisees, rent, marketing costs on sales and many like that. The franchisee fees and other revenues are differ based on the locations and countries and it had various packages that are different from its competitors
Products of Mc Donald’s: The following are the products that are changing over times and the present food items sold at Mc Donald’s mentioned below
French Fries
Soft Drinks
Milk shakes
Deserts and Breakfasts
Mc Donald’s currently operating more than 110 countries and serving to the millions of people and facing hug competition from its competitors like Starbucks Corporation, Wendy’s, Taco Bell, KFC restaurants, and Burger King. The main policies of Mc Donald’s are Quality Value and Cleanliness and they concentrate more on the Safety of the food and they knew well that their reputation mainly based on the Safety measures they take to ensure the customers the hygienic quality
Review of Management Accounting: Management Accounting is “the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities”
Chartered Institute of Management Accountancy (CIMA)
Management Accounting refers to only recording the financial results of the managers and act basically as a Historic Score keeper role. Apart from that it tries to evaluate the values and results of certain periods and why they took place. At a minor level it also tries to forecast the outcomes of the future implementations and their effects for long time. But unfortunately no one can predict the future certainly thus its role is limited to analysing the past data and possibly giving the reasons why they occurred.
The role of Management Accounting: To Identify Current Business Position: through analysing the past accounting data Management Accounting tries to identify the current position of various areas of business and their performance.
To know the potential new resources: Management Accounting tires to identify whether there any resources available for the business and evaluate its profitability.
Identifying the Internally available Resources: The Management Accounting tries to tries to identify the available resources if any and the possibility of using them
Finding Available Business Alternatives: it further tries to find out the available alternatives for the current business and asses the profitability to reduce the risk of investment
Dealing with Current external environment: managing Management Accounting is not only with accounting data available, it should understand why the business has failed if failed and why it made profit if it is so.
Anticipated Future Changes in environment: The Management Accounting tries to anticipate the future though no one can anticipate it correctly, it tries to reduce the risk for the future.
Key Management Accounting Concepts: Management Accounting techniques and its applications will vary from one company to other and must suits to its needs. The following are the few of the key accounting techniques to be followed by the company
Every country has their own accounting standards to be followed, UK is under the influence of Accounting Standard Board (ASB), has issued a series of standards of statements of Standard Accounting Practice (SSAP).
The Consistency: The interpretation and presentation of likely things should be treated consistently within each accounting period and from one accounting period to the next. To meet the requirements of each individual decision maker Management accounting need to be prepare the reports according to their requirements and delete the un necessary data . it is fallacy that all internal accounts and reports should be consolidated for the sake of neatness to give overall total.
The going concern: Measuring the balance sheet details like inward and outward details of the company and accessing their future value and making the future inwards assessment of the company.
Accruals/Matching: to build the logical relationship between the costs incurred in the current financial statement and future value of it. That is making the expected value of the investment for the future. This is achieved by deducting the total costs from the sales revenue produced as the resource is used rather than when it is purchased.
Prudence: it states the future revenue and hence the profit.
Key Techniques of Accounting Management: Analysis Techniques
Stock Valuation
Determining the Economic Order Quantity
Stock Valuation and pricing
CVP analysis
Planning Techniques
Discounted Cash flow(DCF)
Internal Rate of Return(IRR)
Capital budgeting
Weighted Average cost of Capital
Controlling Techniques
Investment Centres
Profit and Contribution centres
Revenue Centres
Cost or expense centre
Recommended Techniques to the company: Stock Valuation: in cost analysis stock valuation is one of the important concept, as Mc Donald is a food retail based business, the inward food and its consumption is very high and will be done on regular basis, this can be done carefully to avoid the excessive costs. This can be done either by the following methods
LIFO method, FIFO method, Average cost, Replacement Cost method
EOQ: Economic Order Quantity is important to determine especially when the costs involved in the material is high or when they need some special storage capacities like frozen conditions. To know the EOQ value for a good we can use the following formula
Q = d for period*Cost per order/Holding cost per unit
Q =
CVP analysis: The CVP analysis is used to measure the profit in terms of the utilizations and usage of the stock to make the long term planning if needed to focus on the variable costs. This can be calculated in the following manner
Profit = Revenue – Expenses
Profit = Revenue – (Fixed Costs Variable Costs)
Thus the business will begin to make profit beyond the level of activity where revenue equal expenses, known as breakeven point
As the Mc Donald has operations in various countries it need to be analyze the performance of each country and area wise to identify its range of profits and needed planning for the future.
IRR: When comparing the profitability of two similar projects and their profitability we need to calculate the IRR called as Internal Rate of Return. This can be achieved by accessing NPV and if the NPV is Zero then the cash flows is equal to the present cash out flows. This is known as the Internal rate of Return or Internal Yield of the project.
Capital budgeting: Maximization of the long term value of a business is the main objective of Capital Investment Budgeting (CIB). To plan the investments on the various projects held by the company it needs the proper way to distribute between the projects held by the company as the resources held by the company are limited. This can be illustrated by the following simplified example
Project NVPs@20% Ranking on NVP
A £ 10m 1
B £5m 2
C £4m 3
D £3m 4
The PI of the each project will be 20%, 25%, 22.2%, and 25% respectively. The budgeting for these projects can be done based on their PI value and then the investment of the company will be profitable. This can be done by using IRR method to allocate the funds to each project that are available with the company
Weighted Average Cost of Capital: The cost of capital is the rate of return the company has to pay to the various investors of funds in the company. The sources in general are equity and debt. This can be calculated by applying the following applications
The cost of Debt
Cost of Equity
Weighted Average Cost of Capital (WACC): The WACC represents the minimum overall return which is needed if the business is to be able to satisfy the expectations of its sources of capital say as Equity holders and the debtors of the company.
The strengths and Weaknesses of the Analysis: The report is based purely on the accounting reports of the particular period and as it is based on numbers purely. The external factors like social and other cannot be considered some times.
To better implementation of the results the managers must be consider the other factors also.
The period of accounts considered in the report is very less as it is for the short period and for fast assessment, so that many influencing factors in the past may not be considered in the report
The real time values are far more different and complex in nature and so it can be consider the more values and more in depth analysis.