Page 153 - Accounting Information Systems

124 PART I Overview of Accounting Information Systems

WorldCom was another culprit of the improper accounting practices. In April 2001, WorldCom
management decided to transfer transmission line costs from current expense accounts to capital
accounts. This allowed them to defer some operating expenses and report higher earnings. Also,
through acquisitions, they seized the opportunity to raise earnings. WorldCom reduced the book
value of hard assets of MCI by $3.4 billion and increased goodwill by the same amount. Had the
assets been left at book value, they would have been charged against earnings over four years. Good-
will, on the other hand, was amortized over a much longer period. In June 2002, the company
declared a $3.8 billion overstatement of profits because of falsely recorded expenses over the previ-
ous five quarters. The size of this fraud increased to $9 billion over the following months as addi-
tional evidence of improper accounting came to light.
SARBANES-OXLEY ACT AND FRAUD. To address plummeting institutional and individual inves-
tor confidence triggered in part by business failures and accounting restatements, Congress enacted SOX
into law in July 2002. This landmark legislation was written to deal with problems related to capital mar-
kets, corporate governance, and the auditing profession and has fundamentally changed the way public
companies do business and how the accounting profession performs its attest function. Some SOX rules
became effective almost immediately, and others were phased in over time. In the short time since it was
enacted, however, SOX is now largely implemented.
The act establishes a framework to modernize and reform the oversight and regulation of public com-
pany auditing. Its principal reforms pertain to (1) the creation of an accounting oversight board, (2) audi-
tor independence, (3) corporate governance and responsibility, (4) disclosure requirements, and (5)
penalties for fraud and other violations. These provisions are discussed in the following section.
1. Accounting Oversight Board. SOX created a Public Company Accounting Oversight Board
(PCAOB). The PCAOB is empowered to set auditing, quality control, and ethics standards; to
inspect registered accounting firms; to conduct investigations; and to take disciplinary actions.
2. Auditor Independence. The act addresses auditor independence by creating more separation between
a firm’s attestation and nonauditing activities. This is intended to specify categories of services that a
public accounting firm cannot perform for its client. These include the following nine functions:
a. Bookkeeping or other services related to the accounting records or financial statements
b. Financial information systems design and implementation
c. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
d. Actuarial services
e. Internal audit outsourcing services
f. Management functions or human resources
g. Broker or dealer, investment adviser, or investment banking services
h. Legal services and expert services unrelated to the audit
i. Any other service that the PCAOB determines is impermissible
Whereas SOX prohibits auditors from providing these services to their audit clients, they are not pro-
hibited from performing such services for nonaudit clients or privately held companies.
3. Corporate Governance and Responsibility. The act requires all audit committee members to be inde-
pendent and requires the audit committee to hire and oversee the external auditors. This provision is
consistent with many investors who consider the board composition to be a critical investment factor.
For example, a Thomson Financial survey revealed that most institutional investors want corporate
boards to be composed of at least 75 percent independent directors. 15
Two other significant provisions of the act relating to corporate governance are (1) public compa-
nies are prohibited from making loans to executive officers and directors, and (2) the act requires
attorneys to report evidence of a material violation of securities laws or breaches of fiduciary duty to
the CEO, CFO, or the PCAOB.
4. Issuer and Management Disclosure. SOX imposes new corporate disclosure requirements, including:
a. Public companies must report all off-balance-sheet transactions.

15 Ibid.