A Literature Review of Accounting and Sarbanes-Oxley Act 4

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This review focuses on the influence of the Sarbanes-Oxley Act 4 on accounting standards and regulatory boards of different institutions in the United States. The review will establish that not all the firms have agreed to comfort, to the Act’s requirements because of the increased auditing costs. This review will be based on peer-reviewed articles dating back from 2007 to 2018. This review will demonstrate that most of the information provided rely on past financial reports of firms to determine how they were affected by the policy. A review of the most recent financial reports and how they are affected by the policy is rare. To arrive at this conclusion, the review is divided into the following subsections: “Impact of the Act on Accounting Standard Boards”; “Increased costs associated with the added Guidelines of the Act”; Impact of the Act on “Accounting Standards of Small Firms”; and “Increased Audit Fees Associated with the Act”; and conclusion.

Impact of the Act on Accounting Standard Boards

Since the Sarbanes-Oxley Act 4 was implemented, some sources have examined by the Act affects accounting standard boards. For instance, Baranek (2018) focused on how the Act affects the Financial Accounting Standard Board (FASB), precisely its effect on accounting regulators and regulatory processes. Baranek (2018) hand-collected information from financial accounting standards filed per year from the FASB library and found that the Act seemed to increase the workload, and at the same time, made the speeding of standard-setting shorter. Ge, Koester, and McVay (2017) shared similar findings of the impact of the Act on financial accounting, but focused on a specific clause of the Act. The authors conducted a literature review of how the Act affected internal control disclosures for small firms in the United States by focusing on the costs and benefits of section 404(b) of the Act (Ge, Koester, and McVay, 2017). After conducting descriptive research on an estimate of 11,000 forms exempted from the policy from 2007 and 2014, they found that the net benefits and costs of regulations were elusive. This finding was noted in a review conducted by Baranek (2018), who established that the Act seemed to increase the workload of FASB. Moreover, Baranek noted that literature on how the Act affected the cost associated with FASB accounting was shallow, suggesting that it was not detailed how the accounting costs increased after its legislation.

Increased costs associated with the added Guidelines of the Act

The study results of Ge, Koester, and McVay (2017) seemed to resolve the gap in the literature that Baranek (2018) had founding concerning how exactly the Act increased the cost of accounting among firms. Ge, Koester, and McVay’s (2017)’s results were conclusive that the exemption of the Act saved small firms from losing an estimated $388 million in terms of reduced audit costs. The act seemed to attract some incremental costs associated with auditing guidelines. This might explain why firms that had adopted the Act produced misleading reports on the financial accounting standards. Although this was an assumption that Ge, Koester, and McVay (2017) deduced from their findings, they argued that the reason the Act had not been fully adopted by firms was due to the opposition from investors. This is noted by Ge, Koester, and McVay (2017), who claim that small firms that were exempted from the Act lost an estimated $719 due to lower operating performance that was linked to their weak internal controls. Based on this inference, Ge, Koester, and McVay (2017) seem to arrive at the conclusion that since the policy increases the cost of accounting associated with added accounting and reporting guidelines, investors of small firms would deliberately engage in misreporting to discourage the full execution of Sarbanes-Oxley Act 4.

Impact of the Act on Accounting Standards of Small Firms

While Baranek (2018)’s and Ge, Koester, and McVay (2017)’s sources addressed the effect of the Act on accounting boards and reporting standards of small firms, other sources, such as the COHEN, KRISHNAMOORTHY and WRIGHT (2010) covered its impact on financial reporting of banks in developing countries. COHEN, KRISHNAMOORTHY and WRIGHT (2010) explored the impact of the Act on corporate governance to establish its pros and cons in developing countries. COHEN, KRISHNAMOORTHY and WRIGHT (2010) found that the Sarbanes-Oxley Act 4 improved the standard reporting standards of banks, thus allowing managers and shareholders to give better credit rates to developing countries. Other researchers, such as Zhang (2007) examined how the act affected economies of countries, particularly their effects on earnings management of companies. The author noted that although the policy led to a slight increase in conservatism, this was not statistically significant in assessing the impact of the policy on industries. More importantly, the study established that most of the United States-listed firms scored poorly on earnings management due to the increased auditing costs. These findings are shared by Ge, Koester, and McVay (2017), who also noted that the Act was not adopted by small firms because shareholders and investors tended to exempt themselves from the costly financial obligations associated with its implementation.

Increased Audit Fees Associated with the Act

Although the Act was introduced to improve disclosure in financial reporting, some sources show that it led to increased audit fees. For instance, Daniel et al. (2007) demonstrated that under section 302 of the Act, the administration should file annual reports highlighting the potency and suitability of internal controls, affecting firms’ financial reporting procedures. The source reveals that section 302 of the Act stipulates that the internal audit system of an organization must be reviewed by external auditors to dictate changes that should be made and to adjust internal control reports. They found that were that the Act caused an upsurge in Audit fees due to the restatement of internal audit reports, book value, pricing strategy, and earnings. Gupta (2013) shared a similar finding with Daniel et al. (2007) by establishing that section 404 of the Act has been the most criticized clause due to its burdening audit costs. Gupta further looked into public reporting standards that were greatly affected by the Act due to the strict requirement of the issuer’s administration and auditing by independent auditors. The study involved reviewing the discussion over public reporting of internal control by public firms listed in the United States, which had been operational since the Mckesson & Robbins fraud. The investigation involved reviewing legislative proposals from the United States Congress, and the results showed deliberate precursors had been codified in Section 404 to benefit external auditors from increased audit fees. Other researchers that made a similar finding include Zhao et al. (2017) and Abbott et al. (2019), who found that there was an increased audit fee caused by the Act. However, both Zhao et al. (2017) and Abbott et al. (2019) agreed that these increased fees led to reduced misreporting and increased cooperation between internal and external auditors.

Conclusion

Based on this literature review, the Sarbanes-Oxley Act 4 has had a positive impact on the financial reporting of banking institutions, small enterprises, and accounting standard boards. However, the literature reveals that the act has been rejected by public institutions and private firms because it attracts audit costs, which are paid to external auditors. Also, the Act improves on the accountability of internal control systems, thus reducing the likelihood of misreporting of financial statements. However, most of the sources included in this review were from financial records of firms dating back to the 2008 financial crisis. There is limited data on how the Act affects the financial accounting of firms in the present time, and this is an area that warrants future investigation.

References

Abbott, L. J., Parker, S., Peters, G. F., & Presley, T. J. (2019). Control Self-

Assessment and Costs of Compliance with Sarbanes-Oxley Section 404. Journal of Management Accounting Research, 31(3), 5-24.

Baranek, D. (2018). The Impact of Sarbanes-Oxley on The Fasb And Accounting

Regulation. Academy of Accounting and Financial Studies Journal, 22(1), 1-17.

COHEN, J., KRISHNAMOORTHY, G., & WRIGHT, A. (2010). Corporate Governance in the

Post‐Sarbanes‐Oxley Era: Auditors’ Experiences. Contemporary Accounting Research, 27(3), 751–786. https://doi.org/10.1111/j.1911-3846.2010.01026.x

Daniel A. Cohen, Aiyesha Dey, & Thomas Z. Lys. (2008). Real and Accrual-Based Earnings

Management in the Pre- and Post-Sarbanes-Oxley Periods. The Accounting Review, 83(3), 757–787.

Ge, W., Koester, A., & McVay, S. (2017). Benefits and costs of Sarbanes-Oxley Section

404(b) exemption: Evidence from small firms’ internal control disclosures. Journal of Accounting and Economics, 63, 358–384.

Gupta, P. P., Weirich, T. R., & Turner, L. E. (2013). Sarbanes-Oxley and Public Reporting on

Internal Control: Hasty Reaction or Delayed Action? Accounting Horizons, 27(2), 371-408.

Zhang, I. (2007). Economic consequences of the Sarbanes–Oxley Act of 2002. Journal of

Accounting & Economics, 44(1-2), 74–115. https://doi.org/10.1016/j.jacceco.2007.02.00

Zhao, Y., Bedard, J. C., & Hoitash, R. (2017). SOX 404, Auditor Effort, and the Prevention

of Financial Report Misstatements. A Journal of Practice & Theory, 36(4), 151-177.