The Sarbanes-Oxley Act (SOX) is a federal law that the United States Congress enacted in 2002 in response to corporate scandals that eroded public trust in accounting and corporate governance. The document got its name after Senator Paul Sarbanes and Representative Michael Oxley and aims to encourage transparency and accountability in financial reporting. Despite pros and cons, SOX “is widely viewed as the most significant piece of accounting and auditing legislation since the Securities Act of 1933” (Gorshunov et al., 2020, p. 73). The Sarbanes-Oxley Act is a critical piece of legislation that has significantly impacted accounting and financial reporting during the period of 16 years since the act’s implementation.
The Sarbanes-Oxley Act Highlights
SOX was created to improve accounting by requiring increased financial disclosures from firms, more detailed explanations of documentation practices, and establishing more severe penalties for financial fraud. One of the main ideas of SOX was the creation of the Public Company Accounting Oversight Board (PCAOB). It is an independent organization overseeing the auditing industry and establishing auditing standards (Gorshunov et al., 2020). First, SOX requires companies to disclose more financial and accounting information. This makes it easier for stakeholders to assess risks and opportunities. Second, the act places the legal responsibility for the accuracy of the information on the directors. Third, the PCAOB oversees audit firms to comply with the law and quality standards.
The Sarbanes-Oxley Act Costs and Benefits
Naturally, creating a new organization and increasing the financial responsibility of businesses has its costs and benefits. SOX has increased compliance costs for firms, especially for smaller companies (James & Lirely, 2022). Moreover, higher regulatory requirements and compliance costs associated with SOX can make it difficult for businesses to raise capital. This can be especially difficult for companies in emerging markets with less access to capital and fewer resources (James & Lirely, 2022). The benefits of SOX include higher openness and responsibility in financial reporting, which helps restore investor confidence and prevent fraud. In addition, for companies themselves, improved accounting can help them better manage risk and make better business decisions.
The Sarbanes-Oxley Act’s Impact on Accounting
SOX has significantly influenced accounting over the past 16 years and led to changes in auditor behavior and improvements in financial reporting quality. It increased regulatory scrutiny of public companies and their accounting practices through PCAOB and improved reporting requirements. SOX changed auditor and businesses’ behavior in providing documentation, report control, and risk management. For example, a study by Cohen et al. (2021) found that restatements declined by 84% from 2002 to 2018, suggesting that the act significantly impacted improving accounting quality ( p. 4). Before SOX, restatements were relatively common, with many companies making material errors in their financial statements. After the passage of SOX, the number of restatements declined significantly.
Pros and Cons of the Sarbanes-Oxley Act
SOX fulfills its goals and objectives, which is the main advantage of this document. It improves the quality of financial reporting, reduces errors and fraud, improves accounting standards, and restores investor confidence (Cohen et al., 2021). However, SOX has disadvantages, primarily due to increased compliance costs (James & Lirely, 2022). Adherence to SOX can be an expensive and time-intensive process, which can be particularly challenging for small firms and companies that are struggling financially. Moreover, SOX makes it difficult to attract capital and investors in emerging markets, which stops the development of new industries.
Conclusion
SOX has been a pivotal federal accounting and financial reporting law for the past 16 years. Its primary purpose was to increase transparency and accountability in documentation by requiring more detailed financial disclosures and accountability. The act has created the PCAOB, which oversees and enforces auditing standards, improving reporting quality and restoring investor confidence. Although SOX has brought many benefits, drawbacks include increased compliance costs and reduced access to capital for small and emerging firms. Nonetheless, SOX has been considered a significant accounting and auditing legislation since the 1933 Securities Act.
References
Cohen, D., Kang, S., & Liu, Q. (2021). The effect of the Sarbanes-Oxley Act on accounting quality: Evidence from restatements. Journal of Accounting and Economics, 71(1), 105423. Web.
Gorshunov, M. A., Armenakis, A. A., Feild, H. S., & Vansant, B. (2020). The Sarbanes-Oxley Act of 2002: Relationship to magnitude of financial corruption and corrupt organizational cultures. Journal of Management, 21(2), 73-86. Web.
James, H. L., & Lirely, R. (2022). The propensity to save: The effect of Sarbanes–Oxley act. Review of Financial Economics, 40(1), 77–96. Web.