The Sarbanes-Oxley Act - Accounting and Conservatism

An analysis mainly based on section 404 of the Sarbanes-Oxley Act

Term Paper, 2012

39 Pages, Grade: 2,0



List of figures

List of tables

List of abbreviations

1 Introduction

2 The History of SOX

3 Overview about SOX
3.1 Title I - Public company accounting oversight board
3.2 Title II - Auditor independence
3.3 Title III - Corporate Responsibility
3.4 Title IV Enhanced financial disclosures
3.5 Titles V to XI

4 Implications of Section 404
4.1 Content of the internal control report
4.2 The COSO framework

5 Relevance of SOX for conservative accounting
5.1 Overview about conservative accounting
5.2 Analysis of conservative accounting

6 Conclusion

7 List of literature

8 List of world wide web sources

9 Appendix

List of figures

Figure 1: COSO framework

Figure 2: Conservatism vs. Optimism

List of tables

Table 1 Overview about the structure of SOX

List of abbreviations

illustration not visible in this excerpt

1 Introduction

At the beginning of the current millennium several economic scandals shocked the US economy and the stock exchanges all over the world.[1] As a result President George W. Busch singed the Sarbanes-Oxley Act (SOX) on July 30, 2002 that he called: “[…] the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt.”[2] The aim of this act is to restore the trust of the investors in the financial reports of the issuing companies and to avoid that scandals like Enron or WorldCom can recur. This act increased the demands on the financial reporting and costs a lot of effort for the companies which have to be SOX compliant. Especially the implementation and the maintenance of section 404 is very complex and focus the issuing company on its risks and its internal control structures and procedures.[3] Thus it could be possible that the accounting measurement practices of the issuing companies might have changed after the enactment of SOX. Especially because the US accounting measurement practices were more optimistic compared to other countries.[4]

The question is, if the Sarbanes-Oxley Act and especially section 404 change the US companies’ attitude to a more conservative accounting.

The goal of the assignment is to analyse, if the Sarbanes-Oxley Act and especially section 404 is laid out to change the attitude of the US companies to a more conservative accounting. Beyond that an overview about the Sarbanes-Oxley Act and the requirements of section 404 for the issuing companies will be given. In addition to that the value and the system of conservative accounting will be described.

The assignment is divided into three major parts. In the first part the history of the SOX and an overview of the act will be given. In the second part the requirements of SOX section 404 for the issuing companies will be described. In the third part conservative accounting will be introduced and the implications of SOX on conservative accounting will be analysed. This analysis is mainly based on SOX section 404. The assignment is rounded off by a conclusion. The next chapter will give an overview about the history of SOX.

2 The History of SOX

Before the Sarbanes-Oxley Act was enacted in the year 2002 many economical scandals shocked the US economy and the stock exchanges all over the world.[5] The following chapter gives an overview about the biggest of these scandals which lead to SOX and shows the timeline of enacting the Sarbanes-Oxley Act.

Before the end of the year 2001 the Enron Corporation (Enron) seemed to be a very profitable company that primarily traded with raw materials and energy.[6] Based on its revenues Enron was the seventh biggest corporation in the US and was audited in the preceding sixteen years by the well-respected audit firm Arthur Andersen, LLP (Andersen).[7] In addition to that the audit company did internal and external auditing work for Enron and established offices in the premises of Enron. On October 16, 2001 Enron had to issue a net loss of 618 million USD for the third quarter of the year 2001 and a reduction of shareholder equity of 1.2 billion USD. As a result the share price collapsed.[8] The reasons for the collapse of Enron were founded into the company’s intransparent financial structures.[9] Beyond that liabilities of more than one billion USD were not shown in Enron’s balance sheet, because they were transferred to offshore partnerships. This procedure made it possible to disclose inflated earnings.[10] Although the audit company was informed about irregularities and possible fraud at Enron’s accounting methods, Anderson did not inform the public. Beyond that Anderson destroyed evidence about Enron.[11] On December 2, 2001 Enron filed for creditor protection, which made Enron to the biggest insolvency in the US history so far.[12] Only a few months later on June 25, 2002 the telecommunication company WorldCom disclosed for the years 2001 and 2002 that 3.8 billion USD expenses were improperly booked as assets. This illegal way of accounting led to a positive net income of 1.38 billion USD instead of a net loss, because this way of accounting made it possible to write-off the expenditures for up to ten years.[13] On July 21, 2002 WorldCom filed for creditor protection. After this WorldCom disclosed on August 8, 2002 that an amount of 50.6 billion USD have to be written-off in goodwill and intangible assets due to a revision of the balance sheet. This revision cut the assets formerly shown in the balance sheet in half.[14] Like at the Enron case Arthur Andersen was the auditor of WorldCom in the years before the bankruptcy and top management of Andersen was involved in the company’s actions. These exemplary scandals lead to a lack of confidence of the investors towards all companies on the US financial market.[15]

As a result of the financial scandals described above, the US government enacted the Sarbanes-Oxley Act on July 30, 2002 that was drafted by the democrat Senator Paul Sarbanes and the republican Senator Michael Oxley.[16]

To sum it up the Sarbanes-Oxley Act is a reaction of the US government on the preceding scandals like Enron or WorldCom that shocked the US economy and the stock exchanges all over the world. In the next chapter an overview about SOX will be given.

3 Overview about SOX

Enacted by the Senate and House of Representatives of the USA on July 30, 2002 the aim of the Sarbanes-Oxley act is: “To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.”[17] The Sarbanes Oxley Act applies for all companies that are registered at the US Securities and Exchange Commission (SEC). At the SEC are companies registered that provide their stocks on the US market and stock exchanges.[18] The aim of this chapter is to give an overview about SOX, because of that this chapter is mainly based on the law itself.

The Sarbanes-Oxley Act is divided into elven titles. These titles are subdivided into various sections. The following figure shows the number of tiles, the number of sections and the principal themes of the titles:

Table 1 : Overview about the structure of SOX[19]

illustration not visible in this excerpt

The content of each title of SOX will be described in the following.


[1] Cp. [b] SPIEGEL ONLINE GmbH (2002), w.p.

[2] U.S. Government Printing Office (2002), w.p.

[3] Cp. Chapter 4

[4] Cp. Chapter 5.1

[5] Cp. [b] SPIEGEL ONLINE GmbH (2002), w.p.

[6] Cp. [a] SPIEGEL ONLINE GmbH, 2002, w.p.; Solomon (2007), p. 33

[7] Cp. [a] FindLaw (2002), p. 1 f.

[8] Cp. [a] FindLaw (2002), p. 2 f.

[9] Cp. SPIEGEL ONLINE GmbH (2002), w.p.

[10] Cp. Ploaris Institute (2002) p. 3

[11] Cp. [a] FindLaw (2002), p. 5 f.

[12] Cp. Piper (2009); p. 58

[13] Cp. The Wallstreet Journal (2002); p. 1 ff.

[14] CRS Report for Congress (2002); p. 5

[15] Cp. [b] SPIEGEL ONLINE GmbH (2002), w.p.; Menzies (2004), p. 11

[16] Cp. Menzies (2004), p. 11 ff; Financial Times Deutschland (2002), w.p.

[17] Cp. Menzies (2004), p. 13; [b] FindLaw (2002), p. 1

[18] Cp. Menzies (2004), p. 13

[19] own construction based on [b] FindLaw (2002), p. 1 f

Excerpt out of 39 pages


The Sarbanes-Oxley Act - Accounting and Conservatism
An analysis mainly based on section 404 of the Sarbanes-Oxley Act
The FOM University of Applied Sciences, Hamburg
Master of Business Administration
Catalog Number
ISBN (eBook)
ISBN (Book)
File size
1472 KB
Appendix one contains a risk report of Fresenius Medical Care.
Controlling, SOX, Sarbanes-Oxley Act, Accounting and Conservatism, Conservatism in Accounting
Quote paper
BBA Denis Stein (Author), 2012, The Sarbanes-Oxley Act - Accounting and Conservatism, Munich, GRIN Verlag,


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