Auditing and the Law
The purpose of auditing is to provide oversight to the financial management process. Auditing is defined by the accounting best practices within GAAP as a systematic and independent form of oversight that utilized records and factual inquiry to ensure that policies, procedures, and regulations are fulfilled in the accounting process. This is what is known as the assurance service which is part of ensuring credibility for companies.
Assurance services are independent professional services that are provided by Certified Public Accountants (CPAs). These services are part of the accounting process such as auditing in which financial records are examined with the purpose of providing oversight, and managerial decision making (Kimmel, Kieso, & Weygandt, 2011). These services are typically provided in conjunction with maintaining compliance or policies. For example, public companies must provide independent audits as part of their accounting process (Kimmel, Kieso, & Weygandt, 2011). This an accounting process but more so an assurance service because it maintains compliance. There are a variety of laws that govern the accounting process and these laws must be considered in relation to the auditing process.
SEC Act of 1933
The SEC Act of 1933 was created in order to that investors would have complete and accurate information concerning the a security. This law sets standards for reporting financial information about a security in the form of a prospectus. It is considered fraudulent to report inaccurate information concerning a security such as fudging the numbers within any of the financial statements. Failure to report information accurately can result in serious legal consequences. In particular Rule 10b-5: Employment of Manipulative and Deceptive Practices, dictates the legal provisions for being honest in accounting:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security (SEC, 1933).
SEC Act of 1934
The Securities Exchange Act of 1934 was enacted to further protect investors by requiring that secondary markets such as stocks and bonds to also protected from fraudulent reporting. This act gave strength to the Act of 1933 by forming the SEC which would have the enforcement power to deal with securities fraud. Prior to this Act, enforcing securities laws were difficult but with the formation of the SEC, investor fraud now had a proactive agency. Provisions for fraud were expanded in this act broaden the criteria of fraud to include:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange…
(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm–Leach–Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors (SEC, 1934).
The Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act is perhaps the most sweeping form of accounting oversight. The largest feature of this act is that it provides the ability to prosecute CEOS and executives for accounting fraud. As such, fraud become the responsibility of officers in the company. But more than just increasing punitive measures, the Sarbanes-Oxley Act reinforced corporate ethics and increased transparency in corporate accounting process. This reinforcement was accomplished by the SOX enhancing the Generally Accepted Accounting Principles (GAAP) for auditing and reporting in public companies (Kimmel, Kieso, & Weygandt, 2011). SOX specifically protected investors by “establishing specific auditing, quality control, ethics, independence, and other standards” (Kimmel, Kieso, & Weygandt, 2011). Some of the new rules established included:
- The Statement of Responsibility by Company Management (the CEO and CFO) which establishes responsibility for an adequate internal control structure and the procedures for financial reporting.
- The report must include a statement identifying the framework and effectiveness of the internal control over financial reporting.
- The management must include an assessment of the effectiveness of Internal Controls over financial reporting.
- Attestation by the company’s external auditor on Management’s assessment of the effectiveness of the company’s internal controls and procedures for financial reporting (Kimmel, Kieso, & Weygandt, 2011).
The Dodd-Frank Wall Street Reform & The Consumer Protection Act of 2010
The Dodd-Frank Act and the Consumer Financial Protection Act of 2010 worked together to build the Bureau of Consumer Financial Protection (CFPB) which reinforces existing and new federal consumer financial laws. This had a powerful and positive effect on the transparency and efficiency accounting practices. Specifically, these laws worked to end the “too big to fail” issue with companies. In the aftermath of the Great Recession, companies such as AIG needed to be bailed out after their own poor accounting and financial management practices. Specifically these provisions guarded against companies being unstable. Such rules included items such as dealing with financial activities:
…the consolidated assets of the company and all of its subsidiaries related to activities that are financial in nature (as defined in section 4(k) of the Bank Holding Company Act of 1956) and, if applicable, related to the ownership or control of one or more insured depository institutions, represents 85 percent or more of the consolidated assets of the company (Government Publishing Office, 2010).
Rules such as this provided exact specifications for companies to show solvency and sustainability. These rules provided the basis for a new era in accounting oversight by creating specifications that could be measured efficiently.
Connecting many of these laws into a viable system of oversight is the Public Company Accounting Oversight Board (PCAOB). The PCAOB established rules and auditing standards for the auditors of public companies. The functions of the PCAOB are reflected in its vision statement:
The PACOB seeks to be a model regulatory organization. Using innovative and cost-effective tools, the PCAOB aims to improve audit quality, reduce the risks of auditing failures in the U.S. public securities market and promote public trust in both the financial reporting process and auditing profession (PCAOB, 2017).
The rules outline the how auditors show handle information and sets ethical guidelines that make auditors and executives responsible for proper reporting. The standards and practices created by the PCAOB are approved by the SEC (PCAOB, 2017). The PCAOB operates as a nonprofit corporation established by Congress. As well as overseeing the auditing of public companies, the PCAOB also set standards for securities exchange brokers and companies selling stock to make sure that they are compliant with federal laws in order to protect investors.
Government Publishing Office. (2010, July 21). DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT. Retrieved 2017, from Government Publishing Office
Kimmel, P. D., Kieso, D. E., & Weygandt, J. J. (2011). Financial accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons.
PCAOB. (2017). PCAOB Strategic Plan. Retrieved from Strategic Plan
SEC. (1933). SECURITIES ACT OF 1933. Retrieved 2012, from SEC
SEC. (1934). SECURITIES EXCHANGE ACT OF 1934 . Retrieved 2017, from SEC