Accounting

Eight factors influence the accounting system in a country. These include culture, legal system, political and economic ties, source of finance, taxation, inflation, level of economic developments, education level. All these factors are apart of the country’s culture and combine to form the accounting policies.
Culture speaks to the norms, values and customs of the people and impacts social systems. Society’s values can be influenced by accounting practices and therefore accounts for some differences in national accounting systems.  One of the most important determinants of accounting regulations and practices is the political and economic system of the country. Differences in political systems will be reflected in differences in how the economy is organized and controlled. This will then influence the objectives or role of accounting (Roberts et al., 2002).The legal system also plays a vital role in the development of any accounting standards. In countries that practice the code law, in order for governments to ensure orderly business conduct, they regulate accounting. Researchers speak to a direct correlation between the level of education in a country and its accounting systems. Sources of finance speaks to how companies are financed, issuing of stocks or loan from financial institutions. Inflation occurs when the amount of money in circulation far exceeds the supply of goods and services. Research has highlighted a number of institutional consequences that might affect the development of a country’s accounting systems, such as historical factors, level of economic development, trading patterns, and membership of economic organizations (Cooke and Wallace, 1990).

America’s Accounting System
The accounting principles of the USA are influential beyond the country’s national boundary and have, of themselves, provided a means of harmonization for those other countries and business enterprise choosing to follow the US lead. They act as a block to harmonization where the US regulators will not accept any practices other than those conforming to US standards without a statement of reconciliation of the differences. The source of the widespread influence of US accounting lies in the country’s worldwide political and economic dominance and in the importance of its capital market. The market is closely regulated by The Securities and Exchange Commission (SEC). The entirety of US accounting principles and practices is referred to as US GAAP (Generally Accepted Accounting Principles).
Accounting practices were to some extent imported from the UK by early pioneers establishing business practices in the USA. The American Association of public Accountants, formed in 1886, and the Institute of Bookkeepers and Accountants, started a New York State law establishing the profession of Certified Public Accountant in 1896 and similar laws followed in other states. The Association established the Journal of Accountancy as a means of professional communication and published a terminology of accounting in 1915. Consolidated financial statements have been published in the USA since the end of the nineteenth century. They are produced so commonly that single-company statements are generally published only by entities having no subsidiaries. There is no law in the USA that mandates their publication; the requirement emerged within US GAAP.
The Impact of the Political and Economic System
The process through which the government controls the economy and the resources it uses will influence the way they control or regulate accounting, alongside the regulatory structures used and types of regulation. The ways in which the relationship between government and businesses are organized, and the government’s view of any business will affect the attitudes of business managers. If big business is viewed with suspicion, managers are likely to use financial statements to manage business-society and business-government relationships. On the other hand, if business-government relationship is generally co-operative and profits are seen as a measure of success, companies will generally be less concerned with justifying themselves (Roberts et al., 2002).
The USA is a federal republic of separate states. Each state has its own constitution but the separate states unite under a federal government operating under a federal constitution. The federal government has the power to impose taxes, the responsibility for national defense and foreign relations the power to create a national currency and the authority to set country wide laws regulating commercial and business practice. Sates also have power to regulate business practice. The economic system is one of the open market. The nature of the economic system has developed and changed as the political climate changes.
The Impact of the Legal, Taxation, and Sources of Finance
Accounting regulations are one part of a complete system of commercial regulations that apply to all business organizations. The Companies Act takes into consideration the disclosure of information by limited liability companies whose owners are their shareholders. Companies have to follow the specific rules and regulations governing the companies Act and take up their general duty to present financial statements that are true and fair.
The political doctrine of separation of powers in the federal constitution means that business may be affected by each of the executive, the legislative and the judicial arms. Independent regulatory agencies are also in existence as a fourth arm to the processes of the legal system. The federal government has general regulatory powers, but much regulation of business enterprises is by state law.
With regard to the system of taxation, the US Congress passes the laws that govern income taxes. The legislation is contained in the Internal Revenue Code and administered by the Internal Revenue Service (IRS). Generally, taxes are imposed on each company separately, but an affiliated group of Domestic Corporation may file consolidated return and be taxed as one corporation. In some countries, the taxation is an important influence on accounting, whilst in others it has little or no influence on how the reporting and practice of accounts is done. Code law countries tend to have common tax and financial reporting regulations, while on the other hand common law countries tend to keep the tax and financial reporting regulations separate from each other. There are three main types of taxation systems.
1. The tax rules and the financial reporting rules are kept entirely, or very largely independent of each other.
2. There is a common system, with many of the financial reporting rules also being used by the tax authorities
3. There is a common system with many of the tax rules also being used for financial reporting purposes.
With regard to corporate financing systems, the US Stock Exchange provides an important market for raising new capital. They attract listings by foreign registrants which seek to raise capital in the US market. Commercial banks are prevented from owning controlling blocks of shares in non-banking companies.
Corporate financing system allows companies to be financed in a variety of ways. Debt and equity can take many different forms and may be provided by many different types of individuals and institutions. The way in which a company is financed affects accounting in a number of ways. For example, if equity is relatively of more importance than debt finance, accounting regulations are more likely to be designed to provide information looking to the future in order for investors to make effective decisions. If debt finance is seen as more important, accounting measurement rules would be relatively more conservative, as they seek to protect creditors.
Impact of Culture
Salter et al.’s (1995) research found that Masculinity, which refers to a society’s preference in society for achievement, heroism, assertiveness, and material success, appears to be significantly related to the rule setting and measurement process. They also found that Uncertainty Avoidance, which refers to the degree to which the members of a society feel uncomfortable with uncertainty and ambiguity, correctly predicts a country’s level of Professionalism, Uniformity, Conservatism, and Secrecy (in terms of financial reporting) in about eighty percent of the cases. These cultural factors also interact. For example, Salter et al. (1995, p. 385) postulate that:
…countries that are low Uncertainty Avoidant/high Masculinity (e.g., the USA), driven by the need to achieve and unhampered by the need for certainty, encourage the operation of a market that provides a timely and optimal information set. For each country, the market, in turn, appears to arrive at a common set of acceptable rules (financial reporting practices) that are used by the vast majority of firms in measuring income and assets.
Overall, it would appear that it is the desire for certainty or, conversely, the willingness to manipulate an uncertain future, which is the strongest cultural construct in determining the overall structure of the accounting profession, the nature of regulation, the nature of measurement, and the volume of information. Market capitalization, which is itself related to Uncertainty Avoidance, enhances the effects of this cultural construct, and in the case of Professionalism and Conservatism is equally powerful in determining the final accounting systems. Taxation, which is uncorrelated with any cultural variable, acts to reverse the effects of market development, reducing the professionalization and judgment of the audit profession and moving reporting towards a more conservative perspective.
Conclusion
Accounting and auditing regulations in the USA are probably more voluminous than the rest of the world and substantially more detailed than any other country (Choi et al., 2002).
Salter et al.’s (1995) research showed that a country’s culture was good at explaining actual financial reporting practices, but also noted that a country exists professional and regulatory structures could be best explained by looking at culture as well as the development of financial markets and levels of taxation.
This paper has shown that it is important to know how and why accounting develops because it allows us to better understand a nation’s accounting by knowing the underlying factors that have influenced its developments because accounting differs around the world.

In this article, the author talks about the need for transparency in the organization. The author tells us that there is a need for the organization to be transparent to its clients so that they can have some trust in it. However, the problem is that very few companies are transparent and this means that when some information about the company finally comes out, some clients can no longer trust the company and the flee to other companies that they trust.
The author opens up the article by telling us that external auditors are now being scrutinized as they do not seem to be doing their work in the right way. This is after an energy company was declared bankrupt in December of 2001. The main reason as to why the company was not able to detect and then deal with the problem is due to the existence of some directors who were non- executive. The author tells us that these directors are out of reach and they make decision making and implementation in the company difficult. (The Economist)
Another problem came from the auditors’ tools of trade that is the accounting standards. Auditors seem not to properly utilize the basic accounting principles. Some of the recommendations that are raised to deal with this problem are first by splitting consulting business from the auditing business. This would eliminate the conflict that exists between the two. This is a move that is appraised by the big international auditing firms such as PricewaterhouseCoopers, KPMG and Deloitte. However, some firms felt that auditing firms should be banned from offering consulting services.  (The Economist)
There has been a number of recommendations that has been raised that needs to be implemented so as to ensure that there is effective auditing. There is a suggestion that single universal sets of accounting standards should be adopted. This call for the use of GAAP and this should not be weakened so as to accommodate the foreign companies in the New York Exchange Listing. There is therefore the need to set rules which would ensure that these recommendations are implemented. These rules can be set using two broad approaches. The first one is to define how to deal with all the situations and then to spell out the principles and leave the auditors to decide how to implement them.
Some of the areas where accounting rules is not in effect are the employee share options, in the off-balance sheet activities, in derivatives, intangible assets and revenue recognition. It is possible to manipulate figures in these areas as there are different methods or arguments for doing them. This has also been complicated by the growing use of pro-forma accounting that is non standard especially in high-tech industry. The reason behind this is that some people especially those in the IT believe that this gives a more accurate figure than the GAAP numbers.
The other problems is said to come from the people. That is the quality of the auditors themselves as some of them are not able to attend to accounting duties diligently. The other problem with the people lies in the reading. It is required that all the information be written in the legalese language. This language should be the normal English as it is easy to understand for everyone.
In our corporate world today, there is a need that an organization makes the best decision and implements the best recommendations so that it can remain in operation in these difficult economic times. This calls for proper financial information and activities being conducted. This is the main work of an auditor and therefore, they are the ones who will determine the survival of the organization.
I therefore fell that this article really presents the information that would be useful to any organization and which would help it to realize its goals. The article provides a comprehensive analysis of auditing activities and how one can deal with the various problems that are associated with them. Through following what has been discussed in the article, it is possible for an organization to realize and then correct the mistake that may be there.

Success in business is never a product of guess work or sheer lack. Neither is it as a result of coincident or accident. All success can be attributed to the ability by the management team of the business to carefully strategize and come up with different ways of approaching a given business issue that is deemed invaluable to business success. Of all the business strategies ever to be considered, planning has been universally accepted as very critical to business performance, as planning will make or break an organization. The failure to plan will more often than not lead to business failure, while careful planning will almost guarantee success in business. Apart from planning, the deliberate setting of targets is another very critical practice in business. When targets are set before one embarks on the journey to achieve them, the tendency is that such a person will meet those targets than if he/she went on the business journey without having set any targets.
Targets will always lead the business manager to the place where he/she will remain focused and looking forward to the set goal. A target is actually a goal to achieve. It is only acceptable that everything be done with a specific goal in mind. Life itself is lived because people want to accomplish a certain purpose. Just like life becomes boring and a monotonous formality when it is lived without any specific purpose, the lack of goals or targets in business operations is boring as work will be performed out of a sense of duty and not purpose. Such are fertile grounds for the breeding of failure. The following five sources are ideal in their presentation of information on planning and target setting.


Shannon, Kilkenny 2006 “The planning Session” in The complete guide to successful event planning. Atlantic Publishing Company
One of the most crucial areas in business where planning is very critical is events. Events are usually activities that are very important to an organization and whose success is an important milestone to the organization as well. Planning for an event is a must-do activity for all businesses. This book chapter clearly provides a stepwise approach to planning for an event. It points out that planning ought to come before any other operation is undertaken, and that any failure to plan is tantamount to planning to fail. It emphasizes the value of allocating time to planning.
This view extends what has been discussed in all the other sources in that the value of planning is emphasized. However, the book chapter’s coverage of the subject of target setting is just implied. It presents target setting as being ingrained in the overall planning process, unlike in most of the other sources where planning and target setting are divorced from each other. This chapter’s information is necessary for any business manager, not necessarily one who is planning for an event. The value of this book chapter can be deduced from the manner in which the author tackles the subject of planning, giving it a comprehensive coverage throughout the book. The information is authentic in that the author uses cases to illustrate points. The overall point communicated is the value of planning, and how indispensable it is in general business operations and events in particular.

This web page presents the idea of planning from the context of the business environment. It comprehensively covers the role that planning as well as target setting plays in achieving business success. The page actually offers the advantages that come with planning for every business venture, and the possible outcomes that come when planning is not done. Unlike the information provided by the book chapter above, the web page does not comprehensively address target setting differently from planning, implying the two are related or work together to produce synergistic effects to the advantage of the business that adopts their use. Using various examples and illustrations, the web page presents planning as a core component of business strategy and as ideal for all managers.
The author of the web page is of the opinion that planning and setting targets are essentially children of the same mother, even though they can be used and applied in different settings differently. The reliability of this information, however, has not been proven except that it concurs with all the other sources analyzed in this report as far as the importance of planning and setting business targets is concerned. On the whole, however, the web page seeks to point out that success in business is linked to planning and setting goals. Compared with other sources on the area of subject coverage, this web page addresses the subject well in a relatively shorter time frame (the information is precise and straight to the point)


Allison, Michael 2005 “Get ready” in Strategic planning for nonprofit organizations: a practical guide and workbook. John Wiley and Sons

This book extract is a pointer to what it means to have an organization moving forward towards its set goals. According to the extract, preparedness is the way to start before making any move. The author categorically exposes the value that is to be found in careful, goal-driven planning that seeks to make preparations with the overall goal in perspective and as the main aim. The book extract underscores the importance of seeking to understand the reasons why planning is important and has to be implemented as the first step in the strategic execution of a business. This extract is a part of a larger discussion in adjoining chapters about the much wider topic of strategic planning for businesses.
The author conveys the message of planning or preparing to plan. The book extract, just like the other book chapter, does not provide a separate discussion of targets and goals but incorporates them into the discussion of planning and preparing for the future. As far as the views put across by the book extract are concerned, they are in conformity with those presented in all the other sources, that planning is indispensable; and is directly responsible for the performance of any organization or business. The information provided by this book extract is relevant in that it offers one of the most issue-based approaches to the subject, drawing from relevant illustrations and primary sources for its arguments. Its information is authentic based on the author’s open reference to other scholarly secondary and primary sources.


Bowes, Brent 2009 “Investors Pay Little Heed to Business Plans.” The New York Times, May 13, 2009

This newspaper article gives the information about planning in a rather different approach. The article does not offer the importance of planning directly as the other sources have been addressing the issue, but uses the other side – the negative side of the matter, to prove this importance. In essence, the article is pointing out what risks organizations expose themselves to when they fail to plan. In fact, the article uses a case to prove the authenticity of its information, citing from recent primary sources that have statistical information on the negative impacts that certain managers have undergone for failing to pay close attention to business plans. Business planning starts at the point of setting up the business itself.
The author argues that if indeed senior managers can ignore to adhere to such valuable resources as plans, then the failure by some of the large business corporations can be directly attributed to this. In a rather unusual way, the author agrees with the other sources on the great importance of plans in business, and almost metaphorically lashes out at such acts of negligence by some managers. The article agrees with others on the critical role that is played by planning, and adds that business plans are no less critical to the organization. Although not referencing any specific sources, the information can be relied on based on the verification that results from its matching with others on the importance of planning and target setting.


Aharony, Joseph 2009 “Corporate Long-Range Quantitative Goals: Profit or Growth?” b Journal of Wealth Management, Summer2009, Vol. 12 Issue 1, p75-88

This journal article gives a comprehensive coverage of the subject of planning and setting of business goals (targets). It also compares the long-range quantitative targets that are put in place by corporations, with a particular focus on growth and the making of profit. The article uses a rather different kind of setting, focusing more on how goals and plans are put in place in the larger corporations. The message, however, does not change in any way. Instead, just like the other four sources, it reiterates the elevated place of the plans and goals or targets in society as far as importance and use is concerned. Planning, argues the author, can never be substituted by setting goals.
Instead, goals ought to be the focus of the plans, with the planner having in mind what is to be achieved. The author invariably uses goals and targets, adding more weight to the ideas developed by the other sources that goals are no much different from targets. The article not only covers the subject of importance and use of planning and target setting but also does so with an illustrative approach that draws from real-life cases. It is explicit in its approach and its authenticity and reliability is proven by its wide referencing to other sources of current information.

Conclusion
The role that is played by planning and target setting in the business environment is a critical one because both planning and setting of business targets are important components of the overall strategy of an organization. Strategic management plans for organization are essentially used to serve as direction pointers to the future of business or organization. Goals or targets, on the other hand, provide the impetus that a business needs to navigate forwards. As part of the larger strategy of the business, both plans and targets enable businesses to realize their long term and short term success as far as profitability is concerned. The five different sources used in their report are in agreement regarding the importance and use of plans and targets in businesses. Where they are lacking, the success rate expected for the organization is lowered. On the whole, therefore, all businesses and organizations ought to adopt the use of targets and plans to spur their operations to faster, more focused growth.

The Generally Accepted Accounting Principles (G.A.A.P.) are the conventions, traditions, assumptions and rules that the accountants are required to use when recording the transactions as well as when preparing the final financial statements. These principles are adopted to ensure that the financial statements are objective and free from any material misstatements, whether intentional or accidental. However, in the United States, these GAAP are not written in law.
The Financial Accounting Standards Board (FASB) is the body that is entrusted with the work of coming up with the generally accepted accounting principles, while the United States Securities and Exchange Commission (SEC) ensures that the public companies adopt these principles when reporting their financial accounts. These principles must have some characteristics that make them regulate the manner in which the financial statements are presented. The principles themselves must be acceptable by the reporting entities, allow for objective reporting, and must be simple to comprehend.
The United States generally accepted accounting principles are categorized into four basic assumptions, four principles and four constrains. The four basic assumptions are: business entity, the going concern, money unit principle and time period principle. The business entity assumption proposes that the business enterprise should be treated as a different entity from its owners and the revenues and expenses of the business should be accounted for separately from those of the owners. The going concern assumes that the enterprise will continue with operations in the foreseeable future while the money unit principle assumes that the US dollar will be the currency used. The time period principle supposes that the accounting periods can be divided into periods like one year or half a year and present financial statements that relate to that specific period.
The principles are: historical cost principle, the revenue realization principle, the matching principle and the disclosure principle. The historical cost principle requires that items should be accounted for based on their historical cost and not the market values. The revenue recognition principle requires that revenues should be recognized when earned and not when cash is received. This principle forms the basis of the accrual accounting system. (Nikolai, Loren A., John D. Bazley, and Jefferson Jones, 2007).
 The matching principle requires that the revenues be matched with the expenses so long as it is possible to do so. The disclosure principle requires that the information provided to the third parties should be just enough to allow for decision making. If necessary, supplementary notes should be attached.
The four constrains are: objectivity principle, materiality principle, consistency principle and prudence principle. The objectivity principle calls for the information contained in the financial statements to be gathered objectively. Materiality principle holds that significant items should be reported whereas the trivial items should be ignored. Consistency principle requires that the same accounting methods should be applied from period to period. However, this does not mean that a company should be rigid. Prudence principle means that profits should not be overstated and provisions should be made for losses.
Due to these detailed requirements, companies are now subverting the generally accepted accounting principles and presenting, to third parties, financial statements that are not in line with the principles. There are limited situations in which departure from the generally accepted accounting principles is allowed. These are situations in which it is evident that following the principles would make the financial statements become misleading. For instance, where it has been noted that the useful life of an asset is shorter than initially expected, a company may be forced to change its depreciation policy to reflect that fact. Continued use of the current depreciation policy would lead to material misstatements and therefore it is imperative to deviate from the consistency principle and adopt a new policy.
Another instance where deviation from the GAAP is called for is where a company has ceases to be a going concern. In other words, in a case were the company’s future is very uncertain. In such a case, the company would be compelled to show cognizance of this fact by stating the balance sheet items at their net book values as well as at their net realizable values. The net book values are the historical costs less the accumulated depreciation while the net realizable values are the estimated current market value of an item.
However, companies are also deviating from the principles for other reasons and through other ways. The companies may, at some instances, present revenues and costs that belong to the owners so that they appear as if they are making huge profits whereas they are not. This is subversion of the business entity assumption.
Subversion of the time period principle occurs when a company, includes in its financial statements, some information that does not relate to the period under consideration. Similarly, a company may fail to capture all the information that relates to the period being reviewed. This misapplication of the principles is an intentional act that is meant to distort the financial statements or to defraud the owners of the company. It is a requirement that the statement of comprehensive income should only contain revenues and expenses items that strictly relates to the period being reported.
Corporations that are faced with liquidity problems will always try to conceal this fact to the third parties. For this reason, such companies usually ignore the revenue recognition principle and record, as if earned, revenues that have not yet been earned. The revenue recognition principle requires that mere promises to purchase should not be recorded but the companies are recording promises as debts. These mere promises are reported as being part of current assets.
It is a requirement by the generally accepted accounting principles that the information disclosed should be enough to enable a third party to make informed decisions based on the financial reports. The disclosure principle requires that supplementary notes be provided to support the figures in the financial statements or to expound the statements. Some companies ignore this requirement when presenting their repots. For instance, since a pending litigation against the corporation cannot be recorded in terms of figures in the financial reports, they should be disclosed by way of notes. This is because the outcome of the lawsuit could negatively impact on the financial strength of the company.
The materiality principle was established to guide the companies on the items to include in the financial statements and the items to leave out. What is material to one company may be immaterial to another.  Materiality depends on the sensitivity of the item and the amounts involved. It is left to the discretion of the companies to decide what items is material to them. However, companies subvert this principle by failure to disclose certain items, which if disclosed, would affect the decisions made by the third parties.
The prudence principle requires that profits should not be overstated when reporting while there should be provision for losses. This principle requires that provisions should be made for bad and doubtful debts, provision for loss in inventory values, and any other provision that the company may find fit to make. For instance, if a debtor is declared bankrupt, the company should make sufficient provisions to cater for the loss.
The value of the debtors in the balance sheet should be adjusted accordingly so as to show only the valid debtors. This principle notwithstanding, corporations continue to present their financial reports without making the necessary adjustments to reflect a probable loss. (Bragg, Steven M., 2004).
The United States Securities and Exchange Commission (SEC) has been charged with the responsibility of ensuring that the investors are protected against fraudulent companies. The SEC does so by ensuring the GAAP are properly followed. The commission takes necessary action against the companies that fail to comply with these principles and the action may even involve lawsuits against those companies.
For instance, in 2007, the commission instituted a lawsuit against Ernst & Young Chartered Accountants and Denis O’ Hogan who carried out an audit on SmartForce PLC and wrote an unqualified audit report, despite the fact that SmartForce PLC had not complied with the requirements of GAAP. “SmartForce’s financial statements, which the company included in its annual and quarterly reports during the Restatement period, were materially false and misleading in that they overstated net income and revenue in some periods and understated net income and revenue in other periods by failing to comply with the GAAP”.(Administrative proceeding, File No. 3-12703).
In some cases, the commission may require the companies to restate their prior years’ profits and the chief executives may be compelled to refund compensation paid to them by these fraudulent companies. The commission issues a Wells notice to the Chief Executives of such companies informing them that its staff wishes to recommend an action against the company or the individuals. “In doing so, the SEC is relying on a provision of the Sarbanes-Oxley Act that lets the government try to recover incentive-based compensation from senior executives when their company is accused of reporting inaccurate financial data” (Otapka, Dawn W., & Maremont, Mark, 2009).
The US GAAP and the International Financial Reporting Standards share some similarities as well as differences. The generally accepted accounting principles are established by the Financial Accounting Standards Board (FASB) while the International Accounting Standards Board (IASB) establishes the International Financial Reporting Standards (IFRS). Some differences have come up as a result of different interpretations of the standards.
The similarities between the two relates to the presentation of the final accounts. The two frameworks requires that the final financial statements be comprised of the statement of balances of assets and liabilities (the balance Sheet), income statement, cash flow statement and a set of notes to the accounts. The two regulations also require that the accrual system of accounting should be adopted except when preparing the cash flow statement. The two frameworks also emphasize on the need to observe consistency as well as materiality principles when reporting. (Epstein, Barry J. & Eva K. Jermakowicz, 2008)
One of the notable differences between the two frameworks is on the layout of the financial statements. Under the US GAAP, there is no specific layout of the balance sheet or the income statement, but the public companies must follow requirements of Regulation S-X. Under the IFRS, there is no standard layout but there are minimum items that must be disclosed. When presenting the balance sheet under the US GAAP, the previous periods may be shown or a single year may be shown in certain circumstances. The IFRS requires that comparative figures for all items of the previous period must be presented.
Regarding the disclosure of deferred taxes, the US GAAP requires that they be presented as current or non current. However, the IFRS strictly requires them to be shown as non current asset or liability. The expenses in the income statement are classified according to their function under US GAAP while under the IFRS the expenses are classified according to their function or their nature. However, notes on the nature of the expenses must be attached if the function category is chosen. (Ernst & Young, 2009)
In conclusion, it can be pointed out that the principles as well as the international standards are very important when preparing the financial statements because they ensure uniformity and understandability of the financial statements.

The Sarbanes Oxley Act of 2002 was established after there was a huge outcry from the investors who had lost their invested funds. The Act was meant to protect the investors by ensuring that the audit reports are independent and fair.

Why was the Public Company Accounting Oversight Board (PCAOB) created?

The Public Company Accounting Oversight Board (PCAOB) is a non governmental, non profit corporation that was established under Title I of the Sarbanes Oxley Act of 2002. The main reason why this board was created was to protect the investors by ensuring that the audit reports are fair and independent. It has five members, all of whom are appointees of the Securities and Exchange Commission. Two of the board’s members must be or must have been certified public accountants.
 The Sarbanes Oxley Act of 2002 was enacted in July 30, 2002 after the investors lost billions of their funds invested in Enron and WorldCom. It was alleged that the auditors’ independence in these scandals had been compromised with the companies paying excessive audit fees to the auditors. (Holt Michael F. 2008).
The duties of the PCAOB are: to register public accounting firms that carry out audit of issuers, to establish rules related to the ethics and independence of auditors, to set the standards required for preparation of audit reports, and to inspect registered public accountants. The board performs any other duties as the SEC may deem necessary for promotion of high professional standards (Spillane Dennis K. 2009).
 The powers of PCAOB are set out in Section 101 of the Sarbanes-Oxley Act. These powers include: investigating the public audit firms and taking disciplinary action against the firms and staffs that fail to comply and taking necessary disciplinary action against registered public companies and auditors who fail to comply with the set standards. No firm or individual is permitted to carry out an audit on a public company unless that auditor is registered with the board. While carrying out its investigations, the PCAOB may require that an audit firm produces, as documentary evidence, notes and other materials in its possession. Failure to do so would lead to automatic deregistration. According to Siegel Joel G., et al. (2005):
National audit firms will be subjected to inspection annually; other firms will be inspected every three years. The PCAOB is empowered to impose disciplinary action (including sanctions on accepting new audit clients) on firms that have unsatisfactory inspections. (p.595)
The board inspects the non-audit services such as advisory services on tax management provided by the audit firms to their clients. However, the audit firms can appeal to the decisions taken by the PCAOB and the Securities and Exchange Commission (SEC) may overturn the decisions reached by the board. The board also has powers to hire staffs, accountants and other professionals, as it may deem fit to help it accomplish a certain mission. It also collects the fees that support it. The board has powers to act as a legal person. It can sue, be sued and represent itself in defense in any federal or state court of law. It also has powers to enter into legally binding contracts, execute instruments and perform any other act that may be necessary, appropriate and incidental to its activities as spelt out in the Sarbanes-Oxley Act. (Welytok Gilbert Jill. 2008).
Disclosure is defined as the providing of all significant information by a company to the third parties (owners, prospective investors, or government) in accordance with the standards set out by the regulatory bodies or by the terms of the agreement between the company and the third parties. The specific disclosures required by the Sarbanes-Oxley Act are: disclosure of all material off-balance sheet transactions in Periodic Reports, enhanced conflict of interest disclosures, disclosures of transactions involving management and principal stockholders, disclosures on the management assessment of internal controls, disclosure on whether the issuer has adopted the required Code of Ethics for senior financial officers, disclosure on whether the audit committee has a financial expert, and disclosures on any material changes that are likely to affect the issuer.
The first disclosure is detailed out in Section 401 of the Act. It relates to the disclosures in periodic reports. This section requires that all the financial reports should follow the generally accepted accounted principles. The Act requires the SEC to ensure that all the financial statements prepared either quarterly or annually do not contain material misstatements (untrue statements) or fail to disclose any material item.
The Enhanced Conflict of interest Provision requires an issuer to disclose all the loans that are advanced to its directors and executives. The law prohibits a company to give credit or loans to its directors unless the ordinary activity of the issuer is to advance loans to clients. In such a case, the company should give credit to its directors under the same terms and conditions as the other clients.
Section 403 deals with the disclosure of transactions involving the management and principal stockholders. The section requires every person who directly or indirectly owns 10% of the equity shares or who is a director or officer of the issuer to file a statement with the Securities and Exchange Commission, showing the amount of all the securities in which the person is a beneficial owner. Sub section 3 of Section 403 also requires that the person indicates the “ownership by the filing person at the date of filing, any such changes in such ownership, and such purchases and sales of the security-based swap agreements as have occurred since the most recent such filing under such subparagraph” (Public law, 107-204) .
The statements must be filed either at the time of registration of such securities, or within 10 days after such person became the beneficial owner or director. In case there has been a change in ownership or a purchase or sale of a security based agreement has occurred, the filing should be done before the end of the second day after the day on which the owner executed the transaction.
The management should also make a disclosure regarding the internal controls system. In the disclosure, the management should report on the structure of the internal controls system and also contain a self assessment report on the effectiveness of the internal controls towards accurate financial reporting. The auditors should carry out an audit to determine whether the assertions made by the management are correct and this should be considered a part of the audit and not a separate engagement.
Every issuer is required to disclose whether it has adopted a code of ethics and if no, give satisfactory reasons. The issuers are also required to disclose whether the audit committee of such an issuer is headed by a financial expert and if not, provide satisfactory reasons. The term ‘financial expert’ for the purposes of this Act is understood to mean a person who has, either through training or experience, had a thorough understanding of GAAP and is experienced in carrying out audit of financial statements and internal controls.
Finally, Section 409 requires real time issuer disclosure. This means that each issuer should disclose, in plain language, any information relating to changes in the conditions that may have tremendous effects on the issuer. This information should be disclosed by way of qualitative analysis, analysis of trends, and providing facts and figures where necessary so as to give the investors as enough information as possible. The information can also be provided, where the Securities and Exchange Commission deems necessary, in diagrammatic representations such as graphs (Center for Audit Quality 2002).
All the above disclosure requirements are very important to the investors. A strong disclosure regime ensures that all the information contained in the financial statements is free form untrue assertions or does not omit any information that is very significant. The investors can not personally run the companies they jointly own and therefore it requires a management team to run the companies on their behalf. However, if this management team is left unchecked, it can defraud the investors. Therefore, the government needs to step in and resolve this agency problem by passing legislations that require the managers to disclose all the material information.
A strong disclosure regime ensures that the investors’ confidence is restored and this is a healthy thing for the growth of an economy. The investors, the government and the financial lenders rely on the financial statements when making a decision regarding the companies. When these companies disclose enough information without having to omit anything material, these third parties make informed decisions based on facts. This is very beneficial to all the involved parties because the dealings between them are made a lot fairer.
Section 404 deals with the management’s assessment of the internal controls. The internal controls are the controls, financial or non-financial, that the management team of a company puts in place to ensure that the assets of the company are not misused as well as to ensure that the accounting system captures, quite accurately, all the transactions of the company. The management is supposed to disclose on the structure of the ICS (internal controls system) and evaluate the effectiveness of the internal controls. The auditors should then attest to the assessment of these internal controls.
Agency costs are classified into the costs that are directly related to using an agent (misuse of the resources) and the costs incurred in reducing the direct costs. The costs associated with collecting, analyzing, classifying and reporting the financial information on behalf of the stockholders are the agency costs. Section 404 of the Sarbanes Oxley Act of 2002 imposes agency costs on the issuers because they will be required to disclose more information as required by the Act.
In particular, the Act requires that the management team states its responsibilities towards the internal controls and the effectiveness of the controls and also imposes an obligation on the auditors to audit the management’s assertions and verify the effectiveness of these internal controls. (Ramos Michael J. 2004).
 These requirements of disclosure increase the agency costs in that the management has to evaluate the internal controls and report on how effective the internal controls have been in ensuring accurate financial statements. For the small public companies, the compliance costs are very high compared to the revenues that these companies generate. Although the SEC issued interpretive guidance in June 2007 to assist in the reduction of compliance costs, the costs still remains disproportionately high and are persuading the small public companies to go private. However, the SEC has issued a final extension requiring the external auditors to conduct an assessment after the financial years ending after June 15, 2010.
In conclusion, the enactment of Sarbanes Oxley Act was a very important thing towards the protection of investors. The Act establishes the PCAOB which is an oversight board over the audit of public companies. Since the generally accepted accounting principles are not written in the law, the Act ensures that these principles are followed whenever an issuer is preparing financial statements.

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