The Sarbanes-Oxley Act (SOX) was passed in 2002 in response to major corporate accounting scandals to strengthen auditor independence and oversight. SOX restricted auditors from providing non-audit services, required audit partner rotation, established the Public Company Accounting Oversight Board to regulate auditors, and mandated that auditors report on companies' internal controls in addition to their financial statements. These changes significantly altered the auditor's role and increased their responsibility under SOX to act as a gatekeeper protecting investors through verifying companies' financial reporting.

1. The Sarbanes-Oxley Act’s
Effect on Audit
By Nina Richardson
Seminar in
Audit/Information
Assurance
03/26/2015

2. Table of Contents
Executive Summary……………………………………………………………………………3
Introduction………………………………………………………………………………………4
The Question of Auditor Independence……………………………………………….5
What is Auditor Independence……………………………………………………………5
Importance of Auditor Independence………………………………………………….6
SOX and Auditor Independence…………………………………………………………..6
SOX Created Stronger Rules………………………………………………………………..7
Public Accounting Oversight Board……………………………………………………..8
SOX Impact on Auditor Role………………………………………………………………..9
Auditing Financial Reports………………………………………………………………….10
Changes in Audit Due to Sarbanes-Oxley……………………………………………..11
Conclusion…………………………………………………………………………………………12
References…………………………………………………………………………………………13

3. Executive Summary
Prior to Sarbanes-Oxley accounting firms had let standards go in the pursuit
of greater profits and a willingness to retain clients at any cost. The change in
accounting and audit attitudes happened with the age of the computer. The old
fashioned ways became obsolete and firms needed to find ways to bring in new
revenue. Partner's pay linked to billable hours began shrinking in comparison to
investment bankers. Firms realized there was much more profit potential in
providing consulting services. Auditors were pushed to sell as many services as
they could to the audit client. The more consulting fees an auditor brought in the
faster the rise to the coveted partner position. The pursuit of profits meant
standards had to give way. A new culture of keeping the client at all costs and
making them happy took shape. Audit firms developed cozy relationships with their
clients and didn’t’ tell them no when clients were practicing aggressive accounting.
Some auditors went so far as to suggest aggressive accounting practices for the
client. The end result was disaster. In between the years 2000 and 2002 accounting
scandals like Adelphia, WorldCom, Rite Aid, Waste Management, and ultimately
Enron shocked the world. Arthur Andersen the accounting firm who once had the
reputation of being tough and standing up to clients was disgraced. The firm was
forced to close their doors because they could no longer perform audits. Something
had to be done to prevent these events from happening again. Sarbanes-Oxley was
enacted as law to re-establish auditor independence and regain investor trust in
financial statements once more.

4. Introduction
On July 30, 2002, George W. Bush signed into law the Sarbanes-Oxley Act
(SOX). The act was created to restore investor confidence in the markets.
Previously, the world was shaken by the collapse of Enron and the one hundred year
old accounting firm Arthur Andersen due to financial statement fraud. Many people
lost entire retirements along with several billion dollars of investor and creditor’s
money when Enron’s stock became worthless overnight. Congress and the White
House had to act to prevent events like these from happening again.
SOX contained many new provisions that affected accounting specifically.
“These provisions include: establishing a comprehensive framework for reforming
the oversight of public company auditing; strengthening the independence of
auditors; requiring greater corporate responsibility and accountability among
senior management of public companies; and improving the quality and
transparency in financial reporting by public companies” (Thompson & Lange,
2003). One of the largest changes was the creation of the Public Accounting
Oversight Board (PCAOB). PCAOB is a nonprofit corporation overseen by the
Securities and Exchange Commission (SEC). The purpose of PCAOB is to monitor,
inspect, investigate, and discipline registered public accounting firms and persons
associated with the firms. All accounting firms who conduct audits must register
with the Oversight Board. Firms who perform over 100 audits a year must be
inspected annually. Firms that do less than 100 audits are inspected every three
years.

5. The Question of Auditor Independence
The question of auditor independence has been around along time. The main
issue is for whom does the auditor work for: the investing public or the client. The
lack of an answer to that question is what impairs auditor independence. Society
wonders what is the trade off between providing high quality audits or
independence being threatened by the auditor providing non-audit services.
History has proven through the accounting scandals of WorldCom, Enron, and
Waste Management that auditor independence is impaired when there is a
profitable business relationship with the client and consulting fees are involved. An
incentive structure within the CPA firm rewarding client retention has also
contributed to impairment of independence. “Alleged breaches of independence
due to profitable business relationships with clients can be costly to the CPA firm.
As the Enron and WorldCom episodes further document, independence loss may be
catastrophic for client employees, shareholders, creditors, and the markets and
society generally” (Anandarajan, Kleinman, & Palmon, 2008). After Enron
collapsed there was a large uproar over the involvement of Arthur Andersen. The
relationship and internal processes between the auditor and client were brought
into the public arena. When both houses of the Senate addressed the matter, SOX
was enacted into law.
What is Auditor Independence?
The SEC defined independence. “Independence is understood to refer to a
mental state of objectivity and lack of bias” (Securities and Exchange Commission,

6. 2001). Auditor independence can also be described as a characteristic of a good
practitioner, who must be independent of any interest that might affect his/her
judgment. Independence is important for the audit profession because it is the
foundation for auditing. Without independence, auditing loses its legitimacy.
Importance of Auditor Independence
The SEC stresses auditors are the gatekeepers to the public security markets.
“To a significant extent, this makes independent auditors the “gatekeepers” to the
public security markets. This statutory framework gives auditors both a valuable
franchise and an important public trust. Within this framework, the independence
requirement is vital to our securities markets” (Securities and Exchange
Commission, 2001). By requiring auditors to be independent two important goals
are met. The first goal is to ensure high quality audits with minimal external factors
affecting the auditor’s judgment. Each audit must be performed with skepticism and
a willingness to decide on issues objectively. The second goal is ensure investor
confidence in the published financial statements. Investor confidence in the
integrity of financial statements is the foundation for a secure and stable economic
system. Investors are more likely to invest their capital and pricing of securities is
more efficient when financial information is reliable.
SOX and Auditor Independence
In the summer of 2002 there were several accounting scandals that rocked
the world. Most unforgettable was the scandal of Enron and Arthur Andersen. The
tragic story became a tale of caution and case study information in countless

7. textbooks. The admission by managers they had purposefully misled investors
caused everyone to question the integrity of auditors. A major downfall perceived
for Arthur Andersen was the auditor's did not have true independence because the
lines between Enron and Arthur Andersen were blurred. The firm had developed a
cozy relationship with the client over several years. The revolving door between the
companies meant auditors knew they would be guaranteed a high paid position at
Enron. They also did not have a voice to raise objections against unethical and
illegal accounting procedures performed by Enron. Enron was considered a crown
jewel due to the amount of revenue from consulting fees. Auditors who raised
objections were demoted or terminated. SOX requires external auditors to report
directly to the audit committee, a publicly traded corporation must rotate auditors
every five to seven years, and there is a mandatory cooling off period of 1 year
before an auditor can be hired by a client. Title II of SOX further strengthens auditor
independence by having stronger rules on prohibited activity, audit committee
approval of non-audit services, and reporting of critical accounting issues and
alternative treatment to the audit committee.
SOX Created Stronger Rules
The rules for non-audit services were revised. “Except as provided in
subsection (h), it shall be unlawful for a registered public accounting firm that
performs for any issuer any audit required by this title or the rules of the
Commission under this title or, beginning 180 days after the date of commencement
of the operations of the Public Company Accounting Oversight Board established
under section 101 of the Sarbanes-Oxley Act of 2002, the rules of the Board, to

8. provide to that issuer, contemporaneously with the audit, any non-audit service
including – bookkeeping, financial information systems design and implementation,
appraisal or valuation services, actuarial services, internal audit outsourcing
services, management functions or human resources, legal services and expert
services unrelated to audit, and any other service that the Board determines, by
regulation is impermissible”(Sarbanes-Oxley Act, 2002). SOX also required partner
rotation on an audit engagement team every five to seven consecutive years
depending on the partner’s involvement. Accountants on the audit would not be
considered independent if they had received compensation for providing the client
with services other than auditing.
Public Accounting Oversight Board
When Sarbanes-Oxley became law the key component was the creation of
PCAOB. “There is established the Public Company Accounting Oversight Board, to
oversee the audit of public companies that are subject to the securities laws, and
related matters, in order to protect the interests of investors and further the public
interest in the preparation of informative, accurate, and independent audit reports
for companies the securities of which are sold to, held by and for, public
investors”(Sarbanes-Oxley Act, 2002). The Board was given authority to adopt
independence and quality control standards. The authority to inspect and require
audit deficiencies to be fixed, impose fines, and revoke registrations was also given
to PCAOB. PCAOB is overseen by the SEC and is not government sponsored or tax
payer funded. Its purpose is to restore confidence of investors and society in the
integrity of published financial statements. The duties of PCAOB are as follows:

9.  Register public accounting firms that prepare financial statements.
 Conduct inspections of firms that provide audit services.
 Enforce compliance by registered firms and persons employed to
professional standards and laws.
 Investigate, discipline, and impose sanctions.
 Establish or adopt auditing, quality control, ethics, independence and
other standards in regards to the publishing of financial statements.
(Carmichael, 2004)
SOX Impact on Auditor Role
After SOX was passed the role of the auditor changed. A new approach to
audits was required. The methods used by auditors pre-SOX were no longer
acceptable. Previously auditors would use substantive procedures instead of testing
controls or would use a combination of the two. They would use a method of cycle
rotation to test controls. Controls would be tested in the entity’s transaction cycles
while doing a walk through to make sure no changes had been made in the process.
SOX requires auditors to report on the effectiveness of management’s internal
control for the financial statement process on an annual basis. “Since auditors now
must report comprehensively on the effectiveness of management’s internal control
over financial reporting on an annual basis, cycle rotation is no longer acceptable in
public company audits” (McConnell & Banks, 2003). Previously, it was acceptable to
minimize testing of preventative controls. Preventative controls are necessary to
make sure transactions are being recorded properly. SOX required auditors to
obtain greater evidence about the operating effectiveness of preventative controls.

10. Testing should include substantive procedures, tests of details and analytical
procedures for every material account or transaction. Auditors are also required by
SOX to attest to management’s assessment of the effectiveness of internal controls.
“With respect to the internal control assessment required by subsection (a) each
registered public accounting firm that prepares or issues the audit report for the
issuer shall attest to, and report on, the assessment made by the management of
issuer” (Sarbanes-Oxley Act, 2002). Management must report and document how
effective internal controls are. “The auditor cannot accept management’s
responsibility to reach conclusions on the effectiveness of the entity’s controls nor
can management base its assertion about the controls design and operating
effectiveness on the results of the auditor’s tests” (McConnell & Banks, 2003).
Auditing Financial Reports
AICPA AU-C Section 200 provides objectives for the independent auditor and
the conduct of an audit. The purpose of the audit of financial statements is to
provide an opinion on whether or not the financial statements are presented fairly.
“The overall objectives of the auditor, in conducting an audit of financial statements,
are to obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error, thereby
enabling the auditor to express an opinion on whether the financial statements are
presented fairly” (AICPA, 2014). The evaluation of financial statements should
"consider the qualitative aspects of the entity’s accounting practices” (AICPA, 2014).
The auditor will evaluate if accounting policies were consistent and appropriate,
accounting estimates are reasonable, information is reliable and relevant, there are

11. adequate disclosures, and the terminology is appropriate. An auditor’s report must
be included. The report should include a description of management’s
responsibility in preparing the financial statements. The auditor must include their
opinion and the audit was conducted in accordance with generally accepted auditing
principles.
Changes in Audit Due to Sarbanes-Oxley
One of the main goals of SOX was to reestablish auditor independence,
strengthen the role as gatekeeper, and restore confidence in the auditor’s opinion.
One of the major changes caused by SOX was the restriction against auditor’s
providing consulting and other non-audit services for a client. The second major
change was the requirement for auditors to report directly to the audit committee
instead of the managers. The rule was created to prevent the auditor from feeling a
conflict of interest and helping them retain professional skepticism. A third change
that was less noticeable was the requirement for an auditor to give a second public
opinion in addition to the traditional opinion on the financial statements. The
second opinion is the auditor’s observance on the effectiveness of a company’s
internal controls. Lastly, SOX brought an end to the audit and accounting profession
self-regulation. The purpose of creating PCAOB was to monitor auditing firms,
auditors, and create audit standards.

12. Conclusion
Sarbanes-Oxley has been in place over 10 years now. Criticisms of the law
state auditor independence has not improved, companies are still publishing
inaccurate financial statements, and the law is prohibiting the growth of business
because of the cost for compliance. Laws are not perfect but they can be revised to
make things better and adapt with changes in the economic landscape. Despite the
negativity there have been improvements in auditor oversight and independence.
However, the law in itself cannot create and maintain auditor independence.
Auditors must continually seek to improve their work and remain committed to
professional standards and ethics. There must be increased communication
between auditors, audit committees, shareholders, and PCAOB. People must
continue working towards greater transparency in regards to financial statements
while remaining committed to high standards in an effort to safeguard investor
confidence.

13. References
AICPA. (2014, February). AU-C Section 200 Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing
Standards. Retrieved March 26, 2015, from AICPA.org:
http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments
/AU-C-00200.pdf
Anandarajan, A., Kleinman, G., & Palmon, D. (2008, May). Auditor independece
revisited: The effects of SOX on auditor independence. International Journal of
Disclosure and Governance , 112-125.
Carmichael, D. R. (2004, June). The PCAOB and the Social Responsibility of the
Independent Auditor. Accounting Horizons , 127-133.
McConnell, D. K., & Banks, G. Y. (2003, August 31). How Sarbanes-Oxley Will Change
the Audit Process. Journal of Accountancy .
Sarbanes-Oxley Act 2002, Public Law 107-204, 116 Stat. 745
Securities Exchange Commission. (2001, October 12). Final Rule: Revision of the
Commissioner's Auditor Independence Requirements. Retrieved March 26, 2015, from
U.S Securities and Exchange Commission: http://www.sec.gov/rules/final/33-
7919.htm
Thompson, J. W., & Lange, G. (2003). The Sarbanes-Oxley Act and the changing
responsibilities of auditors. Review of Business , 8-12.