The Effectiveness of the Sarbanes-Oxley Act of 2002 in Detecting Fraud during the Audit Process
A Dissertation Prospectus
Submitted to the
Faculty of Argosy University Campus
in Partial Fulfillment of
The requirements for the Degree of
Doctor of Business Administration
Your Full Name
Argosy University (Your Campus)
04/2011
Dissertation Committee Approval:
________________________________________________________________________
Type in Name of Dissertation Chair, Degree Date
________________________________________________________________________
Type in Name of Committee Member, Degree
________________________________________________________________________
Type in Name of Committee Member, Degree
________________________________________________________________________
Type in Name of Program Chair, Degree Date
Table of Contents
Page
a) Introduction…………………………………………………………………………………..3
b) The Problem……………………………………………………………………………………………………………….2
Research questions ………………………………………………………………………………………………4
Statement of problem……………………………………………………………………………………………4
Assumptions……………………………………………………………………………5
Importance of the Study……………………………………………………………………………………….7
c) Literature Review………………………………………………………………………………………………………10
e) Research methodology…………………………………………………………………………14
Research Hypothesis…………………………………………………………………………………………….15
f) References …………………………………………………………………………………………………………………17
Introduction
Auditing in this concept means the main activity of the certified public accountant, and entails a separate examination of accounting statements, the interior control system and other proof to support the expression of an impartial expert opinion concerning the financial statements reliability. Financial statement according to this paper will be used to mean the mean through which accountants pass information to users. The financial statements can either be unaudited or audited, depending on what is needed from the corporation, and entail the balance sheet, the income or profit and loss statement, the statement of cash flows, subsidiary notes, and detailed schedules, when necessary (MorBarak, 2005).
The word fraud will be used to mean the dishonesty intentionally practiced to protected unlawful or unfair gain. It is also considered the deliberate misrepresentation of a material present fact made by an individual to another when in fact he or she is fully aware that the claim is wrong. According to Albrecht 2001, financial statement fraud is regarded as a deliberate attempt by individuals or organizations to mislead or trick users of in print financial statements, particularly creditors and investors, by arranging and propagating materially misstated financial statements. Reports on financial statements or accounting information should always be done with reference to the accounting standard which means that the preparation of an accounting report on the financial status of a company or a firm should be done on the accounting standards that are widely accepted. Accounting standards surround all the factors that are concerned with the authoritative support that is considerable in standards of accounting (Albrecht, 2001). The detection and fraud prevention during the audit process is significant in the financial candle light for most organizations.
Research questions
The main aim of this research is to determine the effectiveness of the Sarbanes-oxley act of 2002 in detecting fraud during the audit process. This would entail numerous aspects of the question one being to address whether or not SOX addresses accounting and auditing revisions by both private and public companies. The other aspects that will be addressed in whether or not SOX should revised t make it more efficient or whether it should be discarded as ineffective.
The response to the main research question of whether SOX is efficient can be affirmed by the legislative, judicial statistical analysis, and reporting enforcement actions. The research described herein, if completed, would have fully determined the effectiveness of SOX not only to ascertain if or if not the legislation is fulfilling the purpose of preventing and detecting fraud during the audit process, but the research aims also at establishing suppose adjustments are needed or necessary to enhance the usefulness and achievements of SOX (Pettinger, 1999). The lack of information about the effectiveness of the SOX might lead to increase in occurrences of frauds.
The study will also contribute to answering the question suppose enforcing SOX is worth the other related issues that have arisen since its formation. One of the issues that will be determined is whether the legislation has contributed to the rising costs, and specifically the internal control standards of SOX.
Through the research, the other question that will be answered is whether SOX affect the legislation of foreign companies. This is in regard to the diminishing number of the foreign companies listed in the stock market from 2003. For example, in 2003, only 19 non-American companies were listed but in 2000, 50 were listed.
Fraud detection by independent auditors is an important requirement to emerge from the recent corporate scandals. Kramar 2000 agreed that auditors must do more to discover fraud, which is what the public needs, and that audits reduce the probability of occurrence of fraud by a significant value. To detect fraud, Lawrence 2001 says that auditors should practice professional skepticism during an audit, and that the audit personal should be knowledgeable, skilled, and well-trained so that fraud can be recognized and the fraud risk determined. Auditors should also be wary of questionable accounting principles utilized by management, to ensure that the interior control system is adequately effectual to prevent and detect fraud occurrence probability. When fraud is detected, the audit steps should be obtained more reliable audit evidence, and include extra audit closer to the end of the audit year. Kinzel 2005 details some of the keys the auditor can use to detect management of the financial statements manipulations. The keys as he highlights are; the examination of the extent of the changes in account receivable and accounts payable that do not respond with company and industry trends, comparing inventory turnover and trends within the industry, examination of the controls over inventory, and examination of the contingent liabilities for feasibility.
Statement of problem
Has the legislation contributed to the rising of the internal control standards of SOX?
Does SOX affect the legislation of foreign companies?
Is SOX fulfilling the purpose of preventing and detecting fraud during the audit process?
Are there any adjustments required to enhance the usefulness and achievements of SOX?
Assumptions and strengths
One of the assumptions that will be made is that the enforcement and financial statement restatement data used in the research enough and of great relevance to the study to answer all the research questions and validate the conclusions. The sampled centers or institutions will be enough to provide all required information. The data that will be obtained during the research will be sufficient to determine the effectiveness of SOX. Due to the high reliability and validity issues in sampling, data collection and data analysis, the analysis will provide enough and consistent response to point to a single result, and any diverging result will be of no importance as long as majority of the data point to one thing.
The research is also expected to point out the present outcomes of SOX and suggest various method of improving SOX. Various viewpoints will also be employed to enhance the accuracy and relevancy of the collected data and this will adds strength to the conclusions made. The other assumption is that the data that will be collected during the research will be valid and the respondents will be as accurate when providing the data as possible and the results that will be obtained will truly reflect the actual case.
Kabala 2005 points out relevance to fraud auditing which states that the majority of fraud occurrences are either not reported or not discovered. He placed fraud into three categories. According to him, the first grouped composed of fraud that has been detected and known by the public. The second group is a fraud that has bee detected, but the concerned personal has chosen to hide it for various reasons and so not know by the public. The last group is a fraud that has been detected and is known by the public. Hellmann 2005 gives estimation that about 25% of fraud is a group one fraud, while 42% is a group two fraud. The detection of the financial fraud can be detected through audit process. This is because auditing is more concerned with the transactions that compose the balance in account, and not just the balance itself. He claims that minus the fraud auditing, “internal controls neither are nor effective, especially when two or more perpetrators are involved” (p. 8).
Proactive fraud is hard since it needs auditors to institute search procedures to detect fraud in circumstances where there is not evidence to show that fraud can exist. However, most auditors are not trained in fraud auditing or fraud detection, and do possess sufficient knowledge of evidence and its collection. Hesketh 2006 assert that proactive fraud auditing is not generally done because no generally accepted auditing standards or accounting principles have been developed to use a guide for the auditors. The contention of the authors is that such standards and principles should be written so that auditors are prepared to prevent and detect fraud through such auditing methods (Hesketh, 2006). In investigating suspected fraud, interviewing of key workers is very essential, as well as efficient note-taking and the recording of written statements, when necessary. Sufficient evidence must also be collected to purse any action taken against the perpetrator(s).
Importance of the Study
The examination of SOX is very important, considering that legislation is the most recent of SOX is therefore to this most recent problem. The examination of SOX and determination of its effectiveness in detecting and preventing fraud during the audit process is of utmost importance. Hartmann 1998 suggested that a good economy is normally hiding the problems that companies are experiencing, creating more of an incentive to “cook the books”. He also noted that the use of stock options as earnings for company executives is encouraging the executives to manipulate financial statements to come up with higher stock prices.
The significance of the research in determining if or not SOX has been effectual in detecting and preventing fraud will be mostly to check whether SOX has been effective. Suppose the SX result are insufficient, then the study would assist in determining if it is to be supplemented, or if an alternative solution needs to be implemented in its place. The study will also examine whether the existing programs supporting SOX like Securities And Exchange Commission (SEC) are capable of regulating the auditing filed effectually through the use of SOX, and suppose the result will show that it has been ineffective, then other method would be recommended base on the analysis of the auditing department of various organizations that will be examined (Nankervis and Compton, 2008).
The research will also be beneficial to numerous organizations and individuals. Certified Public Accountants will benefit from the study as it will help them in assessing the effectiveness of SOX, and in determining if other steps will be necessary so that they can prevent and detect fraud in the audit process. Companies and corporations will also be beneficiaries of the research outcomes. SOX in the past, has caused extra costs by corporations in order to comply with the internal control standards imposed by SOX. According to Fleetwood 2006, all officers of organizations, whether public or private, may be affected by the new standards of SOX.
The investor will also benefit from the program. This will be in finding out whether or not SOX is protecting their interests. A poll of investors, done in 2003 by Dowling shows that investors confidence is closely aligned with companies’ compliance with SOX. Three out of five investors believed that SOX assists in protecting their stock investments. However, the rest totally disagreed. It would behoove the investors to read and study and be informed as to how effective SOX actually are in prevention and detection of fraud in the audit process.
In accounting, the financial status of a business is a very vital issue that should always be handled carefully since it is the backbone of a business and this means that a business without a strong financial management is not competent in competitive market in the modern world thus effective decision making in the business. Financial accounting should not be done with reference to what a single worker plays his role in a business but it should be done as a combined effort of all the members in the managerial sector of a firm or a company thus it should be decided by all the members. Financial accounting again is not performed without following the principles of accounting that is generally accepted and it should always follow the guidelines of accounting (Jackson, 2003). Working as an accountant is not an easy thing because it requires someone who is professionally trained as an accountant. With this information, it is of great significance to monitor and effectively manage the present SOX.
Strategic human resource management (SHRM) generally refers to a managerial process that is comprised of human resource practices and policies which are linked to the strategic objectives of the alleged organization. The past decades has witnessed human resource practitioners and researchers shifting their attention towards addressing vital issues such as fraud, the factors that determine the kind of strategic approach that an organization should adopt and the ways in which these strategies can be practiced (Aldrich, 1999). Moreover, a lot of Human resource research exercises have been geared towards discovering the impact of Strategic human resource management on the overall organizational performance. The study will be useful as the mangers will be able to detect and determine the magnitude and the extent to which fraud can affect their respective organizations and the possible methods for its detection and prevention.
Donald 2005 suggest changing audit procedures in order to detect fraud, audits should be conducted using the bigger picture or from a wider view perspectives. Employee fraud is normally for individual gain and does not result in fraudulent financial statements, while management fraud is usually for the purpose of falsely improving the appearance of the financial condition of the organization, which is considered fraudulent financial reporting. Management fraud is very hard to detect and prevent. The three characteristics of fraud that are usually present are
Perpetrators of fraud always have a reason for committing the fraud
The opportunity to commit the fraud presents itself
In the mind of the perpetrators, the perpetrators can justify the crime (Pawan, 2004)
When the client has an effective internal control system, and the auditor can assess the risk of the client, understand the business and industry of the client, utilize analytical procedures, and redesign the workplace of the auditor to help assess the risk of fraud, then the auditor can more effectively prevent and detect fraud in the financial statements of the client.
Literature review
Frauds lead to risks in organizations. A risk can be described merely as a hazard. It however can be described in more depth as a deviation of the results received of the future expected results. Risks are a part of activities that humans engage in. Enterprises are more prone to frauds and the managers of these enterprises have to manage these frauds in different ways. Risk management is the process of dealing with the risks that come in hand. Enterprise identity management systems are usually used with information technology based systems and enterprises. According Daniel 2004, this system is used to manage risks in enterprises because of its efficiency and the method that it uses to control the risks. It takes into consideration the costs and the benefits of managing risks in an organization and it also considers the setting of the organization. Identity management is important in managing risks in an enterprise because of its strong variables which include authorization, compliance, and authentication and user management. A viable risk management strategy must therefore include an identity management process because it helps in authorizing the users of any enterprise data and information system to avoid any breaches or hacking (Brewster & Vernon, 2007). The identity management process will validate the identity of the users by either putting codes to be used by the users when accessing the system or giving an authorizing word or phrase when accessing the system. This process also allows the management to issue permission to access the system on a continuous basis and therefore ensure security and reduce risks. The auditing process is therefore effective in managing the risks and reducing chances of more frauds.
Financial accounting mostly rely on some of the following concepts; Assumptions, Principles and Modifying convections. Under the concept of assumptions, financial accounting relies on assumptions that are related with the stability of the amount of money that the company has, the period in which the company should exist in the market, individual assumption that the business should have and the on going-concern of the business that focuses on how the company is thriving (Clegg, and Sparrow, 2007). It also relies on its own principles that focus on the history of the cost of money that has been incurred and paid in the business, recognizing the revenue that is incurred in the business, its matching principle and the full disclosure of all the underlying principles of the business. Finally, financial accounting relies on modifying conventions that mainly deal with the essential practices that should take in the company, the amount of money that the company has and is willing to invest in, what the company or the business should conserve as part of business management and the cost benefit in the business.
The United nations Congress officially passed the Sarbanes-Oxley Act of 2002 (SOX), and there was a legislation designed to protect those who had interest in making their investments by reducing the errors and enhancing corporate disclosures reliability made pursuant to the securities laws, and for other reasons. In order to finish the task and make better the investment, the main aim of SOX has been to prevent and detect fraud in financial statements, policed by the Securities and Exchange of whether or not SOX, after functioning for a period, had effectively and had been actually been efficient in preventing and detecting fraud. The institutions that were affected by Sarbanes-Oxley Act of 2002 were most notably non-private businesses that were obliged to comply with the numerous needs of the law (Burke & Cooper, 2005). The shareholders and investors depend on the financial statements of the complying corporations were found to be positively affected by SOX, to the extent that it satisfied the users by fulfilling its purposes of preventing and detecting fraud in financial statements.
Various factors have contributed to the prior incidences of fraudulent financial reporting, including deficiencies in the audit process, lack of suitable corporate governance, and unethical management practices. For example, after the collapse of Enron in America, the country took upon itself to make a legislation to detect and thwart the kind of fraud that resulted to the downfall of Enron. A committee started the devising a bill to deal with the newsworthy matters that were brought about by filing of bankruptcy by Enron and the subsequent loss of pension suffered by its workforce. The situation would have been prevented suppose the existed a thorough and effective Sarbanes-oxley acts of 2002 in detecting fraud during the audit process. According to Armstrong 2006, the problem must have been caused by the insufficient oversight of accountants, the lack of auditor independence, weak corporate governance procedures, a stock analyst conflict of preferences, and even insufficient provisions of disclosure of which all revolve around the auditing. More specific, most authors, in reacting to the condition have pointed out that one of the major problems that must have led to the problem is the Sarbanes-oxley acts of 2002 in detecting fraud during the audit process (Armstrong, 2006).
The accounting and auditing professions have been shaken by the Enron collapse and the resulting ban from auditing public companies. There has therefore been a great need to alter the auditing process to enhance the accuracy of the obtained data of change the professional, which has yielded next-to-nothing results (Salaman & Storey, 2005). Congress has reacted to the events with the passage of SOX, aimed at preventing another Enron scandal. To make the stock offerings of the publicly traded corporation a more better investment, various companies that have undergone the same way do develop and use special purpose entities (SPEs) as liability receptacles aimed at removing millions of dollars of debt from the balance sheet. However, SPEs are only meant to operate as trust for the parent company or institution that initiated them.
SOX’s main functions have been to restore investing public’ confidence, accounting profession regulation, auditing and financial reporting process, and have acted as a directive to raise the standards of corporate accountability and transparency. Presently, many organizations and institutions, more so in US, are subject to SOX, most of which are big companies. SOX provision entails areas such limiting the services offered by human auditors, documentation and audit of internal controls, corporate governance, personal accountability, enhancing disclosure, protection for whistleblowers, analyst of interest conflicts, and professional conduct for the mangers. Mandan 2005 says that, “the most sweeping legislation offering accounting, disclosure and corporate governance in the generation has been SOX”. Regarding its importance to the auditors and other bodies, there is a great need to determine the effectiveness of SOX. The legislation, though having numerous merits, has been associated with demerits. In America, as noted by McGrath and Baird 2004, most of the companies are choosing to be private to do away with the SOX regulations. As from the new reporting needs of SOX, there has been a rise in the number of companies announcing privatization. SOX have been for only more than nine years. One assumption that has been made by those who employ SOX has been that it has bee effective in detecting and preventing the fraud in auditing.
Throughout their studies, subsidiary study questions including if or not the costs to comply with SOX are worth the result, and whether SOX is substantially different from former studies have not been explicitly discussed. Additionally, whether or not the Congress is qualified to give the remedy to the present fraud situation, and if SX will correspondingly lead to the return of investors confidence in the securities market by giving sufficient corporate transparency into the financial status of the target investment.
Research Methodology
The study will use statistical methodology in order to examine the collected data. The data will be randomly collected from a survey that will be conducted in organizations to evaluate the level of the effectiveness of the Sarbanes-Oxley act of 2002 in detecting fraud during the audit process. Among these factors that were subject of the assessment were the SOX outcomes referring to the period, personal attitude regarding SOX and the balance between the number of companies entering and those leaving SOX. The respondents will be classified into tow categories, as either of private companies and of public companies. A total of 30 private companies and 30 public companies will be randomly selected and their audit departments will be assessed on the basis of how effective the SOXs are (Dewe and Cooper, 2007).
Majority of the data that will be analyzed will start from the point where the fraud is detected. The mean number of occurrences of fraud before and after the inaction of SOX will be determined and tested using the unpaired t-test. The chi test will be employed to test the significant difference between the number of fraud occurrences before SOX and after. One advantage of the methods is that they are the most reliable in producing the most accurate data.
The other method that will be used is the involvement of the financial statements prior to the introduction of SOX and after its introduction and this will only apply to the public companies where SOX is used (Camilla, 2003). The methodology that will be used throughout the study will entail correlation research. Correlations will be examined between numerous statistics and the fraud occurrences in relation to the enactment of SOX.
Research Hypothesis
For clarification of the research direction, a research hypothesis will be of great significance. The hypothesis will be a statement that states or describes the expected outcomes of the research. It is also important for it to state the expected differences, relations between any two variables.
In order to investigate the question further and attempt answering it, the following hypotheses are formulated to aid in answering the question:
H0: SOX is not effective in detecting and preventing fraud in the audit process, that is μ1 – μ2 = 0. This will be the null hypothesis. It is the negative form of the research hypothesis.
H1: SOX is effective in detecting and preventing fraud in the audit process, that is μ1 – μ2 ≠ 0 will be the alternative hypothesis.
A very close examination will be provided as in some cases, two types of errors can arise. A type of error can take place when the null hypothesis is rejected when it is in fact true. The second type of error occurs when the null hypothesis is accepted when it is in fact incorrect. Type one of error might occur suppose the research reveals that SOX is effective, when it is not or when the results leads to conclusion that SOX is ineffective, when it effective (Caldwell, 2003).
In the analysis, some assumptions have been made to ease the investigation and curb complications. First, it is assumed that the samples come from a population with a standard normal distribution mean = μ. In addition, in the z-test, it is assumed that the variance for the samples is known with certainty as indicated in the tables below.
Rejection Regions
Suppose the claim does not give one particular direction it is non-directional and therefore a two- tailed test shall be used to carry out the test. At a significance level of 0.05 the z- value is 1.960 the rejection regions will be indicated by the graph as shown below in the shaded areas.
The p-value on each side of the tails becomes 0.05/2 which is 0.025. At this p- value the z- value is 1.960. our rejection region will be any value exceeding this value meaning that it will be falling within the shaded region and the corresponding p- value will be greater than 0.025.
Conclusion
In business management, accounting plays a very essential role since it gives information that is required for effective decision making in any business that wants to thrive well in competitive business environment. Financial accounting is the system that offers all the necessary information about a business through giving reports on how the business is doing and on how it relates with its investors, tax authorities and creditors.
References
Albrecht, M. (2001). International HRM: managing diversity in the workplace. New York.
Wiley-Blackwell Publishers.
Aldrich, H. (1999). Organisations evolving. Asia Pacific Journal of Human Resources (Australia): Sage Publications 33 (3): 4- 16.
Armstrong, M. (2006). Strategic human resource management: a guide to action. New York.
Kogan Page Publishers.
Brewster, C., & Vernon, G. (2007). Global Human Resource Management. 2nd Edition, London.
Chartered Institute of Personnel and Development.
Burke, J. & Cooper, L. (2005). Reinventing human resource management: challenges and new
Directions. New York. Routledge Publishers.
Caldwell, E. (2003). Research Designs and their applications: Connecticut, USA. Engage Learning.
Camilla, M. (2003). Textbook of basic Research Methods. New York, USA. Lippincott Williams & Wilkins.
Clegg, C. & Sparrow, P. (2007). Predicting future proficiency supplies: a three-phase tactic.
Personnel Review, 36 (1): 65-90.
Daniel, J. (2004). Challenges of globalization. New York. Gabler Verlag Publishers.
Dewe, P. & Cooper, C.L. (2007). Managing Research and Measurement of Work Related Stress.
Global Review of Organizational Psychology, 22: 141-192.
Donald, S. (2005). Integrated Research designs (IRD). Journal of research, vol. 33, no. 5, pp.
42-69.
Dowling, P. (2008). International human resource management: managing people in a
multinational context. New York. Cengage Learning.
Fleetwood, S. (2006). Competent management- recitals research: underprovided instructive
Power. International Journal of Human Resources Management, 17(12): 191-195
Hartmann, L.C. (1998). The impact of trends in labour-force participation in Australia. Warriewood, Australia. Woodslane Pty Limited.
Hellmann, C.M. (2005). Job satisfaction and intent to leave. Journal of Social Psychology 137
(5), 67-109.
Hesketh, J. (2006). Speculate: Research on the Human Resources. Journal of Critical Realism, 5
(2): 228-250.
Jackson, E. (2003). Diversity in the Workplace: Human Resources Initiatives. New York.
Guilford Press.
Kabala, M. (2005). Modern Research Methods and Techniques. New York, USA. Lippincott Williams &
