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Sarbanes-Oxley Section 404 Impacts on European Companie S Acknowledgements

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Sarbanes-Oxley Section 404 Impacts on European Companie S Acknowledgements Master thesis Spring semester 2007 Supervisor: Gary Cunningham Author: Julie Bonnefond Karell Lounkokobi Sarbanes-Oxley section 404 Impacts on European companie s Acknowledgements Acknowledgements We would first like to thank our supervisor Gary Cunningham for his precious work and for guiding us along this journey. We would equally like to thank Margareta Gällstedt for giving us advice during the most difficult moments of our thesis. We are grateful to the different members of USBE and the student expedition for the different guidance they provided us with. We are equally grateful to all our respondents, this study would not have been possible without their cooperation. We would like to thank Scott Davies for his precious help concerning writing in English. Finally we would like to thank our families and friends for supporting and encouraging us every day in our work. Abstract ABSTRACT With the advent of corporate scandals in North America most notably the Enron case, the US congress passed the Sarbanes-Oxley Act to redress the situation. This act aims to restore confidence of investors in financial markets, and to improve the management of companies. The three main principles of the Act are: exactitude and availability of information, responsibility of managers, and independence of auditors. The section 404, which is one of the main sections of the act, deals with internal control and requires that management undertake an assessment of internal control over financial reporting. This section can be considered to be the focal point of the Sarbanes-Oxley law and is the main focus of our study. The Sarbanes-Oxley act is an American law but European companies who seek funds in the US markets also have to comply with the act. This led us to formulate the following question: How does the section 404 of Sarbanes-Oxley Act impact on European companies in terms of Internal Control over Financial Reporting? To answer the research question, we have chosen to undertake an exploratory study, concentrating on Sweden. We have conducted our study using a qualitative method, making interviews to gather primary data. The companies we interviewed all had their headquarters located in Sweden and had to comply with SOX. We conducted four interviews with companies of different sizes, different industries and which most importantly, had implemented Sarbanes-Oxley for different reasons. Basing our research on the following theory: Risks when realizing the financial statements. Material misstatements (errors) in financial reports. The Sarbanes-Oxley act, And more precisely the section 404 of the act, We built up an interview guide that we used for the interviews. Our theory and the interview guide helped us to focus on key points during our research. We looked for the consequences of the implementation of Sarbanes-Oxley, the impact of section 404 on material errors, the European perspective following Sarbanes-Oxley and the general point of view of the interviewees. The result of our studies is that the implementation of the section 404 of the Sarbanes- Oxley Act had a positive impact on the companies. Indeed many improvements have been noticed after the implementation of Sarbanes-Oxley, such as the improvement of the organization of the company, the level of competence of the employees (especially of the management and the employees of the financial department), better communication, and improved IT systems. Companies are more able to focus on internal control and they recognize that it’s an important and useful tool for the company. Companies also agreed on the benefits of the COSO framework for developing internal control within the company. Table of contents Chapter 1: Introduction ---------------------------------------------------------------------------1 1.1/. Background--------------------------------------------------------------------------------------- 1 1.2/. Research Question------------------------------------------------------------------------------- 3 1.3/. Objectives ----------------------------------------------------------------------------------------- 3 1.4/. Limitations of the study ------------------------------------------------------------------------ 3 Chapter 2: Research considerations ------------------------------------------------------------5 2.1/. Methodological considerations---------------------------------------------------------------- 5 2.1.1/. Choice of subject------------------------------------------------------------------------------------------- 5 2.1.2/. Theoretical preconceptions------------------------------------------------------------------------------- 5 2.1.3/. Perspective of the study----------------------------------------------------------------------------------- 5 2.1.4/. Underlying philosophy------------------------------------------------------------------------------------ 6 2.1.5/. Research Method------------------------------------------------------------------------------------------- 6 2.1.6/. Scientific approach ---------------------------------------------------------------------------------------- 7 2.1.7/. Research Design ------------------------------------------------------------------------------------------- 7 2.2/. Collection of data -------------------------------------------------------------------------------- 8 2.2.1/. Collection of primary data-------------------------------------------------------------------------------- 8 2.2.1.a/. Selection of the companies ------------------------------------------------------------------------- 9 2.2.1.b/. Interviews process ----------------------------------------------------------------------------------- 9 2.2.2/. Collection of secondary data ---------------------------------------------------------------10 2.3/. Criticism of data --------------------------------------------------------------------------------11 2.3.1/. Criticism of primary data --------------------------------------------------------------------------------11 2.3.2/. Criticism of secondary data -----------------------------------------------------------------------------12 2.4/. Validity criteria ---------------------------------------------------------------------------------12 2.4.1/. Researchers’ discussion about validity in case studies ---------------------------------------------12 2.4.1.a/. Validity criteria--------------------------------------------------------------------------------------12 2.4.1.b/. Generalization ---------------------------------------------------------------------------------------13 2.4.2/ Credibility of our study -----------------------------------------------------------------------------------13 Chapter 3: Theoretical framework ------------------------------------------------------------ 16 3.1/. Risks and Risk management------------------------------------------------------------------16 3.2/. Material misstatements in financial reporting --------------------------------------------17 3.2.1/. Detection of material items------------------------------------------------------------------------------17 3.2.2/. /. Material misstatements and Internal control over financial reporting -------------------------19 3.3/. Sarbanes-Oxley ---------------------------------------------------------------------------------20 3.3.1/. General presentation of the law-------------------------------------------------------------------------20 3.3.2/. Section 404-------------------------------------------------------------------------------------22 3.3.2.a/. Internal control definition--------------------------------------------------------------------------23 3.3.2.b/. Section 404 overview ------------------------------------------------------------------------------23 3.3.2.c/. Compliance with section 404 ---------------------------------------------------------------------24 Section 404 Compliance Review Work Breakdown Structure-----------------------------------------25 3.4/. An internal control framework: the COSO Model---------------------------------------27 3.4.1/. The PCAOB and its Auditing Standards--------------------------------------------------------------27 3.4.1.a/. Internal control over financial reporting --------------------------------------------------------27 3.4.1.b/. Limitations inherent to internal control over financial reporting ---------------------------28 3.4.2/. Framework for assessment by the management under Auditing Standard 2--------------------29 3.4.2.a/. Requirements ----------------------------------------------------------------------------------------29 3.4.2.b/. COSO -------------------------------------------------------------------------------------------------29 Table of contents Chapter 4: Empirical Findings ---------------------------------------------------------------- 36 4.1/. Findings from the first company-------------------------------------------------------------36 4.1.2/. General background of the company ------------------------------------------------------------------36 4.1.2/. The interviewee -------------------------------------------------------------------------------------------37 4.1.3/. Findings ----------------------------------------------------------------------------------------------------37 4.1.3.a/. Consequences of the implementation of section 404 of SOX -------------------------------37 4.1.3.b/. Internal Control over Financial Reporting (ICFR) and the reduction of material errors in financial statements--------------------------------------------------------------------------------------------40
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