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Sarbanes-Oxley Section 404: a Toolkit for Management and Auditors

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Sarbanes-Oxley Section 404: a Toolkit for Management and Auditors 2118 SOX brochure 1/28/04 2:35 PM Page 1 SARBANES-OXLEY SECTION 404 A TOOLKIT FOR MANAGEMENT AND AUDITORS VOLUME 1 This volume addresses PwC risk management policies and audit methodology and is for internal distribution only. This toolkit volume should not be issued to clients or third parties. 2118 SOX brochure 9/3/03 2:15 PM Page 2 Sarbanes-Oxley Section 404 – An Introduction A Roadmap for On May 27, 2003, the Securities and Exchange Commission (SEC) voted to adopt final rules on Management’s Report on Internal Control over Financial Reporting, as mandated by Section 404 of the Sarbanes-Oxley Act of 2002. STEPS The final rules will be effective for fiscal years ending on or after June 15, 2004 for SEC registrants with a public 1. Risk Assessment 2. Map Financial Statemen float >$75 million; other than foreign private issuers; or for fiscal years ending on or after April 15, 2005 for other line items to cycles/proc registrants, which includes small businesses and foreign private issuers. 3. Agree upon key risks an controls 4. Document existing Under Section 404, SEC registrants will be required to include processes (detailed with their annual filing: flowcharts and narrative 5. Identify controls in plac • A statement of management’s responsibility for establishing 6. Gap Analysis • Identify weaknesses and maintaining adequate internal control over financial • Assess impact • Identify compensatin reporting; controls • Fill gaps • A statement identifying the framework used by management 7. Test controls for effectiv to evaluate the effectiveness of internal control; 8. Gap Analysis 9. Deliver completed pack • Management’s assessment of the effectiveness of internal control as of the end of the company’s most recent fiscal Key Ev year end; and Most US-based registrants will be required • A statement that the company’s external auditor has issued to meet the Section 404 requirements for fiscal years ending on or after June 15, 2004; an attestation report on management’s assessment The following co April 15, 2005 for foreign registrants. for an entity to Canadian companies will be impacted by the new regulations in Section 404: two ways. Foreign private issuers will be required to meet the new requirements starting in fiscal 2005. In addition, Canadian inbound subsidiaries of SEC registrants may be impacted by the new regulations for the 2004 fiscal year, • Management based on the parent’s assessment of the materiality of the subsidiary, in terms of the company’s overall internal the effectivene control structure. • Controls are The level of effort required by the audit team to conduct the attestation will depend primarily on the thoroughness implemented of management’s own assessment, and the level to which it is formally documented. Therefore, it will be beneficial objective (re and necessary for management and the auditor to work closely together to prepare for these requirements. In reporting) usin addition, while the extended implementation period may now cause some companies to re-evaluate their current •Control object readiness plans, the reality is that companies will ultimately need to address the requirements of this section, and need to be app they should not wait until the last minute for preparation. The extension provides companies with the opportunity to address control weaknesses prior to going “live” with the required 404 reporting requirements, including the • Management possibility of performing a “dry run” before the deadline. effectiveness financial repo Action Plan – A Suggested Timeline (on both the Major Project 2003 2004 2005 effectiveness o Activities Jul - Sept Oct - Dec Jan - Mar Apr - Jun Jul - Sept Oct - Dec Jan - Mar Some companie substantial docum controls, includin Project Initiation formal policy and Documentation and manuals, etc. Mo Evaluation will not have com Remediation of evaluation of their Identified Gaps the organization. documentation m Attestation “Dry Run” meet the demand Assertion and virtually all organ Attestation formal plan to add 2118 SOX brochure 9/3/03 2:16 PM Page 2 A Roadmap for Section 404 Readiness The COSO Co Financial Cycles / Controls Monitoring Statements Processes BENEFITS • Assessment of a • Sustainable STEPS Scoping system’s perfor 1. Risk Assessment Risk Assessment and Scalable • Focused 2. Map Financial Statement time. High Level Benchmark Approach line items to cycles/processes • Collaborative • Combination o 3. Agree upon key risks and Controls Maturity Model • Knowledge and separate ev controls Transfer 4. Document existing Data • Auditable • Management a processes (detailed Collection Inventory Policies Conclusions and Procedures supervisory act flowcharts and narratives) 5. Identify controls in place Controls Documentation • Internal audit a TEAM 6. Gap Analysis • Corporate • Identify weaknesses Maturity • Business Unit Assessment • Assess impact Gap Analysis and Remediation • Internal Audit • Identify compensating • External Audit Information & controls Communication • Fill gaps Validation & Control Environment Treasury Cycle 7. Test controls for effectiveness Testing • Pertinent inform Information and 8. Gap Analysis Communication Purchasing Cycle identified, capt 9. Deliver completed package Revenue Cycle Monitoring Controls communicated manner. • Access to intern Key Events: Agree Key Risks and Project Launch Controls to be assessed Re-assess Test Plan Deliver 404 Package externally gene information. • Flow of informa The following conditions are necessary allows for succ for an entity to be “auditable” under actions from in Section 404: responsibilities of findings for m • Management accepts responsibility for action. the effectiveness of control • Controls are suitably designed and Audit of Financial Statements versus Internal Cont implemented to achieve the control 404 Controls Attestation The Committee objective (reliability of financial 1980’s with the Audit of Financial Statements Section 404 Attestation reporting) using established criteria publication in 1 •Control objectives and related controls • Understanding and • 100% controls-based assessing a struc consideration of internal approach. No comfort need to be appropriately documented Section 404 rep controls only to the extent from substantive/analytical recognized cont • Management assesses the necessary to develop the procedures broad distributio effectiveness of internal control over audit approach • Must evaluate and test framework that financial reporting and reports thereon • Overall objective is an controls across business (on both the design and operating makes reference opinion on the financial and functional areas to become the esta effectiveness of controls) statements, not to opine on opine on effectiveness Some companies may already have internal controls (broader and deeper) Under the COSO substantial documentation of their internal • Internal control reports have • Lack of errors, or material an entity’s board controls, including internal audit files, been very rare in practice adjustment, historically, in reasonable assu formal policy and accounting procedures and are the subject of financial statements is not categories: manuals, etc. Most companies, however, different attestation de-facto evidence onto • Effectivene will not have completed a comprehensive standards itself, of an appropriate • Reliability evaluation of their internal controls across internal control structure • Complianc the organization. In addition, the existing documentation may not be adequate to COSO identifies meet the demands of SOX 404. As such, control activities virtually all organizations will require a in place and int formal plan to address the new regulations. In preparing for which address a 2118 SOX brochure 9/3/03 2:16 PM Page 2 The COSO Controls Framework Monitoring Control Activities • Assessment of a control • Policies/procedures that system’s performance over ensure management time. directives are carried out. • Combination of ongoing • Range of activities and separate evaluation. including approvals, authorizations, verifications, • Management and recommendations, supervisory activities. performance reviews, asset • Internal audit activities. security and segregation of duties. Information & Communication • Pertinent information Risk Assessment identified, captured and • Risk assessment is the communicated in a timely identification and analysis manner. Control Environment of relevant risks to • Access to internal and • Sets tone of organization- achieving the entity’s externally generated influencing control objectives- forming the information. consciousness of its people. basis for determining • Flow of information that control activities. • Factors include integrity, allows for successful control ethical values, competence, actions from instructions on authority, responsibility. responsibilities to summary of findings for management • Foundation for all other action. components of control. Internal Control Framework The Committee of Sponsoring Organizations of the Treadway Commission (COSO) was charged in the mid 1980’s with the responsibility of defining an effective framework for systems of internal controls. Since its publication in 1992, the COSO framework has become widely accepted as the benchmark for establishing and assessing a structure for internal controls. Section 404 reporting requires that management’s evaluation of internal controls be based on a suitable, recognized control framework that is established by experts using “due process”; a process which includes the
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