R5-2 Flashcards
The Sarbanes-Oxley Act of 2002 requires that the members of the audit committee of a public company be independent. Receipt of which of the following would destroy independence within the meaning of the law?
~~President’s Salary
~~Board Member’s Salary
a.
Yes
Yes
b.
No
No
c.
No
Yes
d.
Yes
No
Choice “d” is correct. Audit committee members must be members of the public company’s board of directors and may receive compensation for their service on the board. However, they cannot accept compensation from the public company or be affiliated with it in any other way. Thus, an audit committee member may receive compensation for serving as a director, but not for being the company’s president. Receipt of a president’s salary would destroy independence.
Choices “a”, “c”, and “b” are incorrect, based on the above explanation.
Under the Sarbanes-Oxley Act of 2002, which of the following statements is correct regarding an issuer’s audit committee financial expert?
a.
The audit committee financial expert must be the issuer’s audit committee chairperson to enhance internal control.
b.
If an issuer does not have an audit committee financial expert, the issuer must disclose the reason why the role is not filled.
c.
The issuer’s current outside CPA firm’s audit partner must be the audit committee financial expert.
d.
The issuer must fill the role with an individual who has experience in the issuer’s industry.
Choice “b” is correct. Sarbanes-Oxley requires that an issuer’s audit committee have at least one financial expert, or disclose why that role is not filled. The financial expert must have an understanding of GAAP and financial statements, be able to assess the application of accounting principles, have comparable experience applying accounting principles to entities that present a similar level of complexity of the issuer, and understand both internal controls and audit committee functions.
Choice “c” is incorrect. The audit committee is charged with negotiating the engagement of the external auditor and supervising their work. The auditor is accountable to the audit committee. The partner in charge of the audit firm engaged to do the audit should not be the financial expert on the audit committee.
Choice “d” is incorrect. Sarbanes-Oxley requires that the audit committee’s financial expert understand the application of accounting principles to the issues representative of the complexity of the issuer but does not require specific experience in the industry. Four ways are defined in which the necessary attributes of a financial expert can be achieved: education, experience supervising a financial officer, experience overseeing auditors, or other relevant experience.
The Sarbanes-Oxley Act of 2002 was enacted in response to corporate scandals that largely centered on the quality of corporate financial disclosure and highlighted the inadequate oversight of management, auditors and the the Board of Directors of publicly held companies. The Sarbanes-Oxley Act addresses the problems related to inadequate board oversight by requiring public companies to have an:
a.
Internal auditor.
b.
Annual audit for all issuers.
c.
Independent Board of Directors.
d.
Audit committee.
Choice “d” is correct. Public companies are required to establish an audit committee comprised of board members who are otherwise independent of the company. The audit committee is directly responsible for the appointment, compensation, and oversight of the work of the public accounting firm employed by that public company.
Choice “b” is incorrect. An annual audit provides meaningful information about financial reporting but it does not address the issue of board oversight.
Choice “c” is incorrect. The independence of the Board of Directors may provide some assurance about the objectivity of the board but does not address the issue of board oversight.
Choice “a” is incorrect. An internal audit function improves the control environment but it does not engage the Board of Directors in oversight.
The Sarbanes-Oxley Act of 2002 requires that the officers of a corporation be held accountable to a code of ethics. According to the Act, codifications of ethical standards should include provisions for all of the following, except:
a.
Compliance with laws, rules, and regulations.
b.
Honest and ethical conduct.
c.
Prompt internal reporting of code provisions and accountability for adherence to the code.
d.
Full, fair, accurate, and timely disclosure in periodic financial statements.
Choice “c” is correct. Although the SEC proposed standards for codes of ethics to include both internal reporting of code provisions and accountability for adherence to the code, the Sarbanes-Oxley Act itself does not have this requirement.
Choice “b” is incorrect. The Act specifically requires that the code of ethics include provisions for honest and ethical conduct.
Choice “d” is incorrect. The Act specifically requires that the code of ethics include provisions for full, fair, accurate, and timely disclosure in periodic financial statements.
Choice “a” is incorrect. The Act specifically requires that the code of ethics include provisions for compliance with laws, rules, and regulations.
The Sarbanes-Oxley Act of 2002 requires that the management report on internal control include all of the following, except:
a.
A statement that there are no disagreements between management and the auditor as to the effectiveness of internal controls.
b.
A statement of management’s responsibilities for establishing and maintaining adequate internal controls.
c.
A statement that the auditor has attested and reported on management’s evaluation of internal controls.
d.
A conclusion about the effectiveness of the company’s internal controls.
Explanation
Choice “a” is correct. Financial statement disclosures include management’s assumption of responsibility for internal control, management’s assessment of internal control effectiveness and a statement that the auditor has reported on management’s evaluation. Management does not describe disagreements, if any, between management and the auditor.
Choices “b”, “d”, and “c” are incorrect, based on the above explanation.
Conflict of interest provisions of the Sarbanes-Oxley Act of 2002 generally prohibit the directors or executive officers of public companies from:
a.
Receiving a personal loan from the issuer not in the ordinary course of business.
b.
Owning more than 10% of common stock.
c.
Receiving perquisite compensation.
d.
Owning more than 10% of any form of equity.
Explanation
Choice “a” is correct. Issuers are generally prohibited from making personal loans to directors or executive officers under the Sarbanes-Oxley Act of 2002. Exceptions exist for loans made in the ordinary course of business.
Choice “b” is incorrect. Although there is no 10% cap on ownership, disclosures are required for persons who directly or indirectly own more than 10 percent of any class of most any equity security.
Choice “d” is incorrect. Although there is no 10% cap on ownership, disclosures are required for persons who directly or indirectly own more than 10 percent of any class of most any equity security.
Choice “c” is incorrect. There are no prohibitions on perquisite compensation but disclosures may be required.
The Sarbanes-Oxley Act of 2002 requires that one or more members of the audit committee be a financial expert and that the financial reports disclose:
a.
The existence of financial expert(s) on the audit committee or the reasons why the audit committee does not have a financial expert.
b.
The name of the Board member(s) serving as financial expert(s).
c.
Confirmation of the audit opinion by the financial expert.
d.
Certification of independence of the financial expert.
Choice “a” is correct. In the financial reports, the issuer must disclose the existence of financial expert(s) on the committee or the reasons why the committee does not have a financial expert.
Choice “b” is incorrect. Although the SEC proposed requirements that the name of the financial expert be disclosed, the Sarbanes-Oxley Act only requires that the existence of a financial expert(s) (or lack thereof) be disclosed.
Choice “c” is incorrect. The financial expert is not required to report on the audit opinion.
Choice “d” is incorrect. Although audit committee members are required to be independent and the SEC has proposed disclosure of independence, certification of independence is not required in financial reports under the Act.
The primary benefit of having a financial expert on a company’s audit committee is:
a.
The financial expert certifies compliance with SEC requirements and thereby reduces audit fees.
b.
The financial expert checks the auditor’s work and verifies the appropriateness of the audit opinion.
c.
The expert designation conveys a higher level of due diligence on the expert and shields audit committee members and the corporation from most liabilities.
d.
The enhanced level of financial sophistication of the financial expert can serve as a resource for the audit committee.
Choice “d” is correct. The benefits of a financial expert on the audit committee relate to the expertise that the board can bring to its oversight function.
Choice “b” is incorrect. The audit committee provides oversight of the annual audit; however, the audit committee and its financial expert do not verify the auditor’s work.
Choice “c” is incorrect. The term “expert” within the context of the Sarbanes-Oxley Act does not convey the same requirements as SEC regulations and does not convey either a higher level of due diligence or provide insulation to other board members. The Act is silent as to the meaning of expert outside of the qualifications to be deemed an expert.
Choice “a” is incorrect. The financial expert does not certify compliance with SEC regulations.
Arnold Astor, CPA, is a local tax practitioner who has been asked to sit on the Board of BigLarge Corporation, a multinational issuer. Astor has never had any involvement either as an employee or as an auditor with publicly traded companies but does teach an accounting principles class at the community college. Under the provisions of the Sarbanes-Oxley Act of 2002:
a.
Astor must petition the SEC for a waiver of prior experience requirements to be considered a financial expert.
b.
The Board of Directors would likely evaluate Astor’s qualifications to serve on the audit committee and be designated as a financial expert based on mix of knowledge and experience.
c.
Astor qualifies as a financial expert based on achievement of a CPA certificate.
d.
The audit committee would immediately certify Astor’s qualifications as a financial expert based on his CPA license and academic experience with GAAP and experience with internal control.
Choice “b” is correct. Qualification as a financial expert is a judgmental issue is typically made by the Board of Directors. The Sarbanes-Oxley Act is silent as to what group has the authority to designate an individual a financial expert but in practice, the board most often makes that decision. The Act provides some guidance but does not prescribe specific qualifications.
Choice “c” is incorrect. The Act provides some guidance but does not prescribe specific qualifications. The achievement of the CPA license generally does not qualify an individual as a financial expert.
Choice “a” is incorrect. The Act provides some guidance but does not prescribe specific qualifications. The idea of a petition to the SEC is a distracter.
Choice “d” is incorrect. The Act provides some guidance but does not prescribe specific qualifications. In addition, the audit committee would likely not regulate or evaluate the expertise of its own membership. The Board of Directors would likely make the decisions regarding the designation of financial experts.
The Sarbanes-Oxley Act of 2002 seeks to improve investor confidence by providing greater transparency for all of the following issues, except:
a.
Means and methods for balancing risk and growth.
b.
Compliance of senior officers with a code of ethics.
c.
Adequacy of internal controls.
d.
Competency of audit committees.
Choice “a” is correct. The issues surrounding risk and growth are significant to investors and generally addressed by enterprise risk management concepts; however, the Sarbanes-Oxley Act focuses less on strategic operations and more on the financial reporting issues impacted by the audit committee’s competence, the ethical behavior of senior officers and the adequacy of internal controls.
Choices “d”, “b”, and “c” are incorrect. The Sarbanes-Oxley Act focuses on the financial reporting issues impacted by the audit committee’s competence, the ethical behavior of the financial officers and the adequacy of internal controls as a means of improving investor confidence. Competency of audit committees, compliance of senior officers with a code of ethics, and adequacy of internal controls are all issues addressed by Sarbanes Oxley.
How many audits of public companies per year does a CPA firm that is registered with the Public Company Accounting Oversight Board (PCAOB) have to perform in order to to be subject to mandatory annual inspection by the PCAOB?
a.
More than 10 audits.
b.
More than 100 audits.
c.
One audit.
d.
More than 50 audits.
Choice “b” is correct. The Sarbanes-Oxley Act requires the PCAOB to perform an annual inspection of each registered public accounting firm that regularly provides audit reports for more than 100 issuers.
Under the provisions of the Sarbanes-Oxley Act of 2002, registered public accounting firms are required to prepare and maintain audit work papers and other information related to any audit report for a period of:
a.
Seven years.
b.
Five years.
c.
Three years.
d.
One year.
Choice “a” is correct. Registered public accounting firms are required to maintain audit work papers and supporting documentation for a period of seven years. Thus, choices “d”, “c”, and “b” are incorrect.
The Sarbanes-Oxley Act of 2002 prohibits a registered public accounting firm from providing any non-audit service to an issuer contemporaneously with the audit, except:
a.
Appraisal or valuation services, fairness opinions, or contribution-in-kind reports.
b.
Bookkeeping or other services related to the accounting records or financial statements of the audit client.
c.
Financial information systems design and implementation.
d.
Tax services pre-approved by the audit committee.
Choice “d” is correct. Most services that audit firms previously provided to publicly traded clients have been prohibited by the Sarbanes-Oxley Act of 2002, except for approved tax services.
Choices “b”, “a”, and “c” are incorrect, per the above explanation.
Under the provisions of the Sarbanes-Oxley Act of 2002, the lead audit or coordinating partner and the reviewing partner must rotate off the audit:
a.
Every seven years.
b.
Each year.
c.
Every three years.
d.
Every five years.
Choice “d” is correct. The lead audit or coordinating partner and the reviewing partner must rotate off the audit every five years. Thus, choices “b”, “c”, and “a” are incorrect.
Rules issued under the Sarbanes-Oxley Act of 2002 prohibit a registered accounting firm from performing an audit at a public company if any person serving as the public company’s chief executive, chief financial or chief accounting officer, or controller or chief accounting officer worked for the registered accounting firm within the preceding:
a.
Within two years of the current audit.
b.
Within three years of the current audit.
c.
Within five years of the current audit.
d.
Within one year before the current audit.
Choice “d” is correct. To avoid conflicts of interest, a registered company public accounting firm cannot perform an audit for a public company if one of the indicated officers of the company worked at the auditing firm within a year before the audit.
Choices “a”, “b”, and “c” are incorrect, per the above discussion.
