Imagine your organization undergoing an audit that reveals discrepancies in financial reports. This scenario shows how important SOX compliance is. SOX, established by the Sarbanes-Oxley Act of 2002, requires companies to maintain robust internal controls and accurate financial reporting, with the aim of preventing fraud.
By complying with SOX, companies can adhere to the highest standards of financial transparency and accountability. This involves conducting regular audits, documenting all financial processes, and keeping detailed records. It’s an ongoing process that requires constant monitoring of internal controls.
In this guide, we will go over the key requirements of SOX compliance, along with practical steps to achieve it and common questions.
What is SOX compliance?
The United States Congress enacted the Sarbanes-Oxley Act of 2002 to protect the public from unethical and fraudulent practices by business entities. Resulting from a series of financial scandals, SOX compliance seeks to elevate accountability and transparency in financial reporting while setting proper checks and balances in corporations.
This law applies to all US-based public companies, international companies in possession of a tradable financial asset registered with the SEC such as stocks, and accounting and auditing companies providing services to the businesses as mentioned above.
What are the key requirements of SOX compliance?
The provisions of the SOX law can be summarized into these four key requirements that public companies must comply with:
- All financial statements must be audited by independent auditors and presented periodically.
- Any material change that can potentially affect the market value of the company’s securities and its financial situation must be reported to the public immediately.
- Robust internal controls must be implemented to identify and avoid fraud and protect the company’s financial information integrity. This includes finance-related and IT-related controls.
- An assessment of internal controls checked and authorized by independent auditors should be furnished by companies every year.
To make these easier to follow, you can download any of these pre-made SOX compliance checklists and adapt them based on your own needs.
What are SOX controls?
SOX controls are the internal mechanisms and procedures that companies must implement under the Sarbanes-Oxley Act of 2002 to ensure the accuracy and reliability of their financial reporting. These controls are designed to prevent and detect errors, fraud, and other irregularities in financial statements.
They cover a wide range of activities, including financial reporting processes, IT controls, and operational controls. For example, IT controls safeguard the security of financial data within the company’s IT systems. These controls protect against data breaches, unauthorized access, and other IT-related risks that could compromise financial information.
What are the most critical sections of SOX?
SOX has 11 key sections or titles that are meant to enhance corporate governance and financial transparency. Still, there are two sections that are the most critical:
Section 302: Corporate Responsibility for Financial Reports
Section 302 mandates that the CEO and CFO of public companies personally certify the accuracy, completeness, and reliability of the company’s financial reports. This section aims to ensure that top executives take responsibility for the financial disclosures and internal controls of their companies.
Section 302 also requires executives to confirm that internal controls are designed for reliable financial reporting. Executives must disclose any significant deficiencies, material weaknesses, or fraud involving management or employees with key roles in these controls. This encourages transparency and accountability at the highest levels of management.
Section 404: Management Assessment of Internal Controls
Section 404 requires public companies to establish and maintain a robust internal control structure for financial reporting. Management is responsible for evaluating and reporting on the effectiveness of these controls every year. This involves using recognized frameworks like COSO as well as conducting regular risk assessments to identify potential weaknesses.
Independent auditors are then required to confirm the accuracy of management’s assessment, adding another layer of oversight.
Who is required to follow SOX guidelines?
These are the main types of organizations that have to comply with SOX:
- Public companies in the US – All publicly traded companies in the United States must adhere to SOX regulations, including those listed on stock exchanges such as the NYSE and NASDAQ.
- International companies – Non-U.S. companies with tradable financial assets registered with the U.S. Securities and Exchange Commission (SEC), such as stocks, are also subject to SOX compliance.
- Accounting and auditing firms – Firms that provide auditing services to public companies must comply with SOX standards. This ensures that financial audits are conducted independently and with integrity.
Private companies generally do not have to follow SOX, but in some special situations, they might choose to adhere to SOX standards to demonstrate financial integrity. For example, a company might do this if they are preparing for an initial public offering (IPO) or looking to attract investors.
By mandating compliance among these entities, SOX aims to protect investors and restore public confidence in the financial markets.
What happens in a SOX audit?
A SOX audit is a thorough examination that involves several steps.
The process begins with planning and preparation, where the audit team defines the scope of the audit and reviews the company documentation. They’ll then form a plan for testing the effectiveness of the company’s controls.
The auditors then move on to testing the controls. They’ll perform walkthroughs of key processes to understand how controls are implemented, as well as testing the design of these controls. Special attention is given to IT controls, including access controls and system security.
After testing, the auditors write a report on their findings, identifying any deficiencies or weaknesses in the company’s internal controls and suggesting corrective actions. These deficiencies are classified based on their severity and potential impact on financial reporting.
Finally, the company develops and implements these corrective actions. Auditors may conduct follow-up testing to check if these corrective actions are effective.
How do you prepare for a SOX audit?
Meeting the Sarbanes Oxley compliance requirements can be an intimidating task with plenty of room to mess up. However, there are some steps you can take to help ease your preparation in time for audit season.
- Establish a plan and define your timelines. To ensure that all relevant reports are available on time, you need to map out a comprehensive plan of what needs to be done and when it needs to be ready. It is recommended to develop a plan starting from the current fiscal year up to the period leading to the year you will need to be fully SOX compliant.
- Select one or more frameworks that can improve your SOX compliance. You can consider employing the help of organizations with established frameworks and models specifically designed to strengthen internal controls and prepare for SOX compliance. Here are some of the ones you can consider:
- The Committee of Sponsoring Organizations of the Treadway Commission (COSO): They can provide support in establishing your company’s internal controls.
- Control Objectives for Information and Related Technologies (COBIT): They can help ensure your IT processes are compliant.
- The Information Technology Governance Institute (ITGI): They can guide internal controls and IT compliance, with more focus on security-related controls.
- Carry out risk assessments. You can pinpoint potential problem areas that need to be addressed when you create your compliance plan through a risk assessment.
- Conduct a company-wide evaluation. Every part of your company — primary divisions and secondary operations — must be compliant. To ensure this, you need to assess all processes and procedures being implemented across the board.
- Document all your processes. Detailing your processes can provide the context needed to establish a more transparent flow of information. Make sure that you document your company’s financial reporting process along with the key personnel involved. Another important thing that must be well-documented is the procedures set in place to protect against fraudulent threats and financial risks.
- Evaluate IT-related controls. Assessing your internal IT controls will help you stay up to par with the industry best practices regarding data security and guarantee better protection from tampering. You can implement a SOX compliance IT checklist specifically aimed to increase your company’s IT infrastructure security to make sure nothing gets overlooked.
- Assess your third-party vendors. You need to pay attention to your vendors to make sure you cover all your bases. If a security or data breach happens at a vendor, your company will still be held liable.
- Put your internal controls to the test. You must ensure your internal controls, especially key controls in your risk assessment, are working the way they should.
- Identify and correct your deficiencies. Any identified deficiencies should be fixed and reported as necessary. For significant deficiencies, only your senior management needs to be kept in the loop. On the other hand, material deficiencies are required to be made public in a 10-K.
- Regularly communicate and update. One of the main goals of SOX is increased transparency and accountability. This means that your senior management, the board, and the internal audit committee are well-updated on the progress and findings of the compliance process.
Minimize errors and ensure SOX compliance with a digital checklist
Getting a better understanding of the requirements and process is just half the battle. To pass the SOX audit with flying colors, you’ll need a reliable tool to help you gather all the data you need quickly and measure the results accurately.
With Lumiform, you create a customized digital SOX compliace checklist that suits your needs so you can quickly evaluate your current company standing, identify areas for improvement, and have complete confidence in your established internal controls.
Here are some of the features you can enjoy:
- Create your custom checklist in minutes with access to over 12,000 ready-made templates.
- Access your SOX compliance checklists any time of the day, whether you’re online or offline.
- Conduct your inspection via the app and consolidate all visual documentation of your processes and procedures.
- Auto-generate in-depth SOX compliance reports and share them with your stakeholders easily.
- Analyze your data via the dashboard to see if you are hitting the SOX compliance.