Section 404 and Small Public Companies

• Date: June 01, 2010
• Source: Admin

Critics of SOX point out several drawbacks of the rule of which the most prominent one is the cost of complying with SOX. SOX is undoubtedly a costly affair for the small public companies as it is comprised of a significant fixed cost. In 2004, large U.S. companies which had revenues more than $5 billion spent only 0.06% of their revenue to be SOX compliant, while small public companies which had revenues less than $100 million, spent 2.55% of the same.

This disproportion called for an immediate SEC and U.S. Senate action. PCAOB also issued further guidance, Auditing Standard No. 5 for public accounting firms on July 25, 2007, which helped companies to alleviate the cost by scaling “the assessment based on the size and complexity of the company”.

AS 5 of 2007 superseded the initial guidance, Auditing Standard 2 of 2004. With the issuance of the new guidance, management and the external auditor both became responsible for performing their evaluation in the context of a top-down risk assessment, which provided the management a wider discretion in its assessment approach. AS2 together with AS5 require the management to -
 

• Assess entity-level controls

• To be aware of the flow of transactions so that any misstatement can be tracked

• Avoid material misstatement by assessing both the design and operating effectiveness of selected internal controls and its accounts and relevant assertions

• Management also need to review the system of controls created to prevent or detect fraud and in order to detect and prevent fraudulence, perform a fraud risk assessment

• Assess the period-end financial reporting process

In order to decrease the cost associated with SOX compliance, it is suggested that companies should centralize and automate their financial reporting systems as findings show that automation help the small private companies to dramatically reduce the cost of complying with SOX.