sox
TRANSCRIPT
Enron
What Went Wrong?
How did the collapse begin?
• Energy companies lobbied congress in the 1980s for deregulation of the energy business
• Energy policy was changed and Washington lifted controls on who could produce energy and how it was sold
• Jeff Skilling took and aggressive approach to expand Enron by trading futures in gas contracts
Skilling’s Plan• Under Skilling’s new plan Enron bet against future
movements in the price of gas-generated energy• “Enron bought and sold tomorrow’s gas at a fixed
price today”• With every trade, Enron took a cut for transaction
costs• Using the internet to promote trading, Enron became
the most successful player in the futures game; 90% of Enron’s income came from trades
Early 2000
• Enron took advantage of the dot.com boom and traded internet bandwidth
• The value of Enron’s online transactions was huge ($880 billion)
• The problem was Enron wasn’t making money on many of their online trades because they made the market very efficient
Fuzzy Numbers
• Enron began tweaking the numbers in their financial statements with accounting techniques to hide their losses
• Enron created partnerships, and then passed the assets (losses) to these partnerships which eliminated the losses from their balance sheets
• Andrew Fastow (Chief Finance Officer) created the partnerships
• Condor and Raptor were two major partnerships
• Sherron Watkins, the Enron “Whistleblower” noticed the fuzzy accounting that had been used in relationship to the Condor and Raptor partnerships and wrote a letter to Kenneth Lay and Arthur Anderson warning him that the Enron was unstable.
Why wasn’t Enron caught earlier?• Throughout all of this,
Enron and its key members were making political contributions to the white house and congress.
• Kenneth Lay donated $100,000 to President Bush in 2000, and in 2001 Bush invited Lay to become an advisor to his transition team.
• In the year 2000, Kenneth Lay met three times with Dick Cheney to discuss energy policy review.
• When the review was published in May 2001, it was very favorable to the Enron and the energy sector.
• Aug 14, 2001 Jeff Skilling resigned, Kenneth Lay became CEO once again.
• Stock prices began to fall, as investors were uncertain about the company’s stability.
• This started a chain reaction: Enron had hedged against its own stock, so as long as the stock price was declining, it could not recover its losses.
• December 2001, Enron filed for chapter 11 bankruptcy
• It’s share price had collapsed from about $95 to under $1.
Chapter 11 Bankruptcy
• Companies and large firms that are facing severe and unmanageable debt may seek to file chapter 11 bankruptcy, which allows them to re-organize so they can either continue their day-to-day operations or go out of business entirely.
• Under chapter 11, a company is protected from damaging lawsuits and other negative measures, but in exchange the company is usually required to have all its major business decisions approved by the bankruptcy court.
SOXSarbanes-Oxley Act of 2002
Section 404 – Management’s Report on Internal
Control Over Financial Reporting
Agenda
• S-OX Timeline• Overview of S-OX• S-OX Compliance• S-OX Project Approach
S-OX Time line
• Securities Exchange Act
– 1934
• S-OX Signed into Law
– July 30, 2002
• Section 404 Final Rule
– June 18, 2003
• Section 404 Effective Date
– June 15, 2004 (Accelerated
Filer)
– April 15, 2005 (Non-
accelerated Filer)
Overview of SOX
Goals of S-OX
– Increase public confidence in capital markets
– Improve corporate governance
– Provide greater accountability by making board members and
executives personally responsible for financial statements
– Improve audit quality
– Place greater emphasis and structure around efforts to
prevent, detect, investigate and remediate fraud and
misconduct
Overview of SOX
Intent of Section 404
– Include a report of management on the company’s internal
control over financial reporting in annual reports
– “An effective system of internal control over financial reporting
is necessary to produce reliable financial statements and
other financial information used by investors.”
Overview of SOX
Benefits of Section 404
– Effective system of internal control is necessary to produce reliable financial
statements
– Annual evaluation
• Encourage companies to devote adequate resources and attention to the
maintenance of internal controls
• Help identify potential weaknesses and deficiencies in advance of a system
breakdown
• Help companies detect fraudulent financial reporting earlier.
Internal Control Reports Include
• Statement of management’s
responsibility for establishing and
maintaining adequate internal
control over financial reporting.
• Management’s assessment of the
effectiveness of the company’s
internal control
• Statement identifying the
framework used by management
to evaluate the effectiveness of
the internal controls.
• Statement that the CPA firm that
audited the company’s financial
statements has issued an
attestation on internal controls
SOX Compliance• Environment– Demonstrate (document) that strong IT
controls over financial reporting are in place.
• Applications– Identify and test instances where manual
controls have been replaced by automated processes.
SOX Compliance
• Recommends COSO Internal Control –
Integrated Framework as the control framework for IT
general controls
• Does not specify what must be included
• Management and independent auditors must decide
what to address
COSO - Committee of Sponsoring Organizations
• COSO Internal Control – focus on controls for financial
processes
• Integrated Framework as the control framework for IT
general controls
• Does not specify what must be included
• Management and independent auditors must decide
what to address
CobIT - Control Objectives for Information and Related Technologies
– COBIT focuses on IT
– Plan and Organize
– Acquire and Implement
– Deliver and Support
– Monitor and Evaluate
IT Governance Institute
Used by UK companies based in the US to govern the standards of internal control
Review COBIT Control Objectives
– Reconciled the objectives to COSO
– Determined if objectives related to financial reporting
– Result:
– 27 IT Processes
– 136 Detailed Control Objectives
Project Approach
S-OX Project Approach
• Assess readiness of IT Department– Determine IT Department integration with 404
• Implementation– Determine extent of documentation– Determine existing controls– Determine senior management’s
• Understanding of the impact of IT controls on 404
S-OX Project Approach
Part I > Plan and Scope
– Identify the key systems and subsystems
that are involved in the initiation, recording,
Processing, and reporting of financial
information
S-OX Project Approach
Part II > Risk Assessment
Assess the impact and risk to
• Information Quality
• Programming change controls
• Access to systems
• Availability of information
• Confidentiality
• Recoverability
S-OX Project Approach
III – Identify Key Controls– General Controls– Application Controls
IV – Document Control Design
Differences between US GAAP, Indian GAAP and International Financial Reporting Standards.
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Summary Of Significant Differences between US GAAP, Indian GAAP and International Accounting Standards.
Particulars Indian GAAP US GAAP IFRS
1. Revenue Recognition
Revenues are recognized when allsignificant risks and rewards ofownership are transferred or on apercentage of completion basis. Nodetailed industry specific guidelines.
Industry specific revenue recognitionguidelines. Could be different fromwhat I-GAAP has recognized.
Revenues are recognized when allsignificant risks and rewards ofownership are transferred.
2. Balance sheet Conforms to statute and captions are in the following order :--Equity and reserves--Debt--Fixed assets--Investments--Net current assets--Deferred expenditure and--Accumulated lossesRequired only for the current year with the prior year comparatives.
Balance sheet captions are presented in order of liquidity starting with the most liquid assets, cash.Also requires disclosure of movements in stockholders’ equity, including the number of shares outstanding for all years presented.
Balance sheet captions are presented in the inverse order of liquidity i.e.illiquid items appear earlier.Requires disclosure of either changes in equity or changes in equity other than those arising from capital transactions with owners anddistribution of owners.
3. Correction of fundamental errors
Include effect in current year incomeStatement.
Restate comparatives.Adjustments required to be made topreviously issued financial statements.
Include cumulative effect in currentyear income statement.For material items, restatecomparatives.
4.Derivative and other financial instrument- Measurement of hedges of foreign entity investments.
No definitive standard yet. Newstandard on financial instruments:Recognition and Measurement ispresently under formulation.
Gains/losses on hedges of foreignentity investments recognized inequity. All hedge ineffectivenessrecognize in the income statement.Gains/losses held in equity must betransferred to the income statement on disposal of investment.
Similar to US GAAP. Except, ineffectiveness of non-derivativesrecognized in equity.
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Particulars Indian GAAP US GAAP IFRS
5. Comprehensive income No standards, not required. Unrealized gains/losses on investment and Foreign currency translation disclosed as a separate component of equity.
Option to present a statement that shows all changes or only those changes in equity that did not arise from capital transactions with owners or distributions to owners.
6. Derivatives and other financial instruments – measurement of derivative instruments and hedging activities.
No definitive standard yet. New Standard on financial instruments: Recognition and Measurement is presently under formulation.
Measure derivatives and hedge instrument at fair value: recognize changes in fair value in income statement except for effective cash flow hedges, defer in equityuntil effect of the underlying transaction is recognized in the income statement.Gains/losses on hedge instrument used to hedge forecast transaction, included in cost of asset/liability.
Similar to US GAAP. Gains/losses on hedge instrument used to hedge forecast transaction, included in the cost of asset/liability ( basis adjustment ).
7. Business Combinations Restricts the use of pooling of interest method to circumstances which meet the criteria listed for an amalgamation in the nature of a merger. In all other cases, thepurchase method is used.
Only accounted for by the purchasemethod. Several differences can arise in terms of date of combination, calculation Of share value to use for purchase price, especially if the I-GAAP method is ‘amalgamation’.
Business combinations under IFRS should be accounted for as an acquisition (purchase method). Where an acquirer cannot be identified then the pooling of
interests method should be
adopted.
8. Cash Flow Statement Mandatory only for listed companies and companies meeting certain turnover conditions.
Mandatory for all entities. Mandatory for all entities.
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Particulars Indian GAAP US GAAP IFRS
9. Property, Plant and Equipment
Use historical costs or revalued amounts.
On revaluation, an entire class of assets is
revalued, or selection of assets for revaluation is made on a
systematic basis. No current restriction on frequency
of valuation.
Revaluations not permitted. Tested for
impairment whenever events or changes
in circumstances indicate that its carrying
amount may not be recoverable.
Use historical cost or revalued amounts. .
On revaluation, an entire class of assets is
revalued.
10. Share Issue Expenses May be accounted for as deferred expenses and amortized.
Expenses are written off when incurred
against proceeds of capital.
There is no specific requirement under
IFRS.
11. Dividends Dividends are reflected in the financial
statements of the year to which they
Relate even if proposed or approved after
the year end.
Dividends are accounted for when approved by the
Board/shareholders. If the approval is after the year end,
the dividend is not considered as a subsequent event to adjust the
financials.
Dividends are classified as a financial
liability and are reported in the income
statement as an expense. If dividends are
declared subsequent to the balance sheet
date, it is not recognized as a liability.
12. Leases Similar to US GAAP but, no quantitative
thresholds defined.
Leases are classified as capital and
operating leases as per certain criteria.
Capital leases are included under property, plant and equipment of
the lessor. Lease rentals on operating
leases are expensed as incurred.
Quantitative thresholds have been defined.
Similar to US except that the criteria for
distinguishing between capital and revenue leases is different.
13. Prior period adjustments
Prior period items are separately disclosed
in the current statement of Profit and Loss together with their
nature and amount in a manner that their
impact on current profit and loss can be
perceived.
Correction of an error in previously issued
financial statement is recognized by
restating previously issued financial
statements.
Prior period errors are generally corrected
in the current financial statements.
However, where the error is of such
significance that the prior period financial
statements cannot be considered to have
been reliable at the date of their issue, the
error should be corrected by adjusting the
opening retained earnings.
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Particulars Indian GAAP US GAAP IFRS
14. Accounting for Foreign Currency Transactions
Exchange differences on foreign currency transactions are recognized in the profit and loss account with the exception that exchange differences related to the acquisition of fixed assets adjusted to the carrying cost of the relevant fixed asset.
All exchange differences are included in determining net income for the period in which differences arise.
All exchange differences are included in determining net income for the period in which differences arise.
15. Goodwill Goodwill is capitalized and tested for impairment annually. Except for goodwill from amalgamation, which is amortized over 3-5 years.
Goodwill is not amortized but goodwill is to be tested for impairment annually.
Goodwill is amortized to expense on a systematic basis over its useful life with a maximum of twenty years. The straight line method should be adopted unless the use of any other method can be justified.
16. Negative Goodwill (i.e. the excess of the fair value of net assets acquired over the aggregate purchase consideration)
Negative goodwill is credited to the capital reserve account, which is a component of stockholders’ equity.
Negative goodwill is allocated to reduce proportionately the value assigned to non-current assets. Any remaining excess Is considered to be extraordinary gain.
Negative goodwill that relates to expectations of future losses and expenses should be recognized as income when the future losses and expenses are recognized. Where it does not relate to identifiable future losses and expenses, an amount not exceeding the fair values of the acquired identifiable non-monetary Assets should be recognized as income on a systematic basis over the remaining weighted average useful life of such assets and the balance, if any immediately charged to income.
17. Related parties Determined by ability to control or to exercise significant influence over the other party. Detailed disclosure required of all material related party transactions. Mandatory for listed companies and companies meeting certain turnover threshold.
Related parties are determined based on common ownership and control. Disclosure required of all material related party transactions, in particular, the nature of relationship involved, a description of the transactions, the amounts of the transactions, the amounts of the transactions for the financial year and the amount due from or to related parties at the end of the financial year.
Similar to US GAAP except that the existence of related parties are to be disclosed even if there are no transactions during the period.
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Particulars Indian GAAP US GAAP IFRS
18.Pension / Gratuity / Post Retirement Benefits
Required to be mandatorily provided Based on either actuarial valuation or Contribution to a defined plan. Follows AS-15, Acturial gain/losses are recognized immediately.
To be provided for and funded based on acturial valuation. Significant disclosurerequirements exist. Acturial gains/losses are amortized.
To be provided for and funded based on acturial valuation. Significant disclosurerequirements exist. Acturial gains/losses are amortized.
19. Stock Options to Non- Employees
No specific guidance Complex guidance with respect to measurement date and timing of recognition of expense.
Disclosures required but, no guidance on recognition and measurement.
20. Balance sheet Does not need segregation of current and non-current portions of assets and liabilities..
Segregation necessary. Disclosed only as part of the footnotes.
21. Stock based Compensation
SEBI requires compensation cost to be recognized based on intrinsic value or fair value. Not mandatory for un-listed companies.
US GAAP had similar rules as what SEBI later required. However, there is new standard effective 2005, which requires fair value to be expensed for all options.
Compensation costs to be disclosed. Recognition of compensation costs is not mandatory.
22. Investment and Marketable Securities.
Only unrealized depreciation on AFS ( Available-For-Sale ) securities is recognized in the income statement.
Both appreciation and depreciation ( if unrealized ) is recognized as Other Comprehensive Income. Separate standard for treatment of cost of development of computer software.
Similar to US GAAP. Except option to recognize gains/losses in AFS eeither income statement or equity. However, the selection is a one-time option. No guideline under IFRS.
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Particulars Indian GAAP US GAAP IFRS
23. Segment Information Specific requirements govern the format and content of a reportable segment and the basis of identification of a reportable segment. The information for disclosure is to be prepared in conformity with the accounting standards used for the company as a whole.
Disclose revenues, profits and assets identified by product and geographically of each reportable segment. Segments based on information reviewed by CODM (Chief Operating Decision Maker)
Largely similar to US GAAP requirements however, mandatory only for listed companies. Segment liabilities are also to be shown.
24. JV ( Jointly controlled assets or corporation )
Allows proportionate consolidation Generally only uses Equity method of accounting except certain specified industries such as Oil and Gas.
Allows either Equity method or proportionate consolidation.
25. Research and development costs
Deferred where technical or commercial feasibility is established and the enterprise has adequate resources to enable the product or process to be marketed.
Research costs can be capitalized and amortized as intangible assets in the following cases:Research costs related to activities conducted for others, costs unique to extractive industries and cost of intangibles which have alternative future uses. All other costs are Charged to expense as and when incurred.
Deferred where technical or commercial feasibility is established and the enterprise has adequate resources to enable the product or process to be marketed.