Internal Controls - Assignment Example

The Sarbanes-Oxley Act of 2002 was passed generally for the purpose of restoring investor trust and confidence. The demand of the government, investors and the American public sought a standard and guarantee on the accuracy of financial reports. So, Section 404 of the mentioned law was strictly devoted in requiring management to assess and report on the effectiveness of internal control over financial reporting or ICFR. Bergen (2005) reported that “the concerns through making executive more responsible for company accounting statements, redefining the relationships between corporations and their auditors, and restructuring the internal audit systems of public corporations.

” Section 404 of Sarbanes-Oxley Act of 2002 has also been experiencing issues regarding its implementation. The legislation of the law “has been subject to furious debate amongst corporations, auditors, regulators and others.” The internal control policy has cause extremely high costs especially for smaller companies and early results left the benefits unclear. A number of academic and professional researches have grown to support the lack of transparency in accounting and corporate governance is growing larger.

The researches show the significant cost attached to the internal controls. One “concludes that corporations with Internal Control Deficiencies (ICDs) as defined by section 404 – companies which are naturally more susceptible to accounting irregularities – pay the price through higher cost of capital and lower stock price returns.” Ockree and Martin (2009) investigated on the internal and external impacts of the financial reporting requirements in internal control. Stock price was one of the external reactions their study had put focused on.

In their study, stock prices were tracked for the three years following the announcement. They compared the data to a broader market measure of comparable companies. The results were surprising though a bit expected; the average return for the study group during that period was only 1.68%, while the broader market had a 17.28% return. There was a higher rick in that period of relative growth. Ockree and Martin also studied the insiders who traded stock during 2007 to be able to measure the risk in that particular sector.

Two years after the announcement, it was found that there were three times inside buyers than seller compared to the broader market. Further, the size of the insider’s sales was over eight times larger compared to the buys. With the effect of internal controls to the company’s stock price, we can say internal controls do have inherent limitations and the risk can’t easily be foreseen or eliminated. On the other hand, there is a risk of weakening internal controls if we modify the existing system.

Internal controls can result to various limitations to the organization functionality and economy. Its limits can affect the effectiveness of internal controls and may result to system omission human factors, resource constraints, or lack of system flexibility. For example, internal control processes in an organization may not reflect changed operating conditions, specific agency activities or potential new risks. It can cause collusion of staff members to be able to achieve their own personal gains. And in