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The Sarbanes-Oxley Act: Definition and Explanation

The Sarbanes-Oxley Act: Definition and Explanation
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  • 0:01 SOX Defined
  • 0:26 SOX History
  • 1:47 Purpose of SOX
  • 3:05 Lesson Summary
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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

Government regulations play a major role in corporate financial reporting. In this lesson, you will learn about one of the most important regulations enacted in the last two decades - the Sarbanes-Oxley Act.

SOX Defined

Have you ever heard of a company called Enron? Or what about an accounting firm by the name of Arthur Andersen? If so, then you know they're synonymous with corporate corruption. They are also two of the reasons that the Sarbanes-Oxley Act was put into place. The Sarbanes-Oxley Act , also known as SOX, is a federal law that protects investors from fraudulent accounting practices.

SOX History

Let's take a closer look at the Enron scandal so that you'll understand better why SOX was implemented.

Enron was, by all accounts, a corporate powerhouse. In the late 1990s and the beginning of the year 2000, the company was not only a successful electricity and natural gas company, but it also blossomed out into the telecommunications field. The company made billions of dollars and employed thousands of people. Stock of Enron was a hot commodity. Everyone wanted a piece of this phenomenon.

In the year 2001, the false façade that Enron had been exhibiting began to crumble when it was discovered that the multitude of dollars reported as earned on the company's financial statement were all fake. That's where the Arthur Andersen firm came into play. They were the accounting firm that chose to act in a corrupt manner and assist Enron executives with their fraudulent reporting scheme. It was only after a young and savvy financial analyst uncovered the false reporting in the financial statements did the scam come to light.

To make a long story short, once the world learned of the scandal, the company went under and investors lost millions. The impact that investors felt was a driving influence for government leaders to implement the Sarbanes-Oxley Act, and that's exactly what they did in the year 2002.

Purpose of SOX

Now that you know why SOX was created, it's time to talk about what it does. The most important thing that this act does is to make corporate executives be accountable for what appears on the company financial statements. Before SOX, it was common for this same group of people to say they weren't aware of false reporting on the financial statements. Now, corporate executives must sign off on the financial statements when they're made available to the public. This validates that they know what's on the financial statements and that the information is true and accurate.

Another very important part of the Sarbanes-Oxley Act is that it requires all financial statements to include an audit report. An audit report is a report that's prepared by an auditor, and it validates the reliability of a company's financial statements. An auditor is a professional whose job it is to examine the financial records of a company and prepare the audit report.

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