Sarbanes-Oxley Act (SOX)
The Sarbanes-Oxley Act is a federal law established in 2002 that mandates best practices in financial record keeping and inventory reporting for corporations. Sarbanes-Oxley or (SOX) was introduced and passed by Senator Paul Sarbanes (D-MD) and Representative Michael Oxley (R-OH) after multiple corporate accounting scandals that occurred in the late 90s and early 2000s. Most notably, the Enron scandal brought to light the depth and seriousness of corporate malfeasance in what was largely an unregulated business environment. The impacts created by Enron’s corruption reverberated throughout the energy industry ultimately costing taxpayers hundreds of millions of dollars. In 2002, the Senate Banking Committee conducted multiple hearings intended to lay the groundwork for the legislation. The hearings revealed that weak corporate governance was widespread and that conflicts of interest were common among stock analysts. The realization that the Securities and Exchange Commission (SEC) was severely underfunded further illustrated the need for legislative action. This new legislation was to give auditors real power in enforcement across the domain that extended into inventory controls.
The Sabarnes-Oxley act has been transformational in that it has fast tracked the implementation and enforcement of financial controls in corporate America. Financial disclosures must be accurate and reliable, they will be checked, and checked again. Count on it. Obviously financial disclosures contain data that often correspond to something “physical”, namely inventory. This makes managing inventory all the more important, yet somehow inventory records are sometimes overlooked or viewed as of secondary importance. Imagine if a balance sheet, which may also list assets, listed 10,000 IPads in the warehouse, yet the warehouse only had 1,000 IPads in-house, the balance sheet was wrong, someone added a zero and it wasn’t caught. Now, the warehouse burns down over the weekend and on Monday the balance sheet is used to file a claim with the adjuster and recompense for 10,000 IPads is initiated. All of those involved have just committed fraud and may be indicted under Title XI under the Sabarnes-Oxley Act for alleged criminal tampering. Now, that’s an extreme example and highly unlikely to occur as other checks and balances would likely flag such an obvious error, but it does demonstrate the importance of implementing solid inventory controls. Under the SOX act, failure to maintain an accurate inventory can now have very dire consequences for those responsible, especially in cases where intentional tampering is concerned, or gross negligence is occurring. Situations less severe than the scenario described can result in criminal proceedings if intent of malfeasance can be proven.
It’s important for warehouse managers and inventory control specialists to have an accurate accounting of all real property, capital assets, equipment and even consumables. It’s also important to know that inventory controls are a critical part of the larger disclosure framework and must be controlled as scrupulously as are balance sheets. That Floor to Record and/or Record to Floor accounting is the single most important aspect of inventory control to maintain. This confirms that your physical count matches your virtual count, which is usually maintained in a warehouse management system (WMS) or enterprise resource planning (ERP) software, such as SAP’s industry leading platform. This can only be confirmed by conducting annual inventories and monthly cycle counts, this cannot be pencil whipped! Cycle counts are partial inventories (10-20%) conducted frequently to confirm and reconcile physical counts to virtual records. Cycle counts are different each month and are usually focused on capital assets, sensitive items or frequently rotated consumable stock. Follow up actions include adjusting the inventory when needed and investigating discrepancies or problems with reconciliations. Maintaining virtual and hard copy records of cycle counts is advisable, an ancillary benefit of having hard copies in hand will be directly reflected in the quality of sleep you receive each night.
Here are other important inventory controls and best practices to follow:
1. Organize your inventory: track all items by location, ensure that they are organized in a logical system that facilitates quick and easy picking.
2. Standardize record keeping for inventory: One WMS and not multiple different spreadsheets
3. Tag all inventory: asset tags are commonplace, but it’s important to clearly identify capital assets, capital assets are >$5,000 in estimated value, ref: Federal Acquisition Regulation.
4. Self-audit Bill of Materials: bill of materials (BOM) are records of the components of a system, periodic audits of BOMs and updates as component swaps, upgrades occur are important, the details matter.
The SOX law has 11 elements, most of which are related to the findings of the hearings.
1. Title I is the Public Company Accounting Oversight Board that provides for the independent oversight of public accounting firms providing audit services.
2. Title II has nine sections and establishes standards for Auditor Independence
3. Title III covers Corporate Responsibility and has eight sections that mandates senior executive responsibility for the accuracy and completeness of financial reports.
4. Title IV Enhanced Financial Disclosures has nine sections and mandates enhanced reporting requirements for financial transactions, such as off-balance sheet transactions – this one brought about a fundamental shift in auditing power.
5. Title V Conflicts of Interest defines codes of conduct for analysts and requires their disclosure of knowledgeable conflicts of interest.
6. Title VI Commission Resources and Authority has four sections that define practices to restore investor confidence in securities analysts and defines SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing.
7. Title VII has five sections and mandates that the comptroller general and SEC perform studies and report their findings periodically.
8. Title VIII has seven sections and is referred to as the Corporate Fraud and Criminal Fraud Act of 2002. This subset act lists the criminal penalties for manipulation, alteration or destruction of financial records while also affording protections to whistleblowers.
9. Title IX has six sections and is also referred to as the White-Collar Penalty Enhancement Act of 2002. It basically states that white collar crimes receive higher criminal penalties and provides guidance for sentencing that may even criminalize certain actions that may not have been previously classified as criminal.
10. Title X covers corporate tax returns and states that the Chief Executive Officer should sign the company tax return.
11. Title XI has seven sections and covers corporate fraud accountability. Corporate fraud involving record tampering is classified as a criminal offense and assigns specific penalties.
