A Complete Guide on SOX Controls with Examples and Best Practices

Introduction

A company’s financial reporting is a crucial part of its accounting process. The financial statements created by businesses at the end of the fiscal year reveal their financial position to the investors and other key stakeholders. Accurate financial information is the key to ensuring financial reporting integrity. What measures should businesses take to ensure accuracy of financial information? 

This is where the Sarbanes-Oxley (SOX) Act, passed in 2002, comes into play. The SOX Act came into effect due to major corporate scandals, in the late 1990s and early 2000s, to protect investors and the general public from fraudulent accounting practices. The act requires businesses to put internal controls in place so they can release accurate financial information.

In this blog, we are going to discuss what SOX controls are, four key focus areas for SOX internal controls audit, and the importance of SOX reporting. . 

What are SOX Controls?

SOX control includes internal controls that enable companies to identify errors and mitigate any kind of risk during the financial cycle, resulting in accurate financial statements. This practice prevents businesses from sharing false financial information and committing any kind of financial fraud. 

Section 404 of the SOX Act mandates organizations to implement internal controls to ensure financial reporting accuracy. The implementation of SOX controls is important for all publicly traded companies listed under the Securities and Exchange Commission (SEC) and private companies aiming for an IPO. 

While the SOX Act governs the internal controls implemented by companies, it does not specify the exact number of controls a company needs to implement. Therefore, the number and types of SOX internal controls may vary for different companies. Businesses need to assess their needs and define which SOX controls they need to implement. 

SOX Controls Examples

SOX controls essentially help businesses pinpoint and address potential issues, maintaining the integrity of their financial reporting. Let’s take a look at a few examples to understand what kind of controls companies establish. 

1. Segregation of duties: It’s important for companies to ensure that no single person has excessive control over the financial processes. Financial duties should be divided among different people so they can identify any errors or anomalies that may occur at different levels of the accounting cycle. 
2. Reconciliations and reviews: In order to release accurate financial information, companies need to perform regular account reconciliations to identify and rectify any inconsistencies in the journal entries. Additionally, these reconciliations should go through reviews to add a layer of accuracy to the process. Companies should also ensure that people other than those who recorded the transactions perform reconciliations and reviews. 
3. Approvals and authorizations: Companies need to establish SOX controls for approvals and authorizations. For example, a control can be implemented where all authorized transactions go through another person (a supervisor or a controller) for approval before the entries are made. 
4. Training and awareness: To ensure that employees are performing their jobs properly, companies need to implement controls around training and create awareness among the employees. Employees should be trained, supervised, and informed about practices and procedures for ethical accounting and financial reporting. 
5. Regular reviews and risk assessments: To ensure the effectiveness of implemented controls, businesses need to perform regular tests and risk assessments. Doing so will allow companies to check for errors and inconsistencies and update the controls if needed. 

SOX Internal Controls Audit: 4 Key Areas of Focus

While different companies implement different internal controls depending on their needs, there are a few key internal controls that are essential for SOX compliance. The SOX audit, which serves as a critical evaluation of an organization’s internal controls, financial reporting processes, and overall commitment to financial integrity, focuses on these four crucial internal controls.

1. Access controls

The audit encompasses both physical and electronic access controls. Physical measures, including biometric scanners and secure doors, guarantee that only authorized personnel can access vital areas. Electronic controls, such as login policies and least-privileged access, are indispensable. 

Maintaining a least-privilege model aligns with SOX requirements, ensuring users have access only as necessary for their roles.

2. IT Security 

A critical evaluation is undertaken to assess how organizations identify and safeguard sensitive data against potential cyberattacks. The audit demands monitoring of data access and robust mechanisms to detect and respond to security incidents. 

The development of a comprehensive cybersecurity incident response plan, orchestrated by management and executives, adds an additional layer to address security concerns in line with SOX compliance.

3. Data backup 

The assessment of data backup practices assumes pivotal importance in minimizing disruption and data loss during a system-wide disaster. Adherence to SOX compliance standards is imperative for both original systems and data center devices containing backups. 

Proactive organizations consider maintaining SOX-compliant offsite backups of financial records, showcasing a commitment to safeguarding critical data.

4. Change management 

Well-defined processes for adding and maintaining users, installing new software, and making changes to databases or applications managing financials are integral components of compliance. Any changes, be it in personnel, infrastructure, or software, necessitate meticulous recording and monitoring for potential abnormalities, ensuring the transparency mandated by SOX.

What is SOX Reporting?

It’s not enough for businesses to just establish SOX controls; they also need to report on the efficacy of those controls. SOX reporting requires companies that adhere to the SOX Act to demonstrate that their internal controls over financial reporting (ICFR) are effective in order to show the accuracy of their financial reporting. Both internal and external SOX reporting is performed at companies to ensure the effectiveness of ICFR and ensure the legitimacy of financial statements. 

• Internal SOX reporting

  Once a company has implemented certain SOX controls, the management needs to maintain the controls and assess their effectiveness. All this information goes into a report that is published along with other financial statements. 

  In order to ascertain the efficacy of internal controls, companies usually follow a recognized framework, such as, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework. 

• External SOX reporting

  SOX reporting does not end with management’s assessment of the controls. An external auditor needs to approve and attest to the said assessment of the ICFR. The auditor is responsible for evaluating how well the key controls are performing and conducting tests to determine whether the controls are effective or to uncover any deficiencies. 

The report created by the auditor is then included in the company’s annual report, just like the internal SOX report. 

Conclusion

All in all, implementing SOX controls is important for companies if they want to remain SOX compliant. SOX controls effectively help companies make sure that all their financial and accounting processes yield accurate information by establishing checkpoints at various levels. Due to SOX controls, businesses can further streamline their accounting processes and mitigate the risk of errors. 

How HighRadius Can Help in Ensuring Financial Reporting Accuracy

SOX controls are implemented so companies can release accurate financial information and don’t engage in fraudulent activities. To ensure the proper implementation of such controls and eventually the accuracy of financial reporting, companies can make use of accounting software, like HighRadius. Our Record-to-Report suite provides you with features that allow you to streamline your accounting processes and improve its overall efficiency.

A key part of the financial reporting process is performing regular account reconciliations. Automating the process can help your accounting teams maintain a much accurate record of reconciliations and make it more efficient. HighRadius’ Account Reconciliation Software has the ability to prepare and post journal entries, automating 80% of your account reconciliation process. 

Anomalies in your financial data can seriously hinder the month-end closing process and delay the year-end closing process and creating financial statements. But with HighRadius’ Anomaly Detection Software you can automate your anomaly resolution process and resolve up to 80% anomalies. The software is specifically designed to detect errors and omissions in your financial data throughout the accounting cycle so you can minimize the risk of publishing wrong financial information. The AI/ML-based technology allows the system to learn to detect anomalies from past data, thereby reducing false positives. 

To add another layer of accuracy and checks to your accounting process you can make use of HighRadius’ Financial Close Software. It provides you with features like Close Checklist and customized trackable dashboards to ensure all the necessary steps are completed by the people responsible on time. 

FAQs

Q1 What are SOX 404 controls?

SOX 404 controls are controls that companies need to implement and maintain internally to ensure accurate financial reporting at the end of the financial year. Section 404 of the SOX Act is considered to be one of the most important sections of the act and is the basis for trustworthy financial reporting.

Q2 What is SOX compliance?

SOX compliance refers to adherence to the Sarbanes-Oxley Act passed in 2002, which aims to increase the transparency and accuracy of financial reporting. In order to stay SOX compliant, companies need to implement internal controls and perform regular internal and external audits.

Q3 How many SOX controls are there?

There is no predetermined number of SOX controls that companies need to implement, and the number may vary from business to business. Companies need to assess their individual needs and establish internal controls accordingly. They further need to maintain and regularly update the controls to ensure their effectiveness. 

Q4. What are SOX key controls?

While companies are not required to implement the same internal controls, there are a number of key controls that must be prioritized. SOX key controls are especially important when we talk about SOX compliance, as they help mitigate the risk of inaccurate financial reporting. 

Q5. What is SOX control testing?

SOX control testing refers to the evaluation of the internal controls implemented by a company. The implemented controls need to go through testing and risk assessments so their effectiveness can be determined. If the controls are lacking efficacy in some way or are implemented wrongly, they should be updated.