In the early 2000s, accounting scandals made headlines around the world. Companies inflated their revenue and earnings and hid their debts, costing investors millions and resulting in serious distrust towards financial markets. To help combat fraud and corruption, the U.S. Congress passed the Sarbanes-Oxley Act (SOX) in 2002.
All publicly traded companies, their subsidiaries, and some private companies must comply with all SOX requirements, which include everything from maintaining internal controls to filing audited financial reports. Company executives can be personally liable for the accuracy of a company’s financial statements. If the financial statements are found to be fraudulent or inaccurate, executives can face significant penalties, including fines and imprisonment.
How can you stay in compliance? By performing an in-depth SOX risk assessment. This assessment helps you uncover risks to your financial data that could impact your reporting and leave you in non-compliance with SOX.
Here, we walk you through the importance of a SOX risk assessment and the key steps you should follow to complete it. We'll also share solutions to common challenges and give you best practices to set you up for SOX success.
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Key Takeaways:
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Table of Contents:
- The Importance of a SOX Risk Assessment
- Key Steps to Conduct a SOX Risk Assessment
- Common Challenges in a SOX Risk Assessment
- Best Practices for Effective SOX Risk Assessments
The Importance of a SOX Risk Assessment
For SOX compliance, you'll need to dig deep into Section 404, which outlines the primary requirements you must follow. These requirements range from establishing internal controls to documenting those controls and conducting regular SOX audits.
A SOX risk assessment is a critical component of those audits, ensuring you're remaining in compliance with Section 404. Without performing a risk assessment and audit, you risk non-compliance. The consequences? Serious fines, imprisonment, or even removal from public stock exchanges.
While compliance with SOX requirements is perhaps the most important benefit of a risk assessment, there are other benefits too, such as:
- Reduced likelihood of material misstatements that could impact your finances, investor decisions, and compliance.
- Enables companies to allocate resources efficiently and addresses potential issues before they can escalate.
- Improved confidence in your financial reporting, which supports you in making decisions, building trust with stakeholders, and identifying growth opportunities.
- Enhanced audit readiness, which improves your efficiency and helps you identify and address potential issues before the start of an audit.
Key Steps to Conduct a SOX Risk Assessment
1. Define Assessment Objectives
The first step in conducting a successful SOX risk assessment is defining the scope of your assessment and relevant objectives. The key objective of your risk assessment should be ensuring compliance with SOX Section 404.
The requirements for Section 404 are as follows:
- Company management must evaluate the operational effectiveness of its internal controls that pertain to financial reporting.
- An external auditor must attest to and report on the above assessment of internal controls.
- Companies must file this evaluation with their annual reports and be prepared to share it with stakeholders when appropriate.
These requirements outline the necessary goals you must complete during your risk assessment. You must identify material risks, evaluate and assess the effectiveness of the controls used to combat these risks, and provide clear documentation for management and auditors.
2. Identify Financial Reporting Risks
Next, you'll need to begin identifying financial reporting risks. You'll want to focus on determining key material risks, or those risks that can seriously impact the accuracy and validity of your financial reporting.
Material risks can be internal or external. For example, an internal risk might be inaccurate ledger entries or weak segregation of financial reporting duties. An external risk could be regulatory changes or cyber threats.
Begin by performing an in-depth analysis of your financial statements. During your analysis, look for accounting risks like the misuse of accounting standards or recording errors as well as any potential fraud risks, such as misstatements or omissions.
After carefully analyzing your financials, you can move towards identifying risks in other ways, such as:
- Reviewing your accounting processes, such as bookkeeping and closing, for inefficiencies, lack of adequate reviews, proper accounting period cutoffs or points of risk entry.
- Comparing regulatory changes and requirements to your statements and processes to identify areas of non-compliance.
- Reviewing how you protect your financial data from cybersecurity risks to protect you from external and third-party risks.
As you conduct this initial risk analysis of your financial reports and processes, document all risks in detail. This includes actual risks found and potential risks that could impact your company.
3. Map Risks to Key Controls
With your risks identified, the next step is to map them to existing controls. These internal controls are the systems and processes you have in place to mitigate risks. Some examples of possible controls include:
- Accounting reconciliation processes to protect the accuracy of financial transactions and recordkeeping.
- IT general controls (ITGC) that keep your systems operating effectively, protecting your financial data and ensuring its accuracy.
- Physical controls, such as locks on doors where financial data is kept, access control software, etc.
- Segregation of duties to ensure work is divided between multiple individuals instead of just one, reducing errors and limiting fraud potential.
4. Assess Control Effectiveness
After identifying both risks and controls, it's time to test the effectiveness of your controls. The goal is to ensure they mitigate associated risks effectively.
This process often includes performing walkthroughs to validate control implementation. For example, you can choose a control, such as accounting reconciliation, observe it, and determine if the control mitigates potential risks or if additional controls are needed. leaves room for more.
5. Prioritize Risks
Prioritizing risk enables you and your team to focus on areas with the highest impact first, getting you closer to SOX compliance and protecting your organization.
Use a SOX risk control matrix (RCM) to categorize risks by likelihood and impact. After mapping risks to the matrix, it's recommended that you focus on those high-likelihood, high-impact risks first. Then, you should prioritize additional risks based on team capacity, cost, and other factors.
As an example, a tech company might focus on risks like data breaches in financial systems, as this is a high-likelihood, high-impact risk.
Document the Process
Per Section 404 requirements, an external auditor must confirm your findings. You must also include the evaluation of your internal controls within your annual reports. This means documentation of risks, controls, and their effectiveness is critical.
Be sure to document every step of this process, all risks, all controls, and any other relevant information.
Review and Communicate Findings
Section 404 also requires you to be ready to share your findings with all key stakeholders when appropriate. This is important for ensuring stakeholders understand identified risks and your mitigation plans.
To review and communicate findings appropriately, there are a few key steps to follow:
- Summarize your risks, processes, and controls for management, audit committees, and external auditors.
- Highlight the areas requiring immediate attention or remediation. This should be easy to do with your risk control matrix in hand.
- Summarize your plan for mitigation of prioritized risks as well as potential risks.
- Outline the ongoing monitoring and testing of controls to ensure their effectiveness and prevent recurrence of deficiencies.
- Communicate the plan to stakeholders, such as employees, management, audit committee and external auditors. shareholders.
This step can be considered the last step in the risk assessment process. An example of this in practice could be a manufacturing company that concludes its risk assessment by presenting prioritized risks and action plans during a stakeholder meeting.
Common Challenges in a SOX Risk Assessment
A process as detailed as the SOX risk assessment isn't without its challenges. Here are some examples of challenges you might face and solutions you can put into practice.
Assessing Emerging Risks
Risks evolve daily. This is especially true when considering the growth of technology and its use within finance. For example, it can be hard to assess risks from new technologies like AI-driven accounting tools and how they might impact your organization.
A best practice is to stay up to date on the evolving tech landscape and relevant regulations as things change, updating your risk assessment and planning accordingly. You can also perform scenario planning by considering how the risk might impact your business and your plans in the event a scenario occurs.
Inadequate Collaboration Across Departments
Silos within your organization are an often-overlooked risk. For example, miscommunication between your IT and finance teams can lead to overlooked risks, such as subpar access control.
Inadequate collaboration can be solved by creating cross-functional SOX compliance teams. For example, bring together key stakeholders from your various teams, including IT, finance, administration, marketing, etc.
This cross-functional team will give you deeper insights into the risks you're up against. It will also ensure risk mitigation strategies are communicated across teams so that everyone can do their part in remaining compliant and protecting your business.
Overlooking IT Risks
A recent article in Forbes outlined the biggest business risks facing organizations today. And two of those risks? Poor cybersecurity and data breaches. These IT risks have the potential to seriously cost your organization — to the tune of $4.88 million as the average cost of a data breach.
Plus, overlooking any risk can knock you out of compliance with SOX requirements, bringing about additional consequences. The solution is to integrate IT risk assessments into your overall SOX risk management.
Specific IT assessments will help you find risks such as vulnerabilities in legacy systems that often go unnoticed.
Best Practices for Effective SOX Risk Assessments
You have the steps and solutions to common challenges. Now, let's cover best practices for ensuring your SOX risk assessment is effective.
Establish a Risk Assessment Framework
When it comes to risk assessments, you don't have to reinvent the wheel. Frameworks exist that can guide you in structuring your assessments and completing them. Examples of these frameworks include COSO and COBIT.
When choosing a framework, make sure it aligns with SOX requirements. It's also important to look for a framework that will result in a holistic view of risks that impact your financial reporting.
Leverage Technology
In addition to frameworks, technology can also assist with improving your efficiency when conducting a SOX risk assessment. For example, governance, risk, and compliance (GRC) tools like AuditBoard or RiskWatch can track risks and relevant controls.
These tools eliminate the need for clunky and manual tools like spreadsheets, ensuring your risks and controls are kept updated at all times.
Ensure Continuous Monitoring
Continuous monitoring means actively analyzing financial data and processes to uncover and mitigate risks in real-time. Monitoring in this way is especially important as the risk landscape broadens due to technology.
There are many forms of continuous monitoring, from network monitoring for suspicious activity to monitoring access controls for misuse of accounts. Continuous monitoring tools can also automate control testing for critical financial processes, helping you find risks quickly.
Provide Training and Awareness
Your employees are on the front lines of defending your organization against risk. It's critical to train employees on how to identify and manage risks to promote a culture of compliance.
For example, communicate common risks within your industry and steps they can take to do their part in mitigating them. For example, discuss the importance of protecting financial data and accounts through careful password selection and identifying phishing schemes. Or, discuss the steps employees should take if they detect fraud.
Elevate Your SOX Assessments with 8020 Consulting
SOX compliance is a non-negotiable for your organization. However, remaining in compliance is often a serious challenge as the requirements can be tedious. Help is available through the support of 8020 Consulting.
Our consultants are experts in financial planning and analysis, performing SOX assessments for large organizations across industries. The team at 8020 Consulting is standing by to optimize your business's financial performance, keep you compliant, and help you protect your business. Connect with an expert now.
