Different types of control of Pacific Sunwear

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Case study for seminar work -Pacific Sunwear of California, Inc. 1. Discuss the different types of control that SOX implies for PacSun; what action, results, personnel and cultural controls are used? Action control: Section 302 of SOX required both the company’s CEO and CFO to personally certify the “appropriateness of the financial statements and disclosures contained in the periodic report”. PacSun top management required their subordinates to share the certification responsibility. Through this responsibility sharing, the whole organization is engaged in this certification requirement.

Results control: Section 404 dealt with internal controls over financial reporting (ICOFR)-the processes that are designed to ensure the reliability of the financial reporting process and the preparation of financial statements. Section 404 required management to (1) accept responsibility for the effectiveness of the company’s ICOFR; (2) evaluate the effectiveness of the company’s ICOFR using suitable control criteria; (3) support the valuation with sufficient evidence (documentations); (4) present a written assignment of the effectiveness of the company’s ICOFR yearly.

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As part of the assessment, management had to determine if identified internal control deficiencies constituted significant deficiencies or material weaknesses. To evaluate the management’s control, an internal audit function was created. Personnel control: several SOX orientation sessions were offered in combination with other training programs, such as for store personnel. Cultural control: PacSun must receive “clean” opinion and financial statement from the external auditors each fiscal year for the company to keep on running. 2.

Discuss the benefits and costs for PacSun of complying with SOX. Is it worth it? Benefits: The Company received “clean” opinion and financial statements from the external auditors, which is good for the image of the company when this information disclosed to public. Also in SOX year two, PacSun have a reduction of 7% in the number of key controls tested, although the reduction is a bit small compared to the other companies. With the SOX, the company has always been in a tight control state. Cost: The cost to PacSun of SOX compliance was significant. In FY 2004 the total cost of ompliance-financial statement audit and 404 compliance- was an estimated $2 million, in year two, the costs declined by almost 40%. There are also implicit costs, for example, SOX had made it more burdensome to serve on the Audit Committee. The meetings with the Committee were frequent and time-consuming. Also added to the costs are training programs for SOX. Lots of unneeded documentation were created. 3. The SOX act isn’t only for the companies as such, but also to protect investor’s money. From this perspective, is SOX adding value in this case?

SOX mandated an evaluation of the effectiveness of a company’s internal controls by both management and the company’s external auditor and formal written opinions about the effectiveness of those controls. In doing this evaluation, managers and auditors are required to examine a broad range of internal controls over financial reporting. The existence of a single material weakness requires managers and auditors to conclude that the company’s internal controls are not effective. SOX has had positive effects on both the quality of financial reporting and the quality of firm’s MCS.

With SOX, the accuracy and reliability of corporate disclosures are improved. Also the federal government continues to refine SOX mandates. SOX makes the investors less afraid of the trap of Enron and Worldcom so that they can invest their money into feeling more secured, which is good for both the investors and the companies. In this perspective, SOX adds value. 4. Evaluate the process that PacSun went through to comply with SOX. Was that process as effective and efficient as it could have been? The Company was already a tightly controlled from the beginning so the SOX compliance process was not in that way so very useful for the company.

But the audit function became a very important factor for mapping out processes and key controls in the company which helped making the deficiencies more visible. The Process could maybe have been more efficient if the company had hired internal audits in an earlier stage. Especially in the two examples that follow. In 2005 the company had to restate their prior two years’ financial statement because of a misinterpretation of how store lease expenses and landlord incentive allowance should be classified. PacSun reated a landlord allowance as a reduction in capital expenditures instead of a deferred lease. The U. S. Security and Exchange Commission, SEC says that it should amortize as a rent expense rather than as a reduction in depreciation expense as the company did. These corrections did result in a multi million reclassifications between rent expense and depreciation expense. The audits firms judged the re-statements as a significant deficiency. Regarding the PacBucs program, PacSun accounting was not recognizing the liabilities and expenses in the proper accounting quarter.

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