Section 404

Definition

Section 404 of the Sarbanes-Oxley Act (SOX) requires publicly traded companies to establish and maintain an adequate internal control structure and procedures for financial reporting. It emphasizes the importance of companies providing an annual assessment of the effectiveness of these controls, which directly links to accountability and transparency in financial reporting.

5 Must Know Facts For Your Next Test

1. Section 404 mandates that management must assess the effectiveness of internal controls over financial reporting and disclose their findings in the company's annual report.
2. An independent auditor must attest to the accuracy of the management's assessment of internal controls, adding an additional layer of scrutiny.
3. This section has led to significant changes in corporate governance practices, emphasizing the role of management in ensuring transparency and accountability.
4. Compliance with Section 404 can be costly for companies, both in terms of financial resources and time required to implement robust internal control systems.
5. Failures in internal controls can lead to severe penalties for companies, including financial penalties and damage to reputation, further emphasizing the ethical implications of Section 404.

Review Questions

• How does Section 404 enhance accountability within publicly traded companies?
  • Section 404 enhances accountability by requiring companies to evaluate and report on their internal controls over financial reporting. This mandates that management take responsibility for the accuracy of financial statements and ensures that there is transparency in how these controls are functioning. By having an independent auditor also verify these assessments, stakeholders gain greater confidence in the company's commitment to ethical financial practices.
• What are some ethical implications for companies in relation to compliance with Section 404?
  • The ethical implications of compliance with Section 404 revolve around the necessity for transparency, accuracy, and integrity in financial reporting. Companies are held accountable for their internal controls, which means they must prioritize ethical decision-making in their operations. Non-compliance not only risks legal penalties but can also damage stakeholder trust and corporate reputation, highlighting the importance of ethics in governance.
• Evaluate how Section 404's requirements impact corporate culture and ethics in finance and accounting.
  • Section 404's requirements significantly influence corporate culture by instilling a sense of responsibility towards ethical conduct among management and employees alike. The need for rigorous internal controls promotes an environment where transparency is valued, leading to increased ethical behavior in financial reporting. This shift often encourages a culture where employees feel empowered to speak up about unethical practices, ultimately fostering an organization-wide commitment to ethics and compliance in finance and accounting.

Related terms

Internal Controls: Processes and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.

Sarbanes-Oxley Act (SOX): A federal law enacted in 2002 aimed at protecting investors from fraudulent financial reporting by corporations, which includes a range of provisions related to corporate governance and financial disclosures.

Management Assessment: The evaluation performed by a company's management on the effectiveness of internal controls over financial reporting, required under Section 404.