Section 404

Definition

Section 404 of the Sarbanes-Oxley Act requires publicly traded companies to establish and maintain adequate internal control over financial reporting and to assess the effectiveness of these controls annually. This section aims to improve the accuracy of financial disclosures and to prevent corporate fraud, thereby enhancing the overall reliability of financial reporting for investors and stakeholders.

5 Must Know Facts For Your Next Test

1. Companies must provide an annual report on the effectiveness of their internal controls over financial reporting as mandated by Section 404.
2. Independent auditors are required to evaluate and attest to the management's assessment of internal controls under Section 404, adding a layer of oversight.
3. Non-compliance with Section 404 can result in significant penalties for companies, including financial fines and reputational damage.
4. Smaller companies were initially exempt from some requirements of Section 404 to alleviate the compliance burden, but many have since had to comply.
5. The implementation of Section 404 has led many companies to invest in better internal control systems and processes to ensure compliance.

Review Questions

• How does Section 404 enhance the reliability of financial reporting for publicly traded companies?
  • Section 404 enhances the reliability of financial reporting by requiring companies to implement and assess internal controls over financial reporting. This ensures that financial statements are accurate and reflect true company performance, thereby protecting investors. The independent audits that accompany these assessments provide additional assurance that management's assertions about their internal controls are valid.
• Discuss the implications for a company if it fails to comply with Section 404 requirements.
  • Failure to comply with Section 404 can lead to severe repercussions for a company, including hefty fines and legal penalties. Non-compliance can also result in a loss of investor confidence, which can affect stock prices and market reputation. Additionally, it may trigger increased scrutiny from regulators, leading to further compliance challenges and operational disruptions.
• Evaluate the effectiveness of Section 404 in preventing corporate fraud compared to previous regulations.
  • Section 404 has proven to be more effective in preventing corporate fraud compared to earlier regulations due to its emphasis on rigorous internal control assessments and independent audits. By mandating a structured approach to evaluating internal controls, it compels management to be more accountable for financial reporting. However, while it has reduced instances of fraud in many organizations, ongoing challenges remain in ensuring compliance across different company sizes and industries.

Related terms

Internal Control: Processes designed by management to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.

Sarbanes-Oxley Act:

A federal law enacted in 2002 that aimed to protect investors by improving the accuracy and reliability of corporate disclosures through increased regulation of public companies.

Management Assertion: A declaration made by management regarding the accuracy, completeness, and validity of financial information presented in financial statements.