Running head: SOX: What is Section 404?

Understanding Sarbanes-Oxley: What is Section 404?

Tameran Bruch

Upper Iowa University

SOX: WHAT IS SECTION 404? 2

Understanding Sarbanes-Oxley: What is Section 404?

Almost every person in the world has heard of the financial scandals of Enron,

WorldCom, and other financial companies. These scandals have left a sour taste in the mouths

of everyone who has heard of them and there was a call for something to be done. That

something ended up being the Sarbanes-Oxley Act of 2002. All financial professionals and

students know of SOX and its importance to the financial industry. The Act is broad reaching

legislation that changed the world of business as we knew it by enacting regulation of corporate

governance and financial practice. The goal of SOX legislation is to ensure that businesses are

held to higher standards and the scandals of the past are not allowed to continue. To do this

SOX requires public companies to strengthen audit committees, perform internal control tests,

make directors and officers personally liable for the accuracy of financial statements, and

strengthen disclosure. The act also establishes much stricter criminal penalties for fraud

(Blokhin, 2020). The Sarbanes-Oxley Act is arranged into eleven 'titles' but over time some of

those titles have become more important than others. One of the most important sections within

the eleven titles is considered to be 404, the section on internal controls.

Since its enaction many finance students have wondered why section 404 is so important.

Public companies have had a long standing requirement to establish and maintain effective

internal controls, so why the need to include it in SOX? Section 404 of the Sarbanes-Oxley Act

aims to rebuild public trust by bolstering the internal controls that under-pin the accuracy and

reliability of published financial information. It seems obvious that control effectiveness is

closely correlated with the reliability of reported financial data and that public confidence in a

company’s controls is therefore closely correlated to public confidence in its reporting (The

cost…, n.d.). Section 404 requires that every public company file a yearly report with the SEC
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concerning the effectiveness of their internal controls, they must also have a public report from

an auditor attesting to the accuracy of those controls. The Act has also dramatically enhanced

the penalties for false reporting placing responsibility and blame for accuracy in the hands of

senior management. They no longer receive a slap on the wrist, but instead face serious fines

and jail time. It might then be assumed that senior executives would be quick to embrace

anything that reduces the risk they face should the financial statement come back inaccurate or

that their company controls do not meet regulatory requirements (The Cost…, n.d.).

Seeing as section 404 is law, and its importance in guaranteeing a company’s honestly, a

company’s internal accountants have become essential in complying with section 404’s internal

control requirements. Accountant and auditors will often review procedures and operations to

confirm that they are being followed correctly and that they support the businesses goals. To

provide support to their companies accountants must be fully educated about the current

intricacies of, implementation strategies for, and compliance with current regulations and

legislation (What Does…, n.d.). This allows accountants and auditors to explain the impact of

non-compliance to management, as well as knowing when to report possible non-compliance.

Accountants should also expect to evaluate their firm’s internal controls for effectiveness and

provide suggestions for improvement as needed. From the perspective of a business the stronger

its controls and the better their internal accountants understanding of those controls the more

efficient, and thus more productive they should be.

Section 404 has not only affected businesses and their internal accounting staff; it has

changed the game for external accountants and consultants. The SEC and the Public Company

Accounting Oversight Board (PCAOB) have declared that leading or directing internal control

documentation or testing engagement for management of an audit client is a conflict for a

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company’s regular auditors. This has opened up a new market for documenting and testing

companies internal controls. With all the extra work auditors must do to comply with new fraud

standards, meet quarterly review requirements, document and audit fair value assessments and

render audit reports on internal controls for clients, there may not be enough qualified advisers

available to meet the needs of companies that postpone their compliance projects (Duffy, 2004).

Despite the concerns of some companies about the costs of implementing the internal

controls required by section 404 of SOX it is clear that these regulations are important for

businesses to be successful. The objective of SOX and section 404 is to restore people’s

confidence in financial reporting. Customers want to know that when they do business with a

company they are not going to be abused. Internal controls that are well monitored and

maintained can prove to investors, customers, and authorities that a business is being operated in

an ethical way.
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References

Blokhin, A. (2020, September 15). The impact of the Sarbanes-Oxley act of 2002. Retrieved

February 08, 2021, from https://www.investopedia.com/ask/answers/052815/what-

impact-did-sarbanesoxley-act-have-corporate-governance-united-states.asp

Duffy, M. (2004, May 01). Section 404 opens a door. Retrieved February 08, 2021, from

https://www.journalofaccountancy.com/issues/2004/may/section404opensadoor.html

Sarbanes-Oxley act SECTION 404. Sarbanes Oxley 404 made easier. (n.d.). Retrieved February

08, 2021, from http://soxlaw.com/s404.htm

The costs & benefits of sarbanes-oxley Section 404. (n.d.). Retrieved February 08, 2021, from

https://pcaobus.org/news-events/speeches/speech-detail/the-costs-benefits-of-sarbanes-

oxley-section-404_126

What does an internal auditor do? (n.d.). Retrieved February 08, 2021, from

https://www.efficientlearning.com/cia/resources/what-does-an-internal-auditor-do/