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    Do SOX 404 Control Audits and Management Assessments Improve...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality 
    Do SOX 404 Control Audits and Management Assessments Improve Overall Internal Control System Quality?
    Practical Implications:

     The authors’ findings are important because they indicate that AS5 may be less effective at improving ICQ than AS2 and provides some evidence that declining material weakness rates under AS5 do not indicate improving ICQ. The findings also suggest that SOX 404(a) management assessments are not an acceptable substitute to ICFR audits for improving ICQ. The results suggest that more rigorous SOX 404(b) audits under Auditing Standard No. 2 had real benefits in terms of improved overall internal control system quality and unaudited accruals quality; however, attempts to reduce ICFR audit costs via reduced requirements of Auditing Standard No. 5 may have resulted in lower material weakness disclosure rates and lower overall internal control system quality.


    Schroeder, J. H. and M. L. Shepardson. 2016. Do Sox 404 Control Audits and Management Assessments Improve Overall Control System Quality? The Accounting Review 91 (5): 1513-1541.

    internal control quality, SOX Section 404, internal control audits, and PCAOB Auditing Standard No. 5 (AS5)
    Purpose of the Study:

    In this study, the authors address whether audits and management assessments of internal controls over financial reporting (ICFR) required by Section 404 of the Sarbanes-Oxley Act are associated with maintained improvements to an entity’s overall internal control system quality (ICQ). Stakeholders and researchers continue to question whether benefits of ICFR audits justify high costs, and regulators and researchers alike have questioned whether control audits under the current auditing standard provide accurate material weakness disclosures. In 2013, the PCAOB disclosed that 15 percent of 2010 inspected internal control audits were ineffective, suggesting that declining material weakness disclosures may not signal improving ICQ and that the current control auditing standard may be insufficient for inducing ICO improvements. The authors believe that the maintained improvement in overall ICQ due to control audits and management assessments is important and largely unexplored. 

    Design/Method/ Approach:

    The authors address the question using a ten-year period that includes three control disclosure regulation changes; initial implementation of ICFR audits, a 2007 reduction in control auditing requirements and implementation of unaudited management assessments for small firms. The authors use unaudited quarterly accruals quality in future periods subsequent to ICFR audits and management assessments to identify sustained improvements in overall control system quality. They use two research designs to estimate the effects of control regulation regime changes and perform analyses on all firms for which they have the requisite data, as well as a size-restricted sample of firms with less than $150 million in market capitalization. 

    • The authors find that UAQ improves after AS2 control audit implementation, providing evidence that AS2-based control audits are associated with maintained improvements to overall ICO.
    • The authors find that in the sample of accelerated filers that UAQ decreased between the pre- and post-AS5 periods, providing evidence that the auditing standards change led to a deterioration in ICQ.
    • Using the difference-in-differences design, the authors find that accelerated filer UAQ deteriorated relative to non-accelerated filers subsequent to implementation of AS% for accelerated filers and SOX 404(a) for non-accelerated filers. Combined results are consistent with the difference-in-differences being causes, at least in part, by ICO decline related to AS5.
    • The authors find little evidence that SOX 404(a) management assessments affect UAQ, but they do find a significant decrease in the likelihood of material misstatement subsequent to SOX 404(a) implementation. 
    Internal Control
    Impact of 404 on Fees and Financial Reporting Quality