The Disclosure of Material Weaknesses in Internal Control after the Sarbanes-Oxley Act

Posted: 20 May 2005

See all articles by Weili Ge

Weili Ge

University of Washington - Michael G. Foster School of Business

Sarah E. McVay

University of Washington

Abstract

This paper focuses on a sample of 261 companies that have disclosed at least one material weakness in internal control in their SEC filings after the effective date of the Sarbanes-Oxley Act of 2002. Based on the descriptive material weakness disclosures provided by management, we find that poor internal control is usually related to an insufficient commitment of resources for accounting controls. Material weaknesses in internal control tend to be related to deficient revenue recognition policies, lack of segregation of duties, deficiencies in the period-end reporting process and accounting policies, and inappropriate account reconciliation. The most common account-specific material weaknesses occur in the current accrual accounts, such as the accounts receivable and inventory accounts. Material weakness disclosures by management also frequently describe internal control problems in complex accounts, such as the derivative and income tax accounts. In our statistical analysis, we find that disclosing a material weakness is positively associated with business complexity (e.g., multiple segments and foreign currency), negatively associated with firm size (e.g., market capitalization), and negatively associated with firm profitability (e.g., return on assets).

Keywords: internal control, material weakness, Sarbanes-Oxley

JEL Classification: M41, M45, M49, G34, G38

Suggested Citation

Ge, Weili and McVay, Sarah E., The Disclosure of Material Weaknesses in Internal Control after the Sarbanes-Oxley Act. Accounting Horizons, September 2005. Available at SSRN: https://ssrn.com/abstract=724481

Weili Ge

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Sarah E. McVay (Contact Author)

University of Washington ( email )

Box 353200
Seattle, WA 98195-3200
United States

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