Material mistatements 2290

  • Is it safe to assume that a material accounting error/misstatement automatically equates at least a significant deficiency? I think that is kind of the definition but want to see if anyone has seen otherwise. Thanks.

  • Not necessarily. although it will be the case most of the time.
    However, you could have a situation where a material misstatement arises without a control deficiency e.g. in a subjective area you make assumptions, they are reviewed and seem reasonable but turn out to be wrong.

  • Thanks Denis, I agree on the scenario about areas with assumptions.
    How about a situation like this: There has been an accrual on the books for years that was not necessary. Recently there is management turnover and we have a new VP overseeing the department making that accrual. The new VP found out the error and had the accrual reversed in Q4. To me, it appears that since we found the error, it showed internal control – although for the previous quarters (and years) the control was not effective, at least Q4 and going forward, the control is effective.
    The error in question is somewhat material, though I think management does not think it warrants restatement of prior year financials. I would also argue that if it was material enough for us to worry about, then the external auditors didn’t do a really good job in auditing our books in prior years since they did not find the error, even just from the financial audit standpoint. I know whether the auditors found it is another story and is unrelated to whether the company has good internal control, but I believe it should go both ways.
    Any thoughts would be welcome and appreciated.

  • I agree that finding and correcting errors is a sign of internal controls operating effectively. What are you doing differently to ensure that there are no additional ‘errors’ in your accounts? Has the new VP implemented a more rigorous review of account reconciliations? Is he now more involved in reviewing assumptions used in judgmental reserves?
    In your case, it could be as simple as the former VP maintaining a reserve based on a perceived need and the new VP not seeing the need for the reserve. It could be that the new VP is being more proactive in his review of the balance sheet.
    I would question the qualifications of the auditors if they allowed a large accrual that had no support to go without review or support. Maybe they have had an audit difference that they have been carrying and the new VP finally agree with their POV.
    It’s hard to make a call on the level of deficiency without having more details and background information. I can see where this one could go either way (material weakness or sginificant deficiency) based on the overall fact set.

  • So you cannot see this being just a regular deficiency? I am still having a hard time seeing what is regular, what is significant and what is material in terms of deficiencies. I know this may just come from experience, and I am pretty new to this area so any pointers will be greated appreciated.
    In this case, the calculation was correct, but there was one deciding factor to whether we needed that reserve or not. That deciding factor was pretty black-or-white but both management and auditors missed it in prior years.
    Now that the new VP is on board, he was looking at things more thoroughly and found the error. Our suite of documented controls would have covered that area, but to put it politically, that control just did not operate as intended. Going forward, the VP will expand the coverage of the control. That VP is not VP of accounting, but VP in another area and so his department is only in charge of a portion of the F/S (and not the entire F/S).
    My remaining question would be, can this be viewed as a regular control deficiency at all, given that we found the error and it was corrected in Q4?

  • Are we talking less than 1% of net income? 5% of net income?%0AI would think that the magnitude of impact on your FS would need to be considered when assessing the level of deficiency. The fact that it was caught at year end does not help show that the control is now operating effectively. That needs to be assessed over several executions of the control.%0AHave you identified a specific control that failed? That isn’t always easy to do. We have had problems in the past in mapping out of quarter or out of year error detections to specific control failures. We then also have problems defending our controls in a specific process as effective. While I agree that detecting errors shows that detective controls are working, it also indicates that maybe we need better preventative controls.

  • Bear in mind that accruals are estimates and will rarely be 100% accurate and that for SOX purposes we are not saying that there will be no errors, just that we have approriate controls.%0AThat an individual has a different view on an accrual does not make the previous view an error per se - although it may be. And that you have processed an adjustment arises from the effective operation of a control to me says ‘so far, so good’.%0AThe remaining question is one of materiality. If the change in the accrual is an error AND it is sufficiently material to require a prior period adjustment then you could have a control deficiency to report. Otherwise you just adjust in the current period and move on.

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