Given the recent events of what can be called the largest bankruptcy in the capitalist world, such as the Enron and WorlCom cases, it has caused the current business environment to change.
Public accountants play a very important role, perhaps today more than ever, from different perspectives, either as company accountants, executives, independent auditors, tax auditors, financial advisers, etc., and we are called to regain the trust of the business world, with reliable information, that anticipates the future, and identify risk factors to prevent situations like these.
However, accountants are exposed to manipulations by management, to present financial information, many times, according to their convenience, and this is where I want to draw attention since the figures in the financial statements are the product of business management, In other words, we reflect the business culture of the country.
This is why I took on the task of translating and adapting a document issued by the AICPA and the Big Five, which can help in this task of presenting reliable information, to which accountants must be faithful, and it should be our creed, as well as determining risk factors, to help readers of financial statements to obtain all relevant information, to get a clear and complete idea of the state of the company at a given time.
The purpose of this document is to provide those who have a high-quality financial reporting role with information pertinent to the current financial reporting environment. It includes an assessment of risk factors that may be important to financial statement preparers, auditors, and audit committees to consider during the current reporting cycle. It also offers suggestions as to how each of these important groups can contribute to improving financial reporting for the benefit of investors.
The current economic downturn, the unprecedented events of September 11, and recent business failures have combined to create a different financial reporting environment in recent times. Investor confidence, already shaken by significant volatility in the capital markets, has been further disrupted by financial statements, which has raised questions about the quality of financial reporting, the effectiveness of the independent audit process, and the effectiveness of corporate management. This environment creates significant challenges for US businesses and their managers, board of directors, audit committees, and auditors.
Something fundamental to the well-being of our capital markets, are reliable and transparent financial reports, particularly important in this disturbing environment. The financial report cannot forecast the strengths and weaknesses of the economy. However, financial statements and related information, such as Management's Discussion and Analysis (MD&A) can provide useful information that enables users to make decisions and facilitates the continued efficient operation of our capital markets. This requires the attention of management, auditors, and audit committees, who not only must bear their unique responsibilities in their respective areas,they must also work together to produce the high quality financial reports that is vital in our capital markets.
We have summarized the particular risk factors affecting financial reporting today, and have identified some of the financial reporting points that are especially relevant in this difficult business environment. We have also highlighted the actions that management, auditors, and audit committees can take to effectively address these risks and produce reliable financial reports.
Environmental Factors Affecting Financial Reporting
Difficult Economic Times
The economic downturn began with a decline in investment spending. With the bursting of the dot-com bubble, businesses took a more pessimistic view of the economic future and reduced spending on equipment, software, real estate, inventory, and other investments. One of the first sectors to suffer the effects of the reduction in capital expenditures was the high-tech industry, where earnings and stock prices plunged.
While the effects of the reductions in corporate spending rippled through the economy, energy costs temporarily took money from consumers and were converted into corporate income. Earnings plunged, lending capacity declined, growth slowed, energy prices fell, and the stock market crashed. Investor wealth was declined by trillions of dollars. Employee layoffs continued, and with the unemployment rate rising (though still historically low), surprisingly strong consumer spending finally began to decline. The companies began restructuring, inventory liquidations, and closings. The events of September 11 and their consequences only worsened the already deteriorating economic conditions.
These factors put downward pressure on earnings and other performance measures that, for most in the past decade, had been on an upward trend. This change in direction has created growing sensitivity in capital markets to bad news.
Pressure for Performance
Businesses deal with pressures that come from a variety of sources, internal and external. External pressures come primarily from the capital markets, where many believe that Wall Street expectations frequently inappropriately direct management behavior. Management is often under pressure to find short-term performance indicators, such as earnings or earnings growth, financial ratios tied to agreed debts, or other measures. Management's intentions are to follow sound and ethical practices, but pressure can build when analysts and shareholders demand short-term performance and when competitors move closer to the edge of acceptable behavior.
Members of top management can also be pressured to show that shareholder value has grown as a result of their leadership. Boards of directors frequently create pressure on management to meet financial and other goals. There is also an established good practice of motivating management with stock options and other participation instruments that attempt to align the interests of shareholders and management. With their own compensation and performance tied to operational and financial goals, management can push hard at the same time on staff throughout the company, including those in operating business units, to find what may be overly optimistic goals.This high-pressure environment can create an environment conducive to adopting practices that may be overly aggressive and / or inconsistently applied, in an effort to meet the perceived expectations of capital markets, creditors, or potential investors. At the same time, the motivation behind earnings management can become strong and sufficient for individuals to move beyond acceptable practices, even though they are somewhat honest individuals. The greater the pressures, the more likely individuals will justify the acceptability of their actions.the motivation behind earnings management can become strong and sufficient for individuals to move beyond acceptable practices, even though they are somewhat honest individuals. The greater the pressures, the more likely individuals will justify the acceptability of their actions.the motivation behind earnings management can become strong and sufficient for individuals to move beyond acceptable practices, even though they are somewhat honest individuals. The greater the pressures, the more likely individuals will justify the acceptability of their actions.
The complexity and sophistication of the structure of the business and transactions
The increasing sophistication of capital markets and the creativity of investment bankers and other financial advisers have fostered a wide variety of complex financial instruments and structured financial transactions. Many companies now use complex transactions that involve transactions with others in the form of asset purchases / sales, derivative transactions, and intricate operating agreements designed to meet a specific objective as well as an economic objective. Some companies have transferred assets off the balance sheet or arranged by units to be acquired by special purpose entities, joint ventures, limited liability corporations, or partnerships, substantially retaining all risks and ownership but without "control." Recent business failures,including the boom of dot.com companies, they have focused attention on the potential risks of these transactions and business structures and the challenge of reporting that is easily understood by users of financial statements.
Many companies have adopted fast and innovative forms of business expansion, or through acquisitions and mergers, or internal development. Such rapid expansion may have been necessary to support the high price of these gains. However, it also creates many challenges, including integrating dissimilar operations, internal control processes, and meeting financing needs. Liquidity crisis or financial reporting failures can result.
Complex and Bulky Standards
In addition to the business challenges are the numerous accounting standards, interpretations, SEC positions, consensus of work groups, position statements, etc., which continue to expand the technical material that must be understood and applied in the process of financial reports. Understanding this extensive body of standards can be a daunting task, even for larger and more sophisticated companies. Furthermore, as transactions become more complex, the accounting rules for them become highly technical and thorough, for example SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities; No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities; No. 141, Business Combinations; No. 142, Goodwill and Other Intangible Assets; Y no.144, Accounting for the Impairment or Disposal of Long-Lived Assets. The complex and detailed rules are perpetuated, causing their complexity to continue to increase. Each new rule, specifying how a certain transaction should be posted, presents an opportunity for someone to find a way to create an even more complex transaction. This creates the need for a new rule to close the gap, and so on. These rules have become so complex that management increasingly struggles to understand and apply them. Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.The complex and detailed rules are perpetuated, causing their complexity to continue to increase. Each new rule, specifying how a certain transaction should be posted, presents an opportunity for someone to find a way to create an even more complex transaction. This creates the need for a new rule to close the gap, and so on. These rules have become so complex that management increasingly struggles to understand and apply them. Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.The complex and detailed rules are perpetuated, causing their complexity to continue to increase. Each new rule, specifying how a certain transaction should be posted, presents an opportunity for someone to find a way to create an even more complex transaction. This creates the need for a new rule to close the gap, and so on. These rules have become so complex that management increasingly struggles to understand and apply them. Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.presents an opportunity for someone to find a way to create an even more complex transaction. This creates the need for a new rule to close the gap, and so on. These rules have become so complex that management increasingly struggles to understand and apply them. Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.presents an opportunity for someone to find a way to create an even more complex transaction. This creates the need for a new rule to close the gap, and so on. These rules have become so complex that management increasingly struggles to understand and apply them. Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.Proper application often requires the attention and involvement of senior financial management and senior technical auditors from audit firms, and decisions are likewise subject to interpretation.
The SEC recently announced its desire to help accountants "get it right the first time" by discussing and pre-settling the accounting record purpose for anticipated events, anticipated transactions, or other unusual accounting transactions prior to their inclusion in the accounting records. financial information. The pre-settlement process would help accountants to apply complex accounting standards to unusual situations, helping to ensure that the financial statements reflect appropriate accounting and disclosure policies and reducing the risk of new approaches.
Financial Reporting Matters
The fundamental objective of financial information is to provide useful information to investors, creditors, and others to make rational decisions. The information must be understandable to those who have a reasonable understanding of business and economic activities and are willing to study the information with appropriate diligence. The financial report, including MD&A, should provide investors with management's perspective on the historical and prospective financial condition and results of operations.
A discussion of the key aspects of financial reporting that are especially relevant in today's environment follows.
Liquidity and viability aspects
The current business environment and market conditions could lead some companies to rapidly deteriorate their operating results and liquidity, particularly those with reduced access to capital. A company particularly sensitive to negative changes in economic conditions can quickly run into a liquidity crisis and ultimately go bankrupt. Certain conditions, considered in the aggregate, may lead company management or auditors to question the entity's capacity for continuity. These include negative trends such as recurring operational losses or working capital deficiencies, financial difficulties in obtaining loans or denial of credit from suppliers, depending on the success of a particular product that is not selling well,of legal processes, loss of a main customer or supplier, destabilization of a business partner or counterpart, and excessive external financing more than the funds generated from operations.
The key in evaluating these risk factors is whether:
- Existing conditions and events can be mitigated by management plans and their effective implementation. The company has the ability to control the implementation of these mitigation plans rather than being dependent on the actions of others. The company's ability to continue as a going concern is based on reality, rather than excessive optimism, evaluating its access to debt or equity or its ability to sell assets in a timely manner. Liquidity challenges have been met and properly disclosed.
Changes in internal control
Layoffs, downsizing, and notifications to employees of impending termination can affect internal control over financial accounting and information systems. The remaining employees may feel burdened by their workloads, lack of time to complete tasks and considerable decisions, and simply perform too many tasks and functions to achieve required levels of accuracy. In addition, rapid business expansion, changes in business strategies, and the integration of diverse businesses can overwhelm the ability of a company's financial systems to maintain effective internal control. Furthermore, the controls in the business units mentioned above may be interrupted. As a result of any of these factors,internal control can become less effective or ineffective.
The relevant considerations are whether:
- Attention to internal control has been maintained in the face of significant changes in the business As a result of empty positions, key control procedures are not performed, are being performed less frequently, or are being performed by missing individuals the proper understanding to identify and correct errors Information technology (IT) staff layoffs have had a negative effect on the entity's ability to initiate, process, or record its transactions, or maintain the integrity of the information generated by IT The key functions to be segregated are now being performed by one person The impact of changes to the control environment has altered the effectiveness of internal control and potentially resulted in a material weakness of the control.Changes in internal control caused by layoffs or downsizing create an opportunity for fraudulent activities, including misappropriation of assets.
Unusual Transactions
Among the most frequently cited sources of financial reporting risk are significant adjustments or unusual transactions that occur in or near the last-quarter or year-end. Unusual transactions could include asset sales outside the ordinary course of business, significant or unusual end-of-period income, introduction of the new end-of-period sales promotion programs, and disposition of a segment of a business. These types of transactions and adjustments that frequently occur outside of the ordinary course of the company's business may often not be subject to verification by the internal control system.
The key points include:
- Recognition of the underlying purpose of these unusual transactions, as well as the resulting financial benefits or obligations. If unusual transactions - particularly those executed near the end of the period - are subject to effective controls. The impact of these types of transactions on annual results and quarterly, and if they have been appropriately described in the company's financial reports. Existence of any "special" arrangement not considered in the proper accounting and disclosure of the transaction. If unusual daily entries, including adjusting entries made in the final of the closing process, are subject to an appropriate review.
Transactions with related parties
Increasing pressure on management to maintain or achieve financial objectives may increase the risk of incorrect accounting or disclosure of related party transactions. Transactions with related parties are not independent negotiations in terms of structure and price, which are present in transactions with unrelated parties. Difficult economic times also increase the possibility that the economic substance of certain transactions may be other than their legal form, or that the economic substance may be missing in the transactions. Parties that do not have any independent relationships have no ability to separate transactions or to stand behind agreements.
The key to these issues is whether:
- Management has a process to identify related parties and related party transactions Sufficient information is available to understand and evaluate the relationship between the parties to a transaction The parties have the substance and the ability to carry out the transaction The essence of the transaction The transaction, including any unusual conditions, determines the accounting for the transaction. Disclosures are complete regarding the nature and relationship between the parties in accordance with FASB and SEC rules.
Transactions involving off-balance sheet arrangements including special purpose entities
Some business entities make use of off-balance sheet arrangements to conduct financing or other economic activities. These may involve unconsolidated, non-independent entities, limited purpose entities, often referred to as financial structuring or special purpose entities (SPEs). These entities can be used to provide financing, liquidity, or market or credit risk assistance, or they can be involved in leasing, hedging, or research and development services. These agreements or entities may give rise to contractual or other commitments, such as requirements to finance losses, to provide additional financing, or to purchase capital assets,or otherwise have financial impacts resulting from the other party's performance or default.
Transactions with special purpose entities attempting to change assets or liabilities off-balance sheet require special attention due to the complicated accounting and disclosure rules applicable to many of these transactions. The ownership structure of these entities and the terms of the transactions can be critical in determining whether the off-balance sheet treatment is appropriate under generally accepted accounting principles. The adequacy of the disclosure is also important since the potential impact of these transactions may not be apparent in the basic financial statements.
Important considerations in transactions involving SPEs include whether:
- SPE are also called "special purpose rating entities"; or non-rating SPE, since different accounting standards apply to each. SPE, if not rating, is appropriately capitalized to utilize non-consolidation, including whether third parties have made a substantive investment that is residual capital in the form have voting control, and have substantial residual risks and the rewards of SPE ownership. The level of capital in non-rating SPE is adequate, particularly when using the multi-tiered SPE structures. indispensable in non-rating SPE existed at the time of the transaction and continues to exist.Any involvement of related parties as investors or is otherwise consistent with the non-consolidation. Any modification that has been made to an existing SPE in the current period that could affect the accounting determined on the date of the transaction.
The arrangement is outside the normal course of business.
Materiality
Materiality is a concept that plays a critical role in various parts of the financial process. Although generally accepted accounting principles recognize the concept that accounting standards need not be applied to intangible items, this recognition is more for the convenience than for the basic purpose of keeping the books accurate and recorded. Therefore, while management may consider materiality in the selection of accounting principles to use in the financial statements (including notes) and in the preparation of MD&A, it is generally inappropriate to allow known errors to remain in financial information based on simply in its immateriality2.
Management may also consider materiality in determining identified misstatements, including those identified by auditors. Auditors consider materiality when evaluating the application of accounting principles, when planning the audit and designing audit procedures, and when evaluating the impact of the misstatement (also called audit differences) identified during the audit if management decides not to register any or all.
Quantitative and qualitative factors should be evaluated when evaluating the materiality of erroneous claims, focusing on:
- Individual and aggregate misstatements and their impact on key accounts, totals, and financial statement ratios If a misstatement increases management compensation by satisfying the requirements for awarding bonuses or other incentives If a misstatement masks a change in earnings or other trend or conceals some type of incident The impact of a misstatement in accordance with financial statements relating to debt covenants The misstatement indicative of intent of misleading financial reporting or illegal acts The misstatement particularly important to a business segment.
Disclosure sufficiency
In a recent editorial in the Wall Street Journal, the SEC chairman outlined the actions managers, auditors, and audit committees should take to enhance the current financial reporting and disclosure system to reassure and restore investor confidence. Among his recommendations, the president urged public companies and their advisers to identify the three, four, or five critical accounting principles on which the financial statements of a company depend, and which involve the most complex, subjective, or ambiguous decisions.. Investors should be advised, succinctly and clearly, how these principles are applied, and be informed about the range of possible effects of various applications of these principles.
As a result of the chairman's editorial, the SEC recently issued cautionary advice regarding disclosure on critical accounting policies, in which it indicated an intention to consider new rules to make more accurate disclosures about accounting policies that management believes are. the most “critical” - that is, they are just as important in showing the company's financial condition and results as in basing management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates. on the effect of matters that are intrinsically uncertain. The SEC states that an exact technical application of the rules on disclosure can, nevertheless,failing to communicate important information if clear analytical disclosures are not included to facilitate an investor's understanding of the company's financial status, and the possibility, probability, and implication of changes in its financial and operating status. The SEC encourages companies to employ a disclosure regime along the following lines:
- Management and the auditor should have determined focus in evaluating the critical accounting policies used in the financial statements Management should ensure that disclosure in MD&A is balanced and fully accountable Before finalizing and classifying annual reports, audit committees should review the selection, application, and disclosure of critical accounting policies If companies, management, audit committees, or auditors are undecided about the application of specific GAAP principles, they should consult with SEC accounting staff.
The SEC has also continually expressed concern that some accountants are simply repeating the financial statement disclosures in their MD&A or are simply recalculating the dollar and percentage changes in the financial statement heading without providing meaningful information on the underlying reasons. for changes that may well happen in the future. MD&A requires disclosure about trends, events, or uncertainties known to management that would have a material impact on the financial information reported. The SEC has observed that, even for where trends, events, and uncertainties are reported, the implications of those matters on the methods, assumptions,and estimates used to repeat and pervasive accounting measures are not always addressed.
The SEC has informally suggested that the following matters be considered for MD&A disclosure in the current environment: loss of a significant customer; durable asset impairments; business restructuring; factors that affect the cost or availability of insurance or energy coverage; declines in the value of the securities or the retirement plan; violations, amendments, or waivers of debt covenants; credit or market risks; and effects of related party transactions.
On another matter, in recent years, companies have increasingly reported earnings and results of operations based on methodologies other than GAAP, sometimes referred to as "pro forma earnings." Such information may be presented to provide a meaningful comparison of results in prior years, to emphasize results of core operations, or for other purposes. While there is no prohibition against public companies publishing interpretations of their results or summaries of GAAP financial statements, there is a growing concern that pro forma financial information may mislead investors if it obscures GAAP results.
The SEC recently issued cautionary advice to preparers, as well as an alert to investors, about the use of pro forma financial information in announcing earnings. SEC staff cautioned that the earnings announcement is in accordance with the anti-fraud provisions of federal security laws and not used to mislead investors through the inclusion of pro forma information. Earnings announcements that are contained in the proforma and other non-GAAP information without a reconciliation to GAAP, including amounts and appropriate explanations, can be viewed as misleading.
Additionally, the SEC suggests that companies:
- Provide an accurate description of the principles you adhere to that are the basis for your pro forma presentation. For example, when a company intends to announce earnings before "unusual transactions" it must describe the transactions determined and the class of transactions that are omitted and apply the methodology described when presenting presumably comparable information for other periods. Consideration of the materiality of the information. omitted from the pro forma presentation. Statements of a company's financial results that are literally true may nevertheless be misleading if they are the result of obscure GAAP or omit material information otherwise included in GAAP financial statements. For example,Investors are subject to being misled if a company uses pro forma presentation to change a loss to a profit, or to hide a significant fact, without clear and understandable explanations of the nature and size of the omissions.Consideration of the guidelines developed in Common by Financial Executives International and the National Investors Relations Institute before determining whether to publish pro forma results, and before deciding how to structure a pro forma statement of purpose.A presentation of financial results that addresses a limited feature of financial results or that provides calculations of financial results on a basis other than GAAP will not generally be judged to be simply misleading due to its departure from GAAP if the company is in the same statement. The public discloses in English how GAAP has deviated and the amounts of each of those deviations.
As a main conclusion, a clear and complete disclosure is key. In particular, complex transactions such as those with related parties, special purpose entities, off-balance-sheet agreements, or situations involving contingent obligations, derivatives, financial guarantees, and liquidity, among others, increase the importance of financial disclosures. to present a complete picture of a company and its risks. Therefore, it is important to assess not only whether the technical GAAP and MD&A disclosure requirements have been resolved, but also to consider the depth and transparency of the disclosures in order to help the reader more fully understand the essence of the risks of the company and profits.
Specific Risks of Financial Statements
In these difficult times, new risks directed at specific areas of the financial statements may present themselves, including:
Durable assets, good will, and other intangible assets
- Are there events or changes in circumstances that indicate that the value of a durable asset may not be recoverable, because of an impairment consideration? Are the assumptions underlying the calculation of fair values of the assets, reasonable and based on current information? Are they based on assumptions that are difficult to determine, for example occurrences over long periods of time? Do the disclosures adequately portray the methods for calculating fair value and the related degree of uncertainty?
Inventory weakening
- Are there events or changes in demand or price that indicate that the quantities they carry in inventory may be too high?
Revenue recognition
- What are the significant areas and estimates underlying the company's revenue accounting? The company's revenue meets required standards, including, where applicable, the four criteria of SEC Staff Accounting Bulletin No. 101, income recognition in statements financial: (1) persuasive evidence of an agreement; (2) delivery occurred or services rendered; (3) fixed or determinable price, and (4) reasonably assured collection? Has any "special" arrangement been properly considered to determine reportable income? Are the company's revenue recognition policies adequately recognized in the financial statements? Are there any unusual seasonal or end-of-period trends in income?
Accounting estimates
- What are the most significant estimates and judgments that management makes when preparing the financial statements? Is sufficient attention - resources, rigor of the process, level of review - given to these estimates? Are the underlying assumptions based on reliable, up-to-date information? Is there appropriate disclosure for significant assumptions, changing assumptions, and uncertainty in estimates?
Deferred taxes
- Have been accumulated losses in recent years or other conditions that may require special valuation for net deferred tax assets?
Restructuring charges
- The company's initial accounting and ongoing accounting and provision restructuring disclosures meet the requirements of EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring), and SEC Staff Accounting Bulletin No. 100, Restructuring and Impairment Charges?
Debt covenants
- Is or is the company in violation of debt covenants, possibly requiring disclosure and reclassification of long-term debt to short-term? Are there provisions for default that could be caused by a simple violation of the debt covenant? Are there any related debt covenants to unspecified "material adverse changes"?
Temporary declines in the commercial value of debt and securities, and investments
- Has the decrease in the value of the securities until maturity or available for sale, or in stock investments or investments based on cost, requiring the recognition of loss been classified “apart from temporary”? Is there a need to disclose any “ early warning sign ”related to a decline that has been experienced but not yet estimated other than storms?
Pensions and other post-retirement benefits
- Factors such as falling trading values of securities, significant falls in interest rates, and projected increases in medical costs require management's review of the underlying accounting estimates related to pension and other post-retirement plans?
Stock options for employees
- Has the company made any changes to its option plans, such as repricing or extending the term of exceptional options, that require cost recognition and disclosure?
Other risks and uncertainties
- Is the company exposed to the risk of credit default from a significant supplier / customer, a service provider, a lessor / lessee, a debtor, a financial guarantor, an investor, a joint venture partner (joint venture), of a counterparty, and / or a business partner due to financial problems or bankruptcy? Have credit and default risks been adequately disclosed? Eventual obligations have been properly identified and disclosed?
Recently published standards
- Have recently issued standards, such as SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities, been adequately addressed and disclosed?
Changes to accounting principles and methods
- Have all discretionary changes to accounting principles and methods that, individually or collectively, materially affect the results of operations reported in interim or annual periods been disclosed?
The risks described above are general in nature. Additional information on financial statement risks related to specific industries can be obtained by reading the industry-specific risk alerts produced by the American Institute of Certified Public Accountants.
A call to action
Management, auditors, and audit committees each have separate roles and responsibilities. However, your goal should be the same - making sure that a company's financial reports are of high quality.
The following are the most important actions to take to achieve this common goal.
Management
- Ensuring the appropriate tone above all else and an expectation that only the highest quality financial reporting is acceptable Review all elements of the company's internal control - control environment, risk assessment, control activities, reporting and communication, and monitoring - in light of changes in the company's business environment and with particular attention to significant areas of financial statements Ensuring that appropriate levels of management are involved in the review of key accounting policies and on financial reporting decisions Establish a framework for open and timely communication with auditors and the audit committee on all significant matters Strive for total quality,the most transparent accounting and disclosures - not just what is acceptable -; in the financial statements and MD&A. Make sure that estimates and judgments are supported by reliable information and the most reasonable assumptions in the circumstances, and that processes are in place to ensure consistent period-to-period application. Identified records of audit differences Economic decisions based on economic reality rather than accounting goals Expand the depth and disclosure surrounding subjective measures used in the preparation of financial statements, including the probability and ramifications of subsequent changes When faced with an area “Gray”, consult with others, consider the need for SEC pre-liquidation,and focus on financial reporting transparency.
Auditors
- Understand how the company is affected by changes in the current business environment Understand the tensions in the company's internal control over financial reporting, and how they can affect its effectiveness Identify key risk areas, particularly those that involve significant judgments and estimates. Undertake the audit with objectivity and professional skepticism, despite past experiences believing in the integrity of management. Pay particular attention to complex transactions, especially those that present difficult matters of form over substance. Consider whether knowledge Additional expertise is needed on the audit team Make management aware of identified audit differences on a timely basis Ask anything that doesn't make senseEncourage open communications with management and the audit committee, including discussions about the quality of financial reports and any pressure to accept lower quality financial reports When faced with a “gray” area, perform appropriate testing and checking procedures management explanations and dealerships, and with others as needed.
Audit Committees
- Assess whether management is displaying the appropriate tone and fosters a culture and environment that promotes high-quality financial reporting, including addressing aspects of internal control Ask management and auditors about how they assess the material risk of misinformation, what are the key areas of risk, and how they respond to identified risks Question management and auditors to identify difficult areas (eg, significant estimates and judgments) and to fully explain how each of them made their judgments in those areas Test how management and auditors have reacted to changes in the company's business environment Understand why critical accounting principles were chosen and how they were applied and adapted,and consider the quality of financial reports and the transparency of disclosures on accounting principles Question management for explanations of any identified unrecorded audit differences Understand the extent to which related parties exist and consider the transparency of the Related disclosures Read the financial statements and MD&A to consider if anything is contrary to your own knowledge Consider whether readers of the financial statements and MD&A will be able to understand the disclosures and risks of the company without access to management that the committee enjoys.Asking auditors about pressure from management to accept lower quality financial reporting.When faced with a “gray” area,increase the level of communication with management and auditors.
Management, auditors, and audit committees must each diligently fulfill their own role and work effectively with others through proactive communication and information sharing. By working together, we can collectively improve the financial process. This requires a renewed commitment by each of the parties to the needs of the users of financial statements.
This document has been prepared and distributed by the five largest accounting firms (Andersen, Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers) and the American Institute of Certified Public Accountants. The five firms and the AICPA recognize the responsibility of our profession to work toward effective financial reporting and audit effectiveness and to have made significant commitments toward those ends. Producing and distributing this document is just one of several actions taken to fulfill this commitment.
2 The SEC has expressed its point of view on the matter of materiality in Staff Accounting Bulletin No. 99, Materiality, August 12, 1999 edition
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