The Missing Piece in the Restatement Puzzle

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Financial restatements continue to be a major concern and focus of the Securities and Exchange Commission (SEC), the U.S. Department of Treasury, Congress, and other federal agencies. The reasons for this are understandable. Restatements have a profound impact on investor protections and on a firm's cost of capital, ability to grow shareholder wealth, and overall effect on U.S. global competitiveness. While there clearly is an overarching mission among the various committees focused on the financial restatement problem, there is a ''missing piece'' to fully addressing the root causes of financial restatement errors in the U.S. and around the globe: a lack of Generally Accepted Control Assessment Standards (GACAS).

To help close this gap, the Institute of Management Accountants (IMA®) recently launched its new Finance GRC (Governance, Risk, and Compliance) Research Practice area with the release of a provocative research discussion paper titled Accounting Control Assessment Standards: The Missing Piece in the Restatement Puzzle ( This discussion paper draws on more than three years of research, Congressional testimony, and thought-leader pieces in the areas of Sarbanes-Oxley (SOX) implementation, Enterprise Risk Management (ERM), and related issues in internal controls and compliance.

Supported by prior research and an assessment of 25 large Accelerated Filers, the research suggests that the lack of focus on and accountability for tracking and reducing ''error rates'' may be a more significant root cause of material financial restatements than the complexity of accounting standards and regulations. Error rates are defined as cases where management and their external auditors attest that they have an effective system of internal controls over financial reporting, but subsequently issue a material financial restatement that can be related back to a breakdown in internal controls.

While the discussion paper is primarily intended to provoke discussion, debate, and, most importantly, more comprehensive and global research to tackle and solve this critical problem, it offers several options and solutions to consider. One solution is assigning accountability to a properly funded private organization to develop GACAS capable of identifying and reducing the incidence of material errors in financial statements over the long term, which would require systemic and detailed analysis of the root cause(s) of errors. Perhaps this organization would be called the ''Center for Financial Reporting Quality,'' focused on error reduction and process improvement throughout the end-to-end financial reporting supply chain. Furthermore, requiring analysis of audit opinion errors, enacting appropriate safe harbors for issuers and auditors to enable disclosures of root cause error analysis, greater understanding and emphasis on technology (such as XBRL) to detect and prevent material errors, and implementing globally accepted risk and quality frameworks are also suggested.

The paper also provides a candid hypothesis as to why companies ''get it wrong'' and produce materially wrong financial statements at a rate in excess of one in every 10 Accelerated Filers (financial restatements as a percentage of total filers) in 2006. These hypotheses include a lack of fact-based, statistical information among the root causes of materially incorrect management- and auditor-certified financial statements. There is also reluctance to tackle the tough, ''indelicate'' risks head-on, with too much money and time spent on low-risk areas. A lack of emphasis on technology and a single organization focused on and accountable for identifying and reducing the frequency of material errors also is at issue.

To help address these critical problem areas, FGRC integrates three bodies of knowledge that have become critical for CFOs around the world to drive business performance inside their organizations: governance, which is the set of accountabilities and alignment of responsibilities in an organization; risk management, including ERM; and compliance, the system of internal controls and processes to satisfy regulatory, industry, and organizational requirements.

The critical work performed by management accountants and finance professionals across the financial and information supply chain directly affects the quality of internal controls, financial reporting, and ultimately, a clean audit outcome. To date, there has been a lack of research, guidance, training, and certification directed to these professionals who comprise more than 90 percent of all finance function professionals in the U.S. and around the world. IMA launched the FGRC practice to address this market need.

The focus on educating management accountants and organizations to produce accurate, reliable, and relevant financial information for an organization’s stakeholders using risk, performance, and quality assessment techniques across the supply chain is essential to curbing the amount of restatement errors.

This research is a first step to shedding light on these issues, while addressing the internal gap in best practices, guidance, training, and certification so that high quality financial information can be delivered to investors around the globe. Nothing less than investor protections, a firm’s cost of capital and value creating potential, and U.S. global competitiveness are at stake.
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Popular tags:

 protections  Enterprise Risk Management  management  Securities and Exchange Commission  assessments  external auditors  errors  committees  United States  Sarbanes-Oxley Act

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