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Accounting policies, internal control key to stemming fraud

A new report says improved accounting policies and internal controls around complex transactions can be a key factor in reducing and stemming fraudulent financial reporting.  

The report, Addressing Challenges for Highly Subjective and Complex Accounting Areas, was released by the Anti-Fraud Collaboration, a group of four professional associations — the Center for Audit Quality, Financial Executives International, the Institute of Internal Auditors, and the National Association of Corporate Directors. The group’s members share the goal of enhancing the quality and reliability of financial reporting through strengthening the awareness of, and skills to participate in, the deterrence and detection of financial reporting fraud.

The group is co-chaired by Cindy Fornelli, executive director of the Center for Audit Quality, and Mary Schapiro, former chair of the SEC. The collaboration worked closely with the SEC in analyzing relevant enforcement actions and designing useful workshops to discuss issues and develop recommendations. These recommendations will help members of four organizations representing key components of the financial reporting supply chain and benefit the SEC’s constituents, which include public company investors and stakeholders in other entities who rely on financial reporting.

“In 2014, the CAQ and the Financial Reporting and Audit (FRAud) Group within the Division of Enforcement at the Securities and Exchange Commission entered into a dialogue to explore areas where the collaboration could work together with the SEC to advance our common objective of deterring and detecting financial reporting fraud,” the report states. “The collaboration undertook an analysis of the SEC’s Accounting and Audit Enforcement Releases (AAERs) — releases announcing financial reporting-related enforcement actions brought by the Commission — that identified a failure in internal control over financial reporting (ICFR).”

The CAQ led a series of workshops at which members of the Anti-Fraud Collaboration participated. The objectives of the workshops were as follows

  1. Provide an opportunity for members of the financial reporting supply chain to learn more about the work of the SEC’s FRAud Group and how it coordinates with other government agencies and the Public Company Accounting Oversight Board.
  2. Facilitate a robust discussion about accounting policy, centering on highly subjective and complex accounting areas, and the design and operating effectiveness of ICFR.
  3. Discuss steps that the various members of the financial reporting supply chain could take in their organizations to mitigate the risk of repeating the errors uncovered in the SEC enforcement actions.

Through analyzing and discussing the AAERS and practices on which workshop participants shared their respective expertise from the realms of financial reporting, internal auditing, board oversight and external auditing, the group believes their joint recommendations will assist companies in not only reducing financial reporting fraud, but also in reducing the number of financial statement restatements.

Key recommendations

Emphasizing the role of accounting policies and internal controls in stemming fraudulent financial reporting, particularly for complex transactions, key recommendations contained in the report include the following points regarding accounting policies:

  • Accounting policies must adhere to technical accounting guidance.
  • Process must be married to policies.
  • Policies must be tested in the field prior to implementation, and then monitored for compliance post-implementation.
  • Accounting policies in regards to revenue recognition should be granular because even slight changes in contract terms can have a major impact on revenue.

The report also outlines key recommendations regarding internal control over financial reporting:

  • Tone at the top is an essential component of an ICFR regime.
  • A risk-based evaluation is the best approach for achieving effectiveness and efficiency in ICFR.
  • Internal controls over unusual and nonroutine transactions are sometimes overlooked or given less attention than core processes when developing an effective ICFR regime.

Learn more

Read the Anti-Fraud Collaboration’s report.

See: SEC cracks down on accounting, internal control

Visit the Committee of Sponsoring Organization’s of the Treadway Commission’s (COSO’s) Internal Control-Integrated Framework



Edith Orenstein