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May 04

Financial reporting issues surge

Posted by Stephen Taub in Section 404Sarbanes-Oxleyrestatementsmaterial weaknessinternal controlsGlass Lewisexpense recognition errorscomplianceAccounting

Stephen Taub

Are companies become more lax with their accounting practices? It seems so.

According to an analysis of first quarter regulatory filings, Glass, Lewis found a surge in financial-reporting issues, a sharp reversal from recent trends.

About twice as many companies filed restatements to correct accounting errors and twice as many reported internal-control weaknesses than in the first quarter of 2009.

If these issues retain their current pace, 2010 is shaping up to show the first year-over-year increase in financial-reporting issues since the passage of Sarbanes-Oxley.

Even so, the number of restatements and control weaknesses at this point seem like they will come in below 2008 levels, according to GL, which analyzed U.S.-listed companies with market capitalizations of at least $250 million as of their filing dates.

Still, the recent uptick is concerning.

Specifically, 38 companies filed restatements to correct accounting errors, up from 18 in the first quarter of 2009. There were 78 in all of 2009.

What's more, the quarterly restatement rate rose to 1.2 percent, double the level of the prior year.

In addition, there were 26 reported material weaknesses in the first quarter, double the first quarter of last year. There were 72 for all of 2009.

What's more, 0.8 percent of U.S.-listed companies disclosed new material weaknesses, up from 0.4 percent a year ago.

Glass, Lewis noted that expense recognition errors and misclassifications remained the most common error types. Corrections for revenue recognition errors were also frequent.

In general, GL says revenue recognition, expense recognition and taxes are evergreen problem areas for corporate finance personnel no matter how much emphasis is given to them by rule makers and auditors.

Keep in mind that the number of financial reporting issues is still way down from a few years ago, which GL attributes to the benefits of Section 404 of the Sarbanes-Oxley Act.

For example, there were 185 restatements in 2008, which in turn were about half the 361 filed in 2007.

There were 214 material weaknesses in 2008.

Even so, Glass Lewis could not resist speculating whether companies are actually making fewer errors or if executives and auditors are simply failing to find and report them, noting that regulators have relaxed some key rules and auditing standards since initial adoption of SOX 404.

One encouraging development: A proposed permanent exemption for smaller companies of the external audit requirements of SOX 404 disappeared from recent versions of the financial reform bill being debated in Congress. As a result, by the end of the year, all companies may finally be required to submit their controls to independent testing, eight years after SOX became law.

"If the effective date isn't extended again, we expect a tidal wave of material weakness disclosures from smaller companies to hit later this year and in the first quarter of 2011," Glass Lewis predicts.

Other findings from GL's first-quarter report:

A total of 34 companies received adverse internal-control opinions from external auditors, up 21 percent from last year.

In the last 15 months, one-sixth of material weaknesses reported affected multiple accounting areas; two thirds were related to systems and procedures.

Companies delayed 43 financial reports, up 16 percent from 2009.

The most commonly cited reasons for late filings were restatements, finalizing accounting treatment for items such as asset impairments, mergers and acquisitions and financing deals
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