Financial Statement Red Flags

Yesterday the Securities and Exchange Commission made available a slide presentation from the Public Company Accounting Oversight Board’s  2010 Forum on Auditing in the Small Business Environment.  The slides include detailed notes on some of the more common issues encountered by the Commission in reviewing company financial statements.  A number of topics are addressed, from reverse mergers and business combinations to MD&A and disclosure controls and procedures, with some of the more universally applicable take-aways being:

• Management’s Discussion and Analysis – Make sure that you are providing a sufficient level of detail in discussing factors that may contribute to fluctuations in your operating results from period to period and when discussing your liquidity and capital resources.  Also, make sure that you are disclosing known and predictable uncertainties that may have a material impact on your income from continuing operations.  In its presentation the Commission notes that it may issue comments in a situation where an event that triggers an impairment or other charge appears to have been predictable but was not addressed in an earlier period.

• Revenue Recognition – Avoid using overly vague or boilerplate language in your accounting policy disclosure and make sure that you clearly state the timing and method you use for recognizing each material stream of revenue.

• Disclosure Controls and Procedures – Disclosure controls and procedures encompass internal controls over financial reporting and even though disclosure controls and procedures may be found effective at the same time internal controls over financial reporting are found ineffective, if you reach that conclusion you should be prepared to support it.

• Internal Control Over Financial Reporting – Make sure that you are explicitly stating, without the use of any qualifying language or limitations in scope, whether or not your internal controls over financial reporting are effective.  If you find a material weakness in your internal controls over financial reporting, you should focus on more than just its impact on the particular line item in which it was discovered, instead, in both your disclosure of the weakness itself and your remediation disclosure, you should consider and discuss its impact on other items in your financial statements.  And, again, avoid using overly vague or boilerplate language that remains static from period to period.

• Changing a Certifying Accountant – If you dismiss your independent accountant because it has been involuntarily deregistered by the PCAOB, disclose that fact in your Forms 8-K, and if your former independent accountant’s audit report contained a going concern opinion it should also be disclosed in the Form 8-K as a modification as to uncertainty.

There are a number of other useful bits of disclosure guidance throughout the slide presentation, and it’s probably worth a flip through as you prepare for you next periodic filing.