FRAUD by decree

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 Understanding the
 Causes & Effects
What is a Restatement?
FASB Says…

  Restatement (emphasis added)
  – The process of revising previously issued financial
    statements to reflect the correction of an error in
    those financial statements.
Error in Previously Issued Financial
 Statements (emphasis added)
   An error in recognition, measurement, presentation,
     or disclosure in financial statements resulting from
     mathematical mistakes, mistakes in the application
     of generally accepted accounting principles
     (GAAP), or oversight or misuse of facts that
     existed at the time the financial statements
     were prepared. A change from an accounting
     principle that is not generally accepted to one that
     is generally accepted is a correction of an error.
Who Is Responsible?
Responsibility – the Company

  CFO –Financial reports & disclosures
  Board of Directors (Audit Committee) –
Management Integrity
Responsibility – the Independent
  Form opinion that financial statements
   presented fairly in conformity with GAAP
  Maintain competency
  Maintain independence
Client & Industry Knowledge
Independence & Integrity
Responsibility – the SEC

  Established in 1934 to protect the investing
    Current mission is to “protect investors, maintain
     fair, orderly and efficient markets, and facilitate
     capital formation”
    Purpose in regard to accounting is to ensure “full
     and fair disclosure of all material facts”
 Division of Enforcement investigates
  accounting irregularities & securities law
    Leads from press reports, investor complaints,
     surveillance, & other sources
    Full investigation may ensue
Effective Investigation
Not so Effective Investigations
Sources of Restatements (GAO – 2002)

    375 – Company
    119 – SEC
     69 – Auditor
     18 – Company with SEC, auditor, or FASB
     16 – Miscellaneous sources
    322 – Unknown
    919 – Total
Nature of Restatements (GAO – 2002)
 389 – Revenue recognition
 183 – Cost or expense
 125 – Restructuring assets or inventory
 66 – Securities related
 65 – Acquisitions & mergers
 37 – In-process research & development
 224 – Reclassification & other
 1,089 – Total (exceeds 919 due to multiple reasons cited)
Response of the SEC
Advisory Committee on Improvements
 to Financial Reporting
  Established July 2007
  Mandate to examine U.S. reporting system
  Make recommendations to:
    Increase usefulness of financial information to
    Reduce complexity of financial reporting system to
     investors, preparers, and auditors
Five Themes in Recommendations
 Increasing usefulness of information in SEC
 Enhancing accounting standards-setting process
 Improving the substantive design of new
  accounting standards
 Delineating authoritative interpretive guidance
 Clarifying guidance on financial restatements
  and accounting judgments
 Increasing the Usefulness of
   Information in SEC Reports
 Executive summary at beginning of annual report on
  Form 10-K
 Include summary information on corporate websites with
  hyperlinks to details
 Continue phase-in of XBRL *
 Private sector should develop key performance indicators
      Industry or activity basis
      Captures aspects not fully reflected on financial statements
      May be non-financial
      Encourage use of consistent definitions and methodologies
Enhancing the Accounting
 Standards-Setting Process
 Increased investor representation on FASB and
  Financial Accounting Foundation (FAF) *
 Increasing field work for proposed standards
  and formalizing post-adoption reviews of new
  standards and periodic reviews of existing
 Creation of Financial Reporting Forum (FRF) to
  discuss current pressures on financial reporting
  system and how challenges are being met
Improving the Substantive Design of
 New Accounting Standard
 Distinguish different sources of changes in
  company’s income
    Distinguish cash receipts from unrealized changes in
     fair value
    Better explains earnings volatility
 Avoid “bright-line” all-or-nothing tests
    Use of intermediate approaches such as proportionate
    Consider qualitative factors
    Enhance disclosures
 Move away from industry-specific guidance *
   Focus on nature of business activity
   Eliminate alternative accounting treatments
Delineating Authoritative
 Interpretive Guidance
  Complete FASB Codification
    Integrate SEC accounting guidance
    SEC should adopt similar format
  FASB to be sole source of authoritative GAAP
    Issues identified by SEC referred to FASB
    SEC inform FASB in advance of announcing
     interpretation of broad significance
    Re-emphasize that comment letters and
     “preclearance” processes are registrant-specific
Clarifying Guidance on Financial
  Restatements &Accounting Judgments
  Separate determination of whether error is
   material from means of correction *
     Prompt correction and prominent disclosure of
      accounting errors unless clearly insignificant
     Instructions to form 8-K clearly to require filing for
      all determinations of non-reliance on prior
      financial statements
     Correction and disclosure would involve
      restatement only if material to current users
 SEC and PCAOB should issue policy
  statements on the subject of accounting and
  auditing judgments *
   Provide transparency on how reasonableness of
    judgments evaluated
   Emphasize that judgments be documented
25 Specific Recommendations

  Divided into 4 chapters
    Substantive Complexity – 9 recommendations
    Standards-Setting Process – 6 recommendations
    Audit Process and Compliance – 5
    Delivering Financial Information – 5
Appendix – Compendium of
    David J. Flanagan, Lori A. Muse, and K.C. O’Shaughnessy; An overview of
     accounting restatement activity in the United States; International Journal of
     Commerce and Management; Vol. 18 No. 4; 2008
    Stephen Taub; Study Points Restatement Blame Back at Cos.; Compliance
     Week, March 25, 2008
    Helen Shaw; Restatements: Stupid Human Tricks?; CFO; November 22, 2006
    Ken Brown and Ianthe Jeanne Dugan; Arthur Andersen’s Fall From Grace Is a
     Sad Tale of Greed and Miscues; Wall Street Journal; June 7, 2002Lynn E. Turner
     and Thomas R. Weirich; A Closer Look at Financial Statement Restatements –
     Analyzing the Reasons Behind the Trend; The CPA Journal; December 2006
    Messod Daniel Beneish; Incentives and Penalties Related to Earnings
     Overstatements that Violate GAAP; The Accounting Review; Vol. 74 No. 4,
     October 1999

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