Is it a Personnel Issue?
Recently, a reporter from the Wall Street Journal, Mark Maurer, asked to interview me about the question: “Are companies picking a new finance chief after detecting a material weakness in their financial reporting controls, at least in part due to a shortage of skilled accounting staff?” The idea is that the two may be related. My initial reaction was that it seemed to be a passing of the buck, at least to some extent, as the control environment of an organization sets the tone and if it does not operate in an ethical manner, some blame should be placed on others in the internal reporting process – such as the CEO and, perhaps, the board of directors. One could add the audit committee because its role is to ensure the financial reporting controls are operating as intended. Let’s not dismiss the possibility that these deficiencies are caused by poor management practices.
Reporting Internal Controls Over Financial Reporting (ICFR)
We need to recognize that material weaknesses in the internal controls over financial reporting (ICFR) are nothing new. What’s new is whether the shortage, which I have identified previously in a blog—the pipeline issue—is the direct cause of the problem. If the number of graduates of accounting degree programs continue its downward trend, that may lead companies to hire outside the field and place someone not as well educated or trained in ICFR matters, and this can lead to deficient work.
What’s new in recent years is the need for additional training in detecting material weaknesses in the ICFR brought on by the passage of the Sarbanes-Oxley Act. Under Section 302, the CEO and CFO, or other financial reporting officials, are responsible for the accuracy, documentation, and submission of the financial reports as well as the internal control structure to the SEC. These officers sign the report attesting to the fact that the report does not contain an untrue statement of material fact necessary in order to make the statements made, in the light of the underlying circumstances under which such statements were made, not misleading.
Blame it on the CFO?
Returning to the question whether the shortage causes increased deficiencies in the controls that go undetected, this may be a manifestation of looking for someone to blame and the CFO pops up. There is a biased tendency by companies and, indeed, all people, to blame an individual rather than an indication that the people in the CFO position are bad accountants due to training or otherwise.
Undoubtedly, there are some CFOs who should be blamed for these occurrences and held responsible, but the overall issue should not be entirely blamed on them. Bill Miller, from the University of Wisconsin at Eau Claire, made this astute point in our communication on these issues: “If it were an easy fix, it would have been fixed already.”
Dr. Miller points out that replacing the CFO when the level of deficiencies is high may be an overreaction on the part of the company. The reasons may be:
- For publicly traded companies, it’s probably the thing to do to show the investing public that they are taking some action.
- It may be motivated to prevent too much of a drop in their share price.
Another colleague of mine, Bob Conway, made an astute observation:
When a material weakness is identified and reported, particularly if the company failed to identify it in a timely manner, indignant audit committees might look for someone to blame and that would likely be the CFO who could be pressured to tighten controls up.
Bob’s book, The Truth About Public Accounting,provides an excellent discussion of the role and responsibilities of auditors, audit committees, and regulators.
Advance Auto Parts
On July 11, 2023, Advance Auto Parts cited a lack of skilled accounting personnel for material weaknesses in their financial-reporting controls, a key predictor of the restatement of financial statements. The company added to its disclosure on May 30, 2024, that an additional material weakness in its ICFR, as per its amended annual filing with the Securities and Exchange Commission, existed. This weakness pertains to ineffective control activities, including account reconciliations, as of December 30, 2023.
The company, a leading automotive parts provider, revealed that subsequent to its original filing on March 12, 2024, management identified the deficiency which led to the restatement of its report on ICFR.
Despite the weakness, the company evaluated the impact and concluded that the errors were not material to its previously issued financial statements for the annual and interim periods up to December 30, 2023. Therefore, those financial statements were not being restated and can still be relied upon.
Advance Auto Parts is just one of many companies dealing with these issues. Wall Street Journal reporter, Mark Maurer, points out that: “Companies must disclose a material weakness in their ICFR, if there is a reasonable possibility that a material misstatement could occur and couldn’t be prevented or detected by them on a timely basis. Such flaws are one of the key predictors of restatements, both major and minor, and generally lead companies to address the problems and improve their controls.”
Dealing With the Shortage Problem
According to Maurer: “The disclosures come as fewer people are pursuing degrees in accounting and entering the field, resulting in more positions open and for longer periods of time. What’s more, academics say, the shortage will likely be compounded as more accountants retire without a robust pipeline of replacements.”
Andrew Imdieke, an assistant professor of accounting at the University of Notre Dame, is quoted as saying: “Smaller companies in need of accounting staff often decide not to fill the jobs because they either can’t afford to or can’t justify the cost-benefit trade-off, while their bigger counterparts might be unable to find the right people.”
The bottom line is there is a need to study whether there is a direct correlation between the shortage problem/lack of training, and an increasing trend of material weaknesses in the controls. I heartedly recommend that academic researchers look into this issue. Their findings could contribute much to the discussion and lead to a supportable conclusion.
Posted by Steven Mintz, Ph.D., aka Ethics Sage, on August 6, 2024. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/.