How to improve fraud controls in complex accounting areas

It stands to reason that accounting areas that are highly subjective and complex also are prone to fraud, errors, and breakdowns in internal controls.

A recent study by the Anti-Fraud Collaboration discovered challenges in these accounting areas and has led to new recommendations for company accounting policies and internal control over financial reporting (ICFR).

The details are described in the Anti-Fraud Collaboration report issued Thursday, Addressing Challenges for Highly Subjective and Complex Accounting Areas.

In examining SEC Accounting and Audit Enforcement Releases issued during 2013, 2014, and the first quarter of 2015, the study found nearly 40 unique filers that were targets of enforcement action that included some discussion of ICFR.

The accounting issues that caused problems for companies under investigation were revenue recognition, loan impairment, and valuation. All three areas are highly subjective and complex, and they were under stress during the most recent financial crisis, during which about two-thirds of the issues in the study occurred.

These issues were discussed during Anti-Fraud Collaboration workshops that gathered regulators, audit committee members, financial executives, internal auditors, and external auditors. The discussions were summarized in the report, which offered the following recommendations for company accounting policies and ICFR:

• Accounting policies must adhere to technical accounting guidance. Supervisors and managers are responsible for implementation. It is critical that nonaccountants who may not know the nuances of technical accounting be able to understand these policies.
• Process must be married to policies. Accounting policies must be reviewed at regular intervals and address how to uncover and monitor changes in activities that affect accounting.
• Policies must be tested in the field prior to implementation and then monitored for compliance post-implementation.
• Accounting policies regarding revenue recognition should be granular because even slight changes in contract terms can have a major impact on revenue.
• 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.

The Anti-Fraud Collaboration consists of the Center for Audit Quality (CAQ), which is affiliated with the AICPA; Financial Executives International; the National Association of Corporate Directors; and the Institute of Internal Auditors. It promotes the deterrence and detection of financial reporting fraud.

“Investors, our capital markets, and public companies all win when we work together to combat fraud,” CAQ Executive Director Cindy Fornelli said in a news release.

—Ken Tysiac ([email protected]) is a JofA editorial director.