Financial Statements Study Finds Problems

RateFinancials has released the results of a two-year study that finds companies still take liberties in reporting their financials. In these overtly regulatory times, balance sheets and income statements still aren’t transparent even when prepared following generally accepted accounting practices (GAAP) standards that provide management with broad discretion at times. Although these statement inaccuracies may not violate GAAP standards, the company’s financial health may not be accurately reflected for intelligent investors and shareholders in clearly worded descriptions. RateFinancials is an independent research firm based in New York.

The study found several disturbing facts among the Standard & Poor’s 500 companies it examined. It found that:

  • Nearly 33 percent do not report their companies’ financial conditions accurately.
  • 64 percent reported inaccurate pension information.
  • 75 percent engaged in some kind of off-balance sheet financing.
  • 28 percent employed aggressive revenue techniques.

An audit committee should be aware of what can be done to further ensure the accuracy of their company’s financial statements. GAAP standards aren’t perfect by any means and Sarbanes-Oxley is a mighty sword for regulators.

Revenue recognition policies can convey much risk as their impacts are amplified in the P&L process. Earnings “smoothing” may be an attractive goal for management so audit committees should examine these policies to catch any language changes that may appear over time.

Any changes to reserves and accrual accounts should be evaluated for their current and future effects on net income. An audit committee should recognize this as a rich area for earnings management.

Members of the audit committee should understand the magnitude and reasoning any off-balance sheet financing in their corporate statements. As a component of long-term debt, the committee should recognize the need for this critical analysis.

A detailed presentation should be requested for the accounting policies for derivatives and other hedging instruments. These instruments are used in companies to isolate themselves from risk. The audit committee should focus on changes in the value of derivatives and derivatives classified as hedges.

Pension plans and other pension liabilities should be of extreme interest to an audit committee. The assumptions for each plan should be understood and under-funded pension plans should be noted on the balance sheet.

The audit committee should discuss the reasoning for any differences in the effective and statutory tax rates. Tax rates on recurring tax items should also be discussed and understood. Any unexplained differences should be full detailed.

Audit committees should understand any changes to a comp0any’s accounting policies. Their impact on the balance sheet and income statement should be detailed and clarified to shareholders also.

Any large changes between net income and cash flow should be explained to the audit committee and the shareholders. Operating problems or lapses in accounting policies can be revealed in these differences.

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