ACCT 650 Week 5 Discussion Board Forum 4 Thread Example

Discussion Board Forum 4 Thread: Internal Control Reporting and Financial Statement Quality

ACCT 650 Corporate Governance and Fraudulent Financial Reporting, Discussion Board Forum 4 Thread

Thread by [Student Name]

The thread answers a composite prompt on internal control reporting; the statutes, framework, studies and Bible passage cited are real.

Internal control reporting has made financial statements more reliable, though less uniformly than its supporters hoped. Under Section 404 of Sarbanes-Oxley, every public company's managers must judge and report yearly whether their controls over financial reporting work, and at larger companies the outside auditor must give its own opinion on that judgment (Sarbanes-Oxley Act of 2002, 2002).

The strongest evidence that the requirement improved reporting comes from studies of accrual quality. In the work of Ashbaugh-Skaife et al. (2008), firms disclosing control deficiencies showed poorer accruals, meaning their earnings were less closely tied to cash flows and more prone to error or manipulation, and that accrual quality improved at companies that remediated their deficiencies. That is the effect the law intended: identifying and fixing weak controls produced better numbers.

The evidence also shows where weaknesses concentrate. In Doyle et al. (2007), material weaknesses turned up most often in small, young or cash-strapped firms and in those that were complex, fast-growing or restructuring. That matters because smaller companies are the ones Congress later excused from auditor attestation. Non-accelerated filers have never been required to obtain the auditor's report on internal control, so their assessments rest on management alone. The companies most likely to have weak controls are also the ones least likely to have an auditor test them.

The benefits came at a cost that shaped the rules. In the first years, companies and auditors tested controls exhaustively, and compliance costs drew sharp complaints, especially from smaller companies. In 2007 the PCAOB replaced its first internal control auditing standard with a top-down, risk-based approach that directed auditors to focus on the controls most likely to prevent or detect a material misstatement, now codified as AS 2201. That change made the requirement more efficient without abandoning it, and it reflects a lesson worth remembering: controls should be judged by the risks they address, not by how many of them a company documents. A company with a hundred low-risk controls and a weak review of its journal entries is not well controlled.

A common framework made the assessments meaningful. Most companies measure their controls against COSO's 2013 framework and its five components, from the tone of the control environment to the monitoring that keeps controls working (Committee of Sponsoring Organizations of the Treadway Commission [COSO], 2013). Because companies and auditors use the same yardstick, a reported weakness means roughly the same thing across companies, which lets investors compare them.

A biblical principle explains why routine control work matters. In Luke's Gospel, Jesus ties faithfulness in large matters to faithfulness in small ones (English Standard Version Bible, 2001/2016, Luke 16:10). Reliable financial statements rest on thousands of small acts done consistently: reconciliations completed on time, entries reviewed before posting, access limited to those who need it. Section 404 asks companies to show that those small things are done faithfully, on the reasonable assumption that large errors grow where small controls are neglected.

My recommendation is that companies exempt from attestation should still treat their internal assessment as if an auditor would test it, documenting key controls and testing them annually, because the research suggests they are precisely the companies that need it most.

References

Ashbaugh-Skaife, H., Collins, D. W., Kinney, W. R., Jr., & LaFond, R. (2008). The effect of SOX internal control deficiencies and their remediation on accrual quality. The Accounting Review, 83(1), 217-250. https://doi.org/10.2308/accr.2008.83.1.217

Committee of Sponsoring Organizations of the Treadway Commission. (2013). Internal control: Integrated framework.

Doyle, J., Ge, W., & McVay, S. (2007). Determinants of weaknesses in internal control over financial reporting. Journal of Accounting and Economics, 44(1-2), 193-223. https://doi.org/10.1016/j.jacceco.2006.10.003

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002).