Top 10 financial reporting deficiencies from regulators and external auditors

A shorter version of this article was published in the December 2015 edition of WIB Directors Digest.

Most companies would rather avoid an audit deficiency, which is, at a minimum, a distraction for both management and the auditor. A deficiency can also be symptomatic of an ineffective internal control environment and raise concerns about a company’s ability to process, record, and report transactions in its financial statements.

The worst case scenario: Deficiencies can bring the audit or compliance process to a standstill and create tension among management, the audit committee, and external stakeholders. Fortunately, many of the most common deficiencies can be avoided.

Top 10 deficiencies in audit findings

Our top-10 list is based on our review of the Public Company Accounting Oversight Board’s (PCAOB) recent audit firm inspection reports, PCAOB Staff Audit Practice Alerts, information from the Center for Audit Quality on restatement trends, and recent comment letters and public statements from the Securities and Exchange Commission (SEC) staff as well as our experience in working with community banks.

Allowance for loan losses

This is the number one issue that requires the most time from auditors and management, which should come as no surprise. Part of the issue is that loan and qualitative data often isn’t accurate or complete. Directional consistency is also a common issue we see when banks continue to maintain elevated levels in the allowance for loan losses when there’s improvement in credit quality. This is often a challenge for both auditors and bankers alike, since regulators may be supportive of higher reserves. Typical audit findings relate to ineffective controls over:

• Changes in loan grades
• Lack of support for cash flow estimates or recent appraisals on impaired loans
• Internal controls over identifying and reporting troubled debt restructuring

Revenue

Accounting firms have been criticized for not focusing on revenue. The auditing standards require external auditors to consider the risk of fraud over revenue on every engagement. In fact, revenue is selected on virtually every audit engagement subject to the PCAOB’s  inspection process, during which it generally focuses on accuracy and whether revenue is recognized in the correct period.