FINANCIAL REPORTING: DO SMALL ERRORS NEED TO BE REPORTED?

Posted: August 25th, 2021

FINANCIAL REPORTING: DO SMALL ERRORS NEED TO BE REPORTED?

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Introduction

Ben’s case represents a clear picture of a situation common among different small and large-scale companies. Over the past years, organizations are finding more accounting errors originating from an intentional and unintentional omission of financial data. In the United States, for instance, preliminary data is showing a trend in which the rate of material accounting mistakes experienced within the public corporations has doubled from the past decade. While Ben could find it unnecessary to report the misstatements, the accumulation of such errors has led some firms to restate and refile the whole financial information to the relevant authority. The most dangerous scenario in an industry is when the investors, executives, and board members lose their confidence in the financial documents considering them unreliable. Thus, no matter the magnitude, it is ideal to report any small errors that could arise in financial statements.

Legal Issues Arising from Failure to Report Minor Financial Errors

Accountancy, a component of financial auditing, is an art of communicating financial details of an organization to the interested parties, such as managers and shareholders. In Ben’s scenario, two legal implications are possible. First, the management and other stakeholders can consider his actions as signs of organized fraudulence.[1] Whereas Ben could feel his mistakes are minor, in business setups, such activities receive a different consideration. For instance, misstatements in financial reports could be as a result of falsification, manipulation, or alteration of the records bearing the economic data.[2] Besides, if properly investigated, audit can reveal the possibility of intentional omission or misrepresentation of various transactions ideal for investigation of the institution’s performance. Finally, no matter the seriousness of mistake, scholars also feel that failing to report financial details could mean the malicious application of accounting principles.[3] Thus, if found guilty, Ben could face conviction in a court of law and subsequently lose his source of income, in this case, his first job.

Secondly, not every restatement arises from innocent errors. Factually, a good number of them have hidden missions. Provision of reliable financial information is the primary responsibility of management for the sake of analysis and evaluation of their organization’s performance.[4] However, as shown previously, some of these actions can be aimed at fraud. For instance, when there are no adequate controls or when the control systems are ineffective, the management can perpetrate fraudulent financial reporting through other employees.[5] Whereas Ben seems to be honest and would not intend to commit any form of professional crime, the chances are high that the management, especially the chief financial officer, has subjected him to an unfavorable environment to help conceal some under-deals. Whatever the circumstances, the business institutions affected have a legal mandate to investigate and hold liable those found guilty of financial misappropriation.[6] In this case, Ben will be the most affected employee with the possibility of undergoing detention for breach of duties and responsibilities.

Ethical Issues Arising from Ben’s Case

Ethics is a branch of knowledge that fosters a person’s moral obligation to the principles underlying their professional engagements. In financial reporting, the accountants follow the guidelines under mandatory standards which dictate how accounting numbers should appear in financial statements. According to the International Accounting Standards Board, financial reporting should capture quality as a way of enhancing fair value for the investors as well as other stakeholders.[7] In other words, fair values are indications that the business owners and the economists can discover and delineate the assets from liabilities. Thus, the auditors should synthesize their reports to ensure traceable benefits for the sake of the organization.Firstly, the information directed to the shareholders should be reflected on a balance sheet.[8] Secondly, figures for profit and loss statements are an actual representation of the economic status of the firm and show its fair value. Unfortunately, with the frequent omission of ideal data by Ben, the chances are high that his employers will not be in a position to assess their worthiness. As a result, some of the ethical implications associated with Ben’s failure to report minor financial errors appear below.

A court of law considers the deliberate or accidental omission of critical financial data as a way of enforcing “the rule of thumbs” in workers like Ben who develop a quantitative threshold to manipulate the reporting process. Often, the auditors believe that misstatement or intentional omission of values below 5% is not material.[9] While this assumption has some benefits, particularly to the employees confronted with incongruent balance sheet value, the truth is that the same workers can use this low percentage to encourage misappropriation by the management. Practically, the use of percentage to represent numerical threshold is a better avenue through which top leadership can hide instances of financial pilferage.[10] In his accord, Ben believes his action is genuine considering his level of commitment to the organization. Sadly, by failing to inform his senior, Ben could be attracting the attention of the Supreme Court which uses its mandate to interpret the Federal Security Laws. Under this circumstance, Ben, who considers his action as immaterial, could still face conviction that his misstatements are intentional; hence, they are unlawful.

In the United Arabs Emirates, the statute is clear on how to deal with illegal acts involving financial or material misappropriation. Even though it is naturally clear that Ben is innocent, his failure to exercise the moral obligation of being honest could result in a material effect on the final financial statement.[11] This situation will result in conflict with Auditing Standards. Subsequently, upon realization of the case, the chief financial officer will have no choice but to report Ben to the auditing committee which will choosethe appropriate legal action against him. At this point, the auditor will rely on the evidence which Ben could regard as petty errors. Fundamentally, failure to report some of the disparities in the financial statements would attract the implication of fraudulent financial reporting.[12] In this case, Ben is liable for falsification of accounting records, the omission of information which could result in an improper evaluation of performance, and intentional misapplication of the principles guiding accounting and auditing procedures.

Professional Implication of Ben’s Action

Public entities and private business institutions have a different consideration of professional practice. However, professional skepticism is not applied in either situation.[13] The fact that Ben considers specific reporting errors to be minor and not requiring extra adjustments is in itself an occupational suicide.[14] Ordinarily, board members, shareholders, and the executives express their trust and confidence in an organization that provides full financial data.[15] Often, these investors show interest insuch information to enable them to make ideal decisions for the sake of their current and future commercial undertakings. Typically, they can assess the credibility of the information presented to them regarding the stock value and use it to estimate the significance and magnitude of uncertainties in the market.[16] In cases of doubts, Ben will be the first one to lose the trust, which could result in losing his job even if Ben was not directly intending to avoid making the desired corrections. Other than losing a job, he is likely to tamper with his reputation as an upcoming employee and above all, take responsibility for fraudulent engagement.

Loss of independence and confidentiality is another professional challenge likely to befall Ben for failure to report small financial errors with the same magnitude he uses for critical variations. As an employee, whether in the public sector or private organizations, one should make sure their data are comparable, credible, and does not represent biases due to influence from the seniors.[17] Failure to observe financial reporting standards may facilitate shareholders and management to consider termination of the contract inthe result of a gross violation of policies. If the organization becomes lenient with the mentioned worker, the decision can as well come at a cost.[18] For instance, there will be higher chances of closer supervision of Ben’s subsequent reporting. Furthermore, by monitoring Ben at a close range, the company will deprive him of the freedom to secure his data from unauthorized access making him vulnerable to further manipulation.

Actions Ben Should Take to Address the Mistakes

Even though Ben is working in a public institution, his enforcement of aggressive accounting strategy could help address the loopholes. He should narrow his focus to financial reporting gimmicks exclusively to encourage more investors to trade with the employer’s company.[19] By incorporating creative accounting processes, Ben will be able to rectify the areas that could raise concerns in the report. Thus, he will be able to fake the balance sheet to ensure congruence, calculate the variations on the debit and liability, and then save his reputation by providing identifiable information. While this approach may seem unethical, it anticipates incorporating accounting standards solely to attract and enhance users’ confidence in the company. In other words, integrating corporate governance as a routine activity in reporting will help Ben to detest accounting manipulation and intentional omission of minor errors.

Ben has an Obligation to Report Every Error Irrespective of the Intensity

As corporate financial statements continue to rely on estimates and judgment calls, Ben, on the other hand, should focus on his professionalism and ethical obligations. Professionally, his execution of duties should depend on building his image when reporting.[20] As such, he will be able to identify and apply appropriate internal control system to help him minimize chances of encountering unintentional errors which can culminate into fraud.[21] Secondly, the tools will serve as detective mechanisms needed to prevent a repetition of minor errors which can ultimately become serious problems. Most importantly, the internal control can help monitor loopholes that could facilitate omission of financial mistakes when reporting.[22] Through internal controls, Ben will manage to interact with sound practices that aid in streamlining duties and responsibilities.

All Errors are the Same in the Accounting Context

Although errors vary in magnitude and intensity, their effect on the accounts balance is the same. Small errors are accumulated into severe financial variations. For instance, the omission of a part of revenue or expenditure could, in the short-term, seem ineffective but very detrimental on the monetary value of an organization in the long run.[23] Any business must encourage transparency, compliance, and respect for professionalism and integrity to uplift its financial base.

Conclusion

Ben presents a common scenario for several organizations locally and internationally. Omissions and other forms of accounting errors affect the quality of financial statements. The dangers of misstatements range from loss of trust among investors to legal, ethical, and professional implications cable of ruining the reputation of the employee involved and the organization as well. Therefore, irrespective of the magnitude of the financial errors, the accountants should be ready to report everything.

Bibliography

American Institute of Certified Public Accountants (AICPA). “Evaluation of Misstatements Identified during the Audit. AU Section 450.” (2010): 375-384.https://www.aicpa.org/research/standards/auditattest/downloadabledocuments/au-c-00450.pdf.

Brazel, Joseph F., Paul Caster, Shawn Davis, Steven M. Glover, Diane J. Janvrin, Thomas M. Kozloski, and Mikhail Pevzner. “Comments by the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the PCAOB Rulemaking Docket Matter No. 34: PCAOB Release No. 2011-003, Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements.” Current Issues in Auditing 5, no. 2 (2011): C1-C14. http://www.aaajournals.org/doi/pdf/10.2308/ciia-50074.

Donelson, Dain C., Matthew S. Ege, and John M. McInnis. “Internal Control Weaknesses and Financial Reporting Fraud.” Auditing: A Journal of Practice & Theory 36, no. 3 (2016): 45-69. http://www.aaapubs.org/doi/full/10.2308/ajpt-51608.

Dzomira, Shewangu. “Internal Controls and Fraud Schemes in Not-For-Profit Organizations: A Guide for Good Practice.” Research Journal of Finance and Accounting 5, no. 2 (2014): 118-126.https://www.iiste.org/Journals/index.php/RJFA/article/view/10685/10890.

Elliott, Barry, and Jamie Elliott. Financial Accounting and Reporting. Harlow, UK: Pearson Education, 2009. https://core.ac.uk/download/pdf/33797479.pdf.

Hassink, Harold, Roger Meuwissen, and Laury Bollen. “Fraud Detection, Redress and Reporting by Auditors.” Managerial Auditing Journal 25, no. 9 (2010): 861-881. https://www.researchgate.net/profile/Laury_Bollen/publication/227429903_Fraud_detection_redress_and_reporting_by_auditors/links/53d1fe050cf220632f3c5654.pdf.

Penman, Stephen H. “Financial Reporting Quality: Is Fair Value a Plus or a Minus?” Accounting and Business Research 37, (2007): 33-44. http://repository.binus.ac.id/content/F0812/F081239153.pdf.

Securities and Exchange Commission. “SEC Staff Accounting Bulletin: No. 99–Materiality.” (August 1999). https://www.sec.gov/interps/account/sab99.htm.

Sherman, H. David, and S. David Young. “Where Financial Reporting Still Falls Short.” Harvard Business Review 94, no. 7 (2016): 76-84. https://hbr.org/2016/07/where-financial-reporting-still-falls-short.

Tassadaq, Fizza, and Qaisar Ali Malik. “Creative Accounting & Financial Reporting: Model Development & Empirical Testing.” International Journal of Economics and Financial Issues 5, no. 2 (2015): 544-551. www.econjournals.com/index.php/ijefi/article/viewFile/1047/pdf.

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1. American Institute of Certified Public Accountants (AICPA). “Evaluation of Misstatements Identified during the Audit. AU Section 450.” (2010):375-384. https://www.aicpa.org/research/standards/auditattest/downloadabledocuments/au-c-00450.pdf.

2. Dain C. Donelson, Matthew S. Ege, and John M. McInnis, “Internal Control Weaknesses and Financial Reporting Fraud,” Auditing: A Journal of Practice & Theory 36, no. 3 (2016): 45-69, http://www.aaapubs.org/doi/full/10.2308/ajpt-51608.

3. Donelson, “Internal Control Weaknesses and Financial Reporting Fraud,” 45-69.

4. Joseph F. Brazel, Paul Caster, Shawn Davis, Steven M. Glover, Diane J. Janvrin, Thomas M. Kozloski, and Mikhail Pevzner, “Comments by the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the PCAOB Rulemaking Docket Matter No. 34: PCAOB Release No. 2011-003, Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements,” Current Issues in Auditing 5, no. 2 (2011): C1-C14, http://www.aaajournals.org/doi/pdf/10.2308/ciia-50074.

5. ShewanguDzomira, “Internal Controls and Fraud Schemes in Not-For-Profit Organizations: A Guide for Good Practice,” Research Journal of Finance and Accounting 5, no. 2 (2014): 118-126. http://www.academia.edu/download/34229027/Internal_Controls_and_Fraud_Schemes_in_Not-For-Profit_Organisations.pdf .

6. Shewangu, “Internal Controls and Fraud Schemes in Not-For-Profit Organizations: A Guide for Good Practice,” 118-126. 

7. Harold Hassink, Roger Meuwissen, and Laury Bollen, “Fraud Detection, Redress and Reporting by Auditors,” Managerial Auditing Journal 25, no. 9 (2010): 861-881, https://www.researchgate.net/profile/Laury_Bollen/publication/227429903_Fraud_detection_redress_and_reporting_by_auditors/links/53d1fe050cf220632f3c5654.pdf.

8. Hassink, “Fraud Detection, Redress and Reporting by Auditors,” 861-881. 

9. Barry Elliott and Jamie Elliott, Financial Accounting and Reporting(Harlow, UK: Pearson Education, 2009). Retrieved from https://core.ac.uk/download/pdf/33797479.pdf.

10. Stephen H. Penman, “Financial Reporting Quality: Is Fair Value a Plus or a Minus?” Accounting and Business Research 37, (2007): 33-44, http://repository.binus.ac.id/content/F0812/F081239153.pdf.

11. Securities and Exchange Commission, “SEC Staff Accounting Bulletin: No. 99–Materiality,” (August 1999),https://www.sec.gov/interps/account/sab99.htm.

12. Elliott, Financial Accounting and Reporting. 

13. David H. Sherman and S. David Young, “Where Financial Reporting Still Falls Short,” Harvard Business Review 94, no. 7 (2016): 17,https://hbr.org/2016/07/where-financial-reporting-still-falls-short.

14. Sherman, “Where Financial Reporting Still Falls Short,” 76-84.

15. Fizza Tassadaq and Qaisar Ali Malik, “Creative Accounting & Financial Reporting: Model Development & Empirical Testing,” International Journal of Economics and Financial Issues 5, no. 2 (2015): 544-551, www.econjournals.com/index.php/ijefi/article/viewFile/1047/pdf.

16. Tassadaq, “Creative Accounting & Financial Reporting: Model Development & Empirical Testing,” 544-551. 

17. Tassadaq, 544-551.

18. Tassadaq, 544-551. 

19. Elliott, Financial Accounting and Reporting.

20. Securities and Exchange Commission, “SEC Staff Accounting Bulletin: No. 99–Materiality.” 

21. Elliott, Financial Accounting and Reporting. 

22. Elliott, Financial Accounting and Reporting. 

23. Elliott, Financial Accounting and Reporting.