Effective internal controls reasonably prevent material misstatements in financial reporting and fraud, but poor internal controls have hurt businesses, investors and the public accounting profession.

In response to the large-scale frauds and lack of internal controls at large, public companies such as Enron and WorldCom a decade ago, Congress passed the Sarbanes Oxley Act of 2002 to restore the faith of the investing public. Section 404 of SOX requires management to explicitly acknowledge responsibility for establishing, maintaining and assessing internal control effectiveness. Section 404 also required auditors and management to provide an opinion on the effectiveness of internal controls.

While SOX was passed a decade ago, regulations on effective controls have loosened since the passage of Sarbanes Oxley. The passage of SEC rule 33-9142 in 2010 permanently exempts SOX 404 (b) requirements for public filers that are neither an accelerated filer nor a large accelerated filer. This means companies with a public float of less than $75 million are exempt from a Section 404 (b) audit. A SOX 404(b) audit requires a public accounting auditor to attest to and report on management’s assessment of its internal controls. The April 2012 passage of the JOBS Act further reduces internal control testing.

 

Top 6 Ineffective Internal Control Accounting Rule Violations Reported by Auditors From 2004-2011
Rank	Frequency	Percentage	Description
1	733	10.82 %	Tax Issues / FAS 109 issues
2	676	9.98 %	Revenue Recognition Issues
3	573	8.46 %	Liability & Accrual Estimation Failures
4	554	8.18 %	Current Asset Issues
5	528	7.79 %	Inventory, COGS Issues
6	423	6.24 %	PPE, Intangible Asset Issues

 

 

Top 6 Ineffective Internal Control Accounting Rule Violations Reported by Management From 2004-2011
Rank	Frequency	Percentage	Description
1	4,098	27.04 %	Unidentified GAAP issues
2	492	3.25 %	Current Asset Issues
3	399	2.63 %	Financial  Statement Issues
4	386	2.55 %	Debt, Security Issues
5	310	2.05 %	Revenue Recognition Issues
6	301	1.99 %	Related Subsidiary Issues

 

Top 6 Non-Effective Internal Controls Identified During Assessment by Auditors From 2004 - 2011
Rank	Frequency	Percentage	Description
1	2,312	25.00 %	Accounting Documentation & Procedure
2	1,459	15.78 %	Material & Auditor YE Adjustments
3	1,255	13.57 %	Accounting Personnel Training Issues
4	938	10.14 %	Restatement of Filings
5	611	6.61 %	Improper Account Reconciliations
6	521	5.63 %	IT Security & Access Issues

 

Top 6 Ineffective Internal Controls Identified During Assessment by Management From 2004 - 2011
Rank	Frequency	Percentage	Description
1	5,653	17.91 %	Accounting Documentation & Procedure
2	4,572	14.49 %	Accounting Personnel Training Issues
3	3,617	11.46 %	Segregation of Duties Issues
4	1,582	5.01 %	Ineffective Audit Committees
5	1,319	4.18 %	Material & Auditor Year-end Adjustments
6	1,020	3.23 %	Inadequate Disclosure Controls

 

Ineffective internal controls and material weaknesses in internal controls over financial reporting in public companies continue to exist a decade after SOX. Our research analyzed the 2004 to 2011 fiscal year trends of internal control deficiencies that led to material weaknesses and ineffective internal controls identified by auditors and management. Material weakness is an internal control deficiency or combination such that there is a reasonable possibility that a material misstatement in a company’s financial statements will not be detected or prevented.

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