The Securities and Exchange Commission is looking for disclosures about changes in internal control over financial reporting not just in annual filings, but in quarterly filings as well.

 

Staff of the SEC told accountants at a national conference of the American Institute of Certified Public Accountants last week that they don't see as much quarterly disclosure regarding changes to internal controls as they'd expect, especially in the current economic environment where companies may be cutting staff and making other changes to try to improve efficiency.

 

Angela Crane, associate chief accountant at the SEC, said the staff is a little puzzled when companies report in one year that they have a material weakness in internal controls, then report in the next that controls are effective. “It's important to make an assessment each quarter as to whether the changes made to address a material weakness should be disclosed,” she said. “This should result in disclosures about material changes in a quarter some time prior to the ultimate conclusion that there's no longer a material weakness, depending on when the actual changes in to internal control occurred.”

 

Crane suggested some specific improvements some companies could make to their disclosures around material weaknesses and internal controls. For example, when companies report they have material weaknesses, the staff will be looking for an explanation. “The disclosures of material weaknesses are designed to provide investors with information as to the reasons behind material weaknesses,” she said. “Not all material weaknesses will be viewed equally by investors. Some can have a more pervasive impact on financial statements and others may not. We expect clear disclosures in this regard.”

 

Companies should be careful not to confuse the reporting of errors with the reporting of weaknesses, she said. The staff has seen a number of instances where companies report they had a material weakness because they made an error in their financial statements, describing the error itself as the weakness. “The error is the result of the weakness, but this is not the weakness in ICFR,” she said. “They should address the underlying weakness in controls” that caused the error.

 

Companies also can expect the staff to question whether there are weaknesses in internal control even if there are no errors in the financial statements. That's because the evaluation of the severity of a deficiency in internal controls is based on both likelihood and magnitude considerations, said Craig Olinger, deputy chief accountant at the SEC.

 

“It only needs to be reasonably possible that a material misstatement could occur without being prevented or detected timely” to conclude there could be a material weakness in internal control, he explained. Olinger said companies may also correct errors in financial statements without reporting control problems, but the staff will have plenty of questions about how that could be, he said. Likewise, the staff will also ask questions if a company reports ineffective control, but doesn't flag a problem with disclosure controls and procedures. The definitions are different, Olinger said, so the scenario is possible, but the staff will examine it closely.

 

Finally, he advised smaller companies to take a careful look at the classifications for a “smaller reporting company” and “nonaccelerated filer” and be careful about how they may apply to their internal control reporting requirements. It's possible for companies to move in or out of one or the other classification during a reporting year, triggering a reporting requirement they may not have expected. “If you're in the gray zone, you should give this matter careful attention,” he said.