The economic blow and staff reductions suffered by companies in the wake of the pandemic are straining safeguards critical to accurate financial reporting, Financial Executives International warned Thursday.
If left unchecked, lapses in internal controls for financial reporting could delay quarterly and annual reports and lead to a spike in material weakness disclosures—a red flag for investors, the group said in a report highlighting an increased risk of accounting and financial reporting errors in the coming quarters.
For many companies, new workflows stemming from the move to kitchens and basements, coupled with furloughed or reassigned staff, has left gaps in important reviews and testing, known as internal controls for financial reporting.
The risk of internal control failures adds to the compliance burdens facing strapped finance teams scrambling to keep their businesses afloat while tackling complex accounting for going concern notifications and goodwill impairments.
“A material weakness is just a symptom of a problem. At the end of the day, controllers and CFOs want to be confident that the numbers they are reporting are accurate,” said Todd Bishop, a risk assurance partner in Armanino LLP’s San Francisco office. “A material weakness would be the least of their concerns if they are restating financials.”
If remote work continues indefinitely, companies will need to rethink those internal controls and consider adjustments to reflect an all-remote environment, said Dillon Papenfuss, a research manager with FEI.
“I think it’s going to be a big challenge,” said Mark Kissman, CFO of Greenlight Technologies, a risk management solutions company that worked with FEI on the project.
Questions From Auditors
Auditors also will be watching closely. Lax internal controls can prevent companies from closing their books on time as auditors ask more questions and test replacement controls to ensure they are working.
The Securities and Exchange Commission has urged companies to take an extra look at their controls as they evaluate the toll the coronavirus has had on their businesses. The regulator has similarly said that companies should consider how working from home has affected their operations, including controls for financial reporting and disclosures.
Routine testing that ensures controls work as intended may also lapse while staff isn’t able to visit offices to review those processes, or they are shifted to other, competing projects.
“We’ve seen companies sort of hitting the pause button on their SOX controls assessment. And there’s risks with those delays inherently,” Bishop said.
The 2002 Sarbanes-Oxley Act requires companies to report whether those controls are working, among other measures intended to bolster financial reporting.
Market volatility that affects materiality thresholds and a lack of resources—including adequate cybersecurity protections—also could increase the risk of a material weakness, the FEI report said.
For many companies, these safeguards remain highly manual—printing and scanning documents, sending emails to obtain approvals, even gathering executives in a room to discuss major changes in customers, vendors or contracts.
But the challenges also provide companies an opportunity to automate many of those manual checks, Papenfuss said.
“You almost can’t afford not to,” he added.