Question

Scenario:

You are an accounting manager at a mid-sized public company with annual Revenues around $200M and Net Income around $15M. The 2017 year has ended and you've been working hard to close the books and support the audit. The company has released earnings (which requires some audit procedures and the "ok" from the audit firm) to the public and is now in the process of wrapping up the full 10K financial report to file with the SEC with the accompanying audit. That's when you realize your team failed to accrue several bonuses before the books were closed totaling $75,000.

Requirement:

Please write a memo (1-1.5 pages) addressed to the CFO regarding this issue. Include the following in your memo:

1) Description of the error and analysis of the error's effects on the financials in 2017 and 2018 as it now stands (what accounts are over/understated each year).

2) Outline two alternatives for handling the error. Here are some things to think about: earnings have been reported, 10k has not been filed, do you tell the auditors?, what is the accounting guidance? If you've had an audit course, you may want to draw on some of that knowledge but it is not required.

3) Make a recommendation and explain why the company should pursue that course.

4) Whenever there is an error, we need to consider internal controls. Explain what control(s) will be put in place to avoid this problem in the future.

Answer 1

To,

The CFO.

Dear Sir,

This memo is being written to highlight the potential error we have come across in finalisation of the financial statements of the entity. The team has just realised that a bonus provision of USD 75,000 has erroneously not been provided for in the year end books of accounts.

As a result of this omission, the profits of the company are overstated and liabilities (bonus provision) understated to the extent of USD 75,000. This error occurred primarily because the HR department changed the criteria for payment of bonuses at the last moment, resulting in the finance team not updating the provision calculations at the last moment. This has already been highlighted to the HR team who have assured us that such last moment changes will not be made going forward.

In terms of handling the current situation, we can potentially deal with this in the following ways:

• Incorporate the adjustment, intimate the auditors and get their sign off on the updated financials statements, especially considering that the stock exchange filings have nto yet been completed. Possible repercussion is they may lose confidence on the financial statements and may revisit certain critical areas (as even their tests failed to detect this). This may lead to a delay in filings. However, the ey concern remains the change in earnings, which have already been reported to the public. Change in net earning numbers will result in loss of confidence among the shareholder, regarding the efficacy of internal controls for preparation of financial statements.
• Another option is to ignore the adjustment for now and consider this as a change in estimate an record the same in the future, as and when the bonus is paid out. Bonus provision, is an estimate, and therefore, subject to change. This can be easily accommodated in the next year financial statements, as the amount is not material in the context of the overall profits. We may even try to convince the auditors on the ground that an amount of 75,000 USd would not have a material impact on the financials statements in a year when the company has earned revenue of 200 mn and profits of 15 mn USD. USD 75,000 on a profit of USd 15 mn is 0.5% and this is an amount which the auditors may agree to accommodate as the amount is legitimately not material. This approach is recommended as it would not be advisable to change the earnings numbers already reported to shareholder as this may potentially impact investor confidence and share price.

As mentioned above, controls and processes are being put in place to avoid recurrence of such issues in the future.

I would humbly request you to advise on what course of action you deem suitable to handle tis situation.