Question

Molex Inc. and their reporting of a financial error found during their audit. This is the only company on the S&P 500 Index to have reported an error during the year.

1. Do you think it is because companies are doing a better job reporting on their financial statements or do you think it is just because they are getting away with the fraud?
2. What techniques have you learned so far in class that you could have implemented to help catch this financial error?

Honesty for Banks Is Still Such a Lonely Word: Jonathan Weil

March 02, 2011, 7:04 PM EST

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By Jonathan Weil

March 3 (Bloomberg) -- So many big companies. So few big mistakes.

Last August an electronics manufacturer named Molex Inc. did something remarkable, at least by today’s standards for disclosing bad news. It filed a special report with the Securities and Exchange Commission known as an 8-K, saying it had overstated its shareholder equity by $101 million and that investors shouldn’t rely on its financial statements for the previous three years.

What made this event so unusual is it was the only negative restatement disclosed in this manner last year by a company in the Standard & Poor’s 500 Index. That’s according to Audit Analytics, a Sutton, Massachusetts, research firm that tracks such data. Molex, based in Lisle, Illinois, included its corrected results in its fiscal 2010 annual report the same day.

You could look at this in different ways. Perhaps the quality of today’s financial reports is so pure that only one S&P 500 company had to disavow its books last year because its results weren’t as good as originally reported. Or it may be that too few of America’s largest companies are willing to admit their errors and disclose them prominently.

“It’s one or the other,” says Don Whalen, research director at Audit Analytics. “Either companies’ internal controls have improved dramatically, so they’re not making mistakes. Or it’s too good to be true, and the information is not getting out.”

Course Correction

Whichever it is, the number of companies correcting errors in their books has declined dramatically. Last year 699 SEC- registered companies filed financial restatements, according to Audit Analytics. That was up from 640 in 2009, but less than half the record 1,566 companies in 2006.

The figures for banks, in particular, look unnaturally low. Forty-four banks restated last year, one fewer than in 2009. Even more curious, there were 133 banks that issued corrections from 2008 through 2010. That was down from 169 banks during the previous three-year period, before the financial crisis took off in earnest, which makes no sense.

Here we had the greatest banking industry meltdown since the Great Depression. Hundreds of lenders failed. And yet the number of banks correcting accounting errors declined while the collapse was unfolding. There were no restatements by the likes of IndyMac, Washington Mutual or Lehman Brothers, for example. The obvious conclusion is the government has been giving lots of banks a free pass, as have their auditors.

Bad Books

It’s not just banks, either. Fannie Mae and Freddie Mac, for instance, took massive bailouts in 2008 without ever conceding errors in their balance sheets. No wonder nobody high up in the financial world is going to jail, when regulators won’t force even those outfits to be honest and acknowledge their books were disastrously wrong.

Molex wasn’t the only S&P 500 company that revised its results last year. There were 10 in all, including Zions Bancorporation. In January 2010, the Salt Lake City-based lender warned investors not to rely on its financial reports for the two previous quarters. Zions’ corrections made earnings and equity look better, though, unlike the fixes at Molex.

The other eight S&P 500 companies that restated last year, including Tyco International Ltd., disclosed revisions without disavowing their previous financial reports in 8-Ks.

Soft Disclosure

About 53 percent of all restatements by U.S. companies in 2010 were handled this way, on the grounds that the errors supposedly weren’t big enough to warrant more prominent disclosures. Sometimes called “stealth restatements,” the corrections instead got tucked elsewhere, such as footnotes in press releases or companies’ quarterly and annual reports.

One explanation for why restatements peaked in 2006 is that the Sarbanes-Oxley Act, starting in late 2004, required many companies to begin subjecting their internal financial-reporting systems to audits by outside accounting firms. As companies improved their internal controls, they found more errors and issued more corrections. Then after they completed their initial overhauls, the theory goes, the number of errors fell sharply.

There’s another school of thought, too. In August 2008, an SEC advisory committee released a report concluding there were too many restatements and that lots of them had resulted from accounting errors that the markets didn’t care about. The panel recommended relaxing the benchmarks for determining when restatements would be needed, drawing howls from some investors and praise from the business lobby.

Who’s Restating

Sure enough, corrections are far fewer today than when the panel began its work, especially at large corporations. The latest increase in the overall figures was driven by tiny companies, which tend to be less mature and easier for auditors and regulators to push around. The number of restaters with less than $75 million of shares available for trading rose to 551 last year from 484 in 2009. Meanwhile, the number of larger companies that restated their books fell to 148 from 156.

Whalen says he still believes improvements in companies’ internal controls are the main reason for the broad decline since 2006. About 40 percent of last year’s restatements had no effect on earnings, according to Audit Analytics. So it’s not as if humdrum errors are never getting fixed.

He’s at a loss, though, to explain how there could be fewer banks that restated their books after the financial crisis started than before. “As a layman, you know there’s something wrong with that,” he says.

No kidding.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

--Editors: Steven Gittelson, Charles W. Stevens

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Answer 1

Answer:

Techniques that could be implemented to help catch this financial error with respect to Shareholder equity

While verifying the shareholders’ equity (Common stock and Additional paid in capital), the following needs to be verified to catch any financial errors involves. PCAOB auditors need to verify them as per US GAAS standards.

1. Check the issued capital from the previous balance sheet. If there is any increase in share capital, the same has to be verified whether the accounting and financial reporting has been done properly or not.
2. Forms filed with SEC with respect to new issue of share capital or additions in paid-up capital shall be verified.
3. Bank statements shall be traced in case of any increase, for any share application money received from stock holders
4. Copies of share certificates need to be called and verified
5. Ensure that there exists proper internal controls in the company while issuing share capital.

Conclusion

In the given case, Molex Inc has did mis-statement in reporting of shareholders’ funds in previous three years. This error or fraud could have been found and rectified while filing very first annual return in Form 10-K, had all the above verification steps been followed.