Driving 40 in a 20 MPH Zone: IPOs with Accounting Material Weaknesses

Herd mentality is a funny thing. There’s a book called (believe it or not): Extraordinary Popular Delusions and the Madness of Crowds. Here’s the link on Amazon:

My father, a 60-year veteran in the securities business, has talked about this book for years. This “going with the herd” mentally has applied in recent years to the Initial Public Offering (IPO) market for stocks.

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The Chicago Tribune references a study on IPO activity in 2013. “30 percent of companies that went public....acknowledged they were at serious risk of incorrectly reporting their financial information. That’s 17 percent of issuers in 2013, the study shows.”

In spite of these accounting weaknesses, investors bought the stocks, anyway. Herd mentality.

This article, however, reinforces some important points about accounting. First, the term “material” mean relevant- a dollar amount large enough to impact the opinion of a financial statement reader. Internal controls are important for two broad reasons: To protect assets from theft, and to ensure that the financial statements are produced accurately.

Here are three examples of material weaknesses in the article:

·       Journal entries were not reviewed for accuracy. This can lead to inaccurate financial statements.

·       Multiple accounting adjustment required

·       The most serious: Restatement of financials. A restatement means that you’re changing and reissuing financials that have already been relied upon for decision-making.

Keep material weaknesses in mind when analyzing a company. Don’t drive 40 MPH in a 20 MPH zone- slow down and assess whether or not the accounting is reliable.

Have you come across this issue? Feel free to comment below.

Ken Boyd

St. Louis Test Preparation

Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies

Co-Founder: accountinged.com

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(cell) (314) 913-6529

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