Accounting Accidentally: audit opinion

Friday, June 5, 2015

Hertz, We Have a Problem: Internal Control Weaknesses

I wrote this prior post about the accounting internal controls and financial restatements at Hertz Global Holdings (the car rental firm). This post goes into more detail on what exactly happened, from an accounting standpoint.

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Restatement and revision

Companies that issue stock and bonds to the public must file annual Form 10-K and quarterly Form 10-Qs with the Securities and Exchange Commission (SEC). These firms also file Form 8-K to disclose any other issues during the interim (Between quarters). Here are the detail from Hertz’s June 6, 2015 Form 8-K:

· Audit Committee: The Audit Committee of the Board of Directors is responsible for hiring the external auditor and overseeing the audit. Hertz’s Audit Committee reports that the 2011 financials are being restated, and the ’12 and ’13 financials are being revised.

· Financial statement review: The Committee is supervising a complete review of ’11, ’12 and ’13 accounting processes. The review may require financial adjustments and additional financial restatements.

· Material weakness: The Committee reports at least one material weakness in internal controls for ‘2013. Management (who is responsible for implementing internal controls) is amending the Management Report on Internal Controls over Financial Reporting. You’ll find that report in the Annual Report.

· Adverse audit opinion: Hertz expects to receive an adverse opinion on internal controls for financial reporting in the 2013 financial statements. Page 96 of the 2013 Hertz Annual Report displays the audit opinion before any changes. Keep in mind that the date of the audit opinion is March 19, 2014- before the Audit Committee report.

Where we disagree

Page 189 (Item 9) of the 2013 Annual Report explains that management and the external audit disagree on accounting and financial disclosure. Management concluded that their controls were effective. Management then explains that the external auditor performed an attestation report on internal controls over financial reporting. Important: An attestation is not an audit. The auditor is not “opining”- giving an opinion- when they perform an attestation.

Based on the June 2015 Form 10-K, both management’s report on internal controls and the audit opinion will change.

Sources of material errors

Interestingly, each of the errors pointed out in the Form 8-K involved accounting estimates. Estimates require judgment- and that’s where disagreements can occur between management and external auditors. According to the Form 8-K (italics added):

“The most material errors identified to date relate primarily to the capitalization and timing of depreciation for certain non-fleet assets, allowances for doubtful accounts in Brazil, allowances for uncollectible amounts with respect to renter obligations for damaged vehicles, restoration obligations at the end of facility leases and certain other items.”

Choices about capitalization vs. depreciation involve judgment. So do decisions about allowance for doubtful accounts.

Have you been involved in discussion about accounting estimates? I’d love to hear from you.

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

(email) ken@stltest.net

(website) www.stltest.net

Image: Maciej Lewandowski, Vintage Cars, (CC By SA-2.0)

Sunday, May 24, 2015

When Little Things Become Big Things: Internal Controls and Theft

In business, as in life, if we don’t take care of little things, they can become big things. I’ve always remembered a quote from a parenting expert I heard years ago: “As time goes on, the mistakes get more expensive”. This concept is particularly true of internal controls.

Accountinged.com is an online training academy. Click here for a free trial.

The Hartford Courant reported in May of 2015 that the Ex-Finance Director of Plymouth, David Bertnagel, was sentenced to 30 months in prison. This individual embezzled $808,000 from the city. If you live in any major city, you’ll see an article about business theft every week. This crime is particularly difficult for a governmental entity. The money that was stolen was public funds- a violation of the public’s trust.

So how did it happen?

The theft

The article explains that: “For several years, Bertnagel wrote checks to himself from Plymouth's accounts, and then simply deleted the entries from the accounting ledger.” He was caught when a bank official reported two suspicious checks to the Mayor. The bank noticed that the checks were written to Bertnagel (a city employee) on town bank accounts.

Understanding the purpose of an audit

Here’s another quote from the article:

“Meyer (The Judge in the case) asked how the town's auditors from Blum Shapiro failed to uncover the theft, which included more than 200 checks.

"That's an excellent question. We've asked that question many times," Merchant (The Mayor) replied, saying the town will be changing firms after an ongoing audit is completed.”

This issue is tricky. An audit is designed to determine whether of not the financials are free of material misstatement. By material, we mean an error large enough that would cause the financial statement reader to change their opinion about the entity’s finances.

Most audits now require the auditor to assess internal controls- and here’s where we have the tricky problem: An audit is not designed to detect fraud. However, the reason that this theft occurred is that the internal controls were woefully inadequate. It’s reasonable to expect the auditor to recognize the internal control weakness and point it out.

Segregation of duties

Whenever possible, these three duties should be assigned to three different people in an organization:

· Custody of assets: Custody refers to the person who has access to the assets. This would include possession of the checkbook, or keys to the company warehouse. In this case, the Finance Director has access to the checkbook.

· Authority to move assets: Authority means the person who can sign a check (move cash) or who can take equipment out of the warehouse. The Finance Director could sign checks. Generally, accountants should avoid signing checks- because of the other two duties that need to be segregated (above and below this duty).

· Recordkeeping: If a person has custody of assets or authority to move assets, that person should not post accounting entries or reconcile the bank account. Fortunately, a banker noticed the issue and pointed it out to the Mayor.

Don’t neglect internal controls. As you can see, a lack of segregation of duties can be devastating to an organization. Every entity should have a written set of internal controls and monitor to take sure those controls are being followed.

Have you seen a lack of segregation of duties in your business experience? Tell me about it- I’d love to hear from you.