Material Weakness in a Ford Financial Statement, Essay Example

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Essay

The question to be answered in this paper is as follows: If an auditor’s report had mentioned a material weakness, what would that have meant in regard to Ford’s financial statements? So I begin with the Securities and Exchange Commission’s official definition of material weakness: “a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a registrant’s annual or interim financial controls will not be prevented or detected on a timely basis by the company’s internal controls”(Kraus, 2007).

To save space I will leave undefined the various other italicized terms to be found here. I am using as one source Ford Motor Credit Company’s Form 10-K for the fiscal year ended December 31, 2007. The independent auditor was PricewaterhouseCoopers LLP, dated February 27, 2008. Beyond that, however, there is nothing in this paper that is unique to Ford as to the specified legal and market consequences of finding a material weakness, because accounting laws are standardized and markets are unpredictable, being dependent on a range of variables, the largest being the state and prospective state of the general economy. Dependent on such variables, there may be an immediate drop in share price (perhaps followed by a spike upwards), greater attention from regulators, and even shareholder lawsuits.

Finding and reporting a material weakness in internal controls will also have ramifications dependent on exactly what kind of problem was found. For example, the Public Company Accounting Oversight Board rates a material weakness more severely than it does a control deficiency, which is itself rated a significant deficiency. Other degrees of error are known as consequential and inconsequential. The 5% rule helps determine potentially material events.

There are four broad kinds of materiality: misstatements (such as incorrect sums, those errors being the most familiar to CPAs); internal control deficiencies; unreasonable accounting estimates; and fraud. For the independent auditor to give an unqualified opinion, the audited company must record whatever errors that fall within that range of material misstatement. This is of course a matter of key importance, and sometimes presents a difficult problem to solve. That is because there is no bright line standard separating degrees of weakness, and it is much more difficult to define an item as immaterial. Contrary to what constitutes a material weakness, there is no straightforward list of offenses that determine immaterial weakness. Below I limit discussion to material weaknesses, specifically the two known as Category A and Category B.

Not all material weaknesses are created equal. Category A kinds are mainly transactional matters like impairment charges, tax accrual, and bad-debt reserves. While they are serious enough to require correction, external auditors can usually find ways to audit the offense in a way that does not legally prohibit their ability to state an unqualified opinion in the financial statement. Basically, they are matters that legally can be attended to later. But this is not the case with Category B, which, although (fortunately) less common than Category A, deal with systemic-level problems built into the organization itself. Examples would be an insufficient or unqualified finance staff or audit committee; a poorly enforced Code of Conduct; weak guidelines detailing fraud-prevention; and badly divided executive responsibilities.

There is another important factor that will determine the financial and legal effects of a material weakness: timing. There will be a tendency to either delay release of a material weakness or to report it immediately. But the latter option must be balanced against the possibility that shareholders acting as plaintiffs in a lawsuit could bring on additional charges for each such additional correction to the financial statements, should they be necessary.

As for Ford’s actual 2007 statement, there were no material weaknesses found in it.

References

Kraus, B. (2007, August 28). Client memorandum. Retrieved from http://www.willkie.com/files/tbl_s29Publications\FileUpload5686\2486\SEC_Defines_Material_Weakness_and_Gives_Guidance.pdf

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