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Year-end toolkit: Materiality assessments · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC's National Office.
• 0:07
  SPEAKER_01: Hello, and welcome back to PWC's The Counting Podcast.
• 0:11
  SPEAKER_01: I'm Heather Horn.
• 0:12
  SPEAKER_01: Today we're continuing our year-end series where we're sharing episodes designed to help you through the year-end close process.
• 0:19
  SPEAKER_01: And as with the rest of the series, even if you're not at year-end or directly involved in the close, there's still something for everyone in this episode.
• 0:27
  SPEAKER_01: In today's episode, we're specifically focusing on materiality assessments.
• 0:31
  SPEAKER_01: This is always one of the most popular topics in our year-end series because materiality judgments sit at the center of so many accounting and reporting decisions.
• 0:40
  SPEAKER_01: We'll talk about how to approach these assessments in today's environment, including how current market conditions and regulatory expectations factor into these judgments.
• 0:53
  SPEAKER_01: Joining us for this conversation, I'm happy to welcome back to the podcast Mike Mullen, PwC's U.S.
• 0:58
  SPEAKER_01: Insurance Risk Management Leader.
• 1:00
  SPEAKER_01: Mike brings a great deal of practical experience working through complex materiality and error evaluation questions with companies.
• 1:07
  SPEAKER_01: And I'm also happy to welcome our guest host, Diana Stoltzfist, a partner in our national office, who brings her own perspectives to this conversation from her time at the SEC.
• 1:17
  SPEAKER_01: With that, let's get started.
• 1:19
  SPEAKER_02: Hi, Mike.
• 1:20
  SPEAKER_02: Thanks so much for joining me today.
• 1:22
  SPEAKER_02: Glad to have you back for our year-end podcast series.
• 1:25
  SPEAKER_02: So as calendar year and companies are preparing their financial statements and many audits are underway, materiality and error evaluations are remain top of mind.
• 1:36
  SPEAKER_02: And I know we're closing out this year and we have a new administration, and there's a lot of change about what's going on from a policy perspective and changes in regulations.
• 1:47
  SPEAKER_02: But I think it's really important to remind our listeners that the underlying principles in the SEC and the FASB guidance on evaluating errors has not changed.
• 1:57
  SPEAKER_02: SAB 99 is still very much the foundation, and the current economic environment obviously continues to be challenging and there's a lot going on.
• 2:06
  SPEAKER_02: So materiality assessments are as important as ever.
• 2:10
  SPEAKER_02: So maybe starting with that, Mike, can you comment on how our regulators have recently expressed views on materiality in financial reporting?
• 2:18
  SPEAKER_03: Yes, certainly.
• 2:19
  SPEAKER_03: And thanks, Diane.
• 2:20
  SPEAKER_03: It's great to be back.
• 2:21
  SPEAKER_03: Yeah, as you said, a lot of changes, you know, in the marketplace and certainly a new administration in place, clearly with different priorities.
• 2:28
  SPEAKER_03: So I do think you'll see a lot of changes in certain aspects of regulatory oversight.
• 2:33
  SPEAKER_03: But with regard to financial statement materiality, I think we're going to be in a very consistent approach.
• 2:38
  SPEAKER_03: You know, 799 obviously published over 25 years ago.
• 2:41
  SPEAKER_03: Nothing's changed in it, and I don't expect any changes.
• 2:44
  SPEAKER_03: So despite all the noise and, you know, the thoughts of regulatory easing or shifts in priorities under a new administration, be careful.
• 2:51
  SPEAKER_03: I think I'd expect those debates to be in different areas.
• 2:55
  SPEAKER_03: And I don't expect a fundamental change in how the SEC or the PCOB think about materiality.
• 3:00
  SPEAKER_03: You know, I actually just returned from directly from the SEC chair of accountant Kurt Hole.
• 3:05
  SPEAKER_03: They commented on the continued focus on a couple of things, ease of capital formation and investor protection.
• 3:11
  SPEAKER_03: I think both of these rely on the reliability of financial reporting.
• 3:15
  SPEAKER_03: Chair Atkins specifically commented on materiality, very focused on financial accounting.
• 3:20
  SPEAKER_03: You know, he's keeping the mission focused on that.
• 3:22
  SPEAKER_03: I think that the change is going to be in other areas, you know, ESG or executive comp, things like that.
• 3:27
  SPEAKER_02: Right.
• 3:27
  SPEAKER_03: Um, but but he he reinforced material, you know, materiality-driven reporting should remain the foundation of the capital markets and the importance of that.
• 3:37
  SPEAKER_03: So I think expect a consistent approach, expect a real focus and an importance on materiality.
• 3:43
  SPEAKER_03: And um, so I think our practice to date will be, and and the best advice will be to kind of keep the course.
• 3:50
  SPEAKER_02: Okay.
• 3:50
  SPEAKER_02: Okay, great.
• 3:50
  SPEAKER_02: That's really helpful, set the foundation.
• 3:53
  SPEAKER_02: So we've been watching closely as the SEC considers any potential refinements to disclosure expectations in 2026 and beyond, you know, your comments around Chair Atkins and reinforcing the importance of materiality, particularly with a real focus on the financial statements and financial reporting.
• 4:11
  SPEAKER_02: So to ground our discussion, can you just give our audience a refresher on SAB 99 and the framework it establishes in evaluating materiality?
• 4:20
  SPEAKER_03: Yeah, I think it's a good time to do that.
• 4:22
  SPEAKER_03: Tend to do that this time of year and, you know, back and reread SAB 99 for the thousandth time.
• 4:27
  SPEAKER_03: Right.
• 4:28
  SPEAKER_03: Um, but you know, so it provides the guidance and then framework for evaluating materiality.
• 4:32
  SPEAKER_03: So core objective is to prevent financial statements from being materially misstated, right?
• 4:37
  SPEAKER_03: It's a simple concept.
• 4:38
  SPEAKER_03: Um, sometimes very clear to apply it, sometimes it can be a little bit more challenging.
• 4:42
  SPEAKER_03: And this is important for um, you know, the registrants and for the auditors.
• 4:46
  SPEAKER_03: Um so basically it says, you know, when an error is identified, we need to determine if it's material.
• 4:51
  SPEAKER_03: And it begins with a core question.
• 4:53
  SPEAKER_03: And it's based in, you know, basically FASBI concept statements and the SEC, you know, the Supreme Court's um determination.
• 5:00
  SPEAKER_03: And basically, if it's, you know, things are material, if it's probable that a judgment or reasonable person relying on the report would be changed or influenced by the inclusion or correction of the item.
• 5:11
  SPEAKER_03: So the the good thing is we now have decades of consistent interpretation of what that means.
• 5:16
  SPEAKER_03: The court decision, commission rules, enforcement actions, SEC comment letters, all reinforcing how SAP 99 is intended to be applied.
• 5:26
  SPEAKER_03: So I'd say experienced practitioners know the framework very well.
• 5:29
  SPEAKER_03: The SECs remain very consistent from administration to administration in its expectations, and we expect that to continue.
• 5:37
  SPEAKER_03: So reinterpreting or reapplying, you know, what those words mean probably isn't very useful.
• 5:43
  SPEAKER_03: So let's start with the fact that it requires a quantitative and qualitative analysis.
• 5:49
  SPEAKER_03: And it's the interplay between that two that's really important.
• 5:52
  SPEAKER_03: The first thing is I would say the starting point is quantitative.
• 5:55
  SPEAKER_03: All right.
• 5:56
  SPEAKER_03: And there is a, you know, a presumptive, um, when we're talking about an income statement approach, uh presumptive 5% of free tax income in a kind of normal profit-oriented entity is probably a good place to start.
• 6:08
  SPEAKER_03: It could be usually a very relevant metric, not in all cases, right?
• 6:12
  SPEAKER_03: So, and we can get into some of those later.
• 6:14
  SPEAKER_03: Sometimes revenue might be more important, sometimes other metrics.
• 6:17
  SPEAKER_03: You have, you know, what the what the SAP won wanted to avoid was a very mechanical approach.
• 6:22
  SPEAKER_03: And that makes sense because think about a break-even situation where a 5% of a very small number for a big company doesn't make sense, right?
• 6:29
  SPEAKER_03: Um, so like I said, sometimes it's pretty clear, sometimes a little bit more judgment.
• 6:34
  SPEAKER_03: So we have if we have an error, if it's quantitatively material, let's say double digit pre-tax income and a normal, like basically that's it.
• 6:43
  SPEAKER_03: You're done.
• 6:43
  SPEAKER_03: Right.
• 6:44
  SPEAKER_03: Um, that I say quantitative and qualitative, but if it's quantitatively, you know, you can't overcome a large quantitative error with a bunch of qualitative arguments.
• 6:52
  SPEAKER_03: Right.
• 6:53
  SPEAKER_03: Not that, not that we haven't seen that uh tried.
• 6:56
  SPEAKER_03: It's the other, the the intent and the and the express or written words in SAB 99, actually the example used in 799 is an error below 5%.
• 7:05
  SPEAKER_03: And it's when it's quantitatively not significant, but it might be qualitatively.
• 7:10
  SPEAKER_03: So it works one way, not the other.
• 7:12
  SPEAKER_03: It's it's not a two-way street.
• 7:14
  SPEAKER_03: So that's one of the things maybe uh misunderstood sometimes about the standard.
• 7:18
  SPEAKER_03: So um, what are those qualitative issues that are important?
• 7:22
  SPEAKER_03: Um, there are actually listed issues in SAB 99, and but it's not an exhaustive list.
• 7:27
  SPEAKER_03: But some of the things you would look at trends, earnings trends, you'd look at um compliance.
• 7:32
  SPEAKER_03: That's gonna be a big one this year.
• 7:33
  SPEAKER_03: We have a lot of um debt covenants.
• 7:35
  SPEAKER_03: Right.
• 7:36
  SPEAKER_03: Um, and so you might have something that's could could trigger uh compliance with a debt covenant.
• 7:41
  SPEAKER_03: Uh always you look at impacts on executive compensation, and I'll come back to that a little bit more because that got a little bit more interesting with the check the box rules that came into play.
• 7:51
  SPEAKER_03: Um, and you also, and and we'll also, I think, cover when we get a little bit further, maybe intentionality, right?
• 7:57
  SPEAKER_03: Which is a really significant qualitative factor that could take, again, uh a quantitatively small number and make it material.
• 8:05
  SPEAKER_03: So you got to consider all those things.
• 8:06
  SPEAKER_03: It's the earnings management types, issues, it's what are the expectations on the street.
• 8:11
  SPEAKER_03: And again, I would remind everyone the the illustrative example in SAB 99 is something that's below the quantitative threshold that have been set, but had material uh you know, qualitative issues that made it made it material.
• 8:24
  SPEAKER_03: Um, the other thing that's important is our errors need to be evaluated individually and in the aggregate.
• 8:31
  SPEAKER_03: So you could have an individual error and then you might have some other things that kind of offset it.
• 8:35
  SPEAKER_03: You you can't use the offsetting to ignore a significant and material error.
• 8:39
  SPEAKER_03: And in the same way, you have maybe you know a number of smaller things on their own that might not be material, but when you when you aggregate them, it becomes a material issue.
• 8:48
  SPEAKER_03: So um you you know there are do's and don'ts in how you how you do the calculations.
• 8:52
  SPEAKER_02: Right.
• 8:52
  SPEAKER_02: A lot of different considerations you have to think through.
• 8:54
  SPEAKER_02: And I think a good point you made, it's obviously facts and circumstances of the entity and you know their operating practices and that type of thing.
• 9:01
  SPEAKER_02: So, okay, so now if an entity's made the materiality determination, what are the next steps and and best practices?
• 9:08
  SPEAKER_02: Yeah.
• 9:09
  SPEAKER_03: So the next thing that needs to be determined is well, okay, you you've you've now had an error, you've determined it's material or not.
• 9:15
  SPEAKER_03: How are you going to deal with it?
• 9:16
  SPEAKER_03: Right.
• 9:16
  SPEAKER_03: Um, so there's there's a couple of I won't say options because usually the the facts will drive you to one of the conclusions.
• 9:23
  SPEAKER_03: Um, but the ways of treating it, first of all, if you have an error that's deemed to be not material, you can record that error.
• 9:31
  SPEAKER_03: Like again, we'll use a PL example, um, an out-of-period PL item.
• 9:36
  SPEAKER_03: If it's not material to the current period or the prior period, and it's not expected to be material, you could record it effectively out of period.
• 9:43
  SPEAKER_03: And generally we would recommend with disclosure as good practice because you you never know what comes down the road further, right?
• 9:50
  SPEAKER_03: You have to always have an allowance for undetected errors.
• 9:53
  SPEAKER_03: So out of period with disclosure is if it's not material to any particular period.
• 9:58
  SPEAKER_03: Um, we have other errors that maybe were not very large in any one year, but they build up and all of a sudden they've accumulated, it's become too big to fix in the current period.
• 10:08
  SPEAKER_03: Sure.
• 10:08
  SPEAKER_03: But it was not material, no individual period was materially misstated.
• 10:12
  SPEAKER_03: There, you could do what we call a revision and um revise the prior financial statements, but it doesn't require a pulling reliance of the opinion or pulling reliance on those previous financial statements because no previous financial statements were materially misstated.
• 10:27
  SPEAKER_03: You just needed to affect the change this way because you would have created a problem in the current period.
• 10:32
  SPEAKER_03: Now, if it's material to any prior or current period, then you're you not option you need to restate, which involves the um, you know, pulling reliance on prior financial statements and getting the corrected financial statements on file.
• 10:44
  SPEAKER_03: Um so those are really your options along with that.
• 10:48
  SPEAKER_03: And um what has arisen subsequent to SAB 99, but it's been around with Sarbenes Oxley, is the need to do your internal controls evaluation.
• 10:56
  SPEAKER_03: And that has to be married to this analysis.
• 10:59
  SPEAKER_03: And, you know, if you have a restatement, the presumption is you have a material control weakness.
• 11:04
  SPEAKER_03: You very well could have a material control weakness without having a restatement because the difference between the two is you have the actual or would and the control is under the could factor.
• 11:14
  SPEAKER_02: Right.
• 11:15
  SPEAKER_03: Um, so that that's something that also catches uh some folks by surprise sometimes.
• 11:19
  SPEAKER_03: So it's really important to have that as part of the analysis.
• 11:23
  SPEAKER_03: Um, and then I would say the other thing and is the the clawback rules relate to executive comp.
• 11:29
  SPEAKER_03: If if the error and the restatement had an impact on you know executive comp, you have to, you know, work with registrants need to work with their SCC council, make sure they're checking the box if that's applicable and dealing with the impact to executive compensation.
• 11:43
  SPEAKER_03: That brought, I think, a whole new focus to this area.
• 11:46
  SPEAKER_03: And I would say some sensitivities as well.
• 11:49
  SPEAKER_03: Um, that's probably one of the things that's made this a little bit more challenging.
• 11:53
  SPEAKER_02: Yeah.
• 11:53
  SPEAKER_02: And I and I think that was a great point on the internal controls, Mike, is is that could factor.
• 11:58
  SPEAKER_02: So it's not only what was the actual error, but what could it have been?
• 12:02
  SPEAKER_02: Uh, what would it have been, you know, given the current control structure.
• 12:06
  SPEAKER_02: And I think an important thing is looking not only at your process level controls, but also entity level controls as well.
• 12:11
  SPEAKER_02: I know is an important factor when you're thinking about that.
• 12:14
  SPEAKER_03: Yeah.
• 12:14
  SPEAKER_03: And you asked about best practices.
• 12:16
  SPEAKER_03: Is that certainly one of them is including the controls evaluation with the error evaluation?
• 12:21
  SPEAKER_03: The other thing is um, you know, companies ought to be prepared, have some good planning around this topic.
• 12:25
  SPEAKER_03: I mean, for first of all, the best the best practices have a really good tone at the top, um, have a really good internal controls, pay attention to it, have accountability, and avoid errors in the first place, right?
• 12:38
  SPEAKER_03: I mean, that's the best practice.
• 12:39
  SPEAKER_03: But we all know things happen.
• 12:41
  SPEAKER_03: So um then you get to having a good process, having a good understanding with your auditor, um, what is being viewed as material, so that you're on the same page with management and the audit committee, um, understanding what are your key metrics and what kinds of things would impact that so that you have um and you can look at the way you're presenting yourself in the marketplace, the way the analysts are following you, um, what's important in your industry.
• 13:06
  SPEAKER_03: So getting a basic agreement on what are the key factors, you you pretty much can have your SAB 99 memo written as far as, and then if you have an error, you you you plop it in.
• 13:16
  SPEAKER_03: Um, and and and you you've already agreed what's material.
• 13:19
  SPEAKER_03: Often happens in its human nature is an error comes up, and then people argue why it's not material.
• 13:24
  SPEAKER_03: Right.
• 13:24
  SPEAKER_03: Right.
• 13:24
  SPEAKER_03: And sometimes inconsistent with the way they present themselves, the way their filings look, um, what have been key metrics that they've disclosed before.
• 13:32
  SPEAKER_03: So I always recommend, like before that, the heat of the issue, you know, kind of have agreement, drive run, have a really good process.
• 13:39
  SPEAKER_03: And then when and if you do have errors, it's really important to have a good process around it, have really good, robust documentation.
• 13:46
  SPEAKER_03: Don't have a bunch of unsupported assertions, run that through a process where the audit committee is on board, your SEC counsel, because what happens in these cases is often the SEC will review the filing, they'll see this disclosure, and they're they'll ask for SAP 99 documentation.
• 14:04
  SPEAKER_03: And if you can demonstrate contemporaneous documentation, well thought out, robust, you know, good judgment and objectivity, right?
• 14:11
  SPEAKER_03: That oftentimes can, you know, can that's very important.
• 14:14
  SPEAKER_03: When you don't have that, it's uh very problematic.
• 14:17
  SPEAKER_02: Yeah, and I think maybe just picking up on two things.
• 14:19
  SPEAKER_02: I think one is your importance of thinking about what are analysts talking about, what's that external view, right?
• 14:25
  SPEAKER_02: Because as you highlighted in the beginning, it is from a perspective of a reasonable investor, what is material to the investor.
• 14:32
  SPEAKER_02: And so, you know, you can get into a discussion around there's different types of investors, but I think that external perspective is helpful in building into those determinations around what a company would think is material.
• 14:41
  SPEAKER_02: And then I think to your point on the SEC, if they do see corrections, they are asking those questions.
• 14:46
  SPEAKER_02: I think it's about the SAB99.
• 14:48
  SPEAKER_02: And we've also seen, too, that the SEC has questions too around the internal controls.
• 14:53
  SPEAKER_02: And so making sure you have that full control evaluation with the error evaluation is an important point that you highlighted as well.
• 15:00
  SPEAKER_02: Absolutely.
• 15:01
  SPEAKER_02: Yeah.
• 15:01
  SPEAKER_02: Okay, well, great.
• 15:02
  SPEAKER_02: Well, I think all of that makes a lot of sense.
• 15:04
  SPEAKER_02: So when we think back uh or think of over 2025, there's been a lot going on this year.
• 15:09
  SPEAKER_02: You know, we already touched on briefly the change in administration.
• 15:12
  SPEAKER_02: We've seen a lot of actions and interventions coming from the government perspective.
• 15:18
  SPEAKER_02: You know, we've seen tariffs, uh the restriction on government grants and funding.
• 15:23
  SPEAKER_02: There's obviously changes in the agenda and potential changes in regulations and different investigations.
• 15:29
  SPEAKER_02: And so I think when we think about all this, some of this is a little bit of noise.
• 15:33
  SPEAKER_02: And a lot of this has things that really impact companies, you know, profitability, their cash flow, uncertainties, and impact the materiality analysis.
• 15:44
  SPEAKER_02: So, you know, when we're thinking about all this stuff that's going on, what should our listeners be thinking about when they're thinking about how to factor this into their materiality assessment?
• 15:53
  SPEAKER_03: Yeah, it's a great question.
• 15:54
  SPEAKER_03: And I like the way you phrase that with kind of separating the noise from what actually impacts the materiality assessment.
• 15:59
  SPEAKER_03: And one thing it brings to mind is first of all, it's not a static one, one, one and done exercise.
• 16:04
  SPEAKER_03: Um, and and we do see, I mean, you're right, all these things, a lot of this does create some, you know, uncertainty.
• 16:12
  SPEAKER_03: And uh it's it's been actually difficult.
• 16:14
  SPEAKER_03: We know it's been difficult for some restaurants to be actually doing their cash forecasts like they normally do in our profitability forecasts.
• 16:20
  SPEAKER_03: Um, and some of these things have affected profitability.
• 16:22
  SPEAKER_03: No doubt tariffs have affected different industries in a certain way.
• 16:26
  SPEAKER_03: So we are seeing some reduced profitability.
• 16:28
  SPEAKER_03: We're also seeing, because of the uncertainties, um, some strategic decisions being made around discontinued operations.
• 16:36
  SPEAKER_03: We've seen maybe new strategic directions.
• 16:39
  SPEAKER_03: So that might result in impairments.
• 16:41
  SPEAKER_03: Now, these are the types of things that do affect the materiality, right?
• 16:44
  SPEAKER_03: So one thing is to be continually updating your materiality and again, making sure you're on the same page with your auditor as you have forecasts that become actual.
• 16:53
  SPEAKER_03: And what does that do to the number?
• 16:54
  SPEAKER_03: It affects the for the auditor, it affects their audit plan for the for the management, it affects what's material or our controls at the right level.
• 17:01
  SPEAKER_03: So certainly like reduce things that reduce profitability are gonna make and affect every dollar more material.
• 17:07
  SPEAKER_03: So I think that is something to be consider.
• 17:10
  SPEAKER_03: Um, we talked about the fact that 5% of pre-tax doesn't make sense all the time.
• 17:14
  SPEAKER_03: And an example would be, you know, you have a large impairment.
• 17:17
  SPEAKER_03: It's gonna dramatically change your pre-tax income.
• 17:20
  SPEAKER_03: You you don't you can't ignore that, but if you just because if you just did the calculation, you'd get a much smaller materiality, right?
• 17:28
  SPEAKER_03: That doesn't make sense.
• 17:29
  SPEAKER_03: Um, or it might throw you into a loss, right?
• 17:31
  SPEAKER_03: Who knows?
• 17:31
  SPEAKER_03: But so you kind of have to look to a look with and without and what is what is material?
• 17:36
  SPEAKER_03: That really probably shouldn't change that much because of of a significant impairment.
• 17:40
  SPEAKER_03: Um, so but you have to think about those things.
• 17:42
  SPEAKER_03: Discontinued operations.
• 17:43
  SPEAKER_03: Now you've you've you have a different classification on the income statement.
• 17:46
  SPEAKER_03: So you got to think about that.
• 17:48
  SPEAKER_03: Um, some of the other things are are maybe just the noise, right?
• 17:51
  SPEAKER_03: So so so I would say keep updated, look at alternative benchmarks.
• 17:56
  SPEAKER_03: It's fine.
• 17:56
  SPEAKER_03: Like there's no prescribed rule that you must use, you know, um sometimes that isn't the right benchmark.
• 18:02
  SPEAKER_03: So we see many um in many audit engagements, alternative materialities being used, which are appropriate.
• 18:08
  SPEAKER_03: Again, the key is is it reflect good judgment?
• 18:10
  SPEAKER_03: Is it based in the facts and circumstances of that entity?
• 18:13
  SPEAKER_03: And is it appropriately documented and communicated?
• 18:16
  SPEAKER_03: Um, some of the non-gap metrics also come into play.
• 18:19
  SPEAKER_03: So, you know, you want to pay attention to that.
• 18:21
  SPEAKER_03: And again, as you as you mentioned earlier, how are you presenting yourself?
• 18:23
  SPEAKER_03: What are the key your key performance indicators?
• 18:26
  SPEAKER_03: But I I I don't want to go too far with that because you know, sometimes people ask me, what are some of the losing arguments you've seen?
• 18:32
  SPEAKER_03: When when people argue that gap doesn't matter or it's not important, that's that's not a good, that's not a good place to be, although some may think it.
• 18:39
  SPEAKER_03: Um, so I think focusing on the gap is always important, the actual numbers, keeping in mind that that's what you're certifying in your financial statements, that's what the auditor is opining on.
• 18:48
  SPEAKER_03: But keep up to date, look for changes and think about how that affects your materiality.
• 18:53
  SPEAKER_02: And I think too, Mike, when I think back to some of my audit days as well, sometimes too, it's helpful to look at a couple different benchmarks too, when you have so much change going on and thinking about again, what is important to investors, what is important to the company and the management.
• 19:08
  SPEAKER_02: But sometimes it's also helpful to look at maybe a couple different benchmarks and think about okay, when I look at these in totality, kind of what number makes sense to coalesce around.
• 19:18
  SPEAKER_02: And so anyway, that's just another thought as well.
• 19:21
  SPEAKER_03: Agreed.
• 19:21
  SPEAKER_03: Yeah, we sometimes we call that triangulation.
• 19:23
  SPEAKER_03: You know, you look at a few different things.
• 19:25
  SPEAKER_03: And and as long as it's all current and relevant, and I think that's good.
• 19:29
  SPEAKER_03: Uh, again, sometimes what people do is you know, is well, you can switch average.
• 19:33
  SPEAKER_03: Yeah, you can't switch every year and you can't some people look at, well, I average three years, but you know, maybe the business has fundamentally changed.
• 19:39
  SPEAKER_03: So as long as it's a current um view supported by, you know, with good judgment, um, I think alternative benchmarks are fine.
• 19:46
  SPEAKER_02: Yep.
• 19:47
  SPEAKER_02: Okay.
• 19:47
  SPEAKER_02: Well, those are all great reminders, Mike.
• 19:50
  SPEAKER_02: So over the years, we've seen a number of recurring patterns in financial reporting errors.
• 19:55
  SPEAKER_02: So most recently, you know, the statement of cash flows comes up pretty frequently.
• 20:00
  SPEAKER_02: Can you talk to us about what trends you're seeing in reporting errors today and if there's any things you you'd highlight from a regulatory perspective?
• 20:09
  SPEAKER_03: Yeah, uh definitely cash flows comes up.
• 20:11
  SPEAKER_03: And that's an interesting one, right?
• 20:12
  SPEAKER_03: Because again, you you you you can only have one materiality metric, but you you you know, you apply it differently when you think about uh the income statement to the cash flow statement.
• 20:20
  SPEAKER_03: Uh again, uh losing argument.
• 20:22
  SPEAKER_03: It's just a classification error.
• 20:23
  SPEAKER_03: Well, cash flow is just a classification statement, right?
• 20:26
  SPEAKER_03: So that doesn't really work.
• 20:27
  SPEAKER_03: Um you know, again, depending upon, I mean, many times cash flow from operations is very important, right?
• 20:32
  SPEAKER_03: And so, you know, liquidity measure, free cash flow.
• 20:35
  SPEAKER_03: Um, it it it depends company to company, but but cash flow from operations is is is significant.
• 20:40
  SPEAKER_03: What we have found is sometimes there's a little less focus on the cash flow statement than there is on the income statement and balance sheet.
• 20:47
  SPEAKER_03: And so we, you know, again, our recommendations are that you have good quality controls around that, that the auditor has good auditing procedures around that.
• 20:55
  SPEAKER_03: Um, sometimes what happens is uh companies we see do really good analysis of the accounting and accounting considerations for a transaction, but sometimes I don't think about the cash flow treatment, right?
• 21:06
  SPEAKER_03: And and it's these unusual, it's the unusual transactions that tend to cause the problem, right?
• 21:10
  SPEAKER_03: The normal activity, you probably have the normal classification.
• 21:13
  SPEAKER_03: So that's something that to keep in mind.
• 21:15
  SPEAKER_03: Don't forget when you're doing uh an accounting analysis and a memo, don't forget disclosures and don't forget cash flow.
• 21:22
  SPEAKER_03: Um uh we see on the on the income statement, you know, errors that pop up, but uh revenue grows to net.
• 21:28
  SPEAKER_03: And again, people say, okay, well, it's not um, you know, that's not a net PL impact.
• 21:33
  SPEAKER_03: It's you know, the net effect zero, but it could still be material, right?
• 21:36
  SPEAKER_03: Particularly if you're a company where revenue or a trend is very important.
• 21:39
  SPEAKER_03: Um, income taxes, just because sometimes how how challenging it can be and difficult, we see you know some errors in that area.
• 21:46
  SPEAKER_03: And then I would say it tends to be um, you know, companies are generally pretty good about what they do every day, day in and day out.
• 21:52
  SPEAKER_03: It's the unusual transactions that come up that, you know, but whether it's business combination or an impairment or a disability.
• 22:00
  SPEAKER_03: Ops, something unusual that you're not doing dealing with every day, that maybe uh drives some more of the errors that we've seen.
• 22:06
  SPEAKER_03: Um, in terms of how that's looked at, again, we've seen some judgments made where to to kind of try to grab onto the qualitative to overcome some of these errors.
• 22:19
  SPEAKER_03: And so we we talked about that before that that that's not probably a good avenue to go down.
• 22:24
  SPEAKER_03: Um, classification errors, uh classification is important.
• 22:27
  SPEAKER_03: So just think about that, including on the income statement, you know, above the line, below the line.
• 22:32
  SPEAKER_03: That's something to be thinking about.
• 22:33
  SPEAKER_03: And then sometimes over the, you know, different industries have an industry practice, and but obviously it still has to be in accordance with gap, right?
• 22:41
  SPEAKER_03: So in those cases, sometimes, again, when there's things like that, pre-clearance with the SEC on your accounting model, that that can be very helpful.
• 22:48
  SPEAKER_03: Um, so that's something that to think about.
• 22:50
  SPEAKER_03: Um, and then always, as we as we said before, be thinking about the controls.
• 22:55
  SPEAKER_03: Um, and um, where we've seen good uh good practice too is really good involvement with SEC council and audit committee, you know, involved in the process along with management and the auditor.
• 23:06
  SPEAKER_02: Okay.
• 23:06
  SPEAKER_02: Well, those are great reminders.
• 23:08
  SPEAKER_02: Maybe we'll we'll move back to something that we touched on at the beginning of our conversation, which was intentionality and fraud and illegal acts.
• 23:16
  SPEAKER_02: And those have been top of mind, obviously, at the SEC and PCAB, that's been a focus there for years.
• 23:22
  SPEAKER_02: Um, but with the changing administration, is there anything that our listeners should be focused on or anything messaging-wise that you would like to highlight?
• 23:31
  SPEAKER_03: Yes, I think there's gonna be a focus there.
• 23:33
  SPEAKER_03: And Atkins was clear on that, you know, on the traditional fraud, financial statement fraud, holding those accountable.
• 23:38
  SPEAKER_03: We don't want people who lie, cheat, or steal, nor do we.
• 23:42
  SPEAKER_03: Um, and so that's that's gonna be really important.
• 23:46
  SPEAKER_03: And again, like people here, maybe enforcement isn't gonna be like it was.
• 23:49
  SPEAKER_03: I think they're trying to get away from the regulation by enforcement, like, think about crypto.
• 23:53
  SPEAKER_03: Um but as far as enforcing where there's bad actors, or I mean, I don't think there's gonna be any step back in that.
• 23:59
  SPEAKER_03: So I think that pressure is gonna be there.
• 24:02
  SPEAKER_03: I also think, and going back to your comments about the environment, some of the pressures are out there.
• 24:07
  SPEAKER_03: I think we see from a fraud risk, we see heightened fraud risk because you have you have pressure on people.
• 24:13
  SPEAKER_03: Yes.
• 24:14
  SPEAKER_03: You have um, you know, so and you have incentives to make numbers.
• 24:19
  SPEAKER_03: You've got a difficult environment.
• 24:21
  SPEAKER_03: And so when you when you when you look at those factors coming together, I think we see uh enhanced fraud risk.
• 24:26
  SPEAKER_03: I mean, a great example is you know, all these tariffs, lo and behold, we've started to see and read about some tariff evasion, you know, frauds, right?
• 24:34
  SPEAKER_03: So you know, anytime there's new rules or you know, people you know tend to look for loopholes.
• 24:39
  SPEAKER_03: So um I think the focus and and the pressures out there would would say that the fraud risk is going to be high.
• 24:44
  SPEAKER_03: And just based on our level of activity of our forensics team, I would say uh that that is the case.
• 24:52
  SPEAKER_03: So I think and an intentionality is one of those real hot buttons um thing very, you know, any intentionality is is likely to be deemed to be that results in in a financial statement impact, likely to be material.
• 25:05
  SPEAKER_03: Right.
• 25:05
  SPEAKER_03: I don't care what what the amount is.
• 25:07
  SPEAKER_03: The whole purpose, if you're if it, if it, and and SAB 99 speaks to this, if it was done with intent to meet some kind of number or something, then by definition, that's going to be viewed as material.
• 25:19
  SPEAKER_03: So um really important that companies have good fraud risk assessments, that they have controls in place to deal with that.
• 25:26
  SPEAKER_03: And from an auditor standpoint, I know it's a focus for auditors.
• 25:30
  SPEAKER_03: And the regulators expect that.
• 25:32
  SPEAKER_03: You know, they want they they really harped on auditors' independence and integrity, their objectivity, professional skepticism, and uh a gatekeeper responsibilities, right?
• 25:43
  SPEAKER_03: All those things speak to our responsibilities to be on the on the lookout uh for that.
• 25:48
  SPEAKER_03: And I think, and for companies, uh uh obviously they need to have, as I said, the right controls and probably most importantly the right tone at the top, so that so that given these difficult circumstances that we're not taking shortcuts to meet, you know, to meet numbers.
• 26:04
  SPEAKER_03: Um, so all that's really important.
• 26:06
  SPEAKER_03: And the other thing it does, um, one of the things that creates a lot of strain in these situations, you know, you're you're in the financial reporting cycle and error is determined, it creates a bit of a crisis and you're worried about timing.
• 26:17
  SPEAKER_03: You're worried about getting filed on time.
• 26:19
  SPEAKER_03: Well, if there's intentionality involved, you now have investigative responsibilities.
• 26:26
  SPEAKER_03: Um, you know, the auditor is gonna have responsibilities, companies gonna have responsibilities to make sure they do an appropriate scope of investigation, find out root causes to determine whether there's been intentionality.
• 26:35
  SPEAKER_03: That takes time.
• 26:36
  SPEAKER_03: It creates a lot of stress.
• 26:38
  SPEAKER_03: Right.
• 26:38
  SPEAKER_03: And so, again, um, when it's under fire, it's tough to come up with a process for the first time.
• 26:44
  SPEAKER_03: So, again, my recommendation is that companies with their audit committees, with their auditors, have a game plan ready, know what responsibilities are, know what the implications are.
• 26:53
  SPEAKER_03: Um, we're seeing a lot of whistleblower allegations.
• 26:56
  SPEAKER_03: We're seeing short selling reports that point to uh potential accounting irregularities.
• 27:02
  SPEAKER_03: And um, there's just a lot out there, and sometimes you have to sift through it, but but all those things need to be taken into account if there's if there's contradictory data or evidence um that needs to be sorted through.
• 27:15
  SPEAKER_03: So this is an area that I think is um uh going to be ripe for you know a lot of effort.
• 27:20
  SPEAKER_03: And um, we're seeing quite a bit of that activity in in the marketplace.
• 27:24
  SPEAKER_03: So that's something that's really, really important.
• 27:26
  SPEAKER_02: Well, I think that's those are great reminders and and an area that continues to receive focus and and should.
• 27:32
  SPEAKER_02: And so I think we've had a great discussion here.
• 27:35
  SPEAKER_02: And as we wrap up, you know, any final advice that you'd want to share for our listeners, Mike?
• 27:41
  SPEAKER_03: Yes, a couple of key takeaways, some of it maybe a bit repetitive, but but uh but I'll I'll do that anyway.
• 27:47
  SPEAKER_03: Um again, I'll start tone at the top.
• 27:50
  SPEAKER_03: Um, you know, how important that is and to have the right discipline, the right internal controls, and really good communication between all the responsible parties.
• 27:59
  SPEAKER_03: Um, that communication should be early and often.
• 28:02
  SPEAKER_03: Again, from the audit team, the audit committee with SEC council involved when necessary.
• 28:08
  SPEAKER_03: Um, it's important for all parties to maintain objectivity.
• 28:12
  SPEAKER_03: This is difficult.
• 28:13
  SPEAKER_03: Maybe a little bit easier for the auditor than the management team, but from an audit committee and corporate governance standpoint, that's going to be important.
• 28:20
  SPEAKER_03: Um, the bias is inherent, but you have to try to overcome it because the judgments and the documentation need to be supported with objective facts, need to be tied to the reality, and not uh it's not an op-ed where you're trying to argue one side because you don't like what the implication will be.
• 28:38
  SPEAKER_03: Um, and again, don't try to get down the route of having qualitative factors outweigh.
• 28:43
  SPEAKER_03: I mean, if you have something that's quantitatively material, you're you're you're kind of there.
• 28:47
  SPEAKER_03: Um, updating, as we talked about, there's a lot of changes.
• 28:50
  SPEAKER_03: It's very fluid.
• 28:50
  SPEAKER_03: Update materiality based on actual results and changes in the business.
• 28:54
  SPEAKER_03: Shift those benchmarks if they need to be shipped and keep keep on top of that.
• 28:59
  SPEAKER_03: When and if there is an error, have a very thorough analysis, considering everything we talked about, quantitative, qualitative, intentionality, investor perspective, the controls, evaluation.
• 29:09
  SPEAKER_03: The documentation does matter.
• 29:11
  SPEAKER_03: You know, again, I say sometimes these things are really clear, but there are close calls.
• 29:15
  SPEAKER_03: And I'll tell you, on the close calls, uh, you know, a well, well done documentation contemporaneous with everybody involved the right way can win the day.
• 29:22
  SPEAKER_03: Whereas if you don't have that, maybe you had a case, but you you might have lost your opportunity.
• 29:28
  SPEAKER_03: Um, expect the scrutiny.
• 29:29
  SPEAKER_03: Um, you know, it's clear from uh from the registrant standpoint.
• 29:34
  SPEAKER_03: Um, the SEC is is very likely to ask for and um have some questions about your materiality assessments from an auditor standpoint.
• 29:42
  SPEAKER_03: Obviously, the PCOV focuses on this area, so that's that's something that those teams need to be prepared for.
• 29:48
  SPEAKER_03: Um again, we can thank Sarbanes Oxley.
• 29:50
  SPEAKER_03: The internal controls are critical.
• 29:52
  SPEAKER_03: And um, you know, better to better the controls, a better attention to that, better quality financial reporting, and and you'll have less of these error outcomes to deal with.
• 30:01
  SPEAKER_03: So I think those would those that would be my uh my my best advice in this area.
• 30:05
  SPEAKER_02: Thanks so much for joining me today, Mike.
• 30:07
  SPEAKER_02: This has been a great conversation and really helpful year-end reminders for our listeners.
• 30:13
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• 30:35
  SPEAKER_01: From Thought Leadership at PwC, I'm Heather Horn.
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