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Understanding Material Weaknesses in Auditing: Insights & Remediation

Explore common types of material weaknesses in auditing and learn about their recurrence tendencies. Discover entity-level and account-specific weaknesses along with insights on remediation processes. This information is based on a new 2012 article by Bedard, Hoitash, Hoitash, and Westermann, shedding light on material weaknesses and earnings quality. Stay vigilant about past weaknesses to prevent future occurrences.

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Understanding Material Weaknesses in Auditing: Insights & Remediation

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  1. Addendum to Chapter 7, Professor Fuerman’s class More information on Material Weaknesses and Remediation

  2. What types of Material Weaknesses Occur most Frequently? • A new (2012) article, Bedard, Hoitash, Hoitash, and Westermann, “Material Weaknesses and Earnings Quality,” provides new insights on this matter • Logically, auditors should be especially vigilant about the Material Weaknesses that occurred in the past at a particular company, since logically there may be a tendency for those same types of Material Weaknesses to recur • I say this because research has shown that accounts that have to be adjusted, after audit, compared to what they were pre-audit, in past years, tend to have the same thing recur with those same accounts in future years

  3. The Most Frequently Occurring Entity-Level Material Weaknesses • Year end adjustments that are numerous and/or large in dollar amount • Problems with accounting personnel e.g. adequacy, competency, training, or experience • Inadequate account reconciliations identified as reason for material or numerous adjustments • IT: Deficiencies in program controls, program implementation, segregation of duties with regard to access to computer records and related problems

  4. The Most Frequently Occurring Account-Specific Material Weaknesses • Tax: Tax expense, benefit, deferral, or other issues, including FAS 109 • Revenues: IC deficiencies in approach, understanding, or calculation re revenue recognition • Inventory: Problems with transactions affecting inventory, vendor relationships (including rebates), and/or cost of sales • Liability accruals: Problems re the accrual or identification of liabilities on the balance sheet

  5. How often do Material Weaknesses occur? • Bedard et al. (2012) report that 834 public companies reported Material Weaknesses in 2004 or 2005 (the time period covered by their study)

  6. Remediation (fixing a Material Weakness) • There are two ways a remediation can be reported by the auditor • In the next year’s audit opinion on ICFR the past year’s Material Weakness issue is not mentioned, implying that it has been remediated (fixed) • Prior to the next year’s audit opinion on ICFR, the auditor performs an engagement called “Reporting on Whether a Previously Reported Material Weakness Continues to Exist” (AS 4) and reports that the previously disclosed Material Weakness no longer exists.

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