Monitoring and enforcement mechanisms ensure the reliability and integrity of financial reports. Some of these, such as the SEC, are set by fiat. Other mechanisms, such as auditing, evolve over time. The importance of these mechanisms for the credibility and survival of financial reporting cannot be overemphasized. Auditors. External auditing is an important mechanism to help ensure the quality and reliability of financial statements. All public companies’ financial statements must be audited by an independent certified public accountant (CPA). The product of an audit is the auditor’s report, which is an integral part of financial statements. The centerpiece of an audit report is the audit opinion. An auditor can (1) issue a clean opinion, (2) issue one or more types of qualified opinions, or (3) disclaim expressing any opinion.
Corporate Governance. Another important monitor of financial reports is corporate governance mechanisms within a company. Financial statements need approval by a company’s board of directors. Many companies appoint an audit committee a subcommittee of the board to oversee the financial reporting process. An audit committee is appointed by the board and is represented by both managers and outsiders. Audit committees are often entrusted with wide-ranging powers and responsibilities relating to many aspects of the reporting process. This includes oversight of accounting methods, internal control procedures, and internal audits. Many believe that an independent and powerful audit committee is a crucial corporate governance feature that contributes substantially to the quality of financial reports. Most companies also perform internalaudits, which are another defense against fraud and misrepresentation of financial records.
Securities and Exchange Commission. The SEC plays an active role in monitoring and enforcing accounting standards. All public companies must file audited financial statements (10-Ks and 10-Qs) with the SEC. The SEC staff checks these reports to ensure compliance with statutory requirements, including adherence to accounting standards. The SEC has brought enforcement actions against hundreds of companies over the years for accounting violations. These violations range from misinterpretation of standards to outright fraud and falsification of accounts. Enforcement actions against companies and their managers range from restatement of financial statements to fines and imprisonment. Recently, the SEC has been actively attempting to curb earnings management.
Litigation. Another important monitor of managers (and auditors) is the threat of litigation. The amount of damages relating to accounting irregularities paid by companies, managers, and auditors in the past decade is estimated in the billions of dollars. The threat of litigation influences managers to adopt more responsible reporting practices both for statutory and voluntary disclosures
Securities and Exchange Commission. The SEC plays an active role in monitoring and enforcing accounting standards. All public companies must file audited financial statements (10-Ks and 10-Qs) with the SEC. The SEC staff checks these reports to ensure compliance with statutory requirements, including adherence to accounting standards. The SEC has brought enforcement actions against hundreds of companies over the years for accounting violations. These violations range from misinterpretation of standards to outright fraud and falsification of accounts. Enforcement actions against companies and their managers range from restatement of financial statements to fines and imprisonment. Recently, the SEC has been actively attempting to curb earnings management.
Litigation. Another important monitor of managers (and auditors) is the threat of litigation. The amount of damages relating to accounting irregularities paid by companies, managers, and auditors in the past decade is estimated in the billions of dollars. The threat of litigation influences managers to adopt more responsible reporting practices both for statutory and voluntary disclosures
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