Risk Assessment: Examining the Quality of Company Management
Management sets the tone in any organization. Inept management that’s lackadaisical about following or enforcing company policies and procedures can be a big issue. Management’s attitude influences all employee behavior. When employees don’t play by the rules, it increases the chance of the financial statements being incorrect.
Mulling over management turnover
You evaluate management attitude through interviews and observations. A possible symptom of mismanagement is high employee turnover, especially among mid- to lower-management. Turnover can lead to gaps in managerial oversight. If a company has to train new staff constantly, procedures may not be followed as closely as they should be.
Having inexperienced managers can be just as bad as (or worse than) having vacancies in the client’s managerial lineup. At least if you know key positions aren’t filled, you’re clued into the fact that managerial oversight is lacking, which directly affects your risk assessment. If you fail to detect that existing managers are unskilled, you may rely on the financial statements more than is appropriate.
Assessing financial adjustments and restatements
If key personnel such as the president, chief financial officer, and chief executive officer have been with the company for many years, that’s usually an indication of quality management. Another good sign is if prior audits have required few, if any, accounting adjustments and there have been no financial statement restatements. Here’s why:
Accounting adjustments are given to the client if a mistake or an aggregate of mistakes is material. The adjustment puts the account balance back to where it should be prior to the issuance of the audit report.
Financial statement restatements are more serious. These include corrections made to financial statements already filed with the Securities and Exchange Commission to correct accounting errors and changes in accounting principles.