Chapter 3: Financial Reports: Statement of Income, Comprehensive Income and Changes in Equity
Material Weaknesses Found in Financial Reporting Oversight
In 2014, Penn West Petroleum Ltd., a Calgary-based oil company, was tasked with restating more than two years of financial statements in response to an internal investigation that uncovered material weaknesses in its internal controls over financial reporting. The impact of the restatement was a reduction in cash flow by $145 million and an increase in its operating costs by $367 million–no small sums, to be sure!
The investigation was undertaken after the discovery of misclassifications in its accounting records regarding its capital spending, operating costs, and royalty payments. The investigation found that operating expenses were recorded to property, plant, and equipment, and significant amounts of operational expenses were reclassified to royalties’ assets. The company claimed that these errors originated with some former employees who were no longer with the company. When news of the scandal reached investors’ ears, fears escalated, resulting in large numbers of shares being sold off in the stock market. In the aftermath, investors launched $400 million in class-action lawsuits in Canada and the U.S., alleging that the company and some of its former top executives were negligent in not ensuring that adequate internal controls regarding financial reporting were in place.
It is unknown whether the misclassifications were due to management bias, intended to deceive, or if they were due to human error and poor judgment. Either way, the financials prior to restatement were making the company look better than it was.
Penn West implemented new internal controls to ensure that this never happens again. A key component of the change relates to its journal entries, to ensure any transactions that are to be capitalized (versus being expensed) are done so only after passing a strict oversight process.
(Source: Jones, 2014)
