Key takeaways
1. For each of the past four years, 26–42 percent of U.S.-based, NYSE and NASDAQ traditional IPOs have disclosed material weaknesses in their S-1/S-1A filings. For 2020, 48 percent of SPACs disclosed material weaknesses in their S-1/S-1A filings, of which fewer were noted as remediated.
2. The root cause of most material weaknesses disclosed in S-1s is a lack of resources with sufficient knowledge to analyze complex transactions for proper accounting treatment, meet reporting requirements of U.S. GAAP, or ensure proper segregation of duty and review procedures.
3. Material weaknesses primarily fall in areas of accounting complexity that require the use of estimates and judgement, such as tax, equity, financial reporting, accounting estimates, revenue, business combinations and non-routine and complex transactions. Private companies often do not have the in-house expertise and/or resources are stretched too thin to appropriately identify, analyze, and account for complex transactions.
4. Material weaknesses are typically the result of control gaps or controls and processes that have not been properly designed, rather than controls that fail to operate. Companies should perform a proper risk assessment including identification of “what could go wrongs” and ensure controls are designed at an appropriate precision level and performed by competent personnel. Additionally, companies should pay special attention to the identification of “what could go wrongs” and associated controls in nonroutine processes/transactions.
5. Companies should not overlook the technology aspect of financial reporting. Often, systems used by private companies are not able to scale to the requirements of public companies. Additionally, IT general controls and application controls are not properly implemented to ensure financial information is appropriately safeguarded and accurately processed. A strong IT team and well-implemented and controlled systems are critical in ensuring internal controls over financial reporting.
