Kritesh Kaushal

Strategy and Business Development Associate

Background

Between February 2012 and March 2014, a leading vehicle-renting corporation materially misstated its pre-tax income due to accounting errors across multiple business units and periods, leading it to pay fines of $16 million to the SEC due to which the corporation to appear to be in a stronger financial position than it was

Nature of financial reporting errors

• Inflated income was reported for key accounts, particularly for allowance-related expenses, due to the use of inappropriate accounting estimation techniques.

• Subrogation financial management
  was very flawed, resulting in a $48 million misstatement due to the methodologies adopted for offsetting the expenses for vehicles damaged by the customers.

• Failure to audit the effects of holding rented vehicles longer in the fleet impacted the depreciation expenses and risk.

• GAAP compliance failure of $235 million in the reported company was later reviewed and identified by the company

• Internal control failures resulted in material accounting errors in 17 areas and separate material weaknesses in 11 areas by the SEC (U.S Securities and Exchange Commission)

Drilling down on accounting error sources

• Undue Pressure on meeting targets and earnings forecasts was one of the major reasons as cited by the SEC.
• Senior Leadership used an inappropriate and inconsistent tone to rework reserve accounts and meet targets.
• Insufficient internal financial controls that allowed accounting methods that favoured inflating the financials regardless of any historical recovery rates and actual risk involved

Consequences of accounting failures

• A $16 million fine was paid to the SEC in December 2018 by the company
• Financial statements had to be restated for the years 2011, 2012, and 2013 along with replacing the CEO, lead independent director, and other senior executives
• Accounting violations were found but the corporation neither admitted to nor denied any of the findings. However, it agreed to “cease and desist” from any future violations

Accounting Errors due to Manual Processes can lead to financial losses

Preventing accounting control failures using Business Rules Framework (BRF)

A Business Rules Framework (BRF) is a structured approach for defining, deploying, monitoring, and enforcing business logic and policies throughout an organization’s processes and systems.

How BRF could have detected the financial anomaly

✅ Standardized accounting methodologies:

A Business Rules Framework would have enforced consistent and transparent rules for accurate calculation of allowance and write-offs, thus reducing the risk of abrupt or opportunistic changes to the methodologies

✅ Automated Controls and Alerts:

Automated checks on income and expenses could help flag deviations from the approved industry norms for estimation methods or any unusual manipulation of the financial records

✅ Audit Trail Software:

Enterprise accounting tools like BRFs can help detect each and every change to business rules or estimation logic, ensuring accountability and tracking of management decisions

✅ Role-based access controls:

A BRF can help enforce role-based access to ensure that no single team or individual can alter financial information under any pressure

✅ Compliance Tracking:

Continuous compliance tracking through a Business Rule Framework to ensure compliance with GAAP and internal policies, flagging any violations in real-time

BRF can help detect financial anomalies

To conclude: How the right tools could have prevented a financial oversight failure

If a Business Rules Framework could have been in place, it could have detected the accounting irregularities and the improper methodologies being used and could have flagged them. This, in turn, would have avoided any material misstatements, penalties, and the subsequent reputational damage.