Under the Public Company Accounting Oversight Board PCAOB procedures companies
Under the Public Company Accounting Oversight Board (PCAOB) procedures, companies are required to disclose “material weaknesses” in their internal controls. A material weakness means a company’s deficiencies are so bad that there’s more than a remote chance of a material misstatement in its financial reports. An example is when a bank does not regularly check for errors in estimating loan-loss expenses. This type of undetected error, for instance, could be rooted in a formula in a computer spreadsheet that budgets how lending will be affected by interest rate changes. Fannie Mae, the mortgage finance company, reported a $1.3 billion error from its computer models prior to a large accounting scandal. Some auditors are reporting that the material weaknesses they are seeing are the result of flawed checks on formulas used to figure, for example, income tax expense.

Consider how errors in formulas, embedded in linked budgeting spreadsheets and used to estimate sales each quarter, can impact the budgeting process.
a. Use Exhibit 23–2 to trace how errors can permeate the various budgets of a company. Explain how an error that causes a material overstatement of budgeted sales will affect other budgets for the organization.
b. Explain how the PCAOB requirements to evaluate internal controls can improve the budgeting process at acompany.
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