Canadian Regulators Propose that Management Report on Internal Control: Moody's Will Apply Existing Methodology to Material Weaknesses Reported

Abstract

The reporting by Canadian public companies on the effectiveness of internal control over financial reporting has been the subject of considerable debate. Recently, regulators proposed that management of public companies disclose they have evaluated their company's internal controls and identify any material weaknesses in those controls. However, the latest proposal drops auditor reporting on companies' internal controls, a major change that differs from the US requirement and from the Canadian regulators' earlier proposal. Moody's welcomes formal evaluation of controls and disclosure of control problems, as material weaknesses in controls are sometimes relevant to a company's credit risk. We expect to apply the same methodology to considering control weaknesses cited by all companies, including Canadian, as we do with US companies reporting control problems. Based on our experience considering control weakness in the US to date, we expect that negative rating actions would result in certain cases in response to disclosures of material weaknesses in accounting controls by Canadian companies. Independent auditors' reports on internal control have been important in restoring confidence in financial reporting in the US in the aftermath of many high profile instances of misleading financial reports. We believe that auditor reporting on controls improves the quality of auditing, management reporting on controls and financial reporting generally. We will not differentiate the credit quality of companies solely as a result of different requirements for management or auditor reporting on controls as we have no objective or consistent means of doing so. Further, a country's infrastructure can promote quality reporting without reporting on controls if other elements of the infrastructure are working effectively. Our confidence in the financial reporting in a country ultimately depends on the frequency in which companies in that country engage in misleading financial reporting. High levels of severe reporting problems increase our perception of credit risk, regardless of whether the country requires reporting on controls.