What is a Significant Deficiency?

A significant deficiency is a single weakness or a combination of weaknesses in the internal controls associated with financial reporting. This deficiency is less severe than a material control weakness and yet is sufficient to merit the scrutiny of those responsible for administering an entity's financial reporting. The presence of such a deficiency does not mean that a material misstatement has occurred, but it indicates the possibility of such an occurrence in the future.

Example of a Significant Deficiency

A notable example of a significant deficiency occurred at Wells Fargo in 2020. Wells Fargo, one of the largest U.S. banks, disclosed in its 2020 annual report (Form 10-K) that it had identified significant deficiencies in internal controls related to accounting for commercial loans. The bank admitted to errors in how it accounted for certain commercial loans, leading to inaccurate financial reporting. Specifically, there were flaws in how risk was assessed and documented, which could impact loan loss provisions (a key financial metric in banking). The deficiency was found in the internal review process for forecasting loan performance.

While the deficiencies did not require restating financial statements, they increased the risk of material misstatements in future reports. To correct the deficiency, Wells Fargo took the following steps:

Strengthened internal review processes for loan risk assessment.
Improved training and oversight within its finance and risk departments.
Enhanced internal controls to ensure better documentation and monitoring of financial reporting.

Significant Deficiency vs. Material Weakness

A material weakness is a deficiency in an organization’s internal controls over financial reporting that creates a reasonable possibility that a material misstatement in its financials will not be prevented or detected. A significant deficiency is less severe than this situation, and yet is sufficiently problematic to warrant notifying management of the issue.

Reporting of Significant Deficiencies

A company’s external auditors will make management aware of any significant deficiencies they find. They also report these deficiencies to the audit committee of the board of directors.