Would the $185 million fines be considered material to the Wells Fargo financial statements?

Question

Visit the website of the U.S. Securities and Exchange Commission (www.sec.gov) and locate the Form 10-K
filed on February 25, 2015 by Wells Fargo & Company/MN (CIK#: 0000072971) for the 2014 fiscal year
(Note: The financial statements are contained in the link to Exhibit 13 of that 10-K filing). Based on that
financial information filed with the SEC just prior to the first public announcement of the alleged sales
improprieties, assess the following:

Answer 1

The December 31, 2014 financial statements for Wells Fargo reflected the following (in millions):

Total Assets $1,787,632
Total Liabilities $1,593,741
Total Equity $ 193,891
Net Interest Income $ 45,301
Non-interest Income $ 40,756
Income before Income Tax Expense $ 33,641
Net Income $ 22,894

Students may overlook the fact that the above numbers are rounded to the nearest million
dollars. That means the bank had over $1.7 trillion in assets as of December, 31, 2014 and almost $23
billion in net income for the year. With that in mind, the cumulative $3 million amount of unauthorized
customer fees and services charges recorded during 2011 through 2014 would be deemed immaterial
relative to total assets and net income. Despite the fact that these unauthorized fees were included in
the financial statements over the four-year period, the financial statements would not be deemed to
be materially misstated. Additionally, while the $185 million fine seems high, it represents less than
1 percent of Net Income for 2014, and thus would be considered immaterial. More importantly, the
penalty, which was announced in September 2016, would not affect financial statements filed in earlier
periods.
While the fees and fine would be considered immaterial from a quantitative perspective, the
fact that the Wells Fargo’s stock price declined by more than 10% in the days after the settlement
with federal regulators suggests that the inappropriate recording of customer fees was material to
investors. Investors were likely concerned about the impact on future revenues and net income from the
inappropriate behavior. PCAOB AS 1001, “Responsibilities and Functions of the Independent Auditor,”
states that “The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement, whether caused by error or
fraud.” That standard notes that the auditor obtains reasonable, but not absolute, assurance about
whether the financial statements are materially misstated. Thus, a properly planned and performed
audit may not detect a material misstatement resulting from fraud especially when the quantitative
amounts involved are very immaterial.