The “last mile” of finance is finally getting the attention it deserves. That’s not because chief financial officers and controllers have run out of things to fix. They don’t have a choice — the close-to-disclose process, particularly the final stretch of financial statement preparation, is rife with inefficiency and complexity. Previous gains made in cycle-time compression are gone. Risks of financial error and internal control failures are on the rise. Experts in U.S. Securities and Exchange Commission (SEC) reporting predict things will get worse.
The close-to-disclose process involves all activities needed to close an organization’s books, perform all necessary inter-company accounting and reconciliation steps, finalize consolidated financial statements and release earnings and publish official statements with regulators such as the SEC. Global corporate expansions in recent years, along with a steady pace of acquisitions, have created accounting and systems problems at many large companies and have made financial statement preparation a high-wire act.
“Intercompany accounting and balance sheet reconciliations pose significant challenges to multinational companies today,” says Kyle Cheney, a partner at Deloitte & Touche LLP. “There is a pervasive lack of central/corporate visibility to these activities, which creates risk from a Sarbanes-Oxley and SEC reporting standpoint.”
These organizations, he adds, “need to improve core processes and technology solutions, thereby providing transparent ability to initiate, settle, clear and reconcile balances. Leading companies have structured initiatives to accomplish this on a global scale, and they are gaining efficiency by doing so.”
Cheney is not alone in calling for serious change. A growing crowd of experts say financial statement integrity is at stake.
Disclosure Explosion
“Yes, more people are taking a look at the close process because financial reporting timetables and disclosure requirements are getting more condensed and expansive simultaneously,” says William Curry, corporate controller and principal accounting officer at Waters Corp. “Over the past 10 years, the level of complexity and the amount of required disclosures have grown enormously.
“Two examples involve fair value and pension disclosures. It’s fair to say there hasn’t been anything like this since the ’33 and ’34 Acts came out [the birth of the SEC after the Wall Street Crash of 1929].” Curry also serves as an instructor at the SEC Institute Inc., a training firm that specializes in financial reporting.
Reed Wilson, who consults on technical accounting and SEC reporting and serves on Financial Executives International’s (FEI) Committee on Corporate Reporting (CCR), concurs: “There is widespread frustration among finance professionals in the preparer community with the ever-increasing SEC and FASB disclosure requirements. This is especially challenging for interim periods given the tight filing deadlines.
“For multinationals, global charts of account and common systems solutions can help, but this is difficult and costly to achieve, especially where frequent acquisitions are involved.” Also, adds Wilson, “information is being requested that does not reside in the ledger.”
One new rule that really irks finance executives is the SEC’s disclosure requirement involving the possible presence of “conflict minerals” in global supply chains. The rule refers to natural resources such as diamonds that are leveraged by perpetrators of violence in central Africa. “How am I supposed to implement that?” asks one controller.
Another executive — one who tunes into current opinion from his post on the Institute of Management Accountants (IMA) Financial Reporting Committee — reports that “people are asking why FASB [the Financial Account Standards Board] wants information that senior management doesn’t use in decision-making. Apparently, somebody at FASB thinks it’s important.”
The irony is that fuzzy rules and confusing directions have prompted statement preparers to take the “kitchen sink” approach. That is, throw in everything but the sink. Terry Iannaconi, senior partner at KPMG and former SEC official, advises against it. “The area of risk factors is one area where people are getting very carried away in attempts to cover themselves. They are including generic risk factors such as: ‘Customers could stop preferring our products and buy elsewhere.’ This is not specific to just your company. And in the end, analysts and investors can’t tell which risk factors are relevant.”
Most companies have not yet taken steps to reduce disclosure complexity, she adds. “It requires an arduous effort to go through everything and decide which things are irrelevant and unnecessary. And I know it can be tough, because you’ve got to make judgment calls that may be difficult.” Still, Iannaconi believes strongly that preparers owe it to investors, particularly individuals, to get this process fixed. (For an in-depth report on this subject, which is coauthored by Iannaconi, see Disclosure Overload and Complexity: Hidden in Plain Sight, by KPMG and Financial Executives Research Foundation.)
Stay tuned for developments on the regulatory front. In a September 2012 webinar, the Financial Accounting Standards Board reviewed a recent Invitation to Comment. This involved a project to establish an overarching framework to improve the effectiveness of disclosures in notes to financial statements. (Relevant documents are on the FASB website.)
Process Improvement: Coming Up
In the first quarter of 2012, APQC conducted a survey on trends in financial management process mprovement. Responses were gathered from 145 senior finance executives from large organizations in the United States and Europe and a small percentage came from Asia. One surprising finding: nearly 75 percent reported that the close-to-disclose process ranked among their top-two targets for financial management improvement over the next 18 months.
A skeptic would question if we’re in for a round of band-aid measures. Or, could it be that CFOs are planning an “open kimono” approach to process transformation? A clue, perhaps, is found in the survey, which indicates that 81 percent of large corporations are currently investing in at least one major program to improve financial management processes.
With the close-to-disclose process high on the target list, expect to see a sizeable chunk of companies in the Fortune 1,000 getting serious about fixing the most fundamental finance mission: stewardship of financial accounting and reporting.
Robert Kugel, senior vice president and research director at Ventana Research, provides this context: “The average company in 2012 takes about one-half day longer to complete the full close-to-report cycle than it did in 2007, which, in turn, was about the same as 2004. While there are companies that do a great job and can close in five business days or less, the majority of companies have gone in reverse. The reason is either that they have a poorly designed process, or there’s far too much reliance on manual processing.”
In addition, Kugel notes, “Over the past three years, things have been exacerbated by staff cutbacks. And when you’ve got a bad process to begin with and fewer people, you’ve got a longer close.” He believes that CFOs and controllers have erred in ignoring this corner of the stewardship tableau.
“If it’s taking until the third week of the month following the end of the quarter to finish your consolidation, and then you have to get SEC documents done on top of XBRL [eXtensible Business Reporting Language] work, a lot of people on your staff are in a lot of pain,” adds Kugel.
To his way of thinking, allowing a heavy reliance on spreadsheets as the primary process-enabling tool is just asking for trouble. “We find about 40 percent using spreadsheets for governance, risk and compliance (GRC) work. But spreadsheets have been shown repeatedly to be prone to errors when used in collaborative processes at an enterprise level.”
The reluctance by CFOs to invest in better GRC tools is out of step with the bulk of Kugel’s recent research findings, which indicate a strong desire by companies to address operational risk.
The situation is particularly disturbing in the financial services sector, says Michael Flagiello, a partner with WeiserMazars, an advisory firm that works closely with insurance companies. “We see some very antiquated infrastructure. More than 20 percent of the firms we looked at recently take more than 40 days to close their books. In fact, 70 percent of CFOs in this sector struggle to close the gap between ideal and actual closing times.”
The culprit, he says, comes as no surprise: an extremely heavy reliance on manual processes and spreadsheets, followed by a lack of functionality in core data systems. “As a result, people are so caught up in manual close steps that they have no time to do meaningful analysis. Even worse, the risk of error is leading to more restatement risk. We know rating agencies are talking about this,” says Flagiello.
It’s impossible to quantify restatement risk in a meaningful way using classic benchmarking tools. But cycle speed and process costs can be benchmarked to gain a sense of relative performance gaps. From there, it’s reasonable to assume that CFOs who have invested in streamlining and automating the close-to-disclose process — those that go fastest and spend the least — have less risk of data entry errors, avoid missed checks on the reasonableness of sums that roll up from local reporting entities, prevent version control problems and so forth.
All those potential mishaps in a high-pressure work cycle add to restatement risk.
Cost is another important dimension, and CFOs will want to look closely at the potential return-on-investment from tools for automating the close-to-disclose process. But in this case, speed (or lack thereof) is very important because of the ripple effect.
Kugel puts it this way: “Automating the close-to-publish process provides members of the board of directors and other external parties with more time to review the documents before the mandated filing deadline. It also gives time back to the finance and legal departments that they can apply to more valuable efforts.”
Playing It Forward
There are signs that more CFOs and controllers are taking stock of the situation. “A few years back, when companies first started to address the SEC’s requirements to file financial statement using XBRL, the answer for some was a quick fix — throw a dedicated XBRL-tagging software solution at the problem or outsource the tagging work,” says James Fisher, vice president of marketing, analytics at business software provider SAP.
“But many of them are now coming around to the idea that you should take an end-to-end perspective with a strong eye on the future. That means fixing inefficiency across the entire process, not just the tagging step. It seems that more people now are discussing the bigger picture because they want to take out more cost and at the same time improve the quality of the process,” adds Fisher.
Looking toward the future, experts say the close-to-disclose process will grow more burdensome and pressured. “Even if we do not have wholesale adoption of IFRS [International Financial Reporting Standards] here in the U.S., as we move closer to convergence, there will be more incremental disclosures,” says George Wilson, vice president at the SEC Institute.
“But every company has its own nuances for getting this work done. So it’s not going to be a matter of flipping a switch on a piece of software. The only way you can stay in front of this is to take a process-based approach and make a commitment to getting better and better as you go along, says Wilson.”
Mary Driscoll is a senior research fellow at APQC, a nonprofit business research and benchmarking firm based in Houston.
This article first appeared in the November 2012 issue of Financial Executive magazine.