Reconciliations: Part of a Global System of Controls to Ensure the Integrity of Your Financial Close

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What goes through your mind when you certify the balance sheet? Most likely there are two points that you think about:

  • The amount of risk in the numbers, and
  • How much it actually costs to get to the final answer

There are no compromises in producing reliable financial statements, and balance sheet reconciliations is one of the most important internal controls over financial reporting that can’t be under-appreciated. In operational teams, F&A is being pushed more than ever to achieve more efficiencies at a lower cost and better output. Said simply, they are driven to deliver ‘more with less’ but that’s a tricky job given risk and efficiency counterbalance each other in the financial close.

How to Take Control of Balance Sheet Reconciliations

No other internal control is capable of mitigating errors and omissions in balance sheet accounts. The objective of internal controls is to prevent or detect errors or fraud, and performing balance sheet reconciliations is crucial to understanding and evaluating the financial position of your business. The timing of the control activity is key to detect misstatements in advance of the filing deadline. Errors that are identified by your auditor and not initially by the company points to a material weakness in the overall internal control environment.

If you are thinking about where to start in your transformation journey, it’s helpful to review this blog which covers these main topics:

  1. Defining what a reconciliation is
  2. Creating a standard process for reconciliations
  3. Driving a reconciliation calendar according to a risk-based policy

As you standardize the balance sheet reconciliation process, you need to be aware of risks inherent in financial operations where complex transactions exist or in situations where there is a high degree of judgement or estimation. This is especially true for multinational companies that need to aggregate information from multiple areas. It’s as if there is a “globalization control penalty” for central finance who can’t readily get the information they need (such as statuses of aged items, action plans, etc.) from dispersed teams. Now more than ever, operational structures include offshore shared services and third-party providers taking on parts of the close including reconciliations, too. This complex structure creates a barrier for collaborative working and sharing of best practices that may ultimately prevent you from industrializing the close process.

Get a Grip on Your Account Reconciliation Process

Recently, we have been taken by surprise with large enterprises going into financial difficulty and finance management should start to think about how confident they are with the internal controls in their business. In any case, it would not be surprising if auditors start to become more demanding given some of the concerns that regulators like the Financial Reporting Council (FRC) has. The FRC aims to prevent user confidence being undermined and has increased its scrutiny on audit standards since the collapse of major organisations which took the public by surprise. The FRC actually sanctioned and reprimanded a major accountancy firm recently for audit misconduct. What this means is that finance management with an opaque view of their balance sheet will need to step up their game, and take the reconciliation and overall close process seriously.

This is not to say that the next year-end audit will be significantly different, but your finance teams may need to provide more evidence as part of the substantive work carried out by the auditors which is likely to increase the cost of preparing financial statements. This is especially true if controls are not operating dependably. When this is the case companies may face a substitution of forward -looking priorities for backward ones, representing an opportunity cost in terms of lost business value.

However, with the emergence of web-based technology solutions though, there are several opportunities to get real-time visibility over all reconciliations that roll into financial statements line items, with a clear view on risks and opportunities aggregated across multiple levels of the organisational hierarchy.

Risk & Efficiency: An Automated Approach

The ability to add a risk profile to accounts is key to deliver the notion of a “smoother” and less intensive period-end. By automating the calculation and application of risk ratings, we are now moving away from a human-centric endeavour with accounting professional engaged as the centrepiece of the activity. A risk-based approach to account reconciliations is a key way to reduce your costs by deferring or removing low risk activities from the schedule, instead focusing on higher risk areas earlier on.

Clearly, we need a way to identify risky accounts, as this is an easy way to accelerate the process, and at the same time reduce the risk of financial restatements. Risk classifications can be based on a set of quantitative and qualitative criteria, with the application of high/ medium/ low classes being based on the likelihood the account is misstated by a material amount (rule of thumb is that accounts will be assigned a higher risk when it is more likely to be materially misstated). Here are some examples of the criteria:

Quantitative Criteria

  • Number of transactions
  • Monetary value of transactions
  • Normal account monetary balance
  • Reconciliation gaps and P&L impact
  • Inactive accounts with a balance

Qualitative Criteria

  • Complexity of transactions, including volatility and subjectivity of accounting rules
  • Fraud susceptibility in transactions
  • Regulatory oversight
  • Quality of internal control over transactions
  • Ownership i.e. is the performer a third-party provider

Risk-based processes may be less than optimal though if managed manually. The “RAG” status can become redundant as new information comes in, so accountants would need to be more involved (i.e. a continuous accounting approach creating a relatively high overhead in terms of cost, with residual risk due to uncertainty). What is considered “normal” can be monitored by Artificial Intelligence with Machine Learning (AI/ML) capabilities. For more insights on how we can apply AI/ML to the closing process, check out this blog.

Implementing a Risk-Intelligent Balance Sheet Reconciliation Process with a System of Controls

Cadency by Trintech is a cloud-based platform that provides customers with a System of Controls to validate the reliability of financial statements produced by the system of record (ERP). Trintech’s approach is key to transforming internal controls over financial reporting, as all processes and controls are interoperable, and this connectedness makes them dependable.

Key requirements for a GL reconciliation solution include:

  1. Dynamic risk-based analysis for GL accounts so that companies are not just spreading accounting activities every day to reduce the month-end burden, but actually eliminate activities altogether i.e. doing “more with less”. In Cadency, this technology is powered by Risk-Intelligent RPA™ which is automation within a defined risk-based, risk-intelligent framework. Account materiality, transaction types, P&L impact and ownership are some of the attributes that drive business workflows.
  2. On-demand visibility via a dedicated R2R console with balance sheet KPIs, performance and financial statement line item risk analysis
  3. Highly flexible data profiles for user security

The above 3 requirements drive the following benefits:

  1. Real-time enforcement of risk-based policies (global and regional) with minimal manual effort
  2. Aggregating reconciling items showing risks and opportunities, and unreconciled balances by financial statement line item
  3. Balance Sheet integrity, accuracy and completeness

Next in this series, we discuss the management of journals entries as a control when posting recurring journals tied to your closing process, as well as non-standard adjustments. Like reconciliation controls, journal entries need to be part of a broader, dependable system of controls which is a catalyst to improved governance yielding the panacea of both risk reduction and efficiency.

Explore the Full 7-Part Series on Trintech’s System of Controls:

Part 1: Don’t Drown in Transaction Data When Closing – Light a Match and See Clearly
Part 3: Eliminate 95% of Manual Journal Entries and Reduce Risk at the Same Time – Mission Possible
Part 4: (Intercompany) Prevention Is the Best Medicine
Part 5: How to Reduce Risk and Ensure Control Over Your Intercompany Transactions with Cadency’s Detective Controls
Part 6: How to Excite An Accountant During Close
Part 7: How to Measure the Impact of Your Control Environment Using a Framework for Compliance