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 Rec-claim Greatness

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 standardise 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 “globalisation 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 industrialising 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.

Cadency by Trintech: Implementing a Risk-Intelligent Reconciliation Process in 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.

Let’s illustrate this through a simple scenario:

By automating reconciliations such as Intercompany transactions and accounts, a list of invoiced amount discrepancies could be flagged. A risk-based algorithm would prioritise and present this list of discrepancies as exceptions to a reconciler, with an immediate focus on higher risk items to ensure there are no surprises at consolidation. In this example, a summary of the invoice discrepancies form part of the balance sheet control, and risk-intelligent automation could trigger an intercompany requisition process to resolve the items. The system includes a set of controls designed specifically for intercompany processing, ensuring data is valid and accurate through a web-service API that integrates directly with a system of record. Typically, there are checks to prevent errors prior to processing, eliminating any need for re-work later on. Additionally, controls are synchronised with master data in the system of record to detect areas of non-compliance. So for example, tax codes can be added based on customer/vendor coding, type of transaction, etc. and this in turn may trigger the relevant calculations and booking within the system of record. As we think about potential disputes as well, the initiation of an intercompany invoice may need to be pre-approved, and this control exists to enhance the validity of the transaction before it is recorded.

When it comes to posting, the solution integrates directly with an ERPs subledgers, including automation to generate invoices in the system of record. The posting is performed simultaneously as a control to ensure entries are successfully booked, no matter where the ERP system(s) are located even if counter party transaction is being recorded in a completely different ERP instance.

We mentioned Risk-Intelligent RPA™ earlier which is automation within a defined risk-based, risk-intelligent framework. To follow the above scenario, the existence of material discrepancies could automatically update workflows so that for example, an additional approver is added to the reconciliation, with task due dates being brought forward. When it comes to remediating the invoice issues, there would be a different routing for the transactions based on materiality, transaction type, P&L impact and ownership.

The key point is that reconciliations should be managed as part of a broader, dependable system of controls; a catalyst to improved governance yielding the panacea of both risk reduction and efficiency.

Written by: David Brightman ACA, Director of Product Management at Trintech 

 

 

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