The Next Step: Extracting Value from Sarbanes-Oxley
By Colleen O’Donnell KnowledgeLeader contributing writer
Accompanying the Sarbanes-Oxley Act of 2002 was a ruling by the Securities and Exchange Commission requiring that publicly traded companies expedite external financial reporting timelines. This ruling would have garnered greater attention if not for SOA, which has consumed finance resources. However, as SOA Year One is wrapping up for a majority of filers, the new financial close timelines have taken the spotlight. In many situations, SOA compliance has added work tasks to the month-end close process and the financial executives are wondering how they will meet the demands of the regulators and continue to run their businesses.
The answer is buried in their SOA documentation; all they have to do is dig. Within the mountain of SOA documentation, there are opportunities to accelerate the month-end close process while reducing both cost and risk.
The task-level process review required by SOA was necessary to highlight internal control weaknesses. However, this granular view also can identify redundancies, inadequate systems tools and process quality (accuracy) issues that reduce effectiveness and efficiency.
With Year One behind most companies, this is the perfect time to mine the data while preparing for Year Two. “Most companies have thoroughly documented their month-end close process,” says Jim Pajakowski, a managing director at Protiviti, “but they haven’t had time to improve it. They’ve learned a lot but haven’t acted yet to comply with the new SEC requirements. Companies have to do more now, and they have less time to do it.”
Does your process measure up?
Companies that have implemented sophisticated ERP software tools continue making a large number of manual journal entries to close their books. These entries are often to correct errors that were made during the month or to capture transactions that were recorded on spreadsheets. While it is comforting to know that back-end, manual controls are working; this is a high-risk strategy. Continued reliance on manual controls is neither an effective nor efficient method to close the books each month.
Key indications that a company’s finance processes would benefit from a month end close review include:
- A month end close cycle exceeding five days
- A lengthy delay between the close and issuing statements
- A history of restatements
- A large number of manual journal entries to record transactions or make adjustments and reclassifications
- A high dependency on spreadsheets to record accounting transactions or support manual journal entries
- Limited time for financial and operational analysis
Long closing cycles minimize the time for value-added analysis. Finance organizations need to migrate beyond transaction processing and error detection in order to become strategic business partners with their customers.
Improving the process
Following Year One, many companies are left wondering how they can improve the efficiency of the close process while ensuring that they don’t endanger the 404 compliance they worked so hard to achieve. The first step is to analyze the existing SOA documentation to determine the current process tasks and performance results. “Because companies already have a baseline, they can hit the ground running pretty fast,” says Brian McGregor, a senior manager at Protiviti.
Tom Batina, a managing director at Protiviti, says companies have the unique opportunity to challenge what they’re doing. At every step in the process, companies should ask:
- Why do we do this?
- Does it add value?
- Is it an effective control?
- Can it be eliminated or simplified?
- Can it be automated?
“This is an excellent opportunity to take advantage of the knowledge gained from Sarbanes-Oxley efforts to make significant improvements,” adds Pajakowski. “Eliminate things you shouldn’t be doing. Simpler processes are more efficient, and they’re easier to control, too.”
As companies work to increase quality, they often find that errors tend to occur outside of accounting and finance: time or production reporting errors, receiving/shipping cutoff issues, and account coding errors. By tracing the error upstream to the root cause, finance organizations can attack the issues that create additional work pressures for them during the financial reporting process. From there, the company can develop the necessary changes that eliminate duplicate work, reduce cycle times and minimize manual tasks. Companies with best-in-class month-end close processes:
- Minimize the number of manual journal entries
- Automate recurring journal entries
- Link subsidiary ledgers directly to the general ledger
- Limit the number of general ledger trial balance runs to two
- Perform account analysis and reconciliations outside the close cycle
- Incorporate estimation techniques in non-quarter month-end closes
- Set materiality tolerance limits for adjusting journal entries
- Use key performance indicators measuring quality, cycle time and cost
- Leverage analytical software tools that are linked to the general ledger to minimize manual data entry and facilitate the preparation and issuance of reports
In order to establish improvement targets and estimate the savings potential, finance organizations can measure their progress against a set of month-end close benchmarks including:
- Month-end close cost as a percent of revenue
- Month-end close cost per full-time equivalent
- Staff per $1M in revenue
- Number of days to close (monthly, quarterly, yearly)
- Length of reporting cycle (earnings, annual report, 10K, 10Q)
- Number of charts of accounts
- Number of non-system journal entries
What you can expect to gain
SOA compliance has placed a heavy burden on public companies. Companies now have an opportunity to drive value from the compliance effort by digging into the documentation to identify where improvement is possible and then taking appropriate action.
Companies that implement finance best practice process techniques have reduced close and reporting cycle times significantly, thus allowing them to meet regulatory reporting requirements and provide value-added analysis for management.
“Getting better data quicker allows you to react to changes and run a business better,” says McGregor.
Batina adds, “What happens when an operating issue surfaces and management has to wait 10, 12, or 15 days for a report with little, if any, analysis? The problem has likely festered and will have an even greater impact on the next month’s results before management has a chance to install corrective measures. A simple process is easier to control than a complex one. As you increase quality, you decrease risk and cost not only in finance but in the business.”