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Don’t wait for a scandal to rein in internal controls

THE REALITY in accounting is that spreadsheets are prone to errors but it’s not until an accounting scandal erupts that regulators begin to look at the underlying processes that failed and ultimately allowed the scandal to happen. It is only then that regulators require more transparency, which in turn, leads to stricter standards and increasing regulations.

The U.S. Sarbanes-Oxley Act was enacted in 2002 in response to such widely publicised U.S. company meltdowns as Enron, WorldCom and Adelphia. The corresponding British law was the Companies (Audit, Investigations and Community Enterprise) Act of 2004.

More than 10 years after Sarbanes-Oxley, the debate rages on-is the positive impact on investor confidence and share price (of having better controls in place) worth the cost of implementing those controls? Even so, similar laws have been passed in a number of other countries. This debate misses the point – the purpose of these types of regulations is to put basic reporting and control in place that should be there as a matter of common sense. It should not be possible to perpetrate fraud by manipulating spreadsheets.

Resistance towards implementing better controls is often well-intentioned. Highly competent accountants will assume that the precision with which they execute their given duties applies to the process as a whole. In reality, the complexity of the financial close necessitates a more controlled, more standardised approach to all finance and accounting processes.

To illustrate this, at a recent conference in Milan, one gentleman from a large German company stood up and said that his company had no reason to reconcile their balance sheet accounts because they had a process whereby they checked every single journal that was posted for accuracy. By his logic, if the sum of the parts was correct, the whole was also correct by inference. When asked how he accounted for potential missing journals that should have been made but were not, he had no answer. No matter how well constructed their journal review process was, a gap in the overall process still introduces the risk of incorrect financials.

The other driver towards increasing regulations is the globalisation of business in general. In response to the proposal to establish an Accounting Standards Advisory Forum, the FRC (UK’s Financial Reporting Council) responded jointly with members from similar industry groups in France, Italy and Germany. There is an implicit recognition that there should be close parallels amongst these countries in all of their standards so that business is easily transferable across borders. As the recent banking crisis has shown, the impact of an individual company’s financial problems is not limited to any one country.

As both companies and regulators wrestle with the costs of implementing better controls around accounting and finance, most concede that the answer lies with leveraging developing technologies. As software designed to standardise and control various financial processes evolves, the cost of implementing it goes down and companies find that they can have better processes at a lower cost than with manual labor.

Therese Tucker is CEO of financial close software provider BlackLine Systems

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