The Financial Close Process: Implications for Future
Research
The Financial Close Process: Implications for Future
Research
Diane Janvrin (Iowa State University)Maureen Mascha (University of Wisconsin – Oshkosh)
Why Financial Close Process Research?Why Financial Close Process Research?
“The economic volatility of the past few years has left businesses hungering for more timely and uniform financial information to help them react quickly to fast-changing conditions.” Emily Chasan, Wall Street Journal, 2012
“Finance organizations need to proactively manage the challenges of data quality and prepare for the upcoming regulatory requirements to avoid creating a perfect storm for their financial close and consolidation processes.” Raj Chhabra, Deliotte Consulting Director, 2010
Financial Close DefinitionFinancial Close Definition
routine process of completing the accounting cycle and preparing internal and external reports
Financial Close ProcessFinancial Close Process
Enter & Process Transactions
Report & Disclose Information
Aggregate & Analyze Results
RemediateControls
Evaluate & Test Controls
§302Certification
Audit Opinion
Form10-Q10-K
BoardBook
AuditOpinion??
AggregateFinancialAmounts
ReviewPreliminary
Results
PerformFinal
Adjustments
Report &Disclose
Information
ERP
Word
Excel E-mail Word
Excel E-mail
Why is financial close process important?Why is financial close process important?
Recent economic volatility and increase in number of restatements
Regulations (i.e., Sarbanes-Oxley, fair value accounting standards, SEC’s XBRL mandate) increase period-end workload
Several recent SEC filings have significant control weaknesses related to financial close process
Time needed to complete the financial close process = internal information environment quality??
Our approachOur approach
Literature review to identify critical issues
Use results to develop field investigation questions
Conduct field investigation with various financial close participants
Analyze results
Develop future research recommendations
Four factorsFour factors
Need to meet expectations
Collaboration between multiple participants
Estimation process
Ability to incorporate new regulations into financial close process
Need to meet expectationsNeed to meet expectations
Companies often attempt to meet or beat analyst expectations during financial close process
Expectation concerns are not limited to year-end earnings
Collaboration between multiple participantsCollaboration between multiple participants
Financial close process may be hidden-profile task
In hidden-profile tasks, teams using bulletin-board computer-mediated communication tool may outperform teams using chat tool or communicating face-to-face
Before collaboration technology can be effective, participants
need to accept the technology Role ambiguity may impact participants’ willingness to
collaborate
Estimation processEstimation process
Even small changes in management’s estimates can trigger material misstatement
Estimates allow analysts to predict future year's earnings, although they are less predictive of future cash flows
Investors find ex post estimate analysis informative
Ability to incorporate new regulations into the financial close processAbility to incorporate new regulations into the financial close process
Many new regulations balance need for standardization with need for professional judgment
Technology may improve financial close process
timeliness In-house processes may increase organizational
knowledge while outsourcing options may be cheaper
Field InvestigationField Investigation
To date, 10 firms ranging from small firms to Fortune 50 companies
Director of Financial Reporting / Controller
12 questions based on literature review
30 to 45 minutes
Need to meet expectationsNeed to meet expectations
Meeting report deadline dates is critical
Meeting target bottom line numbers varies widely among firms
Companies that update forecast monthly tend to face more target bottom line pressure
Collaboration between multiple participantsCollaboration between multiple participants
Very important
Particularly for organizations with decentralized accounting functions
Estimation processEstimation process
Importance of estimation process varies significantly
Internal controls over estimation process vary widely
Some firms conduct detailed estimation reviews prior to period end
Changes in estimates is often last-minute change
Ability to incorporate new regulations into the financial close processAbility to incorporate new regulations into the financial close process
Varies widely among firms
Often can delay and/or add stress to financial close process
Firms have moved from outsourcing XBRL to internal XBRL software (bolt-on)
XBRL tagging process no long delays financial close process although several managers still question why they need to tag financial statement values
Need to meet expectationsNeed to meet expectations
• Research has examined to some degree who analysts and lenders form their early earnings expectations (Beaver 1979; Kim and Verrecchia 1991, 1997; Barron et al. 1998)
• Still opportunity to examine how expectations impact management’s actions and effectiveness and efficiency of financial close process
Collaboration between multiple participantsCollaboration between multiple participants
Collaboration involves performing hidden-profile task
How can hidden-profile task research improve collaboration between financial close participants?
Estimation processEstimation process
• Explore how time pressure impacts effectiveness and efficiency of estimation process
• Could ex post estimate analysis improve not only period-end estimates but potentially financial close process?
• How do improvements in technology and documentation techniques affect estimate accuracy?
Ability to incorporate new regulations into the financial close processAbility to incorporate new regulations into the financial close process
• Limited research discussing how companies incorporate new regulations into current close process
• Examine when and how existing systems need to be modified or if new systems need to be developed to meet needs of new regulations
• What impacts decision to move XBRL from outsource to in-house? Why bolt-on rather than integrated approach?
SummarySummary Financial close is important and potentially under-researched
topic
Important due to Recent economic volatility Increase in restatements New regulations Several recent SEC filings with significant financial close process control
weaknesses Time needed to complete financial close process = internal information
environment quality
• Concentrate future research on factors impacting financial close process
Meeting or beating management expectations Collaboration – hidden profile task New standards Estimation process
Benchmarks and Key Performance Indicators (KPIs) of Financial Close Processa
Benchmarks and Key Performance Indicators (KPIs) of Financial Close Processa
Category Benchmarks KPIs
Costs Cost of non-compliance/control failure Increase in number of non-recurring transactions
FTEs for close
New account requests
Finance as percent of revenue Task re-work; supporting schedules
Audit fees as percent of revenue Journal entries containing errors or requiring re-adjustment
Quality
Number of control remediations
Changes in policies/procedures
Auditor adjustments Increase in issue escalations
Post-close adjustments Increase/decrease in expected results (returns, receivables, etc.)
Timeliness
Days to close
Increase in expected volumes (purchase orders, invoices, paychecks, etc.)
Percent tasks late Post cut-off transaction postings
Current days to close vs. previous days to close
a source: Clark 2010