It is all too easy to treat management review of financial reporting controls as a run-of-the-mill last step in the internal control process or as though it only applies to large organizations. However, management review should not be viewed that lightly. In many businesses, management review of journal entries supporting major transactions and analytical reviews are often the primary controls to prevent financial reporting errors and material misstatements.
Certain business limitations, including operational and financial, may preclude proper segregation of duties. As such, it is in the best interest of management to understand the controls surrounding:
- Journal entries;
- Entity level monitoring controls over operations and financial reporting; and
- Supervisory review of estimations, calculations, and analyses.
Having management review controls in place, is critical to ensuring the following elements of a business’ operations:
- Accurate financial reporting;
- Efficiency of operations;
- Compliance with laws and regulations; and
- Safeguarding of company assets.
During the financial reporting review process, management should consider if the underlying documentation is sufficient to effectively evaluate the design of the control:
- Is there a clear understanding of a control operator’s responsibilities?
- Is there sufficient documentation providing confidence that management review will prevent or detect a material misstatement?
- Is the documentation detailed enough for control re-performance by another individual?
- Can documentation deficiencies be corrected with the organization’s current resources?
Management financial reporting review often reveals universal areas of weakness. The following are among the most common:
Inadequate Definitions – This may come down to inadequate details on how to carry out the review process, where the buck stops on accountability, and the required level of precision to ensure accuracy.
Questionable Data Quality – The quality and reliability of supporting data is fundamental. If management is uncertain about the data or has questions, this is indicative that output may also be unreliable.
Underqualified Reviewers – Sometimes, it is an issue of inadequate or lack of training. Other times it may simply be the wrong people assigned to a vital task. Whatever the cause, reviewers who lack the knowledge and experience to make informed judgment calls can place the business at risk.
Imprecise Reviews – This is often the result of Underqualified Reviewers. Reviews might be slipshod, highly summarized and/or not performed at a level detailed enough to reveal issues. A lack of depth could mean that a crucial point is being missed — a point that could come back to haunt the business.
Personal Bias – This problem may be the most difficult to detect. The bias may be accidental, result from poor training, or stem from a different value system, or worse, it may be criminally motivated. The best hedge against personal bias is to ensure that the other above mentioned common problems are quickly and effectively addressed.
The review process is not only a hunt for problems, it is also a quest for a greater understanding of what amounts to the fundamental parts that make a business function. It is, therefore, critical to gain a better understanding of the following:
Intended Purpose of the Control – It is not merely a rule to follow, it has a purpose and a benefit. Know what those are and why they are important to the overall business. This will give the business a value that may not have been fully understood previously.
Sources of Information – Having reliable information is vital to a business and its leadership. Confirm that the information being used to help make decisions comes from trusted and verifiable sources.
Consistency of Performance – A chain is only as strong as its weakest link and so it is with the controls of a company. Areas of weakness can have a negative impact on a company’s areas of strength.
Criteria of Investigation – Establishing criteria that will be used to weigh against findings will help gauge the degree of a problem and determine the order to address what is uncovered.
Correlating with Relevant Risks – Understanding how the information on hand can be used to make a business more efficient and free of risk might be the most important step to the bottom line. This understanding puts real value on the work performed.
Management review sets the tone for an entire business. The zeal and motivation to maintain proper controls emanate from the very top. As always, a leader leads by example, and the rewards of that leadership will naturally follow.
Berdon LLP, New York Accountants