Editor’s note: Managing Risk is a regular feature for Local Tech Wire. Bob Broda is managing partner of Visage Solutions, LLC.An ever-increasing number of companies are reissuing their financial statements. These restatements do not necessarily indicate fraud. They can be caused by any number of circumstances, including inaccurate data in the companies’ financial systems or gaps in the integration of the day-to-day transaction processing of systems employed to report the financial statements.

Sarbanes-Oxley is concerned with ensuring investors and stakeholders can make financial decisions based upon accurate financial information. It is largely the rules and regulations surrounding Sarbanes-Oxley that cause companies to restate earnings instead of simply making the adjustments in the next fiscal year statements.

There have not been major expenditures in new systems since the Y2K effort, so one can only assume these data and integration problems have existed for some time. But how can so many systems have these integration problems?

Inadequate internal controls

Reasons include: inadequate error checking allowing inaccurate information to enter the system; manual processes that allow for human error; the shear volume of data creating and incalculable numbers of data combinations. However they all translate into one general condition — inadequate internal controls.

The Sarbanes-Oxley Section §404 and PCAOB (Public Company Accounting Oversight Board) rulemakings call for corporate management and their public auditors to assess the “effectiveness” of internal control over financial reporting. This is by far the largest effort that companies are expending with complying with Sarbanes-Oxley. Companies are now documenting and strengthening internal controls. If you think you can feel comfortable that the effort will ultimately fix the problem resulting in fewer and fewer restatements -Think again.

Section 404 dictates that companies document their control activities over financial reporting. However, there are hundreds and thousands of operational processes that ultimately affect the financial statements that also need sound internal controls. Core Business Processes including purchasing, sales, payroll, financing, accounts payable, receipt collections, etc., generate thousands or millions of transactions during the fiscal year. These transaction records are typically maintained on the host ERP, MRP, HRIS, and Accounting systems.

Operations Management Processes including expense management, budget reconciliations, data reconciliations, change orders, customer returns, etc. result in thousands or millions of records which may or may not be reflected back into the originating transaction databases. These records and reconciliations are created and managed with somewhat of a quarterly view. Many of these records are created after fiscal quarter ends and include certain accruals and adjustments to “as-of” dates.

Reconciliations, reconciliations

Financial Closing, Adjustment and Valuation Processes also generate thousands or millions of records that are often not reflected back into the originating transaction databases. They may include spreadsheets, pro-formas, “BI” system projections and other records. These records and reconciliations are created and managed with a quarterly view. Many or most of these records are created after fiscal quarter ends, and fiscal year-end records are more extensive than quarter-end data. Records are ‘reconciled’ to fiscal period “as-of” dates.

Disclosure and Financial Reporting Processes further generate hundreds or thousands of records which are often not reflected back into the originating transaction databases. They may include estimates, reserves, allocations, eliminations, spreadsheets, pro-formas, “BI” system projections and other records. These records and reconciliations are created and managed with a quarterly view. Many or most of these records are created after fiscal quarter ends, and fiscal year-end records are far more extensive than quarter-end data — due to annual reporting, legal and audit-opinion factors.

Many companies’ compliance efforts have largely been focused on creating audit trails of manual control activities. Although the audit trails are becoming increasing necessary, more time and effort should be spent on automating the control activities, ensuring that information contained in the systems are accurate and the integration between the different systems is tightened up.

The effort that companies will expend in the last quarter of their fiscal year will increase exponentially. They will themselves have to attest to the effectiveness of internal controls. If material weaknesses are found during this exercise, they will have limited time to react before the external auditor’s attestment. True, it is acceptable for management to identify the problem and the related fix – but it is far better to identify and solve the problem earlier than it is later.

As you can see, documenting and ensuring sound internal controls in the financial reporting process will not necessarily prevent inaccurate information making its way into the financial statements, nor will it prevent or even slow down the number of financial restatements. Until the core data in the transaction systems are cleansed and proper integration exists between the operational and reporting systems the problem will continue to persist.

Visage Solutions are results-focused operations, financial process and risk management consultants who offer extensive real-world business and executive management experience. Visage Solutions offers a suite of services that provide a strategic approach to operations to improve business processes that affect the bottom line. Sarbanes-Oxley related services include OpsAudit• and SingleVUE Compliance Process Improvement Services supporting Sections 301, 302, 404, 406, 409, 802 and 806. See www.visagesolutions.com for more information and important links.