Category Archives: Financial Reporting and Accounting

17 Principles to Safeguard Assets and Ensure Organizational Effectiveness

One of my favorite aspects of being a financial professional is knowing that others on the management team and in my organization are relying on me. I am expected to handle key functions within the business, and if I do my job well I can contribute integrally to the organization’s success. This can provide a constant sense of urgency but also a rewarding feel of satisfaction and significance.

Among the not so glamorous yet important features of an organization’s structure are internal controls. Accountants are expected to implement sound measures to safeguard assets and reasonably ensure that management’s objectives are achieved toward effective operations, reliable financial reporting, and legal and regulatory compliance.

Even if this sounds boring, take consolation in the fact that your organization’s survival and success depends on it.

The Committee of Sponsoring Organizations (COSO) first released its Internal Control-Integrated Framework in 1992. This document defined internal control and provided accompanying standards. Over twenty years later the framework is still highly relevant.

In May of 2013 changes were made that kept the core intact and added, among other things, seventeen principles to help with implementation of the framework in light of changes over the years. A recent article in The CPA Journal discusses these seventeen principles as organized under the five categories of internal control within the COSO framework.

    • Control Environment

1) Commit to integrity and ethical values – this largely entails setting an effective “tone at the top.”

2) The independent Board of Directors should oversee internal control – among other things, objectively evaluate managers and ask appropriate questions.

3) Establish appropriate authority, responsibility, and reporting structures.

4) Attract, develop, and retain the right talent to achieve objectives.

5) Hold employees individually accountable for fulfilling organizational objectives.

    • Risk Assessment

6) Be able to identify and assess risks by having first formulated objectives with sufficient clarity.

7) Identify and analyze risks throughout the organization to determine how they should be managed – choose whether to accept, avoid, reduce, or share risks.

8) Consider potential fraud risks, including misappropriation of assets and alteration of records, that could deter the organization from achieving its objectives.

9) Be ready for changes, including within the external environment, business model, or leadership, that could impact the internal control system.

    • Control Activities

10) Mitigate risks to acceptable levels by choosing and implementing appropriate control activities.

11) Technology is a special category of importance for implementing control activities that help enable the organization to achieve management’s objectives.

12) Policies establish expectations and procedures put these policies into action in order to deploy control activities.

    • Information & Communication

13) Support internal control functions with relevant and timely information – capture data, transform it into information, and protect its availability and accessibility to appropriate parties.

14) Communicate internally regarding internal control objectives and responsibilities.

15) Communicate with appropriate external parties regarding internal control, carefully considering the timing, audience, and nature of the communication.

    • Monitoring Activities

16) Have ongoing evaluations to determine whether internal controls are working effectively.

17) Communicate internal control deficiencies to senior management and the board of directors so that they can timely take corrective action.

In short, internal controls help management set a proper tone, define organizational objectives, and run the business effectively. A leadership-oriented financial professional who wants to be indispensably valuable within an organization should study and understand how to effectively choose, implement, and monitor internal controls on an ongoing basis.

Poetry and Art for the CFO: Twelve Elements

Are you left or right brained? Analytical or emotional? A number cruncher or a poet?

Although it might run counter to our initial assumptions, CFOs are expected to go “beyond the numbers” and manage key aspects of the business as a whole. We have seen the importance of understanding technology and operations, among other factors not directly related to number crunching.

Very critical is the CFO’s role in dealing effectively with people and relationships. A CFO needs to be approachable. To become CFO material, a finance professional needs to develop habits of ambiguity tolerance, composure, empathy, energy, humility, and confidence.

On that note, the international accounting and finance firm Deloitte has published a poetic and artistic description of the CFO’s twelve elements, which encapsulates the expansive requirements and responsibilities of the CFO’s job:

“As CFOs grow in stature and importance, they keep coming back to the same issues that form their agenda. The elements of the CFO Agenda represent a powerful framework for one of the toughest jobs on earth. Year after year, quarter after quarter, they endure.”

Here are the twelve elements and my summation of the messages:

  • Truth – Be real. Know the true story and tell it.
  • Growth – Plant and water. Make choices and commitments to move plans forward.
  • Relationships – Work together. Manage relationships up and down, inside and out.
  • Decisions – Root your insights in numbers. Don’t manage solely based on your gut.
  • Capital – Manage business investments. Determine timing, amounts, and allocations.
  • Disruption – Be discerning as technologies, industries, and markets constantly change.
  • Crisis – Manage risks. Be ready to respond to various sorts of threats.
  • Infrastructure – Be an enabler. Invest in tech, talent, systems, and solutions.
  • Transactions – Research deals with the right criteria, calmly, thoroughly, and rationally.
  • Transitions – Change is constant. Build your skills and reputation in the midst of it.
  • The Street – Have give and take on forecasts. Be vigilant to represent the company well.
  • Me – Provide solutions. Navigate through complexity to make things happen.

Don’t take my word for it. Take a look at the presentation for yourself. Reflect on the messages. Do you agree or disagree with each of the elements and how they’re presented? How can you apply these insights in your work as you develop your career?

Know Your Enemy: Think Like Fraudsters to Beat Them

The famous ancient military leader and war theorist Sun Tzu is noted for his clear dictum:

“Know your enemy.”

Although the concept can make many people uncomfortable, finance professionals understand that combating devious financial schemes requires not only an understanding of system vulnerabilities. A battler against fraud has to learn how to think like a fraudster:

“If I wanted to steal from this company or misstate financial results, where would I look for weaknesses that would enable my scheme to succeed undetected.”

Of course, beyond concocting potential fraud schemes as a mental exercise, the careful and diligent finance professional is quick to pursue the ultimate aim of this process: Devise countermeasures to combat vulnerabilities.

The consulting firm WorldCompliance published a white paper entitled, Fraud and Money Laundering: Can You Think Like a Bad Guy? by Dennis M. Lormel.

Expanding upon the fraud triangle concept, Lormel lists five elements that characterize frauds:

A potential fraudster who 1) lacks integrity, 2) sees an opportunity due to a poor control structure, 3) has a motive such as greed or a pressure such as a financial hardship, 4) rationalizes the scheme (perhaps by reasoning that he feels underpaid and overworked), and 5) possesses the capability due to positioning and skills; will no doubt execute the fraud.

Certainly, as previously discussed, effective internal controls can mitigate the opportunity for fraud. However, sometimes it is possible for fraudsters to circumvent controls or to collude with partners in their schemes.

Lormel notes: “The elements of fraud include a representation about a material fact; which is false; and made intentionally, knowingly, or recklessly; which is believed; and acted upon by the victim; to the victim’s detriment. The ability to be deceptive and avoid detection is one of the fraudster’s primary keys to success.”

Bad guys are proactive about manipulating the system, even as those who combat them are often reactive. Among other factors, fraudsters look for environments with unethical culture due to poor tone at the top. Fraudsters understand the importance of laundering funds through financial institutions and maintaining a reasonable appearance and a story of legitimacy.

Lormel points out: “Over time, spin and deception get much more difficult to disguise. The veneer of reasonableness tends to fade. A good fraudster usually watches intently for signs that their scheme is unraveling. At that point, they will implement their exit strategy. However, often times, fraudsters are blinded by their own greed and arrogance. They either miss or disregard the warning signs of detection. Instead of following an exit strategy, they find themselves in jail.”

A finance professional, whether an auditor, controller, CFO, banker, investment manager, or someone else entrusted with fiduciary responsibility; has to think several steps ahead of the fraudsters. Know what warning signs to look for, ask questions, don’t believe everything you hear, and be ready to act quickly when something doesn’t look right.

Lormel concludes: “There are two prominent end games. One has a private sector focus, the other, a public sector focus. On the private sector side, the end game is to prevent or minimize monetary losses and reputational risk. On the public sector side, it is to seek prosecution, recover illicit proceeds and assets through forfeiture, and/or bring enforcement actions. Both end games could carry significant consequences. In either event, understanding how the bad guys think and taking preemptive steps to stop them makes the end game easier to handle.”

Know your enemy. Combat a fraudster by knowing how a fraudster thinks and operates. This is especially important with regard to IT-related frauds due to the importance and sensitive nature of electronic records and system access points.

Four Key Standards for Ethical Finance Professionals

What do you think of when you hear the name Enron? How about Madoff? Other names and examples could be multiplied of infamously unethical businesses and individuals.

Finance and accounting professionals all aspire to avoid white collar prison, of course. At the same time, we hear stories and read numerous case studies and articles about those who play fast and loose with laws and regulations, thereby landing themselves in jail. Clearly, it is not enough to simply hope to avoid prison; an ethical professional must resolve beforehand to follow the highest standards of integrity, especially when times of testing come in the “real world.”

One key aspect of being in a profession is conducting oneself according to standards of professional practice. Doctors, lawyers, professional engineers, architects, and various other professionals are expected to master a body of knowledge, obtain experience and certifications, and pledge to perform their work with the highest level of integrity and competence.

The Institute of Management Accountants (IMA) is a highly regarded organization for accountants and finance professionals. Although the CPA designation is the most sought after credential within the accounting profession, the IMA’s Certified Management Accountant (CMA) designation is also well respected.

The IMA has the following four standards to which the organization holds CMAs accountable, and these are highly relevant and worthwhile for all accountants and finance professionals to consider:

  • Competence – The IMA’s standard emphasizes continual professional development, legal and regulatory compliance, effective decision support recommendations, and clarity in communicating limitations in performing work.
  • Confidentiality – The standard requires confidentiality except when disclosure is authorized or required, communication and monitoring of confidentiality standards, and refraining from using confidential information for unethical or illegal purposes.
  • Integrity – CMAs and other accounting/finance professionals should proactively avoid actual or apparent conflicts of interest, should avoid activities that would compromise ethical conduct, and should do nothing to discredit the profession.
  • Credibility – The IMA requires members to communicate fairly and objectively, disclose relevant information (i.e., information that could influence intended users’ understanding and decision-making), and disclose areas of deficiency or noncompliance with laws and policies.

Professional ethics has been and will continue to be a growing area of importance for finance and accounting professionals. We will explore this topic in more depth in future installments.

Second Set of Eyes: The Value of Redundancy

The idea of redundancy is sometimes associated with inefficiency. However, building in redundancy is often crucial to ensuring continuity and effectiveness in business operations.

Building in redundancy can be applied in various settings, including IT-related backups. A company needs to continue operating if a server crashes or a disaster strikes. Data recovery can only happen if a routine backup (i.e., storing data redundantly) is implemented.

Cross training employees is another area of redundancy. Rather than having only one employee who can perform key functions, build in redundancy by training one or two others. Furthermore, documenting key processes and procedures ensures continuity if a key employee leaves.

Another area for redundancy is accounting and internal controls. For example, have a “second set of eyes” check invoices to customers and payable runs for vendors. Finance professionals, especially accountants who deal with many transactions on a daily basis, get inundated with details and can make mistakes. Having a “second set of eyes” is a great form of redundancy to ensure that mistakes are caught, fraud is prevented, and processes are performed effectively.

Accounting firms are known for hiring young accountants and utilizing the process of reviews as a primary tool for development. Whether the project is a tax return, audit or review, or a consulting project, senior accountants review and mark up the work of the less experienced staff. Not only do the more experienced “second set of eyes” catch mistakes before work products are delivered to customers, but the process serves as a very valuable and enlightening means for younger accountants to quickly and directly learn on the job.

Another opportunity for a “second set of eyes” is with business documents such as contracts and agreements. Small clauses can have large impacts, positive or negative. Take advantage of subject matter experts, such as accountants and lawyers, who can provide a “second set of eyes” to avoid costly mistakes during business negotiations.

Accountants are in the Business of Balancing

I was once a young auditor wrapping up audit field work for a client. My boss was a seasoned CPA and auditor, and he said we were going to thoroughly “clean up” the books during the audit for this particular client. Rather than adopting the standard auditor practice of “passing” on auditing certain accounts and discrepancies because they were “immaterial” to the overall financial presentation of the business, the manager of the business wanted us to examine each balance sheet account with a fine-toothed comb and adjust everything to the penny. This gave me an opportunity to learn a lesson that stuck with me about the essence of accounting and how to “think like an accountant.”

One of the balance sheet accounts was an asset account (classified as an “other receivable” account, as I recall) called “returned checks.” Our client was a retailer, and every once in awhile a customer would write the business an NSF check (a.k.a., a “hot check”). If the manager believed the business could collect on these checks, the bookkeeper would classify the amounts as “returned checks” that would show up as an asset/receivable on the balance sheet.

The balance of this account was fairly small, but my boss said we should look at it and adjust it to the penny. I asked the bookkeeper what the amount should be, and she realized the account on her balance sheet likely was wrong (i.e., she had not bothered to “tie it out” to the penny). She really didn’t seem interested in adjusting the amount to the correct balance, and she even attempted to make an excuse about the amount being “immaterial.” (She was apparently taking some auditing classes and learning about the auditor’s concept of “materiality,” but she must have missed the day in class when they talked about who had the prerogative to determine what was considered material. Hint: It’s not the bookkeeper.)

Finally, she gave me an amount to “write off” from the balance of that account because she thought there were some returned checks that the company would not be able to collect. I told my boss that she had given me an amount and that I was going to make an adjusting journal entry for the account.

Without missing a beat, he asked me specifically how the balance of the account should be calculated in order to determine what the adjustment should be. He was trying to get me to consider my source of information. Rather than relying on a “made up” number from the bookkeeper, he wanted me to dig deeper and ask specifically for a listing of the returned checks that the company believed it could collect from customers. And then, if we deemed it necessary, we could have dug deeper into the payment history of the patrons who wrote those checks to make a judgment about whether we believed the amounts would ultimately be collectible. (In one case, the patron had skipped town so we had a high level of confidence that his check would be forever uncollected.)

My boss gave me a memorable line: “We’re in the balancing business.” He meant that we needed to have clear, documented source material that would “tie” to the amount on the balance sheet for that account. We couldn’t take a made up number from the bookkeeper and adjust the account by that amount when we could not prove what constituted the ending balance as of the balance sheet date.

My next job after working for the CPA firm involved “assistant controller” work in which I had a similar process every month of reconciling each balance sheet account. At any given time I could point to my reconciliation spreadsheets to show exactly what made up the balance in each account. I did not merely balance the bank account and move on; every asset, liability, and equity account had a detailed reconciliation sheet (or in the case of inventory, receivables, and payables, we had summary and detail listings of each account so that we could tie the ending amount on the reports to the accounts on the balance sheet).

In summary, accountants are in the balancing business. Every number within the accounting system must “tie out” or “reconcile” to other elements of the system. By its very nature, double entry accounting requires balancing. And accountants develop tools, such as reconciliations, for checking their work and ensuring accuracy regarding every detail of the system.