Quality of Financial Statement Reporting

Financial statements, such as the balance sheet and the income statement, have long been amenable to manipulation euphemistically known as creative accounting. These statements report the financial situation of a company for a given year while the accounting for revenues and expenses extending beyond the year are subject to a variety of special rules. Revenue recognition for earnings from construction contracts, for example, can be by percentage of completion method or the completed contract method. The percentage of completion method is prone to subjective interpretation while the completed contract method can present an overly positive picture of a company for the year when revenues are recognized at the time a contract is fully completed. Misrepresentation of the financial situation of companies has grown as the emerging industries like software and telecom as well as new business models involving off-balance sheet financing have emerged in recent times. In addition, pro-forma statements became a regular feature, especially in press releases of companies in the 1990s, and a means of deception. Pro-forma statements exclude one time expenses, such as goodwill expensing or write-offs of inventories, and help to focus attention of cash flows which are widely seen as a measure of health of a company. Over time, companies found it a convenient method to distract attention from their long-term liabilities.

Recent surveys are indicating substantial improvement in oversight of the frequently manipulated aspects of accounting (mean response of 46%) such as revenue recognition, closing entries and estimates (62%) as well as accounting estimates (46%).

Sarbanes Oxley calls for real time reporting of material facts about the financial health of the company, going beyond the quarterly and annual reporting, that has been common in corporate America so far. Increasingly, companies are under pressure to accelerate the flow of information, improve its quality and accessibility to keep pace with the reporting requirements of Sarbanes Oxley. A recent Ventana study found that 80% of executives agreed that that fundamental process and financial system design is important or very important for compliance. Executives also identified "harmonizing the company's charts of accounts" and "reducing spreadsheet use" as important goals. A harmonized design of accounts across the company can facilitate consolidation and consistency of data and it's reporting besides simplifying external audit processes. Routine processes, such as accounts payable, are accounted in a variety of ways which contributes to inconsistency in data.

Sarbanes Oxley requires the documentation of the audit trail but this is hard to achieve as financial processes are typically spread over numerous spreadsheets, hosted on a variety of IT systems, which are hard to audit and are replete with flawed formulas. In a survey conducted by IDC, jointly with the Revenue Recognition Magazine (a unit of CFO.com), 63 percent of respondents believe that spreadsheets are prone to errors, 58 percent cited the lack of audit trail and 56 percent said they lacked internal controls. It is also hard to build controls to ensure quality in the preparation of spreadsheets which can often have fraudulent schemes. The separation of duties that controls over these spreadsheets would require disproportionate auditing effort.

The shorter reporting intervals mandated by Sarbanes Oxley requires companies to streamline individual processes such as cycle time for financial closure, procure-to-pay and the order-to-cash cycle.

Business Intelligence systems are expected to achieve the goals of consolidating data, improving its quality and its rapid reporting.

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