Virtual Close. July 2015 Joe Hogan Managing Director. kpmg.com

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1 July 2015 Joe Hogan Managing Director kpmg.com

2 The concept of the virtual close has been around for the past 10 to 15 years. Although initially projected to be a future common practice, the virtual close did not gain widespread popularity. But is virtual close gaining traction, given today s improved technology, increased regulatory, control, and reporting demands? The answer is, yes. In addition, we have found that the virtual close is not a reward, but rather an outcome that can be accomplished by leveraging leading practices, governance, and integrated technologies to achieve an organization s strategic goals and objectives.

3 1 The purpose of this discussion document is to communicate why the virtual close did not become a common practice and provide insight on why there is renewed interest in the virtual close. Steps 1 Define the financial statement close and the virtual close 2 Clarify original guidance on the virtual close, discuss why its popularity stalled, and update the guidance to execute a virtual close in Share executive opinions on the virtual close 4 Conclude why the virtual close is back

4 2 Virtual Close Define the Financial Statement Close and the Virtual Close

5 3 Detailed definition of the close The financial statement close process begins with processing basic transactions and ends with the completion of the Board Book: T1 From a best practice perspective, the financial statement close process ends when the Board Book is complete and the balance sheet reconciliations are done. Completeness is key to reducing risk of misstatements and mistakes. The financial statement close process is a perpetual process monitored and supported by a series of cutoffs and controls: Since most companies never sleep, transactions and activities are always taking place. Finance is responsible for providing the business rules on how transactions and activities are captured, controlled, recorded, and reported based on a series of cutoff procedures. This promotes the accuracy of books and records according to the generally accepted accounting principles. Critical to quality for the perpetual process is timely execution, compliance, business partnership, and clarity of requirements. The financial statement close process should be a consistent process, not an event: The close is typically defined by dates, activities, and cutoffs put on monthly, quarterly, and annual calendars. The effort and quality of the financial statement close process should not materially vary by period (i.e., month, quarter, annual). Additional effort is required in the preparation of a 10-K or a 10-Q; however, the effort and quality up to that point should not vary significantly. A quarter-end or year-end should not be an event. The financial statement close process should be managed with precision and discipline: The close process should be managed with clearly defined due dates, milestones, dependencies, cutoffs, and hand-off procedures. Financial statement close processes without governance, including robust plans, schedules, issues tracking, escalations, clarity on roles, and efforts to coordinate are at higher risk for restatements, increased audit fees, higher finance costs, and lower finance effectiveness. Financial statement close processes that are properly managed produce a Board Book on or about the 10th workday. The financial statement close process is better off being accurate than being fast: Before focusing on speed, focus on completeness, transparency, linkage/value to operations, year-end audit requirements, and the timely delivery of all events on the close calendar. Due dates are dictated by the Securities and Exchange Commission (SEC). Speed will come as you identify issues and resolve them. By focusing on accuracy, you can build process reliability, and credibility with your teams and auditors. Summary definition of the close The financial statement close begins with processing basic transactions and ends with the completion of the Board Book (and the 10-Q/10-K or other regulatory reports). The close is a perpetual process monitored and supported by a series of cutoffs and controls, executed in a consistent measured manner, not an event. Lastly, the financial statement close process is better off being accurate than being fast. A virtual close, as defined by Accounting Tools L1 The ability to produce financial statements at any time, on demand. This approach requires enterprise resources planning (ERP) systems, the use of fully integrated company-wide accounting systems, and a great deal of effort to produce accurate financial information on demand. The virtual close is enabled by centralized accounting and accounting systems, standardization of end-to-end business processes across the organization, and robust process monitoring/error tracking/remediation/continuous improvement. The differences between the two The main differences between a monthly close and a virtual close process are the following: The technology to support the process automation, work flow, integration, and reporting necessary to handle real-time analysis for a virtual close is provided primarily through technologies/applications purchased in the marketplace (as opposed to homegrown) and provides better functionality. The process standardization is significantly higher for a virtual close allowing the team to manage exceptions and process monitoring, becoming more efficient and effective. The governance model clarifying roles, responsibilities, escalations, and stewardship for a virtual close is better defined, improving transparency and promoting accountability.

6 4 Virtual Close Clarify Original Guidance on the Virtual Close, Discuss Why ITS POPULARITY Stalled, and Update the Guidance to Execute a Virtual Close in 2015 The 2001 CFO.com article L2 A Virtual Close: Easy as One, Two, Three? provides the original guidance on the virtual close. Based on the article, the virtual close had three key steps and five enablers as documented below: The three key steps are: Step one: Focus on top-level closing and eliminate unnecessary details. Step two: Use technology and automated systems to eliminate interim closes after the preliminary close has been made. Step three: Reduce the number of legal entities to be consolidated.

7 5 The CFO.com article goes on to say that after following these steps and eliminating non-value-added activities, companies can cut the time required to close in half. The real difficulty is addressing the technology issues. The five technology enablers are: Enabler one: As a first priority, companies need to have a single, fully integrated financial application system. Enabler two: Companies must have a fully automated consolidation tool that can take financial data from multiple subsidiary ledgers, and consolidate it to a corporate or business-unit level, permitting the automatic posting of eliminating entries, accrual entries, and allocations. Enabler three: Adopt a fully automated, single-entry, intercompany accounting system, which allows transactions to occur between two different legal entities owned by the company. Enabler four: Create a Web portal for delivery of standard reports so that when information is consolidated, it is reported on a Web site, and users of the information can view it online and make decisions on the same basis. Enabler five: Link the Web portal to an Online Analytical Processing (OLAP) database that allows companies to conduct ad hoc queries and analysis of the data underlying their reports. The article says that taking these five steps will not guarantee success, but without them, the obstacles will be much greater. The main points to the article are: execute your close at the right level of detail and make sure you have good systems to provide real-time information. That said, the main reason the virtual close stalled is because of a lack of execution and misinterpretation. The lack of execution is primarily attributable to the overarching demand to improve the control environment due to Sarbanes-Oxley (SOX). When SOX was being implemented in the early 2000s, finance was so focused on documenting, flowcharting, and mapping controls to systems and processes that the ability to balance efficiency, add value, and make technology changes was difficult. The time to close for most companies increased as did the cost for finance. So the thought of going to a virtual close was too daunting. Then when the SEC requested large companies to file their 10-Ks within 60 days as an accelerated filer, moving to a virtual close became even less of a priority. Plus, due to the misinterpretation below, companies did not consider executing on a plan to create a virtual close because they felt it lacked the controls necessary to be SOX compliant. Misinterpretation can be further shown in the November 2011 CFO.com article L3 What Ever Happened to the Virtual Close? The article starts out by referring to the virtual close as sometimes labeled a soft close. This is an example of where the virtual close was often discussed interchangeably as the soft close. This has definitely caused confusion among professionals. To some, the label soft close and its association to the virtual close is the root cause of why the move to the virtual close stalled. Based on Accounting Tools, a soft close L4 can be defined as: closing the books using an abbreviated closing procedure. By using a soft close, the accounting department can issue financial statements very quickly and then return to its normal day-to-day activities. Where the soft close gets misinterpreted as a virtual close is consistent with the 2001 CFO.com article around the level of detail, the recording of journal entries, and the precision at which the books and records are validated. Once standards are relaxed and precision is no longer required, the people factor kicks in and quality of the execution deteriorates, which can commonly be referred to as the slippery slope. Therefore, virtual close equals soft close. However, this is obviously not true. The virtual close cannot equal a soft close, and in both cases, quality in execution cannot suffer. To do either, the ability must be earned through hard work and investment by the finance and accounting group wishing to implement these concepts. This is where the 2001 article above is somewhat dated. Regardless, the five technology enablers are still valid (with some further clarification and updates). However, all three steps need to be updated to execute the virtual close in 2015.

8 6 Virtual Close Step one: Unnecessary details should still go away and more time should still be spent on value-added activities. However, regulators and auditors require our clients to get more granular and accurate. They want to see the results at the top, in consolidation, then show how it drills down to the transactional level detail. Why? Because technology has improved drastically in the past ten plus years, creating an expectation that the capability exists. As a result, step one needs to be rewritten: The close process utilizes technology to record and aggregate transactions in a transparent manner, reducing/minimizing manual work, making the close process faster and more efficient, and allowing management to make better decisions quickly. To counter the 2001 article, we cannot advocate the reduction of transactions or intercompany activity because of a dollar value mainly because many industries require the proper allocation of costs. Yes, nonsensical transactions should be eliminated. However, complicated issues like transfer pricing and value-added manufacturing create real requirements and transactional activity that must be recorded properly. The point here is design your processes and systems to be accurate without overengineering them. Step two: The use technology and automated systems to eliminate interim closes after the preliminary close has been made remains intact. This step is simply advocating recording information once and maintaining data integrity. The main update here is the significant improvement in technology that helps organizations manage data. As a result, step two needs to be rewritten: Use of technology to centrally manage data/metadata T2 to integrate all operational and financial systems more efficiently reduces the need for manual effort, reduces data redundancy, promotes a single point of entry, improves data integrity, and allows more time to analyze the business in a cost-effective manner. This step is likely to be the most impactful because of the improvements in the way technology can exchange data in 2015 as compared to This allows organizations to consider different application platforms T3 to run their business and still be in synch real-time or near-real-time. T4 Example improvements of step two given today s technology capabilities include revenue recognition (automated accruals and volume analytics), payable/receipt accruals (improved procurement systems and compliance tracking), fixed assets (automated roll-forward and ability to process complex adjustments), payroll reconciliation automation (ability to reconcile all G/L payroll transactions to the net payroll payment), cash flow statement (systemic tracking of cash and noncash movements at a transaction level), and intercompany reconciliation (already mentioned in this document). Step three: The number of legal entities to be consolidated should be reevaluated as well. As the economy becomes more global, so has the need for more legal entities. There are multiple reasons for legal entities to exist and sometimes the facts and circumstances that existed 10 years ago are no longer applicable. However, the answer is not to reduce but to rationalize. As a result, step three needs to be rewritten: Rationalize your legal entities on an annual basis to make the books and records more accurate and reliable, which allows management to better understand business performance and make the right strategic decisions for the company. We cannot simply say reduce your legal entities to lower cost or complexity. By definition, the legal entities exist to accomplish goals like lower effective tax rates and reduce risk. Legal entity structures by their nature are going to be complex; the answer is to rationalize the legal entity structure on a periodic basis (at least annually) and remove unnecessary complexity, especially when a business condition no longer exists. We did not expand on the concept of a soft close in this article. Our goal was not to expound on the virtues of a soft close but merely differentiate it from a virtual close.

9 7 Share Executive Opinions on the Virtual Close Although the November 2011 CFO.com L3 article goes on to state the virtual close became a low priority and that SOX and increased regulation deemphasized speed to promote accuracy, there is a resurgence because companies have tightened their close processes and are ready to improve speed. What is important is understanding your goals and objectives and what you are trying to accomplish. Below are executive opinions in the article to take into consideration: John Van Decker, a research vice president of Gartner said, There is no reason to go particularly slow or fast with the closing process; the important thing is to know what you are trying to accomplish from a fast close and develop a business plan for finance transformation to achieve it. Prat Bhatt, senior vice president and chief accounting officer at Cisco Systems, said in 2011, The purpose of redesigning the close process should not be solely focused on doing it faster. Spending time upfront to determine your objectives is critical. Once the objectives are defined and the organization is working toward these common goals, key metrics such as cycle time tend to improve anyway. Recently, in a February 2015 article from Accounting Innovations Forum, Real-time Accounting: The Virtual Closing, L5 Cisco was referenced: Actually, the one day closing is an incidental benefit to the Virtual Closing. Virtual Closing s true benefits lay in its objectives. Prat Bhatt said: Our objective wasn t necessarily to close the books faster, although there is some inherent advantage to that, but to design a process for continually monitoring critical business information. Prior to the Virtual closing, month-end closing took 14 days and the annual closing was significantly longer. In those years with the traditional closings, [Former CFO Larry Carter] confessed that Cisco was, in fact, operating in the dark. With Virtual Closing, business decisions are supported with realtime operating data eliminating the need for guesswork. There are two points to be made here that yield a faster close: 1 Align the goals and objectives of your strategy to your close process. 2 Focus on improving the efficiency and effectiveness of your close so you can recognize trends faster and explain accurately what is going on in the business.

10 8 Virtual Close Conclude Why the Virtual Close is Back As KPMG LLP (KPMG) described in a recent publication, The Value-Driven CFO, the finance function at many leading organizations continues to evolve in its efforts to align with the goals and strategy of the business. Strategic chief financial officers (CFOs) are now focusing on improving their business partnering models by taking a customer-centric approach to internal customers thereby helping to drive real value for the business and boost the bottom line. Our clients are looking for finance to focus on four main priorities efficiency, effectiveness, growth, and controls. Finance needs to balance managing cost, value, and risk. Taking 14 days to perform the monthly close and operating in the dark as mentioned above is not aligned to the four main priorities nor does it achieve proper balance. Even though there is no directive out there that says all organizations need to go to a virtual close, many organizations are looking for finance to spend more time analyzing the business and adding value, therefore less time on the close. As quoted by Cisco Finance in the Accounting Innovations article: L5 The goal of real-time accounting was providing a deep, accurate, up-to-date understanding of a business s performance. Secondly, Finance needed to change its role from being a gatekeeper of information to being a catalyst for change throughout the organization. This line of thinking is aligned with the following attributes of finance defined by KPMG:

11 9 Attribute 1: Efficient Operations Finance s services, delivered to the organization via leading practice models/ methods, should be cost effective, enabled by clearly defined standards, supported through automation, and provided by a customer service orientated team. Attribute 2: Strategic Decision Support Finance provides value-driven insight that is meaningful and actionable, comparing actual results to budgets and forecasts timely. Attribute 3: Strategic Growth Finance is involved in the business, participating in growth-oriented activities like mergers and acquisitions, funding strategies, profitability analysis, and resources allocation analysis. Attribute 4: Governance Finance is expected to maintain proper control. This includes enterprise risk management, end-to-end process controls, regulatory, tax, and policy support. In closing, when evaluating the need to provide timely, accurate insight to your monthly results, evaluate how your resources compare to the four attributes listed above. Many of our clients look to automate, standardize, and streamline actuals and governance activities if they simply want to spend more time on strategic growth and strategic decision support activities. The by-product may end up being a shortened quality virtual close. Based on Cisco s goals and objectives, that was their outcome. What are the goals and objectives that tie to your organization s strategy? And does it align to your close? Enclosed is a list of leading practices as defined by the KPMG Record-to-Report tool kit. We have mapped these leading practices to whether it enables a virtual close, or does not. This white paper is the point of view of Joe Hogan, CPA, managing director and practice lead for Record-to-Report. Terms and links T1 Board Book: An executive-level reporting package containing summarized income statement, balance sheet, cash flow, and business commentary information T2 Meta-Data: Data dictionaries and repositories providing information about the data elements in a database (e.g., COA values, hierarchies and roll-ups, transaction/configuration values) T3 Application stack: For financials: Oracle EBS, SAP, PeopleSoft; for engineering: Indus; for fulfillment and billing: Amdocs T4 Real-time or near-real-time: Real-time is the availability of data (e.g., calculations, postings, and transfer to another system) instantly. Near-real-time is the availability of data subject to a time lag typically less than one hour. L1 Steven Bragg, What is a virtual close?, Accounting Tools, January 2015, L2 Jennifer Caplan, A Virtual Close: Easy as One, Two, Three?, CFO.com, March 2010, L3 Russ Banham, What Ever Happened to the Virtual Close?, CFO.com, November 2011, L4 Steven Bragg, What is a soft close?, Accounting Tools, June 2013, L5 John Ho, Real-time Accounting: The Virtual Closing, Accounting Innovations Forum, February 2015,

12 For more information, please contact: Joseph A. Hogan, CPA Advisory Managing Director, Financial Management kpmg.com This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through