Optimizing the close cycle using nextgeneration account reconciliation best practices and tools

Point of View February 4, 2016 Complimentary Research Optimizing the close cycle using nextgeneration account reconciliation best practices and tools By Kars Stal, Jason Sacco, and Elvie Lucero Executive Summary The financial close process can be a cumbersome and protracted task. Inefficiencies in the reconciliation process can make it even more difficult, resulting in mistakes and overall inaccuracies in the financial close data. Yet many organizations are ill-equipped to perform effective account reconciliations. Although account reconciliations are a requirement for publicly traded companies since the enactment of the 2002 Sarbanes-Oxley Act (SOX) and other rules and regulations that followed, almost half of U.S. and Canadian companies continue to rely on manual reconciliation of accounts. Only 56 percent of companies use third-party software to reconcile accounts 1. The use of manual reconciliations is one of the reasons companies still have issues in their reconciliation process from a cost, accuracy, transparency, complexity, and comprehensiveness perspective. Other causes of account reconciliation weaknesses include ineffective management of the people and processes that surround it. An effective account reconciliations process ensures the integrity, efficiency, and timeliness of the close. This article discusses how companies can use best practices for account reconciliations to enhance this critical process from a people, process, and technology perspective. Why effective account reconciliation is so critical to a timely and efficient close The purpose of a financial close process is to provide a snapshot of all financial activities and transactions for a given month. Finance and accounting must accurately capture data to indicate actual performance and an educated projection of future performance. This is a very arduous and time-sensitive process, and it requires extensive attention and detail. To ensure validity of this snapshot and related data, account reconciliations are introduced as a control. Reconciliation of, at a minimum, all balance sheet accounts ensures integrity of the financial data as well as reliable and accurate financial statements. It is therefore important to improve both timing and quality of account reconciliations, to ensure that assets, liabilities, and equity reflect the true state of the business as of the reporting date. 1 Financial Executives Research Foundation and Robert Half, 2015 Account Reconciliation Best Practices I The Hackett Group I 1

Account reconciliation also helps detect fraudulent activity at an early stage. An efficient and timely financial close cycle using an integrated account reconciliation process serves as the foundation for evaluating a business s performance, supporting organizational decisions, and satisfying external reporting requirements, while at the same time significantly reducing the risk of write-offs and management surprises. Next-generation account reconciliation best practices and tools The best practices and tools discussed below can help companies work toward a more integrated reconciliation process. These best practices are based on The Hackett Group s comprehensive benchmarking, advisory, and implementation knowledge base and are defined from a people, process, and technology perspective. Make the most of your most valuable asset: People Automated tools and processes provide a framework to ensure quality, efficiency, and completeness in the account reconciliation process. However, hiring the right people, properly training them, and empowering them to use these tools are critical elements to make these automated tools and processes work. Often the difference between success and failure of a process is not the technology, but the people implementing and using it. The following best practices can help improve the performance of the people who conduct account reconciliation: Define clear accountabilities throughout the process. The resources ultimately responsible for the account and owners of the balances should review the reconciliation once it s been prepared by the analyst. The owners of the balances are closest to the information, understand the account content and build up, and can address the reconciling items. They have a thorough understanding of what the accounts are used for and which sources should be used to support the balance. Ownership and accountability provide focus and sufficient attention to the account analysis process for accurate, timely, and complete processing of all transactions during the reconciliation. A proper reconciliation identifies the reconciling items and the actions needed to settle those items. The action plan includes who is responsible for clearing the reconciling item, due date when it needs to be cleared, and steps that can be taken to prevent the same error from recurring. Maintain at least two levels of review for all critical reconciliations. All account reconciliations should be reviewed and approved for completeness and propriety by someone other than the person who performed the reconciliation. Accounting supervisors or peers can perform this role, and they should document the approval of the reconciliation. These reviews should look into the compliance of proper internal controls, and there should be sufficient documentation to support that this control activity was performed. Such a review should also examine conclusions reached on the reconciliation, verify if proper resulting accounting treatments were used, and confirm that company policies and procedures were followed. As an additional best practice, it needs to be confirmed that the person performing the review can do so independently of the preparer. The reviewer should be at an equal level or higher within the organization to prevent any hierarchical issues while doing the review. Establish a quality control team. A team responsible for quality measures should identify improvements based on quality feedback and changes in business operations or organizational structure. In some companies, this team is responsible for reconciliation management, reporting, and developing training for policy and procedural changes. The team should include reconciliation experts who can be called upon to troubleshoot when problems arise. Account Reconciliation Best Practices I The Hackett Group I 2

Establish standards for, and execute on, employee training. Training is vital in any company or organization that aims toward progress. Many common account reconciliation problems can be prevented by properly training individuals performing the reconciliation. Start by defining upfront what the training standards should be and what documentation is required to successfully execute on these training sessions. Providing the necessary training ensures that the personnel performing analysis have sufficient knowledge, essential skills, and experience required in the design and implementation of account reconciliations and subsequent review process. This helps reduce the risk of weaknesses and inefficiencies in the reconciliation, and thus prevents mistakes and overall inaccuracies of the financial statements. One of the downfalls companies experience is that while they do have training sessions and documentation as part of the initial roll-out of a reconciliation tool, when new users join the team they are not forced to follow the same training and go through the same documentation. As a result, critical knowledge deteriorates over time. Establishing an online, web-based training course for account reconciliation protocols, supplemented by live instruction, is one way to ensure training materials remain available for everybody. This also helps to ensure sign-off after going through the documentation and training, and it serves as a requirement to provide access. Supplemental refresher courses should be provided for existing resources as well, based on frequently-asked questions (FAQs) and made available to the user, while ensuring that these users actually follow the training. This training regimen should also be made part of their annual review process. Create a well-defined and documented process It is important to have not only the right people, but also the right process in place to produce sufficient account reconciliations. Well-defined and documented processes are evident in effective internal control systems and compliance with the defined reconciliation process in general. To ensure that the proper process is in place, the following best practices should be taken into account: Establish a risk-based approach to guide the timing of account reconciliations. It is difficult in today s accounting departments to reconcile all accounts on a monthly basis given the numerous regulatory requirements needing compliance within the tight deadline allowed. This often results in errors due to overburdened accounting personnel constantly responding to changing priorities. To alleviate that issue, companies generally establish an assessment methodology based on risk and materiality to reduce the volume and frequency of reconciliation from monthly to quarterly (and even annually). The risk-based approach provides clarity for prioritizing account reconciliation activity, as well as a measure of the financial risk associated with the reconciliation practices. Risks include the potential for financial misstatement, the materiality and volatility of the account, the volume of transactions related to the account, historical trends, and the complexity of underlying accounting. By correctly evaluating and applying these risks, account reconciliations can be staggered. The following items, at a minimum, need attention while applying a risk-based approach for account reconciliations: Materiality Size of account balances Volatility Degree of change in account balance from quarter to quarter as well as changes in account characteristics (such as the introduction of new complexities or subjectivities, or new type of transactions) Activity Volume of activity and the size, complexity, and homogeneity of the individual transactions processed through the account Account Reconciliation Best Practices I The Hackett Group I 3

Subjectivity Subjectivity in determining the account balance, such as the extent to which the account is affected by judgments Susceptibility Susceptibility of an account balance (or group of accounts) to material misstatement, error, omission, or manipulation, as well as to loss or fraud Complexity Nature of the account (for example, suspense accounts generally warrant greater attention), including accounting and reporting complexities associated with its existence of related-party transactions Based on this risk model by account, reconciliations are performed monthly, quarterly, or annually. Another element that drives risk is the duration of the account. Based on the risk associated with the account, a controller can decide that certain accounts be reconciled outside of the actual closing period as long as they are reconciled before the next cycle. The risk levels and associated reconciliation frequency requirements should be evaluated and confirmed annually, at a minimum. Perform an annual account rationalization. Businesses continue to evolve in order to compete across highly competitive markets. As business operations change, so do the usage and related risk of accounts in a company s books. New accounts are added; accounts are rendered inactive due to new processes, new transactions, new customers, new entities, different vendors, and divestiture of entities; and existing accounts can be redefined from a usage perspective. To make sure the finance department is focusing its attention on the right accounts and the full list of accounts, management should instigate an account rationalization process. The process identifies accounts that are no longer required, could be merged with other accounts, or should be reevaluated from a risk perspective, in order to reduce the number of accounts reconciliations required and to reestablish the frequency and the time frame in which all reconciliations should be performed. One key step to successful implementation of account reconciliation is performing this annual account rationalization exercise. Track and report the findings on a timely basis. Visibility of the current status and findings of the reconciliation is the core element of the process. Tracking and reporting the reconciliation status on a regular basis will result in a successful completion of the reconciliation. Reports should include details of the number of accounts not reconciled, the age of unreconciled items, and the total dollar amounts of the differences without right of offset. Quality measures and related criteria should be established to measure the effectiveness of the reconciliation based on, among other things, the successful completion of the standard form, the timeliness of completion, and a thorough review and sign-off process of the account reconciliation. Tracking allows management or controllers to require the account owner to prepare an action plan of delinquent reconciliations and a process for remediating the deficiencies, and to keep track of the progress of this action plan as part of the regular reporting of account reconciliation status. The final building block for successful reconciliations: Technology The right technology can enable successful outcomes of process controls and people s actions. The following technology-related best practices are vital to a successful reconciliation cycle: Implement an automated reconciliation system. Automating the reconciliation process can accelerate the financial close and improve productivity, allowing accountants to focus more of their time on the most important issues that arise from the close and reconciliation process. Automation contributes to consistency and quality. It enforces standardization across the reconciliation process to improve quality and accuracy of financial data and ensures that business rules and policies are applied consistently in ways that are in line with Account Reconciliation Best Practices I The Hackett Group I 4

accounting policies that external and internal auditors accept. Automation also reduces errors and inaccuracies by providing accountants with a streamlined method to verify the correctness and appropriateness of their balance sheets. There are many reconciliation tools on the market. The three big players for Fortune 100 companies are Blackline, Trintech, and Oracle s Account Reconciliation Manager (ARM). The Hackett Group has a strong working relationship with all of these vendors. Below is an overview of their reconciliation products. Three top reconciliation tools The chart below provides an overview of each vendor s product offering and the features of each tool. BlackLine Trintech Oracle Product Offering Account Rec Task Management Transaction Matching Journal Entry Variance Analysis Consolidation Integrity ReconNet (high-volume account reconciliations and data matching) Cadency (Account Reconciliation Software Certification) Financial Close Management - Account Reconciliation Manager - Close Manager - Supplemental Data Manager Main Product Features Cloud based solution Interfacing with all ERP / GL systems and many sub-ledgers Comprehensive out-ofthe-box reporting based on accounting best practices - ~ 70 reports, 7 standard templates Online document repository Built-in workflow process Out-of-the box training, including account, admin and multicurrency training Cloud based solution Integration capabilities with Oracle, SAP and Microsoft Office Flexible business rules for each transaction created Thorough compliance capability - Detective / preventative controls for SOX, BASEL II and other mandates Powerful out-of-the-box reporting Workflow manager with auto-archive capability Fully owned application (cloud- based available mid 2016) Automated integration with all ERP / GL systems and subledgers Enhanced autoreconciliation / automation capability ARM data loads via FDM EE - Combines FDM functionality with effectiveness of ERPi data loads Extensive monitoring and reporting functionality, including multiple dashboards, out-of-the-box reports and a custom report writer tool Source: BlackLine, Trintech, and Oracle websites, as of 2/16 Each of these tools focuses on automation of data flow and user workflow as it enhances internal controls and diminishes the risk of financial fraud. Appropriate controls are embedded to ensure that an audit trail is correctly maintained throughout the reconciliation process and proper segregation of duties among accounting teams is maintained, while allowing auditors easy access to reconciliations and adding transparency and visibility to the financial close process. The choice of tool that will most enhance your account reconciliation process depends on your strategic road map and wish for flexibility related to template set-up. Embrace auto-reconciliation capabilities. Auto-reconciliation enables a higher degree of reconciliations performed in a systematic manner by interfacing with the general ledger and sub-systems where appropriate, generating effective management reporting. It allows companies to substantially reduce the time needed to complete the reconciliation of accounts, because the system performs the purely mechanical tasks and submits and approves the accounts for which auto-reconciliation has been set up. Auto-reconciliation can be defined in numerous ways. Common examples are listed below: Account Reconciliation Best Practices I The Hackett Group I 5

Source and sub-system balances tie Source and sub-system balances tie within a certain threshold An account has a balance, but no activity for X amount of time An account has no balance, no activity for X amount of time An account has a balance that is below a threshold value To ensure validity of the auto-reconciliation, the data feed reliability and the autoreconciliation rules need to be reviewed at least once a year. This ensures compliance with existing policies and procedures, while also ensuring that no data is being missed in the process from changing set-up of underlying data sources. Monitor the status of account reconciliation throughout the cycle in real time. Account reconciliation systems offer prebuilt dashboards to monitor status. Monitoring reconciliation status in real time throughout every stage of the process is vital to ensure proper controls are in place and being performed. Monitoring of status is performed at different levels within the organization. At the preparer level, the preparers need to know which reconciliations they are responsible for and the status of those reconciliations. The reviewer has the same requirement, but usually for an expanded set of reconciliations. Automated workflow and e-mail will drive capabilities for these resources within the cycle to ensure timeliness of the process. They also have worklist reporting at their disposal. Another set of users is the reportingonly users, which typically include controllers and internal audit. These resources need to have a set of reports based on a company s requirements that provide a complete status of the period and materiality of any unreconciled items. Although general reports are available for most products, out-of-the-box customization needs to be done to ensure that the reports provide the level of detail required to measure effectively based on an organization s set-up (such as by regional or balance sheet category). Setting up these reporting elements early in the design process for a reconciliation tool and process ensures success of the cycle. Where does your organization stand when it comes to account reconciliation best practices? Based on a recent study by The Hackett Group, companies have a great opportunity to ensure adherence to the best practices reviewed in this paper. Account reconciliation is a vital part of the financial close process and warrants reliability of the reported financial data. Implementing and adhering to best practices around the people, process, and technology aspects of account reconciliations can enhance controls, while at the same time saving time and costs associated with this element of the financial close. About the authors Kars Stal Director, EPM Transformation Practice Mr. Stal has 10 years of consulting experience in delivering enterprise performance management process and system improvements to Fortune 500 clients. He has focused on designing and implementing enterprise performance management solutions, reducing the monthly close cycle, delivering large-scale implementations of financial and management reporting systems, facilitating client meetings and workshops to support wide-scale change, and acting as a subject-matter expert on consolidation and reconciliation processes and systems. Account Reconciliation Best Practices I The Hackett Group I 6

Jason Sacco Manager, EPM Transformation Practice Mr. Sacco brings several years of performance management experience across many company sizes acting in different roles and capacities. Jason s involvement has been within the professional services industry, as well as working directly for corporations. Main topics of focus have been in finance, IT, and technology with expertise in financial planning and analysis specializing in the creation of short- and long-term financial plans at the strategic, financial, and operational levels. Elvie Lucero Manager, EPM Transformation Practice Mrs. Lucero has 15 years of experience in financial reporting and consolidation with extensive experience in financial close, account reconciliation, and mergers and acquisitions, along with deep knowledge in developing, implementing, and improving financial systems. More recently, she has been involved in the redesign of the financial close process of a Fortune 10 conglomerate. For more papers, perspectives and research, please visit: www.thehackettgroup.com. Or to learn more about The Hackett Group and how we can help your company sharply reduce costs while improving enterprise performance management, please contact us at 1 866 614 6901 (U.S.) or +44 20 7398 9100 (U.K.). The Hackett Group (NASDAQ: HCKT) is an intellectual property-based strategic consultancy and leading enterprise benchmarking and best practices implementation firm to global companies. Services include business transformation, enterprise performance management, working capital management, and global business services. The Hackett Group also provides dedicated expertise in business strategy, operations, finance, human capital management, strategic sourcing, procurement and information technology, including its award-winning Oracle EPM and SAP practices. The Hackett Group has completed more than 11,000 benchmarking studies with major corporations and government agencies, including 93% of the Dow Jones Industrials, 86% of the Fortune 100, 87% of the DAX 30 and 51% of the FTSE 100. These studies drive its Best Practice Intelligence Center, which includes the firm s benchmarking metrics, best practices repository, and best practice configuration guides and process flows. It is this intellectual capital that enables The Hackett Group s clients and partners to achieve world-class performance. Email: info@thehackettgroup.com www.thehackettgroup.com Atlanta +1 770 225 3600 London +44 20 7398 9100 Sydney +61 2 9299 8830 Atlanta Chicago Frankfurt Hyderabad London Miami Montevideo New York Paris Philadelphia San Francisco Sydney Vancouver This publication has been prepared for general guidance on the matters addressed herein. It does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. 2016 The Hackett 2016 The Group, Hackett Inc.; Group, All Rights Inc.; Reserved. All Rights Reserved. Account Reconciliation Best Practices I The Hackett Group I 7