In the US, the Public Company Accounting Oversight Board (PCAOB) is taking steps that are beginning to affect the day-to-day lives of financial planning and analysis (FP&A) professionals – but not many of them are aware. The onus is on FP&A teams to talk to internal audit, accounting and external reporting to learn more about these new pressures, so they can prepare and comply with changing audit requirements.
While companies have been implementing Sarbanes-Oxley (SOX) since 2004, there’s been a recent change of focus in its enforcement. That change is having an effect on the finance department in general and FP&A in particular, according to Findley Gillespie, partner at accounting firm Moss Adams.
“The PCAOB wants a lot of information about management review controls (MRCs),” says Gillespie. MRCs are no longer “binary”; with the focus no longer whether spend is in alignment with budget, but instead about the thought process “and a lot of that resides within finance, treasury and FP&A groups – FP&A is increasingly part of the SOX environment, whether they know it or not.”
Nancy Miller, senior manager of strategy and thought leadership at technology vendor Workiva, spent 10 years in various finance positions at a Fortune 150 company, primarily in financial reporting. She reports that the biggest impact she felt from shifting auditor scrutiny was in forecasting the balance sheet and profit and loss (P&L); specifically in the area of fair value measurement.
“You do a lot of forecasting that includes subjective assumptions for the yearly goodwill and intangibles analysis,” says Miller. “Historically it had been easy to get access to that information as it was rarely requested or under intense scrutiny, internally and from third party.” More recently, with the PCAOB and US Securities and Exchange Commission (SEC) increasing their focus on how assumption and forward-looking information are created and documented, it became difficult to get one’s hands on that more-subjective information.
Internally, according to Miller, many in finance and operations weren’t really aware of why that information – which hadn’t previously been requested – was needed now. “My first response was to learn more about the standard so I can understand whether what the auditors were asking for was truly required.” She discovered that the FP&A team had to go and challenge not just the numbers it received, but also the process by which the business arrived at those numbers and assumptions through the entire value chain. It then had to challenge its own processes, which were being challenged by the auditors.
Documenting key assumptions
Bob Herz, retired chairman of the Financial Accounting Standards Board (FASB), now holds several posts and is a member of the PCAOB’s standing advisory group, director and audit committee chair/member of several companies, and executive in residence at Columbia University’s School of Business.
According to Herz: “The SEC and the PCAOB are placing an increased focus on internal controls; to the extent companies submit information on impairments, “Level 3” fair values, and other areas of the financial statements that are based on estimates that rely on forward-looking analysis and projections.” That covers a lot of ground.
“These projections, including the basis for the key assumptions, have to be carefully documented,” says Herz. To the extent that FP&A is involved in coming up with those projections, it has to document its process. Even if the projections are done by the company’s accounting team, Herz adds. “Care should be taken on how those correlate with the projections and forecasts prepared by the FP&A group for senior management and the board of directors.” The SEC may try to spot any differences between the economic assumptions behind the external reporting and what’s assumed in management reporting.
The push is twofold, according to Gillespie. The PCAOB requires auditors (who, in turn, require companies) to ensure the processes that produce financial information are working properly. At the same time, they want to make certain that the process and controls are properly documented. “That’s the biggest challenge,” he says. “People in FP&A are used to doing the work, but not necessarily documenting it in the way auditors now require.”
FP&A is modelling, developing forecasts and producing forward-looking information that’s served to everyone internally. However, there’s rarely a controlled and highly documented sign-off approach to the review process, according to this internal controls specialist. “So much of what FP&A does is estimating and budgeting, using future predictions; it’s by nature a lot less auditable.”
For example, many FP&A groups perform a fluctuation analysis on the company’s P&L; logically as they’re the individuals closest to the budget. “In the past, that review only required a signature. Now the auditors want to know what the review process looked like and have that written up and documented,” says Gillespie.
The analysis might show, say, that payroll rose 10%; while everyone knows that’s correct, it’s no longer enough as auditors also want to see the ‘why’. They want the reviewer to add a note on the schedule saying why it was OK. They also want to know the level of precision related to this control, essentially how big an error can be associated with any estimate. “That’s where FP&A can be very involved, i.e., when looking at forecasting trends and the gap between estimates and actuals.”
Dealing with a new reality
That’s new ground for many FP&A professionals. Accountants and external reporting staff have grown accustomed to the increased documentation requirements. They’ve been subject to restatements and the SEC and PCAOB finding deficiencies in internal controls and documentation.
“It’s been drilled into them,” says Herz, but “may not have been ingrained in the FP&A department,” where spreadsheets still reign supreme. That calls for a new systematic approach to maintaining documentation and version control, so there’s an instant audit trail to track who created assumptions and how they’ve evolved into the budget and forecasts. “You need the right platform to efficiently capture the information and to provide an audit trail.”
Miller’s previous company came to rely on Workiva’s Excel-based product, WDesk, for collaborating, maintaining version control and audit trail; which is how she subsequently joined the vendor. “The important thing is to understand the risk that’s associated with the detail,” Miller notes, “and have the ability to educate the organisation down to individual contributors that the forecast they input in June counts all the way up to when it’s consolidated in October. The quality and documentation of each assumption and change must be auditable back to Day One.”
Gillespie agrees that FP&A will be challenged to prove that information in its spreadsheets and used in key reports is accurate. The question the PCAOB poses is “How do you know it’s complete and accurate?” Many FP&A teams continue to rely on Excel for their key reports: budget, variance analysis and forecasting. “The challenge is to show that these numbers are accurate and that they include all the right activities,” he says. That falls under the acronym IPE, or information produced by entity. “FP&A prepares the spreadsheets and is coming up with a lot of the assumptions that go into forecasting models.”
Herz feels it is important for FP&A teams to recognise and understand this new reality. “You have to live in a world of greater documentation and an ability to explain and justify any inconsistencies in key assumptions used in forecasts and projections in management reporting and the key assumptions used in developing external reporting information that is based on forward-looking estimates,” he says.
“You ought to proactively think about the extent to which work done by FP&A feeds into accounting estimates that are used for financial reporting.” While external and internal reporting need not be the same, if economic assumptions differ significantly and the cash flow projections used to make decisions diverge accordingly, “you may be subject to challenge by your auditors, by the SEC, and in a PCAOB inspection of the procedures performed by your external auditor.”
The upshot, says Herz, “is that there’s increased scrutiny of the process companies follow to come up with financial projections, what macroeconomic and industry assumptions they use and whether these are consistent with the key assumptions that go into forward-looking estimates used in preparing the company’s financial statements.” After all, “forecasting is where FP&A spends a lot of its time.”
According to Gillespie, “These changes are still not understood by the world of FP&A. While some organisations are aware, some will get surprised. Those who are thinking ahead will understand SOX reliance on their FP&A departments, whether FP&A realises it or not. We’re seeing it more and more.”
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