The Financial Close Process: Implications for Future Research Diane Janvrin (Iowa State University) Maureen Mascha (University of Wisconsin – Oshkosh)

Why Financial Close Process Research? “The economic volatility of the past few years has left businesses hungering for more timely and uniform financial information to help them react quickly to fast-changing conditions.” Emily Chasan, Wall Street Journal, 2012 “Finance organizations need to proactively manage the challenges of data quality and prepare for the upcoming regulatory requirements to avoid creating a perfect storm for their financial close and consolidation processes.” Raj Chhabra, Deliotte Consulting Director, 2010

Financial Close Definition routine process of completing the accounting cycle and preparing internal and external reports

Financial Close Process Enter & Process Transactions Report & Disclose Information Aggregate & Analyze Results Remediate Controls Evaluate & Test Controls §302 Certification Audit Opinion Form 10-Q 10-K Board Book Audit Opinion?? Aggregate Financial Amounts Review Preliminary Results Perform Final Adjustments Report & Disclose Information ERP Word Excel Word Excel

Why is financial close process important? Recent economic volatility and increase in number of restatements Regulations (i.e., Sarbanes-Oxley, fair value accounting standards, SEC’s XBRL mandate) increase period-end workload Several recent SEC filings have significant control weaknesses related to financial close process Time needed to complete the financial close process = internal information environment quality??

Our approach Literature review to identify critical issues Use results to develop field investigation questions Conduct field investigation with various financial close participants Analyze results Develop future research recommendations

Four factors Need to meet expectations Collaboration between multiple participants Estimation process Ability to incorporate new regulations into financial close process

Need to meet expectations Companies often attempt to meet or beat analyst expectations during financial close process Expectation concerns are not limited to year-end earnings

Collaboration between multiple participants Financial close process may be hidden-profile task In hidden-profile tasks, teams using bulletin-board computer-mediated communication tool may outperform teams using chat tool or communicating face-to-face Before collaboration technology can be effective, participants need to accept the technology Role ambiguity may impact participants’ willingness to collaborate

Estimation process Even small changes in management’s estimates can trigger material misstatement Estimates allow analysts to predict future year's earnings, although they are less predictive of future cash flows Investors find ex post estimate analysis informative

Ability to incorporate new regulations into the financial close process Many new regulations balance need for standardization with need for professional judgment Technology may improve financial close process timeliness In-house processes may increase organizational knowledge while outsourcing options may be cheaper

Field Investigation To date, 10 firms ranging from small firms to Fortune 50 companies Director of Financial Reporting / Controller 12 questions based on literature review 30 to 45 minutes

Need to meet expectations Meeting report deadline dates is critical Meeting target bottom line numbers varies widely among firms Companies that update forecast monthly tend to face more target bottom line pressure

Collaboration between multiple participants Very important Particularly for organizations with decentralized accounting functions

Estimation process Importance of estimation process varies significantly Internal controls over estimation process vary widely Some firms conduct detailed estimation reviews prior to period end Changes in estimates is often last-minute change

Ability to incorporate new regulations into the financial close process Varies widely among firms Often can delay and/or add stress to financial close process Firms have moved from outsourcing XBRL to internal XBRL software (bolt-on) XBRL tagging process no long delays financial close process although several managers still question why they need to tag financial statement values

Future Research Opportunities

Need to meet expectations Research has examined to some degree who analysts and lenders form their early earnings expectations (Beaver 1979; Kim and Verrecchia 1991, 1997; Barron et al. 1998) Still opportunity to examine how expectations impact management’s actions and effectiveness and efficiency of financial close process

Collaboration between multiple participants Collaboration involves performing hidden- profile task How can hidden-profile task research improve collaboration between financial close participants?

Estimation process Explore how time pressure impacts effectiveness and efficiency of estimation process Could ex post estimate analysis improve not only period-end estimates but potentially financial close process? How do improvements in technology and documentation techniques affect estimate accuracy?

Ability to incorporate new regulations into the financial close process Limited research discussing how companies incorporate new regulations into current close process Examine when and how existing systems need to be modified or if new systems need to be developed to meet needs of new regulations What impacts decision to move XBRL from outsource to in-house? Why bolt-on rather than integrated approach?

Summary Financial close is important and potentially under-researched topic Important due to Recent economic volatility Increase in restatements New regulations Several recent SEC filings with significant financial close process control weaknesses Time needed to complete financial close process = internal information environment quality Concentrate future research on factors impacting financial close process Meeting or beating management expectations Collaboration – hidden profile task New standards Estimation process

Questions??

Benchmarks and Key Performance Indicators (KPIs) of Financial Close Process a CategoryBenchmarksKPIs CostsCost of non-compliance/control failure Increase in number of non-recurring transactions FTEs for close New account requests Finance as percent of revenue Task re-work; supporting schedules Audit fees as percent of revenue Journal entries containing errors or requiring re- adjustment Quality Number of control remediations Changes in policies/procedures Auditor adjustments Increase in issue escalations Post-close adjustments Increase/decrease in expected results (returns, receivables, etc.) Timeliness Days to close Increase in expected volumes (purchase orders, invoices, paychecks, etc.) Percent tasks latePost cut-off transaction postings Current days to close vs. previous days to close a source: Clark 2010