Haven’t We Always Been Told to … Think Positive?
The concept of conducting a “Financial Reporting Risk Assessment” can be a difficult one to grasp. That’s because this is an exercise which requires the accounting personnel of an organization to put their heads together and think about what could go wrong with the numbers they are generating in their daily work.
Many of us know that focusing on bad things that could happen is a dangerous activity called negative thinking. It’s not a good practice to regularly think negatively because our minds tend to find a way to bring into reality those things that we think about the most. This is why it is better to regularly visualize the positive results you desire in any situation rather than the alternative.
However, there is a benefit to occassional negative thinking. It does allow us to consider what can be done to defend us against what could go wrong. For example, it is commonly known that any time you get into a vehicle there is a chance you could be involved in an accident. Therefore as a precaution, hopefully you obey all traffic laws and put on your seat belt to protect yourself from the possibility of an undesirable outcome.
To determine what precautions are needed to protect your organization from accidents in financial reporting, you should annually be conducting a formalized “Financial Reporting Risk Assessment”. This is simply a process of determining what numbers within the financial statements (or just the accounting system itself if you don’t prepare your own financial statements) might not be correct when it is time for the open house of your books at year end.
Many organizations don’t know where to start the Financial Reporting Risk Assessment discussion. It’s really just a matter though of grabbing the most recent annual financial report and going down the Balance Sheet and Income Statement and brainstorming how errors or accidents might get into these numbers during the year and not get corrected by year end. Then you decide what precautions, or internal controls, you need to implement or already have in place to address the risk of these bad events occurring.
Here are some examples…
Cash & Investments
What could go wrong? Cash and investments could be unknowingly under or overstated on the books for various reasons such as unposted items, errors, or fraud occurring in the accounts.
How are we protecting against these risks? Staff accountant prepares reconciliations for each account within the first two weeks of the subsequent month to ensure all transactions are posted correctly and to identify any potential errors or fraud. The reconciliations are then reviewed and approved by the Director of Finance.
Due To / Due From Accounts
What could go wrong? Due to the heavy volume of activity flowing through these accounts for payroll processing and other transactions, there is a high risk of these accounts becoming out of balance and requiring a great deal of analysis time to correct.
How are we protecting against these risks? The Due To / Due From accounts are checked at the end of each month by the Staff Accountant to ensure that they are in balance. Variances are investigated and resolved so they do not accumulate and become a larger more complex problem.
Salaries and Wages
What could go wrong? The expense account codes used for state and federal grants could be inaccurate and not reflect the true time served by employees for these activities. Amounts regularly paid to employees could be inaccurate. There could be fictitious employees on the payroll.
How are we protecting against these risks? The Payroll Clerk reviews Payroll Distribution Reports by employee on a quarterly basis against the District’s master schedule to ensure salaries coding still reflects actual efforts. At the beginning of each year when approved salary amounts are setup in the system by the Payroll Clerk, the Director of Finance reviews and approves a final salaries report from the system. After each pay run, the Payroll Clerk provides the Director of Finance with a Payroll Check Register to review for any unknown names or unusual pay amounts.
These are examples for only three of the financial statement categories, but I think you might get the picture now. If you would like a more extensive example to help get you started with your Financial Reporting Risk Assessment, send me an email and I’ll be happy to provide you with an Excel template.