The Financial Close Process: Implications for Future Research Diane Janvrin (Iowa State University) Maureen Mascha (Purdue University-Calumet)

“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

Outline Introduction Motivation Method Results Summary

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 E-mail

Why is financial close process important? Recent economic volatility and increase in number of restatements has increased pressure on companies to timely report performance Regulations (i.e., Sarbanes-Oxley, fair value accounting standards, SEC’s XBRL mandate) have increased accountants’ 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 financial close participants from various organizations Analyze results Develop future research recommendations

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

Need to meet expectations Companies often attempt to meet or beat analyst expectations during the 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/ collaboration may improve MFM In-house processes may increase organizational knowledge while outsourcing options may be cheaper

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

Findings: 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 Accuracy and timeliness are often equally important

Findings: Collaboration between multiple participants Very important; particularly for organizations with decentralized accounting functions

Findings: 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 Adjustments not always made at month-end for errors– sometimes made at quarter-end

Findings: 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 SOX generally integrated within systems

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

Future Research Opportunities: Collaboration between multiple participants Since financial close process involves close collaboration among multiple participants performing hidden-profile task, consider how hidden-profile task research may assist in examining how to improve collaboration between financial close participants examine how software may assist in collaboration efforts

Future Research Opportunities: 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?

Future Research Opportunities: 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 the 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 Recent economic volatility, increase in restatements has increased pressure on companies to timely report performance New regulations have increased accountants’ period- end workload Several recent SEC filings have significant control weaknesses related to financial close process Academic research now uses time needed to complete financial close process as proxy for internal information environment quality

Summary Future research is needed regarding the following factors impacting the financial close process meeting or beating management expectations collaboration – hidden profile task new standards estimates

Questions??