Quality Assurance – Important?
What is the Problem?
Many firms, particularly smaller ones, have problems with controls or Quality Assurance (“QA”) over the “downstream” preparation of financial statements, footnotes and MD&A. Typically, “upstream” processes like AP, Cash, Journal Entries, etc. are strictly controlled, but limited staff and insufficient planning can lead to downstream QA issues. The complexities and ever-evolving accounting standards (e.g. Revenue Recognition., etc.) create challenges for any firm, while managements and boards have potential individual liability for errors and misleading reporting. The new administration’s focus on deregulation is unlikely to give relief from getting the reporting right, while senior SEC personnel have publicly stated their concerns about firms’ controls over implementing the new accounting standards.
A weak downstream QA process that results in errors in work papers, statements etc. being passed on to the firm’s independent auditors will cause more audit checking and testing, raising the cost and potentially leading to a material weakness being declared. Worse still, a weak QA process may result in the need for an embarrassing restatement.
Picking up wrong numbers as well as making calculation, factual and spreadsheet mistakes are common errors. “Version Confusion” also happens when nobody is sure which versions have been checked and updated. The risk of error increases with: more Excel spreadsheets; more manual hand-offs; limited available staff time; late changes; multiple, geographically dispersed operating subsidiaries, etc.
What is the Solution?
The goal of the QA process is to substantially reduce the probability of errors by ensuring that all numbers and narratives agree to back-up, all tables foot and, all calculations are correct and all disclosures are complete and make sense and the whole report is internally consistent. Best practices have the QA process built: (1) into the firm’s workflow with specific steps, defined responsibilities including a central point of control; and (2) into the firm’s timeline with sufficient time to ensure quality, with due consideration for last minute changes. All back-up support should be gathered into one location as on-line soft copy for easy access.
Preferably the QA responsibility is assigned to a person/team not involved in the day-to-day report preparation – smaller firm might consider outside support. The QA person then undertakes: checking the whole report; distributing a formal Issues Log; checking and logging changes being made; final checking of the main statements; and signing off with finance management. The QA person needs to be well skilled, not a junior, and should also be able to make a critical assessment of the back-up support.
Additional documentation should be maintained including the Issues log, work papers and a summary of the main QA steps undertaken signed off by the QA person and finance management.
All the same QA considerations apply if the firm is not a public company but is facing a major financial transaction (e.g. equity/ debt raises, PE investment, sale of firm, etc.) to avoid the loss of credibility from errors uncovered in due diligence.
There is real value in having a well-defined downstream QA process as part of robust Internal Control over Financial Reporting (“ICFR”) to ensure the firm’s financial reporting is accurate and transparent.
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