By Richard B. Palanzi
First a note from Brian Maskell: I’d like to welcome a new Guest Blogger. Mr. Richard B Palanzi is a lean expert, black belt, experienced finance professional, and a consultant with Mindfulness Management. Richard’s view of auditing is innovative and refreshing. Please give us your comments and ideas.
Nobody likes audits. They are costly, involve a lot of work, don’t add value for the customers. Yet all companies have to do them. From a Lean point of view, we think of them as “necessary waste.” Even if we cannot eliminate them entirely, what if companies could figure out ways to cut this waste and minimize audit costs?
Consider the potential bottom line impact of the value-added projects these internal resources could otherwise be supporting if the external audits were completed with greater speed.
Here’s Some Background
External audits are expensive and their costs are rising annually. In October of 2014, FEI (Financial Executives International www.financialexecutives.org ) released the findings of its annual “Audit Fee Survey.” Here is an excerpt from this report:
Public and private companies which responded, as well as non-profits, saw an overall increase in their audit fees in 2013 over the previous year. Public companies paid on average $7.1 million in audit fees. The number of audit hours required for a public audit averaged 17,525; which is estimated to be an average of $249 per hour. Privately-held company respondents in 2013 averaged $174,858. The number of audit hours required for a private company averaged 2,927 hours, estimated to be $179 per hour.
Complex business processes and related transactions are one driver of external audit costs. Ask yourself, how and why is this case?
- Certain steps in processes will create business transactions. Some classes of transactions are processes in and of themselves, such as the Purchase to Payables process. Manual, automated, and everywhere in between, these processes may be completely internal to an organization, exist between separate entities of an enterprise or involve external parties. Many of these business transactions result in one and often many accounting transactions.
- Accounting transactions and related accounting processes are what external auditors have to examine. The goal of internal management oversight, internal audit and external audit activities is to prevent, identify or correct any material misstatement possibilities as a result of transactions or accounting practices which might be wrong, missing, or incomplete – whether made so deliberately or accidentally.
- External auditors employ sampling techniques, whereby they may evaluate less than 100% of the items within an account or class of transactions as a way to understand the nature of the entire account or class of transactions. Auditors will pull a random sample of a specific type of transaction, examine those, and draw conclusions about the quality of the information and controls. In performing an audit, auditors must be able to drill down to the source of each piece of data generated by a transaction (the audit trail). This process can be very time-consuming for external auditors and for internal accounting and business staff as well.
Here’s Where Lean Comes In
Lean initiatives often result in processes with fewer steps, thus fewer transactions.
If, as a result of a successful Lean initiative, the number of business transactions is reduced, it follows that the number of accounting transactions will be reduced. This happens because Lean visual controls work better and naturally improve control while cutting transactions. Kanbans that control inventory movement are an example of this.
When transactions are reduced, the samples which external auditors draw from certain accounts or classes of transactions to be audited will also be reduced. This results in reduced external audit cost.
In addition, internal accounting and business operations resources are allocated to the audit process. Not having to dedicate so many hours of internal resources to audits means you can use this resource differently.
Perhaps reduction in external audit costs alone would not be the impetus driving enterprise wide Lean implementation. But I believe this potential cost reduction just scratches the surface. I believe there are other potential benefits and opportunities to be realized when Finance and Accounting teams prioritize continuous improvement of their processes as an important component of any Lean initiative.