Sections

Just What Is Reasonable Assurance?

Norman Marks

compliance with reasonable assurance during an auditDo we care what this term means? We should, because it should guide assessments of internal control by management, internal audit, and external audit (and the latter use it when they express an opinion on the financial statements). It also comes into play as internal auditors and management assess the adequacy of governance and risk management processes.

Is it, as the SEC and PCAOB once told me “a term of science”? Not really. It all comes down to professional judgment by a reasonable or prudent person: judgment as to the level of risk that the assessment is incorrect.

There are regulations that guide the external audit firms and define what reasonable assurance should mean when they use the term.

Auditing Standard Number 5 (AS5) says:

“Effective internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes…The auditor must plan and perform the audit to obtain appropriate evidence that is sufficient to obtain reasonable assurance about whether material weaknesses exist as of the date specified in management’s assessment…When evaluating the severity of a deficiency, or combination of deficiencies, the auditor also should determine the level of detail and degree of assurance that would satisfy prudent officials in the conduct of their own affairs that they have reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in conformity with generally accepted accounting principles. If the auditor determines that a deficiency, or combination of deficiencies, might prevent prudent officials in the conduct of their own affairs from concluding that they have reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in conformity with generally accepted accounting principles, then the auditor should treat the deficiency, or combination of deficiencies, as an indicator of a material weakness.”

AS5 points to AU sec. 230, Due Professional Care in the Performance of Work for a definition of reasonable assurance. However, that document doesn’t provide a great deal more clarification:

“While exercising due professional care, the auditor must plan and perform the audit to obtain sufficient appropriate audit evidence so that audit risk will be limited to a low level that is, in his or her professional judgment, appropriate for expressing an opinion on the financial statements. The high, but not absolute, level of assurance that is intended to be obtained by the auditor is expressed in the auditor’s report as obtaining reasonable assurance about whether the financial statements are free of material misstatement (whether caused by error or fraud). Absolute assurance is not attainable because of the nature of audit evidence and the characteristics of fraud. Therefore, an audit conducted in accordance with generally accepted auditing standards may not detect a material misstatement.”

The guidance continues:

“The independent auditor’s objective is to obtain sufficient appropriate audit evidence to provide him or her with a reasonable basis for forming an opinion. The nature of most evidence derives, in part, from the concept of selective testing of the data being audited, which involves judgment regarding both the areas to be tested and the nature, timing, and extent of the tests to be performed. In addition, judgment is required in interpreting the results of audit testing and evaluating audit evidence. Even with good faith and integrity, mistakes and errors in judgment can be made. Furthermore, accounting presentations contain accounting estimates, the measurement of which is inherently uncertain and depends on the outcome of future events. The auditor exercises professional judgment in evaluating the reasonableness of accounting estimates based on information that could reasonably be expected to be available prior to the completion of field work. As a result of these factors, in the great majority of cases, the auditor has to rely on evidence that is persuasive rather than convincing.”

OK, what does this all mean?

There are some key phrases:

  • “the level of detail and degree of assurance that would satisfy prudent officials that they have reasonable assurance”
  • “audit risk will be limited to a low level that is, in his or her professional judgment, appropriate”

It all comes down to the judgment of a prudent person or official.

AS5 and AU sec.230 both point to the fact that absolute or perfect assurance is impossible. They are concerned about assurance over financial reporting and their opinion on the system of internal control and the financial statements.

What does the COSO Internal Control – Integrated Framework (2013) say? It also refers to reasonable assurance:

“Internal control is a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance.”

It goes on to say that internal control is “able to provide only reasonable assurance, not absolute assurance”.

“The term ‘reasonable assurance’ rather than ‘absolute assurance’ acknowledges that limitations exist in all systems of internal control, and that uncertainties and risks may exist, which no one can confidently predict with precision. Absolute assurance is not possible. Reasonable assurance does not imply that an entity will always achieve its objectives. Effective internal control increases the likelihood of an entity achieving its objectives. However, the likelihood of achievement is affected by limitations inherent in all internal control systems, such as human error and the uncertainty inherent in judgment. Additionally, a system of internal control can be circumvented if people collude. Further, if management is able to override controls, the entire system may fail. In other words, even an effective system of internal control can experience a failure.”

So, let’s see if we can come up with something that makes practical sense

Let’s start with saying that a system of internal control is designed to ensure risks to the achievement of objectives are within desired levels. But, there are limitations inherent in any system of internal control, as described by COSO in the excerpt above.

How much risk should we take that the system of internal control will fail, with significant implications for the achievement of objectives? How much should we spend on controls to limit the risk? That is a matter of judgment: management and the board, as appropriate, should decide. In some cases, regulation and law may guide the definition of an acceptable level of risk that the system of internal control will fail. In all cases, whether a reasonable person (or official) would agree should be a consideration.

If the level of risk that the system of internal control will fail is acceptable, we can call the system of internal control effective.

But the problem is not quite that easy. We also have to consider the use of the term in an auditor’s opinion. External and internal audit seek reasonable assurance that the system of internal control is effective. Said another way, the auditors seek reasonable assurance that the system of internal control provides reasonable assurance that risks to the achievement of objectives are at acceptable levels.

Here, we are talking about the level of risk that the assessment by the auditor is incorrect. Again, the judgment of a prudent person or official comes into play. For the reasons expressed in AU sec.230, an auditor cannot be certain that his assessment is correct.

Where am I going with this?

As I said earlier, this is not a matter of science. It is a matter of judgment and common sense. Professional auditors are presumed to have both and should be required to exercise both when making assessments.

I believe that external auditors, management, and internal auditors should be prepared to form and express opinions on the adequacy of internal control, management of risk, governance processes, and more. They should rely on, without qualms, their common sense and judgment in that process. Perfect assurance that the system of internal control is perfect is doubly impossible. Reasonable assurance based on professional judgment is possible.

I welcome your comments and perspectives.

P.S. I will write a post shortly about the form an internal auditor’s opinion might take on the adequacy of an organization’s overall processes for governance, management of risk, and internal controls.

Comments

About Norman Marks

Norman Marks previously held the role of Vice President, Evangelist for Better Run Business, at SAP, responsible for optimizing business processes for internal audit, risk management, governance, and compliance.

Tags:

audit , awareness

Why 3D Printed Food Just Transformed Your Supply Chain

Hans Thalbauer

Numerous sectors are experimenting with 3D printing, which has the potential to disrupt many markets. One that’s already making progress is the food industry.

The U.S. Army hopes to use 3D printers to customize food for each soldier. NASA is exploring 3D printing of food in space. The technology could eventually even end hunger around the world.

What does that have to do with your supply chain? Quite a bit — because 3D printing does more than just revolutionize the production process. It also requires a complete realignment of the supply chain.

And the way 3D printing transforms the supply chain holds lessons for how organizations must reinvent themselves in the new era of the extended supply chain.

Supply chain spaghetti junction

The extended supply chain replaces the old linear chain with not just a network, but a network of networks. The need for this network of networks is being driven by four key factors: individualized products, the sharing economy, resource scarcity, and customer-centricity.

To understand these forces, imagine you operate a large restaurant chain, and you’re struggling to differentiate yourself against tough competition. You’ve decided you can stand out by delivering customized entrees. In fact, you’re going to leverage 3D printing to offer personalized pasta.

With 3D printing technology, you can make one-off pasta dishes on the fly. You can give customers a choice of ingredients (gluten-free!), flavors (salted caramel!), and shapes (Leaning Towers of Pisa!). You can offer the personalized pasta in your restaurants, in supermarkets, and on your ecommerce website.

You may think this initiative simply requires you to transform production. But that’s just the beginning. You also need to re-architect research and development, demand signals, asset management, logistics, partner management, and more.

First, you need to develop the matrix of ingredients, flavors, and shapes you’ll offer. As part of that effort, you’ll have to consider health and safety regulations.

Then, you need to shift some of your manufacturing directly into your kitchens. That will also affect packaging requirements. Logistics will change as well, because instead of full truckloads, you’ll be delivering more frequently, with more variety, and in smaller quantities.

Next, you need to perfect demand signals to anticipate which pasta variations in which quantities will come through which channels. You need to manage supply signals source more kinds of raw materials in closer to real time.

Last, the source of your signals will change. Some will continue to come from point of sale. But others, such as supplies replenishment and asset maintenance, can come direct from your 3D printers.

Four key ingredients of the extended supply chain

As with our pasta scenario, the drivers of the extended supply chain require transformation across business models and business processes. First, growing demand for individualized products calls for the same shifts in R&D, asset management, logistics, and more that 3D printed pasta requires.

Second, as with the personalized entrees, the sharing economy integrates a network of partners, from suppliers to equipment makers to outsourced manufacturing, all electronically and transparently interconnected, in real time and all the time.

Third, resource scarcity involves pressures not just on raw materials but also on full-time and contingent labor, with the necessary skills and flexibility to support new business models and processes.

And finally, for personalized pasta sellers and for your own business, it all comes down to customer-centricity. To compete in today’s business environment and to meet current and future customer expectations, all your operations must increasingly revolve around rapidly comprehending and responding to customer demand.

Want to learn more? Check out my recent video on digitalizing the extended supply chain.

Comments

Hans Thalbauer

About Hans Thalbauer

Hans Thalbauer is the Senior Vice President, Extended Supply Chain, at SAP. He is responsible for the strategic direction and the Go-To-Market of solutions for Supply Chain, Logistics, Engineering/R&D, Manufacturing, Asset Management and Sustainability at SAP.

How to Design a Flexible, Connected Workspace 

John Hack, Sam Yen, and Elana Varon

SAP_Digital_Workplace_BRIEF_image2400x1600_2The process of designing a new product starts with a question: what problem is the product supposed to solve? To get the right answer, designers prototype more than one solution and refine their ideas based on feedback.

Similarly, the spaces where people work and the tools they use are shaped by the tasks they have to accomplish to execute the business strategy. But when the business strategy and employees’ jobs change, the traditional workspace, with fixed walls and furniture, isn’t so easy to adapt. Companies today, under pressure to innovate quickly and create digital business models, need to develop a more flexible work environment, one in which office employees have the ability to choose how they work.

SAP_Digital_Emotion_BRIEF_image175pxWithin an office building, flexibility may constitute a variety of public and private spaces, geared for collaboration or concentration, explains Amanda Schneider, a consultant and workplace trends blogger. Or, she adds, companies may opt for customizable spaces, with moveable furniture, walls, and lighting that can be adjusted to suit the person using an unassigned desk for the day.

Flexibility may also encompass the amount of physical space the company maintains. Business leaders want to be able to set up operations quickly in new markets or in places where they can attract top talent, without investing heavily in real estate, says Sande Golgart, senior vice president of corporate accounts with Regus.

Thinking about the workspace like a designer elevates decisions about the office environment to a strategic level, Golgart says. “Real estate is beginning to be an integral part of the strategy, whether that strategy is for collaborating and innovating, driving efficiencies, attracting talent, maintaining higher levels of productivity, or just giving people more amenities to create a better, cohesive workplace,” he says. “You will see companies start to distance themselves from their competition because they figured out the role that real estate needs to play within the business strategy.”

The SAP Center for Business Insight program supports the discovery and development of  new research-­based thinking to address the challenges of business and technology executives.

Comments

Sam Yen

About Sam Yen

Sam Yen is the Chief Design Officer for SAP and the Managing Director of SAP Labs Silicon Valley. He is focused on driving a renewed commitment to design and user experience at SAP. Under his leadership, SAP further strengthens its mission of listening to customers´ needs leading to tangible results, including SAP Fiori, SAP Screen Personas and SAP´s UX design services.

Tags:

The Future Of Supplier Collaboration: 9 Things CPOs Want Their Managers To Know Now

Sundar Kamak

As a sourcing or procurement manager, you may think there’s nothing new about supplier collaboration. Your chief procurement officer (CPO) most likely disagrees.
Forward-thinking CPOs acknowledge the benefit of supplier partnerships. They not only value collaboration, but require a revolution in how their buying organization conducts its business and operations. “Procurement must start looking to suppliers for inspiration and new capability, stop prescribing specifications and start tapping into the expertise of suppliers,” writes David Rae in Procurement Leaders. The CEO expects it of your CPO, and your CPO expects it of you. For sourcing managers, this can be a lot of pressure.

Here are nine things your CPO wants you to know about how supplier collaboration is changing – and why it matters to your company’s future and your own future.

1. The need for supplier collaboration in procurement is greater than ever

Over half (65%) of procurement practitioners say procurement at their company is becoming more collaborative with suppliers, according to The Future of Procurement, Making Collaboration Pay Off, by Oxford Economics. Why? Because the pace of business has increased exponentially, and businesses must be able to respond to new market demands with agility and innovation. In this climate, buyers are relying on suppliers more than ever before. And buyers aren’t collaborating with suppliers merely as providers of materials and goods, but as strategic partners that can help create products that are competitive differentiators.

Supplier collaboration itself isn’t new. What’s new is that it’s taken on a much greater urgency and importance.

2. You’re probably not realizing the full collective power of your supplier relationships

Supplier collaboration has always been a function of maintaining a delicate balance between demand and supply. For the most part, the primary focus of the supplier relationship is ensuring the right materials are available at the right time and location. However, sourcing managers with a narrow focus on delivery are missing out on one of the greatest advantages of forging collaborative supplier partnerships: an opportunity to drive synergies that are otherwise perceived as impossible within the confines of the business. The game-changer is when you drive those synergies with thousands, not hundreds of suppliers. Look at the Apple Store as a prime example of collaboration en masse. Without the apps, the iPhone is just another ordinary phone!

3. Collaboration comes in more than one flavor

Suppliers don’t just collaborate with you to provide a critical component or service. They also work with your engineers to help ensure costs are optimized from the buyer’s perspective as well as the supplier’s side. They may even take over the provisioning of an entire end-to-end solution. Or co-design with your R&D team through joint research and development. These forms of collaboration aren’t new, but they are becoming more common and more critical. And they are becoming more impactful, because once you start extending any of these collaboration models to more and more suppliers, your capabilities as a business increase by orders of magnitude. If one good supplier can enable your company to build its brand, expand its reach, and establish its position as a market leader – imagine what’s possible when you work collaboratively with hundreds or thousands of suppliers.

4. Keeping product sustainability top of mind pays off

Facing increasing demand for sustainable products and production, companies are relying on suppliers to answer this new market requirement.

As a sourcing manager, you may need to go outside your comfort zone to think about new, innovative ways to collaborate for achieving sustainability. Recently, I heard from an acquaintance who is a CPO of a leading services company. His organization is currently collaborating with one of the largest suppliers in the world to adhere to regulatory mandates and consumer demand for “lean and green” lightbulbs. Although this approach was interesting to me, what really struck me was his observation on how this co-innovation with the supplier is spawning cost and resource optimization and the delivery of competitive products. As reported by Andrew Winston in The Harvard Business Review, Target and Walmart partnered to launch the Personal Care Sustainability Summit last year. So even competitors are collaborating with each other and with their suppliers in the name of sustainability.

5. Co-marketing is a win-win

Look at your list of suppliers. Does anyone have a brand that is bigger than your company’s? Believe it or not, almost all of us do. So why not seize the opportunity to raise your and your supplier’s brand profile in the marketplace?

Take Intel, for example. The laptop you’re working on right now may very well have an “Intel inside” sticker on it. That’s co-marketing at work. Consistently ranked as one of the world’s top 100 most valuable brands by Millward Brown Optimor, this largest supplier of microprocessors is world-renowned for its technology and innovation. For many companies that buy supplies from Intel, the decision to co-market is a strategic approach to convey that the product is reliable and provides real value for their computing needs.

6. Suppliers get to choose their customers, too

Increased competition for high-performing suppliers is changing the way procurement operates, say 58% of procurement executives in the Oxford Economics study. Buyers have a responsibility to the supplier – and to their CEO – to be a customer of choice. When the economy is going well, you might be able to dictate the supplier’s goods and services – and sometimes even the service delivery model. When times get tough (and they can very quickly), suppliers will typically reevaluate your organization’s needs to see whether they can continue service in a fiscally responsible manner. To secure suppliers’ attention in favorable and challenging economic conditions, your organization should establish collaborative and mutually productive partnerships with them.

7. Suppliers can help simplify operations

Cost optimization will always be one of your performance metrics; however, that is only one small part of the entire puzzle. What will help your organization get noticed is leveraging the supplier relationship to innovate new and better ways of managing the product line and operating the business while balancing risk and cost optimization. Ask yourself: Which functions are no longer needed? Can they be outsourced to a supplier that can perform them better? What can be automated?

8. Suppliers have a better grasp of your sourcing categories than you do

Understand your category like never before so that your organization can realize the full potential of its supplier investments while delivering products that are consistent and of high quality. How? By leveraging the wisdom of your suppliers. To be blunt: they know more than you do. Tap into that knowledge to gain a solid understanding of the product, market category, suppliers’ capabilities, and shifting dynamics in the industry, If a buyer does not understand these areas deeply, no amount of collaboration will empower a supplier to help your company innovate as well as optimize costs and resources.

9. Remember that there’s something in it for you as well

All of us want to do strategic, impactful work. Sourcing managers with aspirations of becoming CPOs should move beyond writing contracts and pushing PO requests by building strategic procurement skill sets. For example, a working knowledge in analytics allows you to choose suppliers that can shape the market and help a product succeed – and can catch the eye of the senior leadership team.

Sundar Kamak is global vice president of solutions marketing at Ariba, an SAP company.

For more on supplier collaboration, read Making Collaboration Pay Off, part of a series on the Future of Procurement, by Oxford Economics.

Comments

The CFO Role In 2020

Estelle Lagorce

African American businessman looking out office window --- Image by © Mark Edward Atkinson/Blend Images/CorbisThe role of the CFO is undergoing a serious transformation, and CFOs can expect their role to continue to evolve, according to a recent CFO.com article by Deloitte COO and CFO Frank Friedman.

In the futurist article, Friedman says one of the biggest factors that will contribute to the CFO’s significant change over the next five years is technology.

Digital technology is obviously expected to drive change in high-tech companies, but Friedman says it’s industries outside of the tech sectors that are of particular interest, as they struggle to understand how to grasp and harness the digital capabilities available to them.

Working with high tech in low-tech industries

Five years from now, a finance team may be defined by how well it uses technology and innovative business tools, regardless of what industry it’s in. The article outlines some examples of ways that digital technology will increasingly be used by CFOs in “non-tech” sectors:

  • Predictive analytics: CFOs in manufacturing companies can forecast results and produce revenue predictions based on customer-experience profiles and current demand, instead of comparing to previous years as most companies still do today.
  • Social media and crowdsourcing: You may not think CFOs spend a lot of time on social media or crowdsourcing sites, but these methods can actually expedite finance processes, such as month-end responsibilities of the finance organization.
  • Big Data: CFOs already have a lot of data at their fingertips, but in 2020 they will have even more. CFOs in both tech and non-tech sectors who understand how to use that data to make valuable, informed decisions, can strategically guide their company and industry in a more digitally oriented world.

To do this, Friedman says CFOs can lead the way by addressing some critical areas:

  1. Know the issues: Gather the key questions that leaders expect Big Data analytics to answer.
  1. Make data easily accessible: Collect data that is manageable and easy to access.
  1. Broaden skills: The finance team needs people with the skills to understand and strategically interpret the data available to them.

The tech-savvy CFO

The role of today’s CFO has already expanded to include strategic corporate growth advice as well as managing the bottom line. In 2020, Friedman says expectations placed on the CFO are presumed to be even greater, and CFOs will likely need a much more diverse, multidisciplinary skill set to meet those demands.

The article details several traits and skills that CFOs will need in order to keep up with the pace of digital change in their role.

  1. Digital knowledge: CFOs must be tech-savvy in order to capitalize on technical innovations that will benefit their company and their industry as a whole.
  1. Data-driven execution: CFOs will need the ability to execute company strategy and operations decisions based on data-driven insights.
  1. Regulatory compliance: Regulations continue to be more stringent globally, so CFOs will need to be proficient at working closely with regulators and compliance systems.
  1. Risk management: With the growing global economy comes increased cyber and geopolitical risks worldwide. The CFOs of 2020, especially those in large multinational organizations, will need to have the expertise to monitor and manage risk in areas that may be unforeseen today.

The future CFO’s well-rounded resume

By 2020, the CFO role will require much more than just an accounting background. According to Deloitte’s Frank Friedman, “CFOs may need to bring a much more multidisciplinary skill set to the job as well as broader career experiences, from working overseas to holding positions in sales and marketing, and even running a business unit.”

So if you’re a current or aspiring CFO, you have five years to round out your resume with the necessary skills to be ready for the digitally driven role of the CFO in 2020.

The above information is based on the CFO.com article What Will the CFO Role Look Like In 2020?” by Deloitte COO & CFO, Frank Friedman – Copyright © 2015 CFO.com.

Want to learn more about best practices for transforming your finance organization? View the SAP/Deloitte Webinar, “Reshaping the Finance Function”.

For an in-depth look at digital technology’s role in business transformation, download the SAP eBook, The Digital Economy: Reinventing the Business World.

To learn more about the business and technology factors driving digital disruption, download the SAP eBook, Digital Disruption: How Digital Technology is Transforming Our World.

To read more CFO insights from a tech industry perspective, read the Wall Street Journal article with SAP CFO Luka Mucic: Driving Insight with In-memory Technology.

Discover 7 Questions CFOs Should Ask Themselves About Cyber Security.

Comments

Estelle Lagorce

About Estelle Lagorce

Estelle Lagorce is the Director, Global Partner Marketing, at SAP. She leads the global planning, successful implementation and business impact of integrated marketing programs with top global Strategic Partner across priority regions and countries (demand generation, thought leadership).