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Linking Strategy to Operations

2010-05-18T15:13:00.002+07:00

Linking Strategy to Operations

Anonymous. Journal of Accountancy. New York: Oct 2008. Vol. 206, Iss. 4; pg. 80, 4 pgs

Abstract (Summary)
In an interview, Robert S. Kaplan, Harvard Business School professor, talked about activity-based costing and balanced scorecards. They found a few companies that had developed more accurate ways of assigning overhead costs to products and customers. That's how the activity-based costing (ABC) movement started. In 1990, David Norton and he developed the balanced scorecard (BSC), which retained financial metrics but supplemented them with metrics on the company's performance with customers, processes, and people and culture. Many accountants and finance professionals may not yet realize the simplicity and power of this new approach. They may remember that they tried ABC 10 or 15 years ago, and it didn't work out as advertised because of the difficulty of working from and maintaining employees' time estimates. The process time estimates used in time-driven ABC are much easier to obtain, verify and update as needed. He thinks that their current knowledge about the effective use of strategy maps and scorecards now offers something uniquely valuable that no other approach can.

Harvard Business School professor Robert S. Kaplan is co-developer of both activity-based costing and the balanced scorecard. In 2006, Kaplan was elected to the Accounting Hall of Fame, and received the Lifetime Contribution Award from the Management Accounting section of the American Accounting Association. In 2008, the Institute of Management Accountants honored him with a Lifetime Award for Distinguished Contribution to Advancing the Profession of Management Accounting. The following is an edited transcript of a recent interview with the JofA.

JofA: Could you give a summary of how you've come to work with activity-based costing and balanced scorecards?

Kaplan: This journey started in the 1980s when I became exposed to the changes and innovations that were going on in management primarily through the Japanese management approach, which included total quality management and just-in-time inventory. And I realized that, if what I was hearing from practice was true, it undermined what we had been teaching and doing research on and actually practicing for the last 75 years. In effect, new approaches would be needed for both costing and performance measurement.

From that stage on, I started working on solutions. We found a few companies that had developed more accurate ways of assigning overhead costs to products and customers. That's how the activity-based costing (ABC) movement started. But even these improved financial metrics captured only what was happening with physical and financial assets, not the organization's intangible assets. The Japanese were gaining advantage through training and motivating their employees, improving the quality of processes, and working better with suppliers and customers-a whole set of performance capabilities that would not be picked up by periodic financial statements.

In 1990, David Norton and I developed the balanced scorecard (BSC), which retained financial metrics but supplemented them with metrics on the company's performance with customers, processes, and people and culture. This was an independent development from ABC, which addresses, "What are the costs associated with our existing processes, products and customers?" The balanced scorecard responds to, "Are we creating current and future value for our shareholders and customers?"

JofA: In the United States, how do you see the implementation of activity-based costing progressing?

Kaplan: I think there was a clear upsurge of interest starting in the mid-1980s when we introduced the concept. I detected a falloff in the late '90s and early part of this decade, just because the approach that we introduced ended up being too complex to implement.

People worried about subjectivity from people's estimates about their distribution of time, and it was difficult to keep the cost estimates up to date. Processes changed, and the cost of re-interviewing people was high. I think that ABCs use has gone down because people tried it, and it just proved too difficult. But I think the new approach, time-driven ABC, which Steve Anderson and I introduced, addresses these problems and makes ABC much more accessible and realistic for all enterprises.

Time-driven ABC works at the transaction and order level, and estimates directly the resource capacity (usually time) needed to process a transaction, build and deliver a product, and service a customer. It eliminates the need for subjective time estimates, which makes it easier to implement. And by directly linking processes to transactions, it is more flexible and accurate since variations in resource consumption can be readily modeled. ERP systems, which did not exist in the 1980s, now are widespread so the data for costing directly from transactions is now feasible.

Many accountants and finance professionals may not yet realize the simplicity and power of this new approach. They may remember that they tried ABC 10 or 15 years ago, and it didn't work out as advertised because of the difficulty of working from and maintaining employees' time estimates. The process time estimates used in time-driven ABC are much easier to obtain, verify and update as needed.

JofA: Has implementation of the balanced scorecard been similar to that of ABC?

Kaplan: I believe the adoption of the balanced scorecard has been much more widespread than even ABC. It addresses a fundamental issue that all enterprises, manufacturing and service, private sector and public sector, and nonprofit as well, face: how to describe, communicate and implement your strategy. We have established the Balanced Scorecard Hall of Fame that now includes more than 100 enterprises from all sectors and from countries all over the world that have used our philosophy to implement BSC and achieved performance breakthroughs. I do an informal survey in an executive program I teach at Harvard. Twice a year we get 160 executives, two-thirds of whom come from outside the U.S., for an eight-week program. This is pretty much a random draw from the world's managerial population. They're not coming to this program because I'm teaching the balanced scorecard; they're coming to spend eight weeks at Harvard.

I start the sessions by asking how many are using the balanced scorecard in some form in their organizations. Consistently, over the past eight years, 65% to 70% of the hands go up. Not all of them may be following the principles that Dave Norton and I have been advocating over the last 10 years, but that still indicates the widespread adoption of the concept in some form.

JofA: In your most recent book, The Execution Premium, you introduce a six-stage closed-loop management system (see Exhibit 1). Does this system tie other management accounting tools such as ABC and balanced scorecards together?

Kaplan: A. Harvard Business Review editor has called the strategy execution management system my "theory of everything." It encompasses not only management accounting and control, but also quality management, beyond budgeting, strategy formulation, activity-based costing, analytics, operational dashboards and management by objectives. So it integrates a whole suite of management tools in a comprehensive and closed-loop system that links strategy and operations.

JofA: In your closed-loop system, it appears that ABC is really an operations planning and monitoring tool?

Kaplan: We describe how to use ABC for operational planning by having it forecast the levels of resource capacity-employees, equipment, space, technology-you need to supply in order to deliver on the revenue targets in your strategic plan. This is a powerful analytic tool that eliminates almost all of the guesswork, subjectivity and negotiations normally associated with the resource planning or budgeting process.

As the strategy is being executed, ABC monitors whether you're making money from your strategy-not in aggregate, financial statements do that-but product by product, by product line and also by customer-by-customer and by segment and channel. So the ABC system gives managers detailed feedback on where the strategy is working and where not, and greatly facilitates decisions managers can make to transform unprofitable operations into profitable ones.

JofA: And the balanced scorecard is used both to translate strategy into operations as well as to monitor strategy?

Kaplan: We are making strategy actionable and helping allocate resources consistent with the strategy. We make an important distinction between monitoring operations, which you can do with dashboards and key performance indicators, versus monitoring the strategy, which is the role for strategy maps and balanced scorecards.

JofA: What do you see as the primary role for the finance organization inside this closed-loop system?

Kaplan: We're advocating for a transformation of the finance function-we're not abandoning traditional financial reporting, internal controls and auditing because all that still needs to be done. But these should not be the only processes that the finance function does. In addition to the statutory compliance role, finance needs to play a role for value creation. We might talk about the finance function being transformed from bean counting and reporting to participating actively in value creation. Instead of just looking in the rearview window, the finance function can use tools such as activity-based costing, strategy maps and balanced scorecards to help the organization look through the front windshield and navigate to a profitable future.

The final chapter of The Execution Premium talks about a new office of strategy management. This office or function coordinates all the activities that go into the six-stage management system. We describe the roles and responsibilities for the strategy management office as well as where it should sit in the enterprise. The most natural place is likely within the finance function because finance is traditionally involved in planning, resource allocation, reporting, monitoring and evaluating. We have given the finance function a new and robust set of tools to help it guide the enterprise into the future. One can think of renaming the CFO to become the CVO, the chief value creating officer, or the CPO, the chief performance officer.

JofA: For CPAs who haven't had a lot of experience up to this point with either activity-based costing or balanced scorecards, how would you recommend they go about learning this? Where should they start and what should their focus be in learning how to become an integral part of a closed-loop system like the one you describe?

Kaplan: On the particulars of ABC and BSC, there are many articles, books and cases available that they can order. As far as having accounting and finance people become more central to the strategy management system, they'll have to get more comfortable being a business partner with the line managers and general managers, the CEOs. You can't just be the scorekeeper, sitting on the sidelines. You actually have to be part of the team. And that's probably a good place to start, is to become a more value-added partner of the team. You still need the finance function to be the corporate conscience or the corporate skeptic. Not all strategic ideas are profitable ideas or ideas worth doing, and the finance function has to retain that skepticism and control mentality. But they must complement the control function with a mind-set of helping the organization create sustainable value.

Accountants don't need to reinvent this stuff; these ideas now have been out about 20 years and there's been enough written about them that they should be able to do some reading or go to some courses to learn the fundamentals.

JofA: How do you see the use of balanced scorecards and strategy maps and strategy execution and dashboards and budgets-the things that are in the center of this closed-loop system-evolving over the next five years or so?

Kaplan: I think that our current knowledge about the effective use of strategy maps and scorecards now offers something uniquely valuable that no other approach can. The ability to describe your strategy, to measure your strategy, get feedback on your strategy-these are fundamental to business. All businesses need these capabilities, but until we formulated strategy maps and scorecards, they lacked the tools to accomplish them. I think that most people now recognize the limitations of attempting to manage competitive organizations with financial metrics alone. Financial metrics remain important, but they're not sufficient for guiding the success of the organization, and we now know how to fill the gap.

Intellectual Capital

2010-05-18T15:08:00.001+07:00

Intellectual Capital: Acquisition and Maintenance: The Case of New Zealand Banks

Kiran Sahrawat. Journal of Internet Banking and Commerce. Ottawa: Apr 2008. Vol. 13, Iss. 1; pg. 1, 32 pgs

Abstract (Summary)
The new knowledge economies have highlighted the importance of intellectual capital (IC) and the imperative need to measure and manage their associated costs and benefits. Banks and financial institutions, which are rich in IC (human, customer, and social capital), are in danger of becoming subject to 'IC walkouts' if they resist accounting for the hidden value that exists in IC and its constituent elements. This paper discusses how New Zealand banks incur the cost of acquiring IC and realize the need to recognize related cost drivers. For banks in New Zealand, one of the most important sources of revenue or interest income is from mortgage business. This investigation looks at the value added by mobile mortgage managers (MMMs) and a possible model for measuring the IC vested in MMMs. Some of the issues and concerns explored should be of importance to accounting (management) academics. A number of potential problems that are identified suggest the need for more diversified research to develop an effective model for IC valuation that includes social networking and political underpinnings, in this age of globalization and value creation.

INTRODUCTION

It is increasingly stated by professional accountants, institutional investors, and e-accountants, especially of the new knowledge economies, that new financial and management accounting concepts and practices need to be established to acknowledge the intellectual capital (IC) of business enterprises. Whether it is in manufacturing or service or technology, the value vested in human IC cannot be ignored. This concept of measurement and management of IC costs is gaining importance in the service industries too. These industries include insurance companies, financial institutions, banks and companies based on high technology. Accountants from different countries, industries, companies and backgrounds agree that the focus should be shifted from IC measurement to another level of accounting for IC that is acceptable to auditors and accountants to fit in the financial reporting regime.

In New Zealand, banks are a special vehicle of the service industry and occupy a unique and pivotal place. Of their various products and services, one of the most important is the residential mortgage and it is this intellectual or human capital (the terms IC and human capital have been used synonymously for this analysis) that drives it and possibly makes it successful. All banks lend funds and have several schemes for residential mortgages, but how many are doing it successfully or recognising that it is human capital that adds the value to their products? Further, there is no evidence of measuring the enhancement of social capital in New Zealand through mobile mortgage managers (MMMs), and their value in creating the rich tapestry of social and political well-being.

Simply put, IC in banks is the vested human capital that builds or expands the customer capital base. In recent years, MMMs in New Zealand banks (NZ banks) have become one of the important means of building a customer capital base. They are a principal generator of revenue, through helping create continuous revenue over a long period of time. Therefore, they are an aid in managing and improving bank profitability. The profitability generated from the IC contributed by the MMM category can be measured directly or indirectly and hence it can be managed.

The main objective of this paper is to investigate how NZ banks incur the cost of acquiring IC and realise the need to recognise related cost drivers (e.g. research and development (R&D), recruitment, maintenance and retention), but are not spending much time or capital on assigning values to MMMs.

The paper also identifies and analyses the important cost drivers that provide insight into the suggested cost-benefit analysis approach and develops a value-creation model in accounting for IC in NZ banks. This can be applied to any human capital-related area in a service industry (e.g. an insurance company or an educational institution) or to any commercial enterprise having a customer base as one of the strands of its capital.

To achieve these objectives an investigation of the following issues was conducted:

(i) the major types of cost traceable to MMMs in NZ banks

(ii) the percentage of residential mortgage business brought in by MMMs from 1999-2006

(iii) whether MMMs add value to the mortgage products.

This paper acknowledges that the social and political underpinnings of capitalism cannot be ignored. Also, the social conflict between labour and capital that is fundamental to capitalism cannot be isolated. Having said that, despite the importance of the above it is not possible to explore value creation on the basis of critical and normative theories in this paper due to the type of information available from the banks.

The paper discusses the constituents of estimating the value of IC and contextualizes it in the MMMs initiative in NZ banks. The author provides an overview of techniques for IC valuation, with particular reference to the work of Baruch Lev, Bob Woods, Ramona Dzinkowski and Ante Pulic. That overview is followed by methodology and links between the theory and the model. The paper then presents some insights into the banking sector and the IC vested in MMMs. Further, against the backdrop of the insights and empirical findings of the MMMs, a comprehensive, simple, straightforward and user-friendly value-added model is suggested. Finally, in the context of product differentiation and change driven by globalization (lifestyle implications, technological advancement), the conclusions and scope for further research are outlined.

WHY INTELLECTUAL CAPITAL?

With regard to IC, over the years many definitions, indicators and measurement techniques have emerged. Some of the widely accepted and all-inclusive definitions encompass organizational (structural) capital; innovation and structural capital; human capital; relational (customer) capital; and social capital. Our ability to understand and measure intangible assets and intellectual capital has progressed greatly in recent years. Some examples of ground-breaking research in this area are the Q model developed by the Nobel Laureate economist James Tobin in the 1950s, the invisible balance sheet (Sveiby, 1989), the balanced scorecard (Kaplan & Norton, 1992), Skandia NavigatorTM (Edvinsson & Malone, 1997), the VAICTM model (Pulic, 2000), IC-Index (Roos, Roos, Dragonetti & Edvinsson 1997), Direct Intellectual Capital (Anderson & Mclean, 2000) and IC Rating (Edvinsson, 2002).

Pulic (1997) developed the VAICTM model to measure the extent to which and how efficiently IC and capital employed create value based on the relationship between capital employed, human capital, and structural capital. Williams (2000) used the VAICTM model and recognised it as a 'universal indicator showing abilities of a company in value creation and representing a measure for business efficiency in a knowledge-based economy' (Pulic (1998) - see Appendix I). Schneider (2000) supported the adoption of this technique as an effective method of measuring IC through the VAICTM model.

One of the authorities on IC is Baruch Lev. He defines IC in the following way (Bernhut, 2001, p. 17):

Any asset is a claim to a future benefit, such as rent from owning a commercial property. An intangible asset is - if it is successfully managed - a claim to a future benefits that does not have a physical or financial embodiment. When that claim is legally secured, as with a patent or copyright, it we generally call that asset 'intellectual property'.

There has been considerable research on IC management and valuation techniques embedded with complex and intricate issues on constituent elements. Researcher Baruch Lev, having initiated the value creation scorecard, is now campaigning the knowledge capital earnings methodology and is finding ways to provide intangible asset valuations corresponding with the financial reporting hypothesis. Critical accounting advocates have admitted and acknowledged the empowerment of middle-class intellectuals as administrators of hegemony, as conceived by Gramsci (Strinati, 1995). The Canadian Institute of Chartered Accountants recently conducted a survey that shows that top executives of the Financial Post 300 firms in Canada and the Fortune 500 firms in the United States consider IC to be a critical factor in a firm's success.

With respect to IC, it is very difficult - even with patent laws - to appropriately secure and derive all the benefits from the assets. This weighs heavily on accountants because for something to qualify as an asset it must control the benefits. But you don't really control the benefits from training employees or labour, for example. So it is said, 'Well you may get benefits from it from time to time, but you don't control it, so it's not an asset' (Bernhut, 2001, p. 18).

A unique aspect of IC is that it contains no markets. There is no market in processes and no market in human assets, except where 'headhunters' focus on senior management, directors and CEOs, making it riskier and more difficult to manage and value these assets. At the same time, it is only by applying market values to human capital that banks in New Zealand compete with each other when hiring human capital or labour or mortgage managers. This type of competition, given New Zealand's small population (approximately 4.2 million population) within which the same people are moving from one organisation to another, and the human and social capital enrichment, may be seen as debatable.

The market provides guidelines for valuations, so investment bankers or employment markets, when valuing companies for initial public offerings (IPOs), usually look at what are known as 'comparable' or similar company valuations. Due to competition in hiring appropriate mortgage managers, and the lack of specific value measurement, the valuation of these assets involves subjectivity.

Recognized authorities on IC like Baruch Lev, Bob Woods and Ante Pulic have created techniques to measure intellectual capital. Notwithstanding the many advantages of these techniques (like those for intangible assets such as brand equity and copyrights), the methodologies for measurement and management of IC have their application problems and limitations.

At a brainstorming round-table conference, 'Leveraging Your Hidden Brain Power' (hosted by Deloitte Touche Tohmatsu), the theme was: 'Harness your company knowledge before it walks out of the door - and takes your business with it' (Haapaniemi, 2001). In their conclusion, attendees at the round-table conference agreed: 'knowledge management - sharing intellectual capital, leveraging intellectual capital, however you want to describe this process - can produce another amazing round of productivity improvement'. Or, as stated by Zhou and Sun (2001, p. 19):

Generally, intellectual capital refers to the difference between a company's market value and its book value. It consists of organisational knowledge and the ability of the organisation's members to act on it. IC is often used synonymously with the terms intangible assets, intellectual assets or knowledge assets.

Lev developed a methodology for valuing intangible assets that consists of three parts: measurement, drivers and validating usefulness. The basis of the methodology is generated by three major inputs: physical assets, financial knowledge and intangible assets.

An Australian project entitled 'Are companies thinking smart?' (Guthrie and Petty, 2000), based on empirical aspects, applied a popular model - the Intangible Asset Monitor, developed by Karl Erik Sveiby, wherein Sveiby classifies firm intangibles into three elements. Firstly, Human Capital: represented by human resources (employee competencies), which are broadly related to education and training of professional staff, who are the principal generators of revenue. Non-revenue generators are called support staff. Employees create value by applying their skills, exerting their knowledge and initiating new ideas. It's a matter of transforming their tacit knowledge into explicit variety. Secondly, Structural Capital: related to internal structure, which includes organisational structure, legal parameters, manual systems, research and development and software systems. Thirdly, Customer Capital: related to external structure, which includes items such as brands and customer/supplier relationships. It also includes customer loyalty and organisational reputation.(Adapted from Karl Sveiby's developed Framework (1997).)

In the abovementioned Australian project, the percentage breakdown of the IC of 70 companies was represented as follows: 40 per cent reporting external capital, 30 per cent the internal capital structure, and 30 per cent the human categories. The skew towards external (customer and relational) capital items was greatest, proving that in recent years rationalizing distribution channels, reconfiguring firm value chains and reassessing customer value have increased in importance. The internal and human categories were evenly matched at 30 per cent each.

Human capital can be interpreted as the engine of intellectual capital, with structural capital providing the support and customer capital deriving benefit from human and structural capital. Banks and financial institutions, which are rich in intellectual capital stock, need to create an environment in which people (human capital) can produce extraordinary results (customer capital).The sum total of this forms the basis of social capital and raises questions about how to sustain this social capital in a political and capitalist environment. The core idea of social capital is that social networks have value. The value of networks is not exactly measurable, but they do increase productivity, both individual and collective. Jane Jacobs tried to define social capital in the 1960s as the 'value of networks'. Portes (1998) identified four negative consequences of social capital. On this basis, and with other established research, it is an economic concept of human capital (see Fig. 1 Influences on the process of economic growth).

Notwithstanding the immense importance of external (customer and relational) capital, it is important to remember the following:

(a) Customer capital is also an intrinsic part of social capital. Social capital theory is based on the core idea that social networks have value. Just as structural capital and human capital can increase productivity, so can social contacts affect productivity? Unlike economic capital, social capital does not deplete on use. In fact, it is based on the reverse analogy - it depletes by non-use ('use it or lose it').

In the context of mortgage managers, the process of sourcing funds is achieved via a procedure known as securitization. This is a process whereby assets (such as mortgages) with an income stream are pooled and converted into saleable securities These assets are purchased and packaged into low-risk, negotiable securities such as bonds and then issued to investors. The MMM's job is to set up the loan and perform a liaison role with all parties involved, namely originators, trustees, credit assessors and the borrowers providing the customer service role. Having said that, NZ banks do not follow the securitization procedure.

(b) Customers can be bought and sold in terms of explicit valuation of future sales, and the potential of specific customer groups is increasingly an important component of merger and acquisition decisions (Schmittlein, 1995).

(c) With the increase in internal sales (business to business) in the area of electronic commerce, customer loyalty has become a greater challenge. Today's customer is exposed to a huge variety of advertisements, competing firms, products, brands and price wars.

Therefore, IC includes traditional intangible assets such as brand names, trademarks and goodwill and new intangibles such as technology, skills and customer relationships. These are resources that an organization could - and should - make the most of, in order to obtain competitive advantage (Zhou & Sun, 2001).

WHY IS IT DIFFICULT TO MEASURE VALUE?

The term 'value' has been the most used phrase since accounting history began. It has been applied in different forms: (i) utility-based (marginalist) forms; and (ii) concept of value (with all its social allegiances) forms, which dominate contemporary accounting and form 'the normative origins of positive theories' (Tinker, Merino & Niemark, 1982, p. 168). Why is it so difficult to measure and assign value to IC, when value theory has traditionally been central to the development of accounting? In fact, value assigning, accounting, measuring and reporting are inclusive of one another, and the alignment of accounting and value seems impossible. If the social concepts of value and social conflicts are treated as another lens that is essential to and an intrinsic part of the social capital, then the valuation of intellectual capital is possibly affected by variables such as land, labour and capital, which again form the basis of different theories of value. Against this backdrop the value addition also includes an element of the evolution of products, in contrast to worldwide competition in response to client demands.

The value given to MMMs in dollar terms may be in line with the economic environment, wages, price index and competition in the New Zealand labour market. However, the value assigned to MMMs in terms of social and political capital, sustainability, healthier and motivated employment or dynamic labour markets and the basic security levels provided to New Zealand's clean, green landscape is immense, and needs to be acknowledged and valued.

Labour and capital are the two critical powerful forces impacting directly on intellectual capital (property rights) to achieve productivity improvements, which are in turn the driving forces behind sustainable economic growth (see Fig. 1, Influences on the process of economic growth). Endogenous growth models speculate that increases in the stock of knowledge, which improve the quality of labour and capital, are important, and at the same time knowledge alone cannot generate sustained economic growth. A number of important mechanisms must be in place to facilitate the conversion of knowledge into productive technology that has the potential to improve economic growth.

Figure 1 makes it clear that the productivity with which labour and capital are combined to create output is potentially influenced by a number of factors. At a fundamental level, a sound legal and institutional framework that enforces a well-defined system of property rights is considered to be an essential part of a well-functioning market economy. Such an arrangement allows firms and individuals to control the assets that they own and thereby retain the benefits of their productive endeavours. The second tier of Fig. 1 indicates that macroeconomic stability is also widely accepted for sustainable growth and instills greater certainty about the future. As a consequence, investment in physical and human capital can be undertaken with greater confidence. A social infrastructure that is favourable to economic growth supports capital accumulation, skill acquisition, innovation and technology transfer. Predetermined geographical factors can have an important influence on productivity. This factor is of special relevance to New Zealand, given the size of the country and its distance from international trading partners, despite it being integrated into the global economy (adapted from Conway & Orr, 2000).

Methodology

The suggested cost-benefit analysis model for finding value addition (VA) by MMMs, developed later in this paper, is a simple process of acknowledging and measuring important cost drivers, revenues, productivity, profitability and other relevant variables. It prepares the basis to measure the value added by MMMs. Therefore, it is suggested that important issues of value addition through the measurement of cost and IC-related costs for an important intangible asset vested in MMMs is probably the secret best kept by banks in New Zealand.

As mentioned earlier, since the social conflict between labour and capital is fundamental to capitalism, the distortions of the role of labour/human capital in the process of value creation are being increasingly recognized. Globalization and communication channels are forcing the sharing of information (the very essence of knowledge economy) and dismantling the high walls built around senior or knowledge managements. Therefore, there is now much less distinction between management and labour. Having said that, in reality the desired level of emancipation among 'middle-level' intellectuals has not yet been achieved, even in the developed world. Secrecy and holding back certain types of useful information from employees is still the preferred way of the employers and senior management in most organizations. Sharing value additions to the firm or a product line due to the improved productivity, profitability and proactive attitudes of employees responsible in the creation of a customer base is still seen as a threat. This is especially true for union-oriented, commercial and industry environments.

Although the techniques used in this paper for measuring value are somewhat subjective, once the importance of the system of cost management of IC is recognized, improvements may follow. This paper focuses on how NZ banks incur a cost in acquiring IC (human capital) and their need to recognize the importance of the related cost drivers: research and development; recruitment and training; maintenance; upgrading; and retaining of MMMs.

Investments are made in human capital (MMMs) and through them in customer capital (customers who take the loans). It is a fundamental business objective and moral responsibility of an entrepreneur (bank owner) or investor in people and management to ensure that they reap the benefits from the investments made and costs incurred.

The VAICTM model can be used in a variety of ways and markets to measure IC in a holistic manner. Pike and Roos (2004) analysed various models of IC measurement and suggested that VAICTM is a model that passes the test of completeness, independence, agreeability and scale measure (ratio), and is therefore more reliable and comprehensive. The VAICTM model is complex in application and its use requires specialists equipped with practical knowledge of the applications (see Appendix I). Unfortunately, even if such specialists are readily available, banks and organisations do not wish to hire such expertise, as the specialists (being few) demand high remuneration packages and most employers and owners try to avoid such a situation if possible. This is the reason they wish to maintain absolute secrecy on a number of variables in the VAICTM formulae.

The NZ banks cannot afford to ignore the adverse implications (in terms of costs and loss of revenue) for their profitability and productivity when their IC is lured out or leaves for other reasons. Peter Drucker (1999, p. 142) emphasised: 'Knowledge has become the central, key resource that does not have geographic boundaries'. However, knowledge has social, cultural and political underpinnings, especially in the New Age globalization bursting with dynamic and powerful levels of communication. The global movement has, therefore, become much easier.

Since 1996 MMMs have revolutionised the residential mortgage business in New Zealand. They are the principal generators of total revenue from mortgage business (approximately 66-85 per cent; see Tables 2 and 3). MMMs form the building blocks of a high value of human and customer capital, and therefore their importance in the social capital formation in the New Zealand economy cannot be understated. (Note that for the purposes of this paper, IC and human capital are treated synonymously.)

My investigation of NZ banks revealed that there is an absence of any costing technique or value-addition measurement method being applied to find out the changes in profitability and productivity as a result of employing MMMs. However, banks do measure the absolute amount of variances in dollars, in terms of targets and actual achievements. The accounting firms auditing the banks' financial statements and reporting systems are also silent about the value added by MMMs to organizations, society and the economy, despite the significance of property and/or mortgage business to New Zealand's society and economy.

My plan for approaching the exploratory research was, first, to approach the banks that have employed MMMs. I then identified my sampling group by selecting those banks that had been using this form of human capital (MMMs) for value addition and revenue generation from the mortgage business for at least 5-8 years (in order to make the period representative). There are five major NZ banks (ANZ National, ASB, Westpac, BNZ and Kiwi bank) and I chose three of them due to availability of information and responses to questionnaires. Finally, I chose to conduct semi-structured interviews, as information and data in response to direct questionnaires was not forthcoming because:

(a) the banks did not have the relevant databases and did not agree to give the detailed empirical evidence needed owing to New Zealand's Privacy Act 1993

(b) the banks were not ready to divulge information that would demoralise other employees

(c) there is competition among the banks.

The semi-structured interviews were conducted with MMMs, their senior managers, branch consultants and some customers. For an overall secondary information analysis, I relied on annual reports, financial disclosure statements, and documents and archived sources. The semi-structured interviews provided some insights on value and scope for further research. Some of the issues raised should be of concern to accounting (management) academics and need to be addressed.

INTELLECTUAL CAPITAL IN THE BANKING SECTOR

The New Zealand banking industry is rich in human capital and customer capital. The industry should try and optimise the advantages accruing from this intellectual capital. Mobile Mortgage Managers provide the banks with the benefits of managing customers as strategic assets. The customers include loyal customers who are less inclined to shop around or buy mortgages at a given price, for a more efficient, effective, highly targeted and focused customer base (Schmittlein, 1995):

It is this customer who provides a stable predictable source of revenue, future revenue and can be reliably differentiated from each other based on his/her behaviour.

Customer networks form one of the main lenses of social capital in the banking sector context in New Zealand, as in most other countries. Despite the overhyped secrecy surrounding information sharing, banks seem oblivious to the role that is played by MMMs in structural capital and labour savings on the one hand and contributions to the social capital in the form of value addition by customer networks on the other hand. From discussions and interviews conducted it emerged that banks were blissfully ignorant, and wished to remain so, about assigning direct and indirect value additions by MMMs. Acknowledging the value addition may cause pressures on management and capital that employers were not ready to deal with. Simply put, it is not on the banks' agenda, due to cumbersome consequential costs and information they may have to deal with or disclose.

The MMMs of the big NZ banks represent the walking, talking intellectual skills that have brought in a huge customer capital base. Since 1996, they have added a completely different flavour to the mortgage business in New Zealand through their creative networking. The personalised networking and methodology may be old, but the style is new. Their innovative strategies have produced unexpected results and yet they are not recognized as contributors enriching the social fabric of communities they are serving in terms of value creation and ultimately measured through some form of accounting. MMMs in New Zealand are not appreciated as high-value contributors to the social capital environment, even though mortgages are one of the intrinsic and basic lifestyle choices of New Zealanders.

Traditionally, the banking industry has a dual driver, unlike manufacturing companies or industries, where the main driver is the product. In banking there is a three-dimensional and three-phased process on the one hand - the organization, product and accounts - and on the other hand there is the service driver, which has its wealth in customer capital. The cost of funds in a bank, like the cost of goods in a manufacturing firm, represents the cost of producing and selling a product. While in manufacturing there tends to be a reduction of production costs per unit as fixed costs are more widely spread with increased production (up to a certain point), this is not so in banking operations (Kiran, 1986).

Efficiency in the banking industry is measured through traditional ratio analysis (for example, earning ratios, expense ratios) and through simple productivity parameters like deposits per employee, advances per employee, mortgage business per manager, total business per employee, and expenses per employee.

Funds used efficiently owing to high productivity of personnel will lead to high profitability. Productivity is an input/output ratio. When we talk of productivity, we enter into the area of employee efficiency, which has a bearing on profitability. Some bank managers feel that one or all of the following could improve profitability in general:

(i) Internal efficiency:

- Operational efficiency

- Managerial efficiency (that is, efficiency of management control).

(ii) External efficiency (that is, efficiency in dealing with customers).

These are interrelated to a certain extent. It is well known that external efficiency is of prime importance in the banking industry.

In general, therefore, a drive for continuous productivity improvement, especially in the Internet economies, is a challenge to the banking sector. The VAICTM method measures and monitors the value creation efficiency in a company using accounting-based figures (see Appendix I). The better a company's resources have been utilized, the higher the company's value creation efficiency will be.

The efficiency of NZ banks in serving customers has been driven by technological advances in the last few years. In New Zealand, electronic funds transfer at point of sale (EFTPOS) terminals have grown in number from 46,360 in 1996 to 84,351 at the end of 2000 (Detoured, October 2001, p. 6). However, there are customers who prefer traditional 'across-the-counter' and 'face-to-face' relationships, and these results in different levels and quality of productivity.

In banking, customer capital refers to the organization's relationship with outside parties. It includes customer loyalty, the organization's reputation and its relationship with suppliers, partners and/or other stakeholders. Customer capital is the organization's ability to meet rapidly changing customer needs, to provide knowledge and financial service to customers and to capitalise on their relationships with outside parties (Zhou & Sun, 2001, p. 19).

It is this customer capital approach that some of the big banks in New Zealand have adapted and refined that has added more value to important, high income generating mortgage business through MMMs. They operate in an almost free business environment, capitalising on their abilities and using traditional relationship-building techniques of servicing customer needs and assessing customer satisfaction on an ongoing basis. It is important here to concede the importance of social capital. The lens of customer capital as part of social capital is important for both the microeconomic and macroeconomic environments, especially capitalist economies, which are based on social and political underpinnings. Another important lens to be recognised lies in the relationship of income and capital, which cannot be ignored when discussing value creation. The customer provides the 'income' and is the essential contributor to the survival of the banking sector. In New Zealand, MMMs are one of the main catalysts or mediums through which considerable cash flows are injected into banks at the micro level and the financial market at the macro level. Hence, by engaging with customers the MMMs are facilitating, supporting and promoting social, cultural, and political stability, as well as motivating society to do better through investments in real estate and thereby lead a higher quality life through property ownership. Among the many positive dimensions, MMMs are also providing sustainability through quality of life, risk-adjusted rate of return (to both banks and their customers), collateral benefits and security for future generations, and this is yet another lens of the social capital, responsibility and social accounting framework. This is also in sync with Maslow's pyramid of needs, security, self-esteem and so on. However, this aspect is beyond the scope of the present investigation.

Mobile Mortgage Managers

Mobile Mortgage Managers are people who are helping other people to achieve one of their major goals in life. They are driven individuals who work closely with the retail networks and have the ability to proactively network while developing new business opportunities. They have almost unlimited earning potential. Their success, however, depends on self-motivation, excellence in maximising customer retention, a technical and flexible approach to working hours and most importantly having a 'can-do' attitude along with outstanding relationship management skills and networking capabilities. They may or may not have a background in the finance and property sector. They are given training and have the capacity to earn commissions on NZ$2-5 million plus loans monthly.

The ANZ National Bank was a pioneer in employing MMMs in New Zealand. It started in 1996 with approximately 20 MMMs and this figure had risen to 52 in December 2006. The BNZ has the second highest number of MMMs. Some of the specific features of value addition through the use of MMMs in New Zealand banking that emerged from interviews with bank staff and MMMs are as follows:

* Relationship marketing: MMMs work on a one-to-one basis, using the most personalised retail sales technique, in the form of relationship building. It is like the haute couture or boutique business, where the word of mouth of an already satisfied and known customer is enough to encourage others to become customers. The average New Zealander changes their house and reorganises their mortgage arrangements six to eight times in their lifetime.

In New Zealand, taking out a mortgage is a comparatively frequent and compulsive decision that affects the person's lifestyle and makes a social statement. A satisfied customer's communication is significant. A customer communicating satisfaction to a friend or colleague has greater influence on whether or not that friend or colleague becomes a customer of the bank or MMM. A customer gained through the recommendation of another customer is already in a positive frame of mind and is more easily satisfied by the MMM.

* Value addition: MMMs add value to the mortgage by working closely with other retail networks and facilitating sales of other related products like insurance (life, property, and contents), credit cards, loyalty programmes, holiday packages, furnishing sweeteners and so on. They end up developing new business opportunities through proactive relationships. The big influx of MMMs into the marketplace in recent years has substantially heightened competition and enhanced global communication.

* Adding brand equity: MMMs help the customer to make decisions and choices through their selling techniques for specialised products, like fixed-interest, floating-interest and flexi-interest loan accounts (these are the brands in one New Zealand bank, the ANZ National Bank - others, like the BNZ, sell air points through global access credit cards, and Fly Buys points for mortgage installments).

* Time management: MMMs have the special advantage of flexi time and are thus able to accommodate a customer at the customer's convenience. They are self-driven individuals who want to work for themselves but are employed by a particular bank. They are not mortgage brokers who work on their own but sell mortgages for several banks at the same time. Unlike mortgage brokers, MMMs do not have a range of choices of different banks for their customers.

* Better verification: MMMs have the hands-on advantage of verifying the creditworthiness and credibility of the customer by personal interaction, as they are able to visit the client's home and workplace. They get to know their client better than a branch consultant (BC), who stays at their office. They can, therefore, conduct a more rigorous loan and client appraisal. Their relationship management skills and networking ability makes verification easier.

* Price competitive: MMMs are price competitive for a number of reasons. They have substantially lower overheads than the BCs working from bank premises. They have no extensive branch networks or shop fronts, as they do not have deposit facilities. Obtaining funds via the securitization process and low overheads often allow MMMs to undercut the bank's rates. In more recent times increasing numbers are offering comprehensive products with numerous features that increase the flexibility of the loan. MMMs normally operate from home and therefore save the bank a considerable cost for space, although banks compensate MMMs by giving them a car and reimbursing them for other maintenance costs (not a common benefit in the New Zealand private sector).

* Increasing market share: MMMs have a better opportunity to add on a segment of customers who would otherwise be left out - those who state 'I'll find out', but don't follow this up. Such a customer probably comes their way easily through the network of solicitors, estate and insurance agents, registered valuers and builders.

* Comparative analysis: The flexi time, mobility and freedom gives MMMs the time to make comparisons with other banks' mortgage products and to analyse other qualitative issues. This matters more in competition, where the product generates a high income (for example, average mortgage funds advanced range from NZ$200,000 to 300,000). These reports help the banks to maintain a competitive edge and improve their own policies.

* High-level motivation: Instant commissions on top of fixed salaries and benefits keep MMMs happy and motivated to achieve higher targets. They feel rewarded and respected and pass on their satisfaction to their customers, who in turn pass on their satisfaction and thereby bring in more potential clients. (For the purposes of this paper the words 'client' and 'customer' have been used synonymously.) Motivation also improves the quality of social networks and value.

Empirical analysis

The mortgage business on an overall basis for the 17 registered banks in New Zealand showed residential mortgages formed 46 per cent (NZ$55,670 million) of the total loans and advances in 1999 and 50 per cent in 2006 (Table 1). Between 1999-2006 the percentage ranged from 46 per cent to 51 per cent. Most of the registered banks are foreign banks (non- New Zealand and Australian banks), with the exception of Kiwi bank, and generally do not employ MMMs for residential mortgage business. A few foreign banks that have initiated this service in recent years are not willing to disclose the amount or percentage of business generated by MMMs. The proportion of bank lending to households has increased from 34 per cent to 44 per cent between 2001 and 2005, increasing alongside the cyclical pick-up in house prices for the four major registered banks (ANZ National, ASB, BNZ and Westpac). During the December 2005 year, NZ$16 billion was attributable to residential mortgages, following on from NZ$12.5 billion in each of the preceding two years. The earning yield of the four abovementioned banks on loans and advances was approximately 7.77 per cent in 2004 and 8.10 per cent by the end of 2005 (Reserve Bank of New Zealand, 2006, p. 47). It is an established fact that mortgage lending is generally viewed as lower risk than corporate lending: the loans are for low amounts relative to corporate loans and are spread across a large number of borrowers. Having said that, there are some risks and risk-management challenges associated with residential mortgage lending. For example, rapid growth in residential mortgages could compromise the quality of risk monitoring or management services in other parts of banks' balance sheets. Despite the importance of the risk-management issues, they are outside the scope of this paper.

For the three sample banks (see Table 2) during 1999-2006, the residential mortgages business generated and attributable to MMMs ranged between 66-85 per cent. The balance of 14-35 per cent of business was brought in by the mortgage managers and independent mortgage brokers. The average productivity of an MMM during 1999-2006 for the three sample banks was approximately NZ$60 million per annum. However, the static mortgage managers' or BCs' average output was approximately NZ$17 million per annum. Therefore, the productivity of MMMs in terms of advances per employee is much higher (almost 30 per cent more) than the productivity of BCs and independent brokers put together. Of the 52 MMMs in the ANZ National Bank (one of the three sample banks) during the year 2006, approximately 22 were very aggressive (those producing more business than the average). In most of the banks each MMM is doing an average business of NZ $2.5 million a month, although three or four bring in NZ$6 million per month. By 2006, the average business of an MMM had nearly doubled to approximately NZ$5 million per month, whereas the number of MMMs had increased by only 7 (total 45 in year 1999).

The total business produced by MMMs for the three sample banks has increased by nearly 33 per cent over eight years. The impact on productivity of advances per MMM in the year 2006 is nearly twice that of the year 1999. It is important to mention here that overall residential property prices have increased by nearly 40 per cent during the same period. The analysis of the increase in property prices is outside the scope of this paper.

The average number of MMMs in the three banks has ranged from 42 to 55 in number (Table 3). The percentage of average business generated through MMMs has increased from 66 per cent in 1999 to 85 per cent in both 2001 and 2002. The average percentage of business produced by MMMs for the three sample banks has dropped from 84 per cent in 2003 to 75 per cent in 2006 (Table 2). This is probably attributable to Bank B, which reduced the number of MMMs employed due to internal policy changes (Appendix III - the figures shown in Appendix III for the three sample banks have been rounded off to keep the anonymity of banks). This bank has engaged more BCs to handle premium business clients (customers with higher mortgage business) for its branches by increasing salary packages to motivate them.

This move was perhaps due to the increasing rivalry and aggressive competition in hiring MMMs among the five main banks in recent years. MMMs were increasingly walking in and out of banks and negotiating higher remuneration packages corresponding to their IC (customer and social networks) on the one hand and the aggressive property market in New Zealand on the other hand.

Successful MMMs have a unique way of networking with customers and branch consultants. The relationship or team-building skills between the branch banking consultant (BC) (the static loans or mortgage manager) and the customer comes second. Sometimes a customer who is ready to sign may suddenly be put off by a little carelessness on the part the BC and walk out. Interview data has shown many times that a little negligence on the part of an MMM towards the end of the deal has also cost them time, money and loss of reputation and, therefore, future business.

One cannot 'buy it' - one either 'has it' or 'hasn't got it'. Some skills cannot always be acquired through training. As highly skilled bank staff, MMMs cannot afford to be careless or negligent because of the time invested in a client. Only when the deal is through and all the add-on products (essential to complete the deal) sold to the customer, arrangements for follow-up by the concerned accounts manager made, and the actual disbursement of the loan on the settlement day made, can an MMM claim the particular mortgage arrangement as their business. This is the time when MMMs make commissions.

When an MMM gives the best deal and gets the next referral customer, they may consider their added value to the bank and the bank in turn must recognize the intellectual capital vested in this MMM. As opposed to MMMs, the BC may work most efficiently in the safe and secure environment of the bank branch, but be uncomfortable outside it. In New Zealand's multicultural environment, where the customer base consists of Maori, Pacific, European, Chinese, Japanese and Indian people, one of the recognised add-on qualities of an MMM is their ability to relate to diverse cultures and to be bilingual where necessary. A loan and customer may be lost when a BC does not give the customer sufficient time, because of routine branch pressures and the consultant's unwillingness to work outside a set routine. Banks in New Zealand are increasingly hiring MMMs from different ethnicities to reach out further and provide additional and specific services relevant to the culture of the client, as long as the mortgage arrangement is within policy limits and the requisite documentation is completed to the satisfaction of the bank.

COST MEASUREMENT AND ACCOUNTING FOR IC

Some companies and banks have already adopted activity-based costing (ABC) techniques and can further refine cost pools and drivers. Others have adopted the income generation or incremental cost or profit approach. However, the foundation of IC is people, and its importance lies in assigning people's abilities and capabilities a value. The reliability of valuations of intangibles such as IC is controversial. The controversy can be resolved through consistently measuring the effects of IC on the profitability of an organization or bank. The valuation controversy has been resolved to some extent by iconic models such as Skandia's Navigator, Balance Scorecard and Value Creation Scorecard. However, these pursuits have not found much practice in New Zealand, especially in the banking sector.

The following are two issues that any bank needs to consider before designing an accounting and measurement model for IC:

(a) Acknowledgement that intangible assets like human capital are non-rival assets that can be simultaneously used by different users. However, rival assets as explained by economists are those physical assets that cannot be used elsewhere at the same time. Different users compete for the use of an asset (adapted from Bernhut, 2001).

(b) Protection or valuation of their own IC and its measurement, especially in the new economy, through value addition.

Generically, a firm's IC is acknowledged as the difference between market value (MV) and book value (BV):

IC = MV - BV of the company or firm

This method is simple, but it is unlikely to capture the complexities of the real world. There are various imperfections in market valuations, and book values can be affected if firms choose or are required to adopt tax/depreciation rates for accounting purposes.

A way of getting around the depreciation rate problem when comparing firms' intellectual capital is to use Tobin's 'q'. This was initially developed by Nobel Prize winning economist James Tobin as a method for predicting investment behavior. It uses the value of the replacement costs of a company's assets to predict the investment decisions of the firm, independent of interest rates. The 'q' is the ratio of the market value of the firm (share price x number of shares) to the replacement cost of its assets.

Tobin's 'q' is subject to the same exogenous variables that influence market price as the market-to-book method described above (Dzinkowski, 2000). Both of these methods are best suited to making comparisons of the value of intangible assets of firms within the same industry, serving the same markets, with those having similar types of fixed assets.

Another measure is the calculated intangible value (CIV). This has been developed by NO Research to calculate the fair market value of the intangible assets of the firm (the method follows Revenue Ruling 680609 of the United States Internal Revenue Service). The CIV calculates the excess return on hard assets, and then uses the figure as a basis for determining the proportion of return attributable to intangible assets. In this approach the company's cost of capital will dictate the net present value (NPV) of intangible assets. In order for the CIV to be comparable within and between industries, the industry average cost of capital should be used as a proxy for the discount rate in the NPV calculation.

According to Bob Woods (2001), measurement of intellectual capital can be seen as follows:

The value of IC = cost + value of goods and services as they increase as a percentage over time

Woods gives an example of a pharmaceutical industry where probably 99.5 per cent of the cost of the product represents IC. In a pharmaceutical industry one pays a few cents for the actual chemical/material that goes into the capsules, pills or injections, and one pays a fortune for the R&D costs of the medicine. This R&D cost is the real intellectual cost of capital for an investment. The accounting school of thought, however, regards and treats R&D skills and endeavors as a cost that must be written off immediately against profits.

EFFECTIVE COST DRIVERS

As in many other organizations, besides the usual recruitment and training costs (RTC), the cost drivers identified below are also relevant in the banks for cost measurement and ascertainment.

The research and development costs (RDC) are equally important in service industries like banking and financial institutions, where the search for streetwise, honest, reliable and flexible personnel is of paramount importance. Another cost can be the cost of researching and developing the type of personnel capable of learning to sell the variety of products and brands to the customers and fulfilling the high expectations of the new economy clientele. Typical bank advertisements for MMMs read along the following lines: 'We require driven individuals, with demonstrated experience, who want to work for themselves. Required skills include: excellence in managing customers; the ability to maximize customer retentions; and outstanding relationship management skills and networking ability'.

The cost of non-communication - that is, not sharing knowledge - is that some people communicate after the event is over. When organizations do not bring their staff together for meetings or brainstorming sessions, they are not using their intellectual capital. Bouncing ideas in person is very different from asking for ideas via emails or circulars, as these methods do not allow theories to develop and discussions cannot take place. This leads to stagnation and underutilization of valuable human capital. These can be termed as maintenance costs (MC) of intellectual capital or retention or harnessing costs. Organizations have to keep coming up with ideas to retain the interest of innovative and creative intellectual capital. In the case of MMMs, it is essential that they have regular meetings so that they can discuss uncertainties and difficult issues and develop new strategies that will help them to generate more business.

Another common set of costs is the upgrade and development cost (UC) of existing intellectual capital. Sending MMMs to self-development courses and workshops, where they are encouraged to up skill (that is, enhance their professional capabilities and personal attributes), allows them to acquire further skills and techniques or accumulate new toolkits. The development courses and workshops range from marketing to real estate to customer psychology.

The upgrading programmes must be custom-built or tailor-made for the type of group or IC being sent to up skill and upgrade their knowledge. Upgrading costs form a part of maintenance costs or retaining costs, depending on the organizations' cost-management strategies. Although these vary from organization to organization, the end result or objective remains the same - to preserve and nurture the organization's intellectual capital.

Among retention costs (RC) may be a number of benefits (in quantity and kind) that can make the employee feel rewarded and special. Paid vacations for the employee and their family, club memberships and special establishment cards have become a little outdated. The new mantra is a balanced lifestyle, meditation, spirituality, business/life coaches and 40 hours a week real time work. Preserving precious intellectual capital needs care and the will to sustain human and social capital. The number of professionals seeking solutions to attain spiritual healing, the higher self, the inner self, happiness, management of ego, self-control and accelerated meditation learning is growing. The costs incurred in sending MMMs to business life coaches are linked to retention.

An organisation must never become confident that their IC will stay forever. However, as noted by sociologist Abraham Maslow, strong relationships with human capital have sometimes proved valuable in meeting needs in terms of esteem and self-actualisation. The cost of assisting employees in the fulfillment of their needs for esteem and self-actualization is another retention cost.

Though all banks have different mission statements, the NZ banks' mission statements require them to retain the IC vested in their MMMs. The interviews revealed that some banks have made a small beginning by doing one or more of the following:

(a) Some senior managers and directors of banks have realised that they cannot achieve their goals by being sales driven only. It is important to have bosses who have a balance-in-life approach or policy for their employees

(b) drawing the attention of MMMs to the investments made in them, in terms of recruiting, training and extra benefits; encouraging them to consider the accounting aspects; motivating them to be more productive; sending them on vacations to rejuvenate them; and providing business/life coaches to help them achieve personal and more balanced goals automatically lead to more mortgages. Hypothetically, if an average MMM generating NZ$3 million per month in business decides to leave, the bank immediately loses NZ$9 million of hardcore sales (as it takes 3 months to recruit MMMs). Besides this, for the next 3 months their sales are lower and three people (the new staff member's network, which may include a mentor) are helping the newly recruited MMM. Add to this the loss of the MMM's personal talent, expertise and networking ability (which cannot always be acquired). Therefore, by the time the new MMM comes up to the level of NZ$3 million a month in sales, the amount of business that has been lost by the bank is approximately NZ$13-15 million. It is estimated that it takes approximately 6 months before a new MMM shows any worthwhile results.

When recruiting, the additional costs such as non-competition agreements and their long-term implications are increasingly important to banks (these are like the non-compete agreements among IT professionals, especially where they have access to sensitive information). Features of non-compete agreements may be:

(a) stipulating conditions about the extent of time that employees stay away from competitors

(b) prohibiting employees from taking secrets or confidential materials to the competition.

Previously, these contracts were common among executives and sales employees. However, today they are common for telecommunications and software and hardware companies. The practice is also expanding into non-technology companies where employees have access to sensitive information. A TMP Executive Search (USA) Survey of 200 companies found 78 per cent of the companies ask all or some employees to sign formal agreements, 98 per cent require confidentiality agreements, and 88 per cent with sales of US$50 million or less have strict non-competes (Goodridge, 2001, p. 59).

Therefore, once the recruitment, training and required level of performance costs and networking costs are added, the total cost becomes quite an encumbrance. Analysing the reasons why an MMM wants to leave and what motivates them, sending them to business/life coaches, and knowing more about their overall ambitions and aspirations in life would be worthwhile. The ANZ National Bank has found this cost to be worthwhile to look after their IC or intellectual property. Besides retention, it also helps in creating a personal balance in life. The costs to the bank as a whole are negligible when compared with the benefits.

Unless the intangible value added by MMMs is explicitly recognized and valued by banks it cannot be socially valuable and sustainable. This form of IC needs to be acknowledged and valued (as in dollar terms in the labour market) just like any other tangible asset or service. It is necessary to recognise that in the case of IC 'what gets measured gets managed' and becomes a requirement or driver of the management control process. The non-acknowledgement of IC is causing concern, as emphasised by Thorbjornsen and Mouritsen (2002), who stated that IC and knowledge management 'is a problem for management, because suddenly the power of an individual over the central resource in society is beyond the immediate grasp and reach of the manager'. This point is outside the scope of this paper, but is by no means to be underestimated or ignored.

SUGGESTED VALUE-ADDITION MODEL

A simple methodology that gives an insight into the cost and value addition of MMMs in a bank is presented below. This procedure enables the calculation of the total cost of MMMs as a percentage of the total cost of acquiring, maintaining and retaining the entire human capital in the bank.

1. The total cost of MMMs may be represented as:

TC = (RDC + RTC + MC + UC + RC)

(Where RDC = research and development cost; RTC = recruitment and training costs; MC = maintenance costs; UC = upgrading costs; RC = retaining costs.)

2. Find the additional costs (AC) incurred to acquire the source of revenue (that is, the residential mortgage) through MMMs [AC (MMMs)]

3. Calculate the cost (C) incurred to acquire and retain branch consultants [C (BCs)]

4. Compare the percentage increase in revenue attributable to MMMs since their introduction [R (MMMs) - R (BCs)]

5. Compare the percentage increase in profitability traceable to MMMs since their introduction [P (MMMs) - P (BCs)]

6. Compare the percentage increase in productivity due to MMMs with pre-MMMs period figures [OP (MMMs) - OP (BCs)]

7. The mathematics of these will give an approximation of the value of the MMMs in the form of added value to the bank:

[TC + AC (MMMs)] - C (BCs) = X (% increase in cost)

R (MMMs) - R (BCs) = Y (% change in revenue)

P (MMMs) - P (BCs) = Z (% change in profitability)

OP (MMMs) - OP (BCs) = U (% change in productivity)

X - Y = VA (value added)

While this model requires certain subjective assumptions, it is argued that it allows an approximation of the value of the MMM function to the institutions, which is preferable to ignoring the costs involved. This model represents a first step in the assessment of the real value of the banks' mortgage products.

Therefore, this empirical and conceptual thinking initiates the concept of cost-benefit analysis that could be used for the accounting of IC in banks. As this concept of MMMs is maturing in New Zealand, with more information and better quantitative tools it can be explored further.

The value-addition model suggested is a result of acknowledging and analysing some effective cost drivers. Like other measurement models or techniques it has its imperfections in terms of subjectivity and approximations, but it is a starting point for measuring the value addition attributable to human and social capital based on achieving a number of global objectives - namely product differentiation, client demands, lifestyle implications and evolution of a global mortgage market. For example, it is quite common for a New Zealand MMM to organise a mortgage for a customer in Australia or vice versa, although this is mainly due to the migration of mortgagees between the two countries. It can also be due simply to the loyalty, dependability and reliability level achieved during previous experiences with a particular MMM and bank.

CONCLUSIONS

With existing research results in view, the major finding of my investigation in the context of NZ banks is that there is human and social capital vested in MMMs. It has added value to the mortgage products of banks and has increased productivity in terms of the amount of residential mortgage business.

In recent years, banks in New Zealand have found a way of accumulating and developing IC by way of MMMs. They have also found a way to generate more income from customer capital by producing diverse and attractive mortgage products for the unique New Zealand marketplace. This evolution of a product in the context of a global mortgage market is largely driven by globalisation issues - such as culture, lifestyle implications and technological sophistication. Recognising the value addition is an evolution of the product in the context of a global mortgage market. Management accountants have still not been able to influence banks or such financial organizations to present IC statements, and accounting regulation has not been able to make this mandatory. Merely conceding it does not imply 'measuring it or fixing it'. MMMs in New Zealand are trying to be recognised as IC of the particular bank that they are working for and yet they do not wish to forego the freedom of movement within the industry. Also, banks are not willing to give valuations or added value in monetary terms due to fears that this category of IC will become more demanding and competition, which is already severe, may become cut-throat. Everyone does not have the makings or discipline required to become an MMM in terms of personality type or attributes or the ability to work from home. Some employees can only produce results within structured workplaces. Some are naturals and yet not all can deliver outcomes in a flexible and relatively free business environment.

When banks in New Zealand downsize (see Appendix III(c)), throwing away their income-producing capability and incurring the costs of terminating people and then hiring others (the two most apparent costs), they need to explore the positive side of their business by researching the talents of the existing workforce. By being given options, those in the existing workforce have the opportunity to diversify their talents and prove their worth. Protecting and securing those who have the ability to create value-adding opportunities is a way of preserving talent. Another option is to retain and motivate the few (10-12) aggressive MMMs, while making the lower output producing MMMs redundant (tried by one bank with positive results). This may result in a larger customer base, greater customer loyalty, and ultimately a better customer fabric. But the question that arises here is: Are banks ready to recognise their responsibility and more so their social responsibility role, by embracing the value of labour and capital cycles created through MMMs?

From 1999-2001 two banks (B and C in Appendix III) showed that fewer MMMs produced a greater volume of business. The average output of an MMM is approximately three times higher than that of the ordinary mortgage manager or BC employed by a particular bank. The residential mortgage business garnered by MMMs is two to four times higher than that brought in by most managers or BCs. On the whole for four of the major banks (ANZ National, BNZ, ASB and Westpac), residential mortgages increased from 34 per cent to 44 per cent between 2001 and 2005. The percentage of the business generated by the fifth major bank through MMMs is not known, as the bank did not participate in the survey.

Since it is accepted that what can be measured can be managed, some NZ banks using MMMs and depending on static branch consultants or even independent mortgage brokers would be advised to explore the benefits of MMMs in building up customer capital and social capital, and building sustainable communities. In relation to the benefits from human and customer capital, it is pertinent to recognise the various costs and variables associated with customers, MMMs and static branch consultants, who are the principal generators of revenue (they are the means to the end - the customer). For each successful mortgage deal, the cost-benefit analysis is a result of networking among all three. Finally, the costs involved include:

(i) acquiring, recruiting and training employees

(ii) maintaining, upgrading and retaining employees

(iii) retaining existing customer capital - that is, keeping customers interested and offering them incentives

(iv) matching competition from other banks

(v) loss of business when human capital leaves

(vi) loss due to below standard or suboptimal level targets in mortgage business when new employees start performing.

The cost of retention, therefore, is important to NZ banks with MMMs. When valued IC leaves, this loyalty may be lost and it is commonplace to see certain customers move on with the MMM to the next bank. The IC vested in MMMs provides customers with knowledge and maneuvering skills to meet or exceed their (the customers') expectations. Therefore, there are additional costs associated with customer psychology and lost loyalty that must be dealt with when customers walk away with MMMs. The long-term impact of such movements is benefits for some banks and losses for others, and it does not effect the overall economic dynamics of the New Zealand banking sector.

In the survey of NZ banks it was found that some banks also entered into a 3-month non-compete agreement stipulating that the MMM will not work for another bank in the same capacity for a period of 90 days. However, in practice this is not good enough, as it takes a minimum of 12-16 weeks of induction and training before a new MMM is allowed to go out into the field and work alone. By this time they are no longer bound by the non-compete agreement terms. If an MMM left a bank and started up an independent mortgage broking business, the dynamics of the non-compete agreement would be different.

Introducing MMMs in New Zealand has proved to the banks that employing a high number of skilled mortgage managers or BCs is no longer required. Banking consultants do not carry the same importance they did a few years back, nor do they contribute directly as much as MMMs in terms of revenue generation (15-35 per cent, including the contribution of independent brokers - see Appendix III ). They have much lower productivity, and are mostly involved in adding value in terms of quality to lending portfolios. Banking consultants mostly complete documentation and service of the product after the sale (mortgage deal) has been completed. Banks can restructure these staff to reduce the cost burden. The increasing number of online users of banking facilities (Internet banking) is also a contributory factor to BCs having a somewhat insignificant role in value creation when compared with MMMs.

It is important to find the right clients, not the most clients. The MMMs have improved not only the number but also the quality of the customer base, through better verification, relationship marketing and time management and a higher level of motivation. They are also creating immense wealth by marketing other products under one roof (like insurance, which is highly competitive). Besides persuading customers through product differentiation, they are enticing customers with holiday packages on behalf of tourism companies. The cumulative effect of this business of mortgages is a win-win situation for socio-economic capital and higher productivity, ultimately leading to higher value of labour and social capital.
[Reference]
REFERENCES
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Bernhut, S., March-April 2001, Measuring the value of intellectual capital: An interview with Baruch Lev, Ivey Business Journal, 16-20.
Conway, P. and A. Orr, 2000, The process of economic growth in New Zealand, Reserve Bank Bulletin 63(1), 4-20.
DeSourdy, L., 2001, Developments in the New Zealand banking industry, Reserve Bank Bulletin 64(2), 4-9.
Drucker, P. F., 1999, Management challenges for the 21st century (HarperCollins, New York, NY).
Dzinkowski, R., 2000, The measurement and management of intellectual capital: An introduction', Management Accounting 78(2), 32-36.
Edvinsson, L., 2002, Corporate longitude: Navigating the knowledge economy (BookHouse Publishing, Stockholm, Sweden).
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Pulic, A., 2000, VAICTM - an accounting tool for IC management, International Journal of technology management 20, 702-714.
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[Author Affiliation]
Kiran Sahrawat
The Open Polytechnic of New Zealand
Postal Address: P.O. Box 31914, Wyndrum Avenue, Lower Hutt
Email: kiran.sahrawat@openpolytechnic.ac.nz
Dr. Kiran Sahrawat is a Senior Lecturer at the Centre of Accounting in The Open Polytechnic of New Zealand. Her areas of interest are Intellectual Capital and International Financial Reporting Standards (Financial Instruments).

[Appendix]
Appendix I: VAICTM Model by Ante Pulic (1997)
Measurement model VAICTM: components
VAIC is a composite sum of three indicators or subcomponents:
(1) Value added capital coefficient (VACA) - indicator of value added (VA) efficiency of capital employed.
(2) Value added human capital (VAHC) - indicator of VA efficiency of human capital.
(3) Structural capital value added (STVA) - indicator of VA efficiency of structural capital.
The higher the VAIC coefficient, the better the efficiency of VA by the firm's total resources: VAi = I+DP+D+T+M+R VA = Interest expenses (I)
+ Depreciation expenses (DP)
+ Dividends (D)
+ Corporate Taxes (T)
+ Equity of minority shareholders (M)
+ Profits retained for the year (R)
Capital coefficient VACA = VA/CA
CA is the capital employed book value of net assets for a firm
Human capital coefficient VAHU = VA/HC
HC is the total salary and wage cost for a firm
Structural capital (SC) = VA - HC
Structural capital coefficient STVA = SC/VA
Source: Adapted from Pulic (1998) and Williams (2001).
Appendix II
Two approaches to asset appraisals for value creation
The cost of an asset doesn't change once it is purchased. The value of an asset like a brand name can change. Consider Ipana toothpaste or Burma shave. These were well-known brands 40 years ago, but now they have only historic interest. Yahoo or Amazon.Com are two of the most valued brands in electronic commerce today, and no one had heard of them a few years back (King & Jay, 1999, p. 36).
The cost approach
If, in the New Zealand real estate market, bank loans or mortgages and valuations are examined, it will be noticed that the cost of the asset (that is, the house/building) has not changed, but the value is changing every year. The government adds value by appraising almost the entire real estate of New Zealand every year (varying estimates according to demand and location and so on). It gives the client a loan based on the Registered Value (RV) or Government Value (GV) today, which has nothing to do with the actual cost of the asset.
Houses or personal property are a tangible asset. Yet, if the depreciation is to be accounted for, the value should be nil for a 25 or 50-year-old house today. But here the value is the price a purchaser will have to pay to build the same building today. A purchaser wouldn't acquire an existing house at a NZ$150 per square meter if a new house could be constructed at NZ$100 per square metre.
The cost approach is considered to be reliable when dealing with tangible estates like real estate.
The notional approach

This is a market-based approach comparing similar assets or products and their selling prices - for example, how would one value a 1999, four-door BMW? A comparison with models of the same horsepower and vintage and with other similar features will establish a market value or sale price. This approach can also be used for well-established products and for consumer durable intangibles like technology, skills and customer relationships. These are the resources in which is vested the very foundation of banking in the new economy.

No-Fear Factor

2010-05-18T15:03:00.002+07:00

No-Fear Factor: For professional clients who fear liability, an accounts receivable factoring plan can be a valuable asset protection tool.

Roccy DeFrancesco. Financial Planning. New York: Nov 1, 2003. pg. 1

Abstract (Summary)
Accounts receivable factoring is now being used as a planning tool to help high-end clients protect their assets and reduce their income tax. Simply put, factoring is selling an account receivable at a discount (as authorized by Section 453). Most of the time, factoring is used when a company has a large account receivable on the books that would represent a good portion of the profits for the company for the year. Factoring is a good deal for the seller because he gets money today to pay bills or pay owners and employees of the company. Factoring is also good for the purchaser, who can afford to wait to collect 100% of the account receivable bought at a discount. Discounts on accounts receivable range from 5% to 50% depending on the industry. Factoring is common in the medical field because payments from insurance carriers are often slow, due to poor billing practices or heavy paperwork in the medical office. Moreover, professionals such as doctors, lawyers, and increasingly CPAs work in areas where malpractice or errors and omissions claims are plentiful. In professional practices, accounts receivable are typically the only real asset of the company, since the value in a practice lies with the individual owners, not in the company's hard assets.

As long as businesses have been extending credit to their customers, accounts receivable have been a fact of life. And accounts receivable factoring has been around nearly as long as accounts receivable themselves, usually to improve cash flow.

Increasingly, accounts receivable factoring is now being used as a planning tool to help high-end clients protect their assets and reduce their income tax. This article will provide an overview of how one particular type of accounts receivable factoring plan can work to benefit your clientsand why financial advisers should be wary of accounts receivable leveraging plans.

What is factoring? Simply put, factoring is selling an account receivable at a discount (as authorized by IRC Section 453). Most of the time, factoring is used when a company has a large account receivable on the books that would represent a good portion of the profits for the company for the year. That particular account receivable might not get paid prior to year-end from a client who has no money. That means the company will have a cash flow problem and potentially no profit for the year unless it can figure out a way to collect the account receivable.

For a company to send a client to collections and hope to get paid on a large debt prior to year-end is unrealistic. Small- business owners know too well how long it takes to collect from clients who have no money (sometimes it take years). What is the alternative to waiting to go through the collection process? Factoring. Many firms specialize in buying other company's accounts receivable at a discount, confident that it will ultimately get all or most of the debt in a timely fashion.

Factoring is a good deal for the seller because he or she gets money today to pay bills or pay owners and employees of the company. Factoring is also good for the purchaser, who can afford to wait to collect 100% of the account receivable bought at a discount. Discounts on accounts receivable range from 5% to 50% depending on the industry.

Let's look at an example for a medical office. Assume the office has $1 million of "real" accounts receivable (not the fluff that comes from what is billed). A factoring company contracts with the medical office to buy the $1 million for $900,000 and will cut a check today for that $900,000. The factoring company runs the risk that the million dollars will not be collected by the medical office, but when and if the accounts receivable in question are collected, the factoring company will be able to make a nice profit.

Factoring is common in the medical field because payments from insurance carriers are often slow, due to poor billing practices or heavy paperwork in the medical office. Moreover, professionals such as doctors, lawyers, and increasingly CPAs work in areas where malpractice or errors and omissions (E&O) claims are plentiful. In professional practices, accounts receivable are typically the only real asset of the company, since the value in a practice lies with the individual owners, not in the company's hard assets.

If a patient of a physician has a bad outcome from surgery or a client of an attorney or CPA is harmed by flawed professional advice, the professional entity will be sued along with the individual who caused the damage. And the claims for damages in any major lawsuit are likely to be above the liability policy limits of the professional's malpractice or E&O carrier. These days, a jury verdict can come in that's far in excess of policy limits. If that happens, the accounts receivable of the professional office could be in danger.

With accounts receivable factoring, the professional office sells an ongoing stream of its accounts receivable to a factoring company. Thus, the accounts receivable are no longer an asset of the company subject to claims of creditors. So if a malpractice lawsuit returned a verdict against a physician and the practice for $1 million more than the policy limits, a judge could not require the medical practice to liquidate its accounts receivable to pay that verdict, since the office no longer owns them.

If I stopped here, you might wonder why a company without any cash flow needs would want to factor accounts receivable, since the cost in the previous example was a $100,000 factoring fee. First, it's always useful to provide asset protection for accounts receivable when possible. Second, the concept of accounts receivable factoring can act as an income tax reduction tool as well.

How? One company in the marketplace will factor your accounts receivable and through a marketing incentive contribute 88% of that factored amount into a supplemental benefit plan for key company employees or owners. The best way to illustrate how this accounts receivable factoring works to reduce taxes and fund a supplemental benefit plan is through an example.

Take Dr. Smith, age 45, who earns $1 million a year as a cardiologist in his company, Dr. Smith P.C. He hears about factoring plans and decides that he would like to protect his accounts receivable and reduce his income by $100,000 a year if he could also invest money in a tax favorable manner.

Dr. Smith P.C. contracts with a factoring company to sell $500,000 of its accounts receivable at a 5% discount four times a year. (In a medical practice, accounts receivable turn over on average every 90 days). By factoring, Dr. Smith creates a $100,000 factoring fee over the year (5% x $500,000 x 4 = $100,000). After factoring, Dr. Smith then takes home pre-tax income of $900,000 for the year.

The factoring company on a post-tax basis contributes 88% of the factored amount ($100,000 x .88 = $88,000) into an life insurance investment. The 88% represents 89% of the total premium going into the life policy. Using post-tax money, Dr. Smith will become an investor in that same life insurance policy, putting in 11% of the premium ($10,876). He then co-owns the policy with the factoring company.

By contract, Dr. Smith will have access to all the cash value in the policy via policy loans, which provide much greater tax-free income than he would have had from a taxable investment account. (See "An Accounts Receivable Primer" at right.) When Dr. Smith dies, the factoring company will receive its premiums paid plus appreciation at the long-term applicable federal rate (i.e., simple compounding) in the form of a death benefit from the life policy.

There are some potential downsides to this plan that you must consider. Accounts receivable factoring tends to work best if the client funds the plan for a certain periodtypically five, seven, or 10 years. If the client stops prematurely, the life policy will stop being funded in a tax favorable manner. As with any life policy, the client can lower the death benefit. For a brief period, however, the client and factoring company would have owned a policy with too much death benefit. The plan will not work as illustrated, but it should work much better then post-tax investing. But if there is even a remote possibility a client will want to get out in the first year or two, an accounts receivable factoring plan is not the right choice.

In addition, the client does well by being able to borrow all the cash out of the life policy. But the client also has the burden of keeping the life policy in place until death, which is a contractual obligation of the plan. If a client used a variable life policy and the stock market went in the tank (and slashed the cash value of the policy), he or she could be on the hook to pay future premiums out of pocket to keep the policy in place until death. That is why I never sell variable life with an accounts receivable factoring plan and recommend using a policy with a minimum rate of return.

There is one final caution. Remember that if the client stops the factoring plan, his or her accounts receivable will no longer be protected assets.

Even considering these caveats, an accounts receivable factoring plan can do a tremendous service for your clients who are looking for asset protection and reduced income taxes. If you are used to dealing with 419 welfare benefit plansa tough sell with the new regulationsor the popular 412(i) plan, you should explore the accounts receivable factoring plan as a more conservative option for your clients.

But be careful as you start looking at these plans. Many insurance agents are pitching accounts receivable leveraging to their wealthy clients, which is not the same as accounts receivable factoring. A typical accounts receivable leveraging strategy works as follows:

Assume Dr. Smith P.C. borrows money that equals the true amount of accounts receivable on the medical practice's books. That borrowed money is invested in a life insurance policy or annuities owned by Dr. Smith individually. The medical office is told to write off the interest on the loan, and the money funded in the life policy grows. When Dr. Smith reaches retirement age, the loan is paid back, and Dr. Smith keeps the life policy with all its cash value. He would then take tax-free loans from the policy as a supplemental retirement benefit.

This plan may seem attractive, but it has serious defects as presented. The accounts receivable leveraging plan has been around in one form or another for almost 20 years. It's a marginal asset protection tool because the medical practice does not actually sell the accounts receivable. What's more, it is an even less effective wealth accumulation tool.

There are four important problems with the accounts receivable leveraging plans currently in the marketplace:

* The interest on the loan to the medical practice may or may not be deductible. I've read legal opinions on both sides of the fence. If the interest is deemed not deductible, the plan becomes worse from a wealth accumulation standpoint than post-tax investing. And whether or not the interest is deductible, the interest payments still go to a bank, never to be seen again.

* The IRS can argue the client is charged with constructive receipt of the borrowed money in the year borrowed. If that is the case, Dr. Smith would have to pay incomes taxes in year one of the plan on all the borrowed money. That would defeat the plan purpose.

* Dr. Smith would have to recapture as income any cash value in the life policy once the cash surrender value gets above the amount of money that was poured into the life policy. For example, assume Dr. Smith P.C. borrowed $300,000 against office accounts receivable and that the entire amount was put into a life insurance policy. Early on, the surrender charges will keep the cash surrender value below $300,000. When the cash surrender value gets above $300,000, however, the physician must recapture that additional value as income each year.

So if the policy grows at 8% each year, Dr. Smith will recapture $24,000 in income the first year the policy grows above $300,000. That number will grow every year thereafter. Dr. Smith pays the tax every year, but he will not get to use the money until he takes tax- free loans from the policy several years down the road.

* The loan has to be repaid. Dr. Smith will have to find $300,000 post-tax dollars to pay back the original loan. Not surprisingly, sales reps pushing the plan usually ignore this topic. A medical practice with $300,000 on the books to pay back the loan won't have sufficient funds because taxes must first be paid on that $300,000.

Some of the problems with an accounts receivable leveraging plan can be salvaged by a few simple structural changes that are outside the scope of this article. Even so, be aware that the topic is not as clear-cut as the marketers of the plan make it out to be. To avoid the headaches of accounts receivable leveraging, it's better to study and understand a simple accounts receivable factoring plan like the one described in this article.

An Accounts Receivable Primer

Dr. Smith, age 45, factors $500,000 of his accounts receivable (A/ R) for 10 years at a 5% discount four times a year. This also reduces his current income tax, since he takes home $100,000 less per year. Assume a 7.9% pre-tax return in the stock market and 7.9% in the life policy used. Dr. Smith then retires after age 65 and lives 20 years.

Outcome Available funds at age 66-85

Post-tax investment account $95,294 a year after tax

with no A/R plan

A/R factoring life policy $243,871 income tax-free annually

loans via life policy

A/R factoring company $2.2 million return on its

investment

The A/R factoring plan as illustrated provides 155% more per year to Dr. Smith than post-tax investing of the $100,000 foregone each year. RD.

Roccy DeFrancesco, J.D., is one of the founders of www.triarcadvisors.com, a Web site and company devoted to the education of financial and legal professionals around the country. He is also the author of The Doctor's Wealth Preservation Guide. DeFrancesco can be reached at 269-469-0537 or roccy@wealthpreservation123.com.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

Oracle Balanced Scorecard

2010-05-18T14:56:00.003+07:00

Oracle Balanced Scorecard Receives Industry Certification

PR Newswire. New York: Feb 16, 2000. pg. 1

Abstract (Summary)
REDWOOD SHORES, Calif. and LINCOLN, Mass., Feb. 16 /PRNewswire/ -- ( http://www.oracle.com/tellmemore/?135836 ) As traditional companies move to e-business models, the need to be proactive in strategy determination and execution becomes imperative for sustaining competitive advantage. Oracle(R) Balanced Scorecard, a key component of Oracle Strategic Enterprise Management, gives companies this capability. Oracle Corp.'s certification by Balanced Scorecard Collaborative, Inc. today further validates Oracle's Balanced Scorecard as a key strategic management tool.

Under the terms of the certification, Oracle Balanced Scorecard is designated as compliant with Balanced Scorecard Functional Standards. The certification is designed and maintained by Balanced Scorecard Collaborative to eliminate confusion in the marketplace by educating suppliers and buyers with the important elements of the Balanced Scorecard management system. The Balance Scorecard is a widely accepted methodology that provides an enterprise view of an organization's overall performance by integrating financial measures with key performance indicators.

Dr. David P. Norton, president of Balanced Scorecard Collaborative, said, "We have developed the Balanced Scorecard Collaborative Certified Program based on Balanced Scorecard Functional Standards to ensure that the Balanced Scorecard name maintains meaning, and that any investment made in associated software retains its value. We are pleased that Oracle Corporation is taking part in this program."

Balanced Scorecard Collaborative Certification(TM) Validates Power of

Comprehensive Strategic Enterprise Management E-Business Suite

REDWOOD SHORES, Calif. and LINCOLN, Mass., Feb. 16 /PRNewswire/ -- ( http://www.oracle.com/tellmemore/?135836 ) As traditional companies move to e-business models, the need to be proactive in strategy determination and execution becomes imperative for sustaining competitive advantage. Oracle(R) Balanced Scorecard, a key component of Oracle Strategic Enterprise Management, gives companies this capability. Oracle Corp.'s certification by Balanced Scorecard Collaborative, Inc. today further validates Oracle's Balanced Scorecard as a key strategic management tool.

Under the terms of the certification, Oracle Balanced Scorecard is designated as compliant with Balanced Scorecard Functional Standards. The certification is designed and maintained by Balanced Scorecard Collaborative to eliminate confusion in the marketplace by educating suppliers and buyers with the important elements of the Balanced Scorecard management system. The Balance Scorecard is a widely accepted methodology that provides an enterprise view of an organization's overall performance by integrating financial measures with key performance indicators.

Oracle Strategic Enterprise Management, a Web-enabled suite of analytical applications, is embraced by companies worldwide and implemented at over 40 client sites across Europe, Asia Pacific, and the United States. It enables the key management processes for strategic planning, integrated budgeting and forecasting, measuring organizational effectiveness, as well as compensation.

Dr. David P. Norton, president of Balanced Scorecard Collaborative, said, "We have developed the Balanced Scorecard Collaborative Certified Program based on Balanced Scorecard Functional Standards to ensure that the Balanced Scorecard name maintains meaning, and that any investment made in associated software retains its value. We are pleased that Oracle Corporation is taking part in this program."

"I've always been a big believer in key performance indicators. If you can measure something, you can improve it. The power of Oracle Balanced Scorecard is that you can measure and improve performance across the enterprise, at all levels," said Jeff Henley, Oracle CFO. "The certification by the industry thought leaders is a clear acknowledgment that our product functionality meets the strict qualification criteria. Oracle's ability to deploy Balanced Scorecards over the Internet offers companies a powerful way to communicate and execute strategy throughout the enterprise."

Users of certified Balanced Scorecard applications are assured that those applications are compliant with Balanced Scorecard Functional Standards, and can thus be used as the foundation of a strategic management system based on the Balanced Scorecard.

About the Balanced Scorecard

The Balanced Scorecard is an organization framework for implementing and managing strategy at all levels of an enterprise by linking objectives, initiatives, and measures to an organization's strategy. The scorecard provides an enterprise view of an organization's overall performance by integrating financial measures with other key performance indicators around customer perspectives, internal business processes, and organizational growth, learning, and innovation. Since the concept was introduced in 1992, Balanced Scorecards have been implemented at corporate, strategic business unit, shared service functions, and even individual levels at hundreds of organizations -- in both the private and public sectors- worldwide.

About Balanced Scorecard Collaborative, Inc.

Balanced Scorecard Collaborative, Inc. (BSCol) is a professional services firm that facilitates the worldwide awareness, use, enhancement, and integrity of the Balanced Scorecard as a value- added management process. Founded and led by the creators of the Balanced Scorecard concept, Drs. Robert Kaplan and David Norton, BSCol provides a global center of Balanced Scorecard excellence through consulting, education, training, publishing, research and development. For more information, visit the Company on the Web where you can join Balanced Scorecard On-line free for the latest insight and resources at http://www.bscol.com.

Activity-based decision

2010-05-18T14:41:00.002+07:00

An integrated framework for activity-based decision

Mike Partridge, Lew Perren. Management Decision. London: 1998. Vol. 36, Iss. 9; pg. 580

Abstract (Summary)
Activity-based costing (ABC) data have the potential to inform a wide range of management decisions. Recently the term Activity-based management (ABM) has emerged to describe any application of ABC data, but there is currently no framework which pulls together the disparate strands of potential uses. Partridge and Perren have conducted a systematic review of internationally reported ABC applications to produce an integrated and comprehensive ABM framework for management decision making. Traditional methods of costing are critically evaluated as a precursor to explaining the ABC model. Partridge and Perren go on to illustrate their ABM framework with case examples.

Non-financial managers have a key role to play in the successful implementation of activity based systems (e.g. Friedman and Lyne, 1995). When deeply involved as members of the activity-based costing (ABC) project team, such managers have been identified as enthusiastic users of and propagandists for the new information systems. Friedman and Lyne (1995), in a study of activity-based techniques in 11 companies, found evidence of an improvement in the relationship between accountants and non-financial managers. Innes and Mitchell (1991), in a longitudinal study of an activity-based system in the Cummings Engines Company's Daventry plant, found that "managerial enthusiasm for ABC was extremely high and became manifest in requests for more and more information based on it".

These findings reinforce the authors' belief that activity-based techniques offer managers a user-friendly, understandable information system whose ownership they can share with accountants. Indeed it is probably essential that accountants take the (for them) revolutionary step of deliberately sharing the system with its users.

ABC data have the potential to underpin a wide range of decision-making processes. It is unfortunate that the design and development of ABC systems has often remained largely within the domain of accountants. This is perhaps understandable: Less justifiable is that the use of ABC systems has in most cases been focused on a narrow range of applications. Recently the term activity-based management (ABM) has emerged to describe any application of ABC data to management decisions. However, the research for this article found an absence of a framework which pulls together the disparate strands of potential uses.

Aim and method

Our goal was to eliminate the confusion which surrounds ABM. We conducted a systematic search of the management accounting literature over the past ten years in order to identify articles and texts which appeared to focus on ABM or associated areas. The sources consulted intentionally span academic and professional literature, as it is uncertain whether academics or professionals were the driving force behind the ABM concept. Each article or text was methodically analysed to discover applications of ABC data which the authors had identified as being a part of ABM. Each application was coded to allow traceability back to its original source (see Appendix). This allowed a flexible approach to textual analysis and categorisation, with the applications identified being iteratively grouped until patterns emerged. These patterns formed the foundation for the integrated framework we present in a later section.

It is our view that managers are insufficiently aware of the potential of activity-based techniques; accountants may also be possessive about the operation and use of information systems that have traditionally fallen within their domain. We are entering an era when collaborative, multi-discipline management is a pre-requisite for competitive advantage. Our belief is that given the will, and given the understanding, a new tool is available for use by managers.

Review of traditional and activity-based costing systems

This section provides an overview of costing systems and readers familiar with these concepts may wish to go straight to the next. The allocation of costs to products and other cost objects has occupied the minds of managers and accountants for more than a century. Whether it be to price stock, and hence to measure profit, to support pricing decisions or to provide factual underpinning forproduct/market decisions, the identification of product costs is a vital component in the process of management.

The accurate allocation of so-called direct costs (costs which are clearly linked with a specific unit of product) presents few problems. The treatment of indirect costs, overhead, provides a more contentious area.

Many firms use a blanket rate approach, where a convenient proxy for resource consumption is used to share overheads in a way which is superficially equitable. The "two-stage model" is a refinement of this approach. In the first stage overheads are allocated to cost centres using proxy measures for usage such as floor area or headcount. In the second stage a cost centre's overheads are shared between products using appropriate proxy measures (e.g. direct labour hours for labour intensive cost centres, machine running hours for mechanised ones).

These mechanisms, while they may produce adequate figures for stock valuation and so satisfy audit requirements, suffer from two defects if their output is to be used for decision making. First, the proxies used are not measures of resources consumed; they are simply a convenient way of allocating what appears to be a fair share of overhead to products. The result is a degree of averaging of unit product costs with all the inaccuracy that this may cause. Second, the cost rates generated are generally based on budgeted output volumes. Fluctuations in these volumes will mean that, because a proportion of all overhead is fixed in nature, the actual cost rates will be higher or lower than those originally calculated. This may lead managers to make inappropriate decisions.

ABC responds to the earlier criticisms by allowing activity based overheads to be allocated to activity based cost pools according to their genuine resource consumption. This is a great improvement over the previous methods although it still leaves a rump of overhead known as facility sustaining costs which are not susceptible to ABC analysis. We shall return to them in a moment. The key stages of ABC are shown as the shaded sections of our integrated framework (see Figure 1):

1 The division of the firm into activities (e.g. set up, procurement, quality etc.) (position 1 in Figure 1).

2 The allocation of overhead resources (position 2 in Figure 1) to activities excluding those indirect facility sustaining costs which are independent of activity levels.

3 The identification and quantification of activity drivers (position 3 in Figure 1) (e.g. Pounds per set up, Pounds per order, Pounds per inspection), which measure the use of an activity by cost objects (position 4 in Figure 1) (e.g. products, customers etc.).

4 The calculation of an activity driver rate for each activity.

5 The charging of an appropriate amount of each activity to each cost object (position 4 in Figure 1).

If total cost data are required, then facility sustaining costs can be allocated to cost objects using any suitable (though arbitrary) basis of the sort that was used in the traditional approaches.

ABC has the advantage of moving away from the simplistic fixed/variable cost model to one in which activity-based overheads may be allocated to cost objects in direct response to their consumption.

We have now described the vertical logic of the ABC system. We will next explain the horizontal axis of the model: from the left, cost drivers (position 5, Figure 1) are those factors such as economies of scale and use of technology which affect the cost efficiency with which activities can be performed; on the right, performance measurement (position 6, Figure 1) can be reflected by activity driver volumes and rates.

So the basic ABC model offers a new approach to product cost measurement, one which generates information that is credible, because its derivation is logical and visible, to both financial and non-financial managers, and which also offers a new visibility to resource management. What then are the uses of this new information? This is the point at which ABC extends into ABM and is the focus of the rest of the article.

An integrated framework for ABM

We have used the results from our meta-level review to extend the basic "cross" diagram (Raffish and Turney, 1991) into a framework which integrates ABC information with its possible applications (see Figure 1). We believe that this provides a coherent agenda for general managers who may wish to apply ABC derived information to a variety of decision making situations. We will now explain the components of the framework, which extends the basic "cross diagram" at its core.

This ABC system generates decision relevant information which may be used in three ways:

1to stimulate resource allocation decisions (position 1, Figure 1), i.e. changing the balance of resources allocated to activities in response to changing activity demand patterns and to changing activityefficiencies;

2 to provide cost object (position 4, Figure 1) information on which to base market interface decisions;

3 to generate performance measures (position 6, Figure 1) with which to monitor activity consumption and efficiency.

Early adopters of ABC saw its cost management role as the most valuable outcome of its implementation and the term activity-based cost management (ABCM) creeps into the literature from quite an early date. ABCM offers a new visibility to an area of hitherto near total mystery. For the first time, managers have a logical, quantified input: output model of overhead consumption in which actions to alter demand, efficiencies or waste can have a measurable effect on levels of resourcing.

Thereafter, uses of the core ABC model proliferated. The availability of believable metrics, based on causal logic, stimulated new applications and breathed fresh life into a range of established management practices.

Cost objects and related applications

If initially we pursue the vertical strand of the framework, then it can be seen that cost objects (position 4, Figure 1) sub-divide into products (position 7), channels (position 8) and customers (position 9). That is, it is technically possible separately to identify the costs of producing products, of using alternative distribution channels and of servicing individual customers. Cost object (position 4) data can be further divided to help with the following decision areas:

Stock valuation (position 10)

While the strategic relevance of stock valuation is debatable, ABC is certainly capable of performing this task. Indeed, Innes and Mitchell (1995) found in their survey of 251 of the UK's largest companies that 40 percent of manufacturing companies used ABC costs for this purpose.

Pricing decisions (position 11)

The determination of selling prices can rarely be effected without an awareness of unit costs, even if the decision becomes one of whether to trade in a particular market or not. There is considerable evidence to demonstrate that ABC unit costs can frequently reveal alarming profit variations between products as a result of prices developed from traditional costing systems. For example, Volkswagen Canada has applied ABC to its quotation pricing process (Gurowka, 1996). A detailed activity costing sheet highlights areas that increase product costs and areas where costs need to be cut. The costing sheet has found uses, both for pricing current products, and also pricing future business.

Product design (position 12)

ABC cost analysis can identify those activities which add to or create product value and those which are unnecessary, wasteful or used in too great a quantity. Turney (1992) suggests that the traditional approach of product design followed by process design can leave the process designers with a time-consuming and costly task. He supports concurrent engineering, where product and process design are performed in parallel, in full knowledge of the activities (and their costs) that will be required.

Transfer pricing (position 13)

There is as yet limited evidence of the use of ABC to generate transfer prices (Innes and Mitchell, 1995; Morrow and Ashworth, 1994) although the benefits of using a visible and equitable cost base must be considerable, apart from the avoidance of argument and negotiation. One can envisage internal customers for products or services being motivated to modify the nature of their consumption patterns and specifications. We are aware of one financial services company where a central data processing facility uses ABC cost measures to charge out transaction processing costs to branches.

Channel costs and channel decisions (position 14)

The original ABC model is capable of generating cost data for a variety of cost objects (position 4), most commonly products (position 7) and customers (position 9). In certain organisations it may be useful to generate costinformation for alternative distribution channels (position 8) (e.g. Booth, 1996) so as to assist management in making informed choices in this area. Cooper et al. (1992) "illustrate the case of a metal fabrication and distribution company whose ABC analysis revealed that the most profitable products were those shipped direct from the mill. Such shipments incurred almost no inventory and material handling costs". The findings caused management to question the competitive advantage of their distribution business.

Customer profitability analysis(position 15)

After product cost analysis, customer profitability analysis provides one of the most frequently cited ABM applications, partly, it could be assumed, because of the dramatic nature of the information that it tends to produce. Bellis-Jones (1989) first put forward the message that at least 20 percent, possibly 30 percent, of customers are actually eroding profits when the full costs of servicing them are accurately attributed. Sweeney and Mays (1997) reference the First Tennessee National Corporation, a regional US bank, where 30 percent of customers were found to be providing 88 percent of the company's profit, while another 30 percent generated a loss of 7 percent. The situation "was corrected through a combination of higher minimum bank balances, new products and process redesign".

Output decisions (position 16)

Decisions as to what products to sell, to which market segments or customers, at what prices and in what volumes, are fundamental to the formulation of competitive strategy. ABC offers medium-term cost data in which cost variability is more realistically measured and which consequently provide bases for product/mix/market and out-sourcing decisions. This is essentially the basis for activity-based budgeting.

Activity-based budgeting (ABB)(position 17)

Budgeting for overhead has long presented insoluble problems for management. Incremental budgeting, characterised as "last year plus 5 percent", remains a widely used mechanism. Zero-based budgeting (ZBB), in various manifestations and for various reasons, has never achieved widespread use. The ABC model, with its quantitative connection between outputs and resource inputs, can meet a long-felt need. This application of ABC methodology is in essence an example of output analysis (position 14), when one of the output variants is selected as the operating plan for the coming budget year.

Activities and activity-related applications

If we now return to activities (position 2) and activity analysis (position 3) in the upper part of Figure 1, there are a number of valuable spin-offs at this level.

Value-adding/non-value adding analysis (position 18)

Cited by most commentators, the analysis of activities into value-adding and non-value adding appears to be fundamental to the cost management capability of ABC analysis. Turney (1992) suggests that an activity has value if it is essential to the customer or it is essential to the functioning of the organisation. Hixon (1995) complements this by defining non-value adding activity as "anything that can be eliminated without detriment to the final product or service". Antos (1992), in an examination of ABM in an Alaskan oilfield water treatment facility, illustrates a number of NVA activities including drilling a hole incorrectly, engaging in litigation because of spills and violations, and dealing with accidents. The identification and cost analysis of NVA activities act as a trigger to stimulate their reduction or elimination.

Value chain analysis (position 19)

This is a particular form of activity analysis which derives directly from Michael Porter's (1985) value chain concept - the overriding requirement for value-creating product attributes to produce a surplus of income over the cost of the activities which generate them. Morrow and Ashworth (1994) summarise the concept as "a business is a series of linked activities which ultimately add value to the customer. Activity based management recognises this fact and therefore helps management to view the organisation by understanding the activities, their cost and how they link together to form a simple chain of value-creating activities for a business."

Organisational re-design (position 20)

Activity analysis will frequently reveal that current organisational structures do not reflect the way in which the organisation operates. Further, as Turney (1993) points out, "the artificial dividing of work into vertical functions creates communication barriers and results in excess cost and time and in poor quality". Hixon (1995) emphasises the point, suggesting that while departments may optimise individually, they may also compete, and there may be little or no cross-functional coordination.

Process re-engineering (position 21)

Business processes are sequentially related sets of activities. Hence activity analysis and activity cost measurement offer, whenwith benchmarking, a springboard for process re-engineering. As Evans and Ashworth (1995) assert "the recent drive to re-engineer business processes is often pursued with no regard to, or real understanding of, before-and after-process costs of the underlying product or the customer profitability realised from performing those processes ... There is often no real framework to monitor the return on investment...". Indeed , without ABC, there is often little to no measurement.

Benchmarking (position 22)

Having already identified that an early product of the ABC model was the generation of performance measures, it is a logical progression to use ABC metrics to conduct benchmarking studies. For example, Coburn et al. (1995) describe how ABC benchmarking was successfully performed for the accounting department at the Marketing ResourceGroup of US West, a publisher of telephone directories.

Continuous improvements (position 23)

Continuous improvement is implicitly an outcome of several of the foregoing paragraphs. Gurowka (1996) describes Volkswagen's process improvement tool called KVP (Kontinuierliche Verbesserungsprozess), where the cost data provided by ABC ensure that the process improvement team concentrate on what is important and so prioritizes its targets.

Cost modelling (position 24)

Cost modelling, cost forecasting, cost simulation are different expressions which mean broadly the same thing: an ability to build future orientated cost models of products, events and processes. Innes and Mitchell (1995) found 61 percent of their respondents used ABC to model costs. The most common applications were to model individual product costs and for decision situations such as capital investment evaluations.

Quality costing (position 25)

Glad and Becker (1996) argue that the costs of wasted resources (e.g. product defects, raw materials, capacity, labour input, energy) should be separately measured and excluded from product costs. They propose that the four classic quality costs (prevention, appraisal, internal and external failure) can and should be measured and reported. It is the authors' experience that external failure costs, when accurately measured under ABC analysis, can provide management with alarming insights. The management of un-used capacity relates closely to the measurement of waste. If the resource is under-used and is not "stockable", then under-utilization is waste. As Glad and Becker (1996) say: "Capacity costs should be charged to the cost objects based on a realistic or practical capacity. Surplus capacity costs should be reported as wastage.". Carolfi (1996) describes an ABC-based quality management system and illustrates this with a case study based on a market research organisation. The study revealed that 50 percent of the analysts' working week was dedicated to rework, and 1,546 annual hours of computer time were required as a result; total cost approximated to US$660,000. The net result of the study was a two thirds reduction in staff numbers.

ABM in action at Volkswagen in Canada

Volkswagen (VW) Canada's plant in Ontario provides an encouraging example of many features of our integrated framework (which we have cross referenced to Figure 1). As Jim Gurowka (1996), a former senior finance officer at VW Canada states, "ABM information will help VW achieve its goal of becoming the ultimate, cost conscious, world-class, customer-focused supplier". The plant manufactures aluminium wheels, catalytic converters and die cast engine parts which are sold to VW and third party customers throughout the world. From being a captive customer, the parent company was encouraged to source product from the cheapest producers, not just sister companies. This led to a 25-30 per cent price fall at VW Canada, as well as a need to find new third party customers to fill the gap left by declining parent company orders.

A pilot ABC project in 1991 revealed that, in the die casting areas, 80 per cent of products were either losing money or were only marginally profitable. Profitability was sustained by a couple of high earning parts, a classic Pareto effect which had been hidden by the old costing system. Management's attention at this time was focused on growth andnothing much was done about the new ABC information. The ABC project, without a champion, "went to sleep".

By 1993, however, massive changes in technology and competition caused the company to take drastic action to maintain profitability. ABC was re-activated and helped management to take tough decisions based on sound information. For example, ABC information was central to a decision to re-engineer the major business processes (position 21).

In evaluating what proved to become a highly successful ABC implementation, a number of factors were felt to be important. For example, the joint project leaders brought strong backgrounds in purchasing and production, as well as finance, to the task; in addition, they made a strong commitment to share the ABC results not just with managers but all employees throughout the plant.

While initial outcomes centred on product (position 7) and customer profitability (positions 9 and 15), activity-based applications gradually moved on to quotation pricing (position 11), budgeting (position 17), quality costing (position 25), process improvement initiatives (position 21), product (design) rationalisation (position 12) and resource utilization (position 1). ABC analysis is now an integral part of VW Canada's continuous improvement drive (position 23). As Gurowka says "process improvement (position 21) projects which lack costing information tend to be unfocused exercises which concentrate on perceived problems. The cost and economic data (position 24) provided by ABC ensure the process improvement team concentrates on what is important."

Discussion and implications

On the surface, many firms will appear to be using some of the applications from the framework. Closer examination may reveal that decision making is either without measurement or is using traditional costing mechanisms with the inherent limitations that we highlighted earlier in this article. Even when managers do have access to ABC data, evidence suggests (e.g. Drury et al., 1993; Innes and Mitchell, 1995) that they tend not to apply it comprehensively. Without measurement, management decision making has to be based on intuition, impulse and hunch. Traditional information is based on departments, functions and nominal codes. Modern management thinking has championed the importance of cross departmental initiatives, of processes rather than functions, of core competencies which transcend the confines of strategic business units. Such notions seem to be the way forward, but without sound quantitative activity-based information, we may see a reversion to intuitive decision making.

Our framework (Figure 1) brings together the disparate strands in the literature to provide a clear agenda for general managers wishing to integrate ABC generated information into their decision making. For managers who already have access to activity-based information it provides a reference point against which to compare their current applications. We suggest such managers conduct a systematic audit of their current decision-making practices against our framework. For most organisations this will identify areas of ABC application which are missing (Innes and Mitchell, 1995). We suggest that the audit forms the foundation for a programme to extend the use of ABC information within the organisation. For managers who do not have access to activity-based information, our framework provides an insight into how such information could be employed in their organisations. We hope this will act as a stimulus for such managers to explore the feasibility and implications of ABM.

Friedman and Lyne's (1995) research has shown the importance of involving a multi-disciplinary team of financial and non-financial managers in the implementation of activity based systems. Our framework has the potential to interest a range of financial and non-financial managers from different areas of the organisation. It not only provides an overview of ABC, but also a coherent picture of how such data can influence different aspects of decision making within the organisation. It provides a common platform of understanding, a standard language and conceptual underpinning, which will help managers from different parts of the business to share ideas and potential applications of ABC information. This transparency of process should help managers maintain objectivity, especially when they are investigating current decision-making practices in politically sensitive areas.

There is a risk of the framework becoming a cage rather than a platform which enables objective analysis. We hope our framework will be applied flexibly, contributing an agenda for analysing current and future decision making approaches, while allowing specific issues to be explored within their organisational context. We do not expect that all features of our framework will be equally important to all organisations, rather we expect organisations to customize the features which fit with their individual circumstances. For example, the use of cost object (position 4) data may vary greatly between different types of organisation: for a small engineering consultancy a key strategic issue may be customer profitability (position 15), so emphasis will initially be placed there, whereas, for a large vertically integrated manufacturer, transfer pricing (position 13) may be a particularly problematic area. Research suggests that ABM is more likely to be successful if an incremental approach to its implementation is adopted (e.g. Player and Keys, 1995). We recommend a phased introduction of ABC applications, which in the early stages emphasizes areas which will provide worthwhile information for decision making and are not too politically sensitive. This should help implementation through the demonstration of its positive effects.

Conclusions

Our analysis has traced the development of ABM from its origin as a product costing technique through to the extended application of ABC metrics. The number of successful ABM applications reported in the source literature is encouraging. Case examples have been used in our discussion in an attempt to bring the framework to life and to show readers the positive outcomes that can be achieved through such approaches.We have great respect for two core books (Morrow, 1992; Turney, 1991) because they were instrumental in setting the embryonic ABM agenda. Indeed Turney's work was especially prescient.

Even ABM's most ardent supporters would hesitate to claim that ABC generates "absolute truth". Its metrics, though, are certainly better than none and better, too, than the flawed data generated by many traditional cost accounting and financial accounting approaches. Having said that, there is sadly evidence from surveys (e.g. Drury et al., 1993; Innes and Mitchell, 1995), that for many organisations ABM remains no more than wishful thinking. Our framework provides an agenda which may encourage managers to employ ABC information proactively in their organisations.

Dealers face end of leases

2010-05-18T14:37:00.001+07:00

Dealers face end of leases

Velvet Spicer. Rochester Business Journal. Rochester: Aug 22, 2008. Vol. 24, Iss. 21; pg. 1

Abstract (Summary)
Ford Motor Co. last month reported a $2.1 billion loss related to unprofitable leases through its Ford Motor Credit Co. Chrysler LLC then announced its financing amt, Chrysler Financial, would stop offering leases as of Aug. 1. In today's economy - especially with gas prices hovering at around $4 a gallon - larger vehicles such as full-size trucks, minivans and sport utility vehicles are in less demand than their smaller, more fuel-efficient counterparts.

Drivers who like to pull away from a car dealership every three or four years in a new vehicle may have to rethink their game plan as the nation's Big Three automakers and their financing arms move away from leasing.

Ford Motor Co. last month reported a $2.1 billion loss related to unprofitable leases through its Ford Motor Credit Co. Chrysler LLC then announced its financing amt, Chrysler Financial, would stop offering leases as of Aug. 1. Many in the industry expect Ford and General Motors Corp. to make it less attractive for lessees by raising payment amounts.

"A critical element to being able to lease a vehicle is predicted future value," said Rochester Automobile Dealers' Association Inc. president Bradley McAreavy. "If you can't predict that, then you can't lease a vehicle."

In today's economy - especially with gas prices hovering at around $4 a gallon - larger vehicles such as full-size trucks, minivans and sport utility vehicles are in less demand than their smaller, more fuel-efficient counterparts. In turn, the gas guzzlers - manufactured primarily by the country's domestic automakers - have not held their residual value.

Three or four years ago, dealers predicted these vehicles would be worth much more than they are. As a result, finance companies and dealerships are taking a hit when drivers turn in their larger cars and trucks at the end of their lease, McAreavy explained. When drivers turn in their leased vehicles, the banks take those cars to auction; these days, they stand to lose a lot of money.

"There's nothing (dealers and financers) can do about that," McAreavy said. "Those leases are on the books and they're maturing and it just happens to be where the market is today. And all they can do is just take their lumps and sell the car."

The Power Information Network, a division of J.D. Power & Associates, reports nearly 20 percent of customers nationwide leased vehicles in 2005, the most recent year for which data is available.

Unless other options are available, the impact of a no-leasing policy through Chrysler, Ford or GM could send buyers elsewhere, such as import companies, to lease their vehicles.

"I find most lease customers are less loyal to the brand and more loyal to the payment," said Vision Automotive Group general manager Douglas Indovina. The dealership represents the Dodge, Nissan, Kia, Hyundai and Ford franchises.

Some 25 percent of Vision Ford's new vehicle sales come from leasing, Indovina said. That is insignificant compared with some other markets, such as Buffalo, where retirees and employees of the company's manufacturing facility there take advantage of favorable leasing plans. With Ford gradually moving away from leasing, Indovina said, sales in the Buffalo market likely will be more affected than in Rochester.

Dealers whose customers prefer to lease will face a dilemma, at least in the short term, he said.

"You are going to have to re-educate your customer, if they allow you to," Indovina explained, "because they're going to have to make a hard decision. They're going to have to stay without a lease. People will accept it at some point, but initially they're going to look for alternatives."

Historically, leasing has been a better deal for some consumers in terms of finances, McAreavy said. But that will soon no longer be the case: finance companies likely will raise rates and lower the residual values of vehicles, thereby minimizing their exposure.

"If I'm just out there looking to buy a vehicle and I have a choice between leasing and buying, if you give me a retail incentive that's pretty aggressive with a rebate, and that incentive is as good (as) or better than that lease incentive would have been, I'd probably buy that car because financially I'm indifferent," McAreavy said. "Give me the good deal and that's what I'll take."

Indovina added he expects leasing to remain an option, at least through Ford, but on vastly different terms.

"I think it'll be much more selective in the future," he explained. "If you have great credit you're going to be offered leasing. I don't think it will be a mechanism that will accept anybody."

Thirty-five to 40 percent of Patrick Pontiac GMC Jeep's vehicle deliveries are from leasing, Vice President Mark Pennella said. Though the traditional financers may back away from leasing, dealerships still have several choices to offer their customers, he added.

"We're just looking at different opportunities out there from different lending institutions that'll lease," he said. "And there are several of them."

Once the smoke clears from the Big Three's leasing changes, Pennella expects his dealership to return to a normal number of signed leases. Competition among financers plays a big part, he said, and he expects that to happen within the next three months.

"(Banks are) actively pursuing every dealer out there that might have had their primary lending institution back away from leasing," he said. "In the long run I don't think it'll be a big deal for the consumer at all. It's just going to he a different bank. They don't really care as long as the payment's in line."

Indeed, Pennella expects the car buyer to benefit in other ways as well.

"This is where it could get better. Manufacturers - and you're seeing it more from GM right now because they're big - are offering some pretty wild regular purchase deals instead of leasing," he explained.

Many deals include interest-free financing on top of big incentives to entice consumers to buy, Pennella noted.

"If I want to buy a car I get these great deals from the factory. If I want to lease a car I get the same (financing) deals, or similar, from an outside source," he said. "If it plays out the way I think it will, I think the consumer wins here."

Utilizing Capabilities to Increase Stakeholder Wealth

2010-05-18T14:32:00.002+07:00

Utilizing Capabilities to Increase Stakeholder Wealth: A Balanced Scorecard Approach

Michael L Pettus. Competition Forum. Indiana: 2006. Vol. 4, Iss. 1; pg. 159, 7 pgs

Abstract (Summary)
The balance scorecard can be used to examine the creation of wealth from a stakeholder perspective. While the balanced scorecard is focused upon metrics which measure wealth creation, this study examines what capabilities the firm needs to build to increase shareholder, employee, customer and future wealth. These capabilities have the potential to create heterogeneity between firms by creating future oriented processes which focus upon both financial and non financial activities

EXECUTIVE SUMMARY
The balance scorecard can be used to examine the creation of wealth from a stakeholder perspective. While the balanced scorecard is focused upon metrics which measure wealth creation, this study examines what capabilities the firm needs to build to increase shareholder, employee, customer and future wealth. These capabilities have the potential to create heterogeneity between firms by creating future oriented processes which focus upon both financial and non financial activities.
Keywords: Balanced Scorecard; Wealth Creation

INTRODUCTION

The creation of firm wealth is a goal of most for profit firms. From a conceptual perspective the resource-based view has added to your understanding as to how firms can increase wealth (Montgomery and Wemerfelt 1988; Chang and Singh 1999). The resource-based view of the firm has emerged as a perspective by which firms build resource positions which are rare, valuable, non-substitutable and not subject to imitation (Barney, 1991). However, it is not specific resources which lead to wealth creation, it is how these resources are accessed, developed, combined and/or deployed which leads to wealth creation (Moran and Ghoshal, 1999). As such, it is not the firm's resources which provide wealth: it is how these resources are transformed into capabilities which lead to wealth creation.

Capabilities represent the productive services that resources generate and the processes by which resources are developed and deployed over time (Amit and Shoemaker, 1993). A capability is a high-level routine that confers upon an organization's management a set of decision options for producing significant outputs of a particular type (Winter, 2000). A capability is substantial in scale and is reflected in a large chunk of activity that produces outputs that clearly matter to the organization's growth and prosperity (Winter, 2000).

One way of determining how capabilities can lead to wealth creation is to utilize the balanced scorecard. The balanced scorecard consists of the following perspectives (1) financial (2) internal (3) customer and (4) future. (Kaplan and Norton 1992) The financial perspective is concerned with profit and risk from a shareholder perspective. The internal element is focused upon the various business initiatives which create customer and shareholder value. The customer aspect is determined by the value that is realized by customers upon purchase of a firm's products. The future component is focused upon growth and innovation. The balanced scorecard also has disadvantages.

One disadvantage of the balanced scorecard is that only the customer and future perspectives are focused upon the future: the financial and internal components are focused upon historical measures. These historical measures do not address future wealth creation. The balanced scorecard can be modified to focus upon future wealth creation.

This study modifies the balanced scorecard framework by identifying capabilities which have the potential to generate future wealth. These capabilities replaced metrics which have been used to measure historical firm performance. Because the focus is upon capabilities, this approach examines how firms can create future wealth. This focus upon capabilities, instead of metrics, allows for a perspective which provides for incorporation of financial and non financial activities for increasing wealth. This is a perspective which the balanced scorecard does not currently address.

This study proposes modifications to the balanced scorecard. The modified scorecard framework developed in this study focuses upon what capabilities need to be developed to increase wealth from a (1) shareholder (2) customer (3) employee and (4) future positioning perspective. The customer wealth component will be discussed first.

Customer Wealth

Creating wealth for consumers is critical for success. Measuring customer wealth is complicated because firms may have multiple sources of revenue and they may have positions within multiple industries. The first step is to identify what industries a firm is competing within. Industries can be defined by the North American Industry Classification System (NAlCS). This industry classification system is used for classifying firms within North America. The International Standard Industrial Classification (ISIC) is used to group international firms outside North America. Once industry boundaries have been identified, it is important to determine how wealth is being created from a customer perspective within each industry.

Increasing customer wealth is dependant upon how much better the firm meets key success factors within each industry compared to competition (Vasconcellos and Hambrick, 1989). Key success factors are those determinants which dictate customer buying decisions (Omhae, 1982; Amit and Shoemaker, 1993). Customers make decisions based upon how well a firm's product meets these factors.

Key success factors are determined at the market level through complex interactions among the firm's competitors, customers, and environment (Amit and Shoemaker, 1993). To determine key success factors, firms engage in market research. Through market research, firms can determine what the key success factors are within each industry, and how firms are positioned with respect to these factors. An analysis of key success factors will determine the relative position of the firm in an industry with respect to competition. It is important not only to determine key success factors within the current time period, but how these factors evolve over time (Amit and Shoemaker, 1993). One of the best approaches to understanding how key success factors change over time is through customer relationship management.

Customer relationship management is achieved through maintaining long-term connectedness to customers over time. As key success factors change over time customers may require new benefits from existing products and services. As a firm continuously adapts its product offerings to changing customer preferences, firms can create greater wealth than competition (Peteraf and Barney, 2003). Firms may choose to allocate more resources to those industries which create more wealth. Without this assessment on an industry-by-industry basis, the firm may engage in reactive as opposed to proactive decisionmaking. One reason is because of customer cost.

Customers incur several costs from a purchase perspective. Money is usually what is exchanged when purchasing a product. However, customers can incur significant non-monetary costs. One such cost is time. Time can be divided into two primary elements (1) amount of time consumers spend on learning about a product/service and (2) the physical time it takes consumers to stop what they are doing and purchase the product/service (Peter and Olson, 2005). The perceived customer benefits plus the consumer costs will determine the price the consumer is willing to pay for the product/service. If the sales price is higher than the sum of consumer costs and customer benefits, the consumer will not engage in the transaction. Reducing customer costs results in additional benefits created for customers and increases the likelihood of engaging in continuous transactions with customers. A second element of firm wealth is the creation of shareholders wealth.

Shareholder Wealth

Most firms are in business to increase shareholder wealth. In other words, the price of the firm's stock needs to appreciate. There is a good reason for increasing the wealth of shareholders. If wealth is not created, shareholders will invest in other firms. Because increasing shareholder wealth is important, more firms are beginning to compensate senior management based upon shareholder performance. (Norton, 2005) Cisco compensates all of its senior management team based upon changes in shareholder wealth (Norton, 2005). This approach to compensating senior management tends to reduce agency problems between senior management and shareholders.

Several firms have implemented processes for linking shareholder wealth to senior management compensation. Caterpillar initiated a new type of management reporting in 2004. Called Transparent Financial Reporting, it aligns the company's internal management reporting system more closely with shareholders' returns. "It's much more 'live' in terms of what's actually happening as a shareholder would see it," stated Mr. Doug Oberhelman, the group president of Caterpillar who has oversight responsibility of the finance operation (Norton, 2005).

Procter & Gamble uses a model for calculating shareholder wealth called Total Shareholder Return (TSR). This model evaluates management performance by calculating bonus payments for senior managers based on firm performance (Norton, 2005). One measure of existing shareholder wealth is obtained by examining financial ratios.

Financial ratios are important because they measure a firm's current and historical performance. Financial ratios can be classified into the following groups: (1) liquidity ratios, (2) asset management ratios, (3) debt management ratios, and (4) profitability ratios (Brealey, Myers, and Marcus, 2004). Liquidity ratios measure the firm's ability to convert assets into cash quickly and at low cost. Asset management ratios measure a firm's effectiveness at managing its assets. Debt management ratios measure the extent to which a firms uses debt financing. Profitability ratios represent how well a firm is allocating its resources.

Ratio analysis should be conducted with respect to historical firm values, industry averages and competitor's ratios over time. Internal capabilities need to be developed to analyze the financial results by comparing the firm's performance to the performance of competition and the industry averages. While ratio analysis is beneficial for determining a firm's current performance, these financial measures cannot be utilized to determine a firm's future wealth. What shareholders desire are increases in wealth. Because shareholder wealth is based upon the future stream of cash flows, it cannot be calculated based upon historical performance. Shareholder wealth can be defined as the present value of the anticipated stream of cash flows added to the liquidation value of the company. As long as the returns from the firm exceed its cost of capital, the firm will add to shareholder wealth.

Most profitability ratios only focus on the cost of debt, not the cost of equity. Economic value added (EVA) focuses on debt and equity (Brealey, Myers, and Marcus, 2004). EVA is an estimate of a firm's economic profit for a specific year. EVA represents the income after the cost of debt and the cost of equity have been deducted. It measures the extent to which the firm has added to shareholder wealth (Brealey, Myers, and Marcus, 2004). EVA is a measure that enables managers to determine whether a firm is earning an appropriate return on capital (Brealey, Myers, and Marcus, 2004). One benefit of EVA is that it is a single performance statistic. It also tends to align the interests of shareholders and management because it reflects how effectively management uses capital.

Fletcher and Smith (2004) believe that EVA is also primarily based upon historical financial measures. One approach to the utilization of the EVA is to base the statistic on both financial and non-financial metrics. Processes need to be developed to identify value drivers. Only then can EVA be used as a measure for managers to ascertain if the firm is achieving the target level of return on capital (Fletcher and Smith, 2004).

One way to determining value drivers is to utilize Porter's ( 1985) value chain. Value chain analysis consists of developing capabilities which can create value from both financial and non financial processes. Examples of processes which can be measured from a financial perspective would include automation or the efficiency gains from total quality management (TQM) initiatives. Processes such as (1) developing an integrated inbound and outbound logistics network (2) utilizing technology to develop new products, or (3) developing a global communication infrastructure, are activities which can be implemented to create value from a non financial perspective.

Employee Wealth

Another group which the firm needs to create wealth for is employees. The firm wishes to retain employees because of two primary reasons. The first reason is economic. If an employee leaves, the firm will spend time and money to recruit and train a replacement. Since the firm has already trained the employee leaving, a competitor will not incur training costs. The second reason is knowledge transfer.

If employees do not perceive that wealth is being created for them, they may decide to leave the firm and work for a competitor. All experience and knowledge that has occurred within your firm will now be available to competitors. This is important because employees build relationships with customers over time. As a result of these relationships, customers may switch to the firm that the employee is moving to. In this case, the revenue that is lost to your firm goes immediately to the firm the employee moves to. The firm the employee is moving to may generate this additional revenue at minimal cost. Creation of employee wealth is crucial for other reasons.

Because employees represent the most important asset of any firm (Barney, 1991), succession plans must be developed to retain high performing employees. Most employees in firms want to advance. Many times succession planning only addresses the CEO and senior management team. These plans should include general parameters for all employees. If employees are unaware of how they can advance within a firm, they may leave and join competitors that have more fully developed succession plans.

Succession planning affects many levels within a firm. Assume a new CEO is chosen from within the firm. Further assume that the former job of the new CEO was chief operating officer (COO) and the new COO was the chief financial officer (CFO). Assume that the new CFO was vice president of North American operations. The selection of an internal CEO puts in place a domino effect that impacts the entire organization. Employees perform important roles within firms

Employees dictate the long-run performance of the firm (Penrose, 1959). Therefore, it is of critical importance that a firm generate wealth for and retain employees. Employee satisfaction surveys, which should be distributed and scored without reference to specific employees, can be a measure of employee satisfaction. Employee turnover by department needs to be closely analyzed. In general, turnover should be approximately the same for each functional group. If it is not, a closer analysis of those departments generating higher turnover is required.

One of the best ways of retaining employees is to make them shareholders. Each year, United Parcel Service (UPS) rewards managers based upon how well the firm has performed during the year. Because these rewards are stocks, employees have an incentive to maximize shareholder wealth. This reward system links the compensation of employees to stock price changes because all employees are rewarded for stock appreciation. If the company has a bad year, all employees within the firm aggressively search to find the source of the stock decline and implement corrective action quickly. These actions increase wealth for external shareholders and all managers within the firm. The fourth element of firm wealth is an assessment of what will determine future wealth.

Positioning for Future Wealth

For the firm to create future wealth, it must design and implement its strategic plan. Some of the issues that need to be addressed are ( 1 ) expansion within domestic and international markets, (2) selection of firms for acquisitions and mergers, (3) costs and anticipated benefits of acquisitions, (4) restructuring, (5) resource utilization and (6) creation of strategic alliances.

Positioning for future wealth creation is due, in part, to identifying, acquiring, and implementing acquisitions. The price paid for each target firm needs to be evaluated versus the actual benefits (e.g. cost savings) realized. To determine changes in wealth, the wealth of the firm before the acquisition is compared to the wealth created after the target is totally integrated within the acquiring firm. Due diligence is a crucial component of a firm's acquisition strategy.

Due diligence is a comprehensive complete analysis of an acquisition opportunity. It is a third party's independent, objective view of the value of an acquisition target. This process should be performed for every acquisition opportunity. Consulting firms and investment bankers conduct due diligence because they have substantial industry experience. These firms perform many tasks. Some important due diligence functions are; (1) determining whether the acquisition will be friendly or hostile, (2) what is the maximum than that the acquiring firm should offer to make the acquisition opportunity profitable, (3) will the acquiring firm have to divest unwanted business sectors of the target firm, (4) what realistic cost savings will be realized as a result of the acquisition, (5) what is the likely reaction of investment bankers, (6) what has been the financial performance of the target over time, (7) what levels of funds will be needed to make implementation successful,(8) should the management team of the target be retained,(9) what type of R&D capabilities does the target firm have that can be utilized by the acquiring firm and (10) what are the cost and timetable for the integration process. If effective due diligence is not completed, acquiring firms may pay too much for acquisition targets or inappropriate targets may be selected.

In order to fund acquisitions, a firm may need to restructure existing businesses. The wealth created, as a result of the acquisition, needs to be compared to any restructuring that was needed to fund the acquisition. In general, acquisitions should add wealth to the firm, while restructuring should not result in decreases in wealth.

The number of strategic alliances a firm has entered into is another measure of future wealth. Alliances may allow firms to generate increases in future wealth more quickly than other modes of growth (e.g. internal development) (Yip, 1982; Chatterjee, 1990). Scale alliances allow firms to combine similar resources to lower costs by increasing utilization of assets. Scale alliances allow firms to combine similar resources to grow quickly. (Dussage, Garrette, and Mitchell, 2004). Scale alliances are also less expensive than acquisitions. In general, costs may be reduced because each firm is using the resources of partners without acquiring them.

Link alliances are formed by firms combining different resources to create new products/services. (Dussage, Garrette, and Mitchell, 2004). Because firms are combining different resources, new sources of wealth may be created because the alliances generate new resources. New resources, or new combinations of existing resources, provide new productive services which creates additional wealth for the firm. (Penrose, 1959; Moran and Ghosphal, 1999).

New sources of wealth creation can be identified by conducting environmental scanning (Garg, Walters and Priem, 2003). Environmental scanning is the means through which top managers perceive external events and trends (Hambrick, 1981). Scanning is the first link in the chain of perception and actions that permit an organization to adapt to its new environment (Hambrick, 1981). This link is important because scanning identifies changes that are occurring in the environment. The better the firm is at ascertaining the changes, the greater the probability that the firm may be able to develop capabilities to capitalize upon these changes.

The environment is made up of factors, external to the firm, which firms have little control over. Sometimes these external factors exert great influence on the firm (Daft, Sormunen, and Parks, 1988). As such, environmental scanning is utilized to provide the firm a better picture of the environment in which it operates (Ginsburg, 1988). The ability to determine the requirements for change and the necessary adjustments depend on the ability to scan the environment, to evaluate markets and competitors, and to quickly accomplish reconfiguration and transformations ahead of competition (Teece, Pisano and Shuen, 1997).

Environment scanning is a necessary but not significant condition for generating wealth. The development of resources and capabilities to match changing environmental conditions is necessary to achieve environmental adaptation. Firms must continuously scan internally to develop resources and capabilities to respond to changes in a firm's external environment. Both external environmental and internal scanning are necessary for effective environmental adaptation (Garg, Wacters and Priem, 2003).

One quick way of creating greater wealth is to capitalize upon competitor's mistakes. Downsizing may be a weakness of many firms. By focusing on downsizing, as opposed to downscoping, firms are only addressing internal cost measures. By General Motors eliminating approximately 25,000 jobs per year, the firm is not addressing changing consumer needs. In many cases, downsizing results in a reduction of human resources. This reduction in resources may create a situation where wealth is reduced because of loss of intellectual capital. By reducing wealth, firms may have less revenue. With less revenue, the firm must cut additional resources. The cycle can continue indefinitely.

Another restructuring approach is downscoping. Downscoping does address changing consumer needs because it focuses resources on the profit generating segments of a firm's businesses. For example, Gillette generates its greatest profits from (1) blades and razors and (2) batteries. It is quite likely that Procter & Gamble will allocate more resources to these lines of business than other Gillette lines.

CONCLUSION

All elements of the modified balanced scorecard framework are linked to each other over time. Increase in shareholders wealth is a result of meeting consumer needs over time. Employees create wealth by building long-term relationships with customers and suppliers. By understanding how consumer needs change over time, the firm's senior managers can design and implement new strategies to increase shareholder wealth. Increases in shareholders wealth result in funds to invest in customers and future wealth initiatives. Increases in employee wealth allow the senior management team to focus upon increases in customer wealth and developing future wealth. As wealth is increased from a shareholders perspective, firm may have additional funds available to invest in the development of capabilities to generate future wealth. As employees become shareholders, they become more cognizant of how the firm can increase its wealth over time. The senior management team may then have funds to begin to generate additional sources of wealth for the firm and its employees. As the firm successfully positions for the future, customer, shareholder and employee wealth should all increase.

By utilizing the modified balanced scorecard over time, the firm can continue to create wealth. This is because the development of specific capabilities can lead to a source of firm heterogeneity over time (Penrose, 1959; Barney, 1991). If the firm is not engaged in the development of specific capabilities, other firms will take customers, employees, and market positions from firms that are not developing these capabilities (Hamel, 2000). This modified balanced scorecard framework awaits empirical testing.

How to Evaluate the Cost Impact

2010-05-18T14:16:00.001+07:00

How to Evaluate the Cost Impact of Using Disposables in Bioma

Andrew Sinclair. Biopharm International. Duluth: Jun 2008. Vol. 21, Iss. 6; pg. 26, 3 pgs

Abstract (Summary)
METHODOLOGIES TO EVALUATE COSTS Disposable technologies have the potential to significantly reduce plant complexity and initial start-up capital costs.1 The benefits of disposable technologies, however, extend beyond reducing start-up costs, and also can include: * reduced time to market, based on a quicker build and validation of facilities * reduced capital investment, resulting from reduced capital infrastructure * reduced cost of operations * improved flexibility in operation, in terms of managing process and product change * improved compliance * simpler material and people flows. No matter which manufacturing cost model is chosen, it is important that certain management accounting techniques, such as lifecycle cost analysis and activity-based costing, be incorporated into the model to account for the significant effect manufacturing efficiency has on the cost of goods.

To understand the overall cost impact of disposable technologies, it is necessary to build a robust model that covers the entire process

The growing acceptance and adoption of disposable technologies raises the question, What is the cost impact of these technologies? This question sounds simple but hides complexity, in terms of what is included in the cost evaluation and the evaluation methods used.

METHODOLOGIES TO EVALUATE COSTS

Disposable technologies have the potential to significantly reduce plant complexity and initial start-up capital costs.1 The benefits of disposable technologies, however, extend beyond reducing start-up costs, and also can include:

* reduced time to market, based on a quicker build and validation of facilities

* reduced capital investment, resulting from reduced capital infrastructure

* reduced cost of operations

* improved flexibility in operation, in terms of managing process and product change

* improved compliance

* simpler material and people flows.

As a result, many companies now wish to understand the broader cost impact of disposables. The critical question is, What is the best evaluation method?

To evaluate costs, a robust cost model is required, in which the methodology and assumptions are transparent. Such a model will provide managers with better insight into the key cost drivers of the manufacturing process and the sensitivity of the overall cost of goods to changes in these key parameters. A good model helps evaluate the cost impact of implementing different technologies and the effect of process changes, such as increasing product titers and yields, and can be validated with financial accounting data.

Some of the commonly used methods for evaluating projects are net present value (NPV), internal rate of return (IRR), return on investment (ROI), and cost of goods sold (COGS). In biopharmaceutical manufacturing, the COGS model is by far the most commonly used method. Although the COGS model has the merit that most people in the industry understand it, it is not the most rigorous or sophisticated method. For example, a COGS model should not be used when there is a need to understand the interplay among the expenditures, timing, and project risk.

The other three methods, NPV, IRR, and ROI, all provide useful tools for decision-making, particularly for capital investment and project approval. NPV and IRR are particularly useful for evaluating potential long-term projects because they account for the upfront investment required as well as the timing of future cash flows and the risk and opportunity cost of the project. Given that disposables can delay and reduce capital expenditure, these methodologies are able to capture that benefit together with the cash flows associated with manufacturing operations.

The NPV methodology is the best technique to analyze alternative technologies and manufacturing strategies, because it accounts for the impact of delays in expenditures and properly accounts for the time value of money.

No matter which manufacturing cost model is chosen, it is important that certain management accounting techniques, such as lifecycle cost analysis and activity-based costing, be incorporated into the model to account for the significant effect manufacturing efficiency has on the cost of goods. For example, the number of successful production runs per year and the cost of facility downtime and batch failure often have a much greater effect on overall manufacturing costs than changes in raw material or labor costs. Also, one should exercise care in comparing cost figures from different sources. Common problems when comparing data relate to consistency in methods and assumptions, especially when it comes to handling capital costs.

THE SCOPE OF THE ANALYSIS

Once the optimum cost analysis model has been identified, the next step is to define the purpose of the analysis, for example, technology evaluation, supplier evaluation, or operations optimization.

The purpose to some extent determines both the detail and the scope of the analysis. If, for example, one wished to evaluate the operational effectiveness of an individual operation, such as buffer preparation, then it is often appropriate to look at the operation in isolation. It is also important, however, to consider all the affected systems. In the following example, we compare a disposable chromatography cartridge as a replacement for a conventional chromatography column in flow-through mode (Tables 1 and 2). This example compares the Sartobind module (Sartorius Stedim Biotech, Goettingen, Germany) with a reusable column processing 6.5 kg of monoclonal antibody (MAb) per batch in a flowthrough anion column.2

The simple approach would be to compare the two operations in terms of the stage throughput, labor, column costs, other consumables, and material costs. To properly compare these two options, however, the scope of the cost model needs to be wider. It should also address the impact on the buffer preparation and buffer hold operations and on maintenance and quality operations. It can also raise other questions. For example, Does the disposable column need a chromatography skid? By taking a broad approach and considering all the factors, it is possible to show the full impact of disposables. The results of our example are illustrated in Figure 1, in which the dramatic reduction in capital and materials is evident.

Taking the analysis one step further, to understand the overall impact of disposable technologies on manufacturing costs it is necessary to build a cost model that covers the entire manufacturing process. A comprehensive analysis makes it possible to assess a particular technology on the overall COGS and thus helps determine whether the technology should be pursued. For example, referring to the previous analysis, does the membrane chromatography significantly reduce overall COGS, or should alternative technologies, such as storing buffers in bags, be pursued instead? Another benefit of a model that covers the whole process is that if constructed correctly, it should provide a framework for "what if" analyses to examine the cost impact of changes in

* scale of operation (e.g., bioreactor volumes and titers)

* process options and improvements (e.g., changes in materials, efficiencies, titers)

* suppliers

* cost assumptions.

WHICH UNIT OPERATIONS PROVIDE THE GREATEST SAVINGS

When assessing the impact of disposables on manufacturing costs, it is interesting to consider that for a stainless-steel MAb manufacturing operation at large scale, most of the capital investment is in support infrastructure (e.g., preparing buffers, media, utilities, clean-inplace [CIP], and steam-in-place), followed by the bioreactors and then by downstream processing. Based on some capital breakdown figures presented in 1999, these areas amounted to about 52%, 32%, and 16%, respectively of capital investment.3 In addition, if one considers that most (between 55% to 85%) of the water used in a stainless-steel biotech facility relates to cleaning reusable equipment (i.e., CIP), then it follows that technologies that reduce the extent of the support infrastructure (e.g., buffer and media preparation and the holding of buffer media and product-containing solutions) will reduce overall costs. Based on capital dominance, one would expect the technology with the next largest impact to be bioreactors. Therefore, one can propose the technologies with the most potential to reduce MAb operating costs to be:

1. holding bags and associated fluid management

2. mixing systems for solution preparation (non-aseptic)

3. bioreactors.

The most mature technology listed above is item 1. The benefits of fluid-handling technologies have been demonstrated in practice, with data in recent papers showing that if the scale fits, storing solutions and products in disposable bags can significantly reduce both operating and capital costs.4 For example, operating costs can be reduced by about 17% and capital costs by about 40% (based on a 1,000-L scale perfusion MAb process).5

The cost of goods model is not the most rigorous or sophisticated approach.

Summary
I hope I have given some insight into how cost models are being used to evaluate the use of disposables technologies in biopharmaceutical manufacturing. I believe that the current focus on COGS models is underplaying the benefits of disposables technology. Typically, disposable technologies result in quicker builds of new facilities or manufacturing suites and reduced capital expenditures. The financial analysis should capture these benefits by accounting for this delay in spending (thereby reducing the project risk). The best method for accounting for these benefits is through the use of NPV analysis.
[Sidebar]
The cost of goods model is not the most rigorous or sophisticated approach.

Accounting for Change

2010-05-18T14:10:00.002+07:00

Accounting for Change

Craig Webb. Association Management. Washington: Feb 2005. Vol. 57, Iss. 2; pg. 58, 6 pgs

Abstract (Summary)
The Healthcare Financial Management Association (HFMA) had a phenomenal year in fiscal 2003, and Edwin P. Czopek will not rest until he figures out why. Czopek, VP of decision support at HFMA, Westchester IL, knows that product sales were up -- but he does not know why. His association's culture encourages program and financial managers to work together to build a system that reflects and tracks, in ever-greater detail, the health care field's fast-changing environment. Similar to the government, associations should strive to update their accounting lines to reflect changes in the wider world. Making sure that the accounts and reality are in sync requires a bit of information gathering, and the ways that associations do this are, of course, varied. To ensure an environment of accountability and well-informed decision making, you need a system that collects -- and links -- as much information as possible.

THE HEALTHCARE FINANCIAL Management Association (HFMA) had a phenomenal year in fiscal 2003, and Edwin P. Czopek won't rest until he figures out why.

Czopek, vice president of decision support at HFMA, Westchester, Illinois, knows that product sales were up-but he doesn't know why. Was the increase in purchasing driven by chief financial officers at health care institutions-HFMA's key constituency-or by a growing group of independent consultants? And given the turnover in health care jobs, what's the possibility that any surge in sales among consultants was attributable to former hospital CFOs who had previously been loyal HFMA customers?

Czopek believes that he'll answer these questions, partly because HFMA has set itself up to do so. His association's culture encourages program and financial managers to work together to build a system that reflects and tracks, in ever-greater detail, the health care field's fast-changing environment.

For example, Czopek can tell you the impact of recent innovations such as e-mail advertising because HFMA has set up accounts to distinguish it from other ad revenue. "Our belief is that product managers should get any information they want," he says. That's true, he adds, even "if the product manager for the conventions wanted to track how much we spend on coffee versus other beverages."

In Debra J. Stratton's experience, such a mind-set often doesn't exist in other groups. As president of Stratton Publishing and Marketing, Alexandria, Virginia, she organized a survey to help provide benchmarks on the revenues and expenses of association publications. Although the survey, first conducted in 1998, revealed many valuable numbers, Stratton notes that it also provided some "scary answers" from associations that had never taken the time to identify publishing-related revenues and expenses. Some groups couldn't answer even simple questions involving one vendor or one bill, such as the amount paid annually for postage on magazines.

Stratum is currently tabulating the results from an update of the publishing benchmarking survey. She suspects that, at some organizations, the rise in online publishing will make finances more muddled than ever. "I think we'll find that...people don't know where the money is coming from and going to," she says. "I'm amazed at the lack of information for people with big budgets and bottom-line responsibility."

The evolving economy

Failing to keep accounts up to date isn't restricted to the association world. Indeed, in 1986, the U.S. Commerce Department discovered that it had undercounted the gross national product (GNP) by at least $6 billion across two years because it had overlooked the birth and spectacular rise of the videocassette movie rental business.

Up to that time, videotapes had been used mainly for industrial films and thus were lumped with janitorial and maintenance expenses. Commerce Department employees might have noticed video rental stores popping up in their neighborhoods, but they overlooked the connection to their GNP-tracking systems and failed to adjust for the change.

The U.S. government learned its lesson; now a program is in place to revise benchmarks every five years to account for how America's economy has evolved. In fact, Brent R. Moulton, associate director of the government's Bureau of Economic Analysis, encourages his staff members to read the newspapers so they can identify and track the next big trend.

Similar to the government, associations should strive to update their accounting lines to reflect changes in the wider world. Take communication expenses. Ten years ago, associations disseminated information mainly via mail and meetings. Since then, we have added the Internet, e-mail newsletters, conference calls, e-commcrce, and webcasts to our arsenal.

Today, successful communication management relies, in part, on the ability to manage this media mix in the most efficient and profitable waysposting documents for download rather than express-mailing them, for instance, or using an online store to capture sales from non-U.S. customers. (See page 32 for an article on finding the right print-electronic communication mix.) But how can you find out whether these changes are really saving money unless you have taken steps to record both the expenses and the revenues from new technology?

Missed opportunities

"If you can't measure it, you can't manage it," executives in for-profit businesses like to say. But for associations there's a corollary: "If you don't bother to measure it, you'll never know what you're missing."

As an example, consider the American Hospital Association, Chicago. In 1999, AHA created a daily e-mail news service that also carried advertising; money from those ads was lumped into the "sponsorships" revenue line. Why? Because no one on staff could ever imagine advertisers giving the same value to e-newsletter advertising that they had historically shown for ads in print products. But lumping numbers together can make it hard to quickly calculate the value of an effort or to inspire staff to meet a particular business goal.

During the early 1990s, all revenues from ads on Web sites managed by AHA's various magazines were lumped into one common account. At the time, Web advertising revenues were paltry and deemed unlikely to rise. But because the revenues were in one program area and the salaries of the people creating content for the site were accounted for elsewhere, calculating the return on AHA's Web investments took some work.

In addition, the people doing the work had little incentive to spend more time on Web-related activities. Any money generated as a result of their efforts didn't show up in their accounts.

The situation began to change about two years ago. Ad salespeople noticed some clients asking to purchase advertising in the e-mail newsletter, and ad agencies started requesting information about AHA's ability to support Web ads. Today, AHA's e-mail newsletter generates more ad revenue than its newspaper. And thanks to accounting changes made last year, managers can quickly identify ad revenue by source (print, e-mail, Web, sponsorship). Then the revenue is credited to the area that created the content supporting the ad opportunity.

AHA's story exemplifies how association operations are getting more granular yet more holistic at the same time-particularly when the resource involved is shared, such as the association's Web site. How can you figure out the Web site's return on investment unless you can categorize and count all the efforts that go into it and all the rewards that go out? How do you allocate revenues, such as sponsorships, when the relationship spans a variety of projects-none of which was the principal reason for closing the deal?

Worth measuring

Wrestling with such questions may prompt your association to reconsider what merits counting. And when you do, you may find out-of-date notions serving as the foundation for your accounting system.

Of course, some numbers are required. The Internal Revenue Service's Form 990 for tax-exempt organizations mandates that a group identify its unrelated business income as well as track expenses such as legal fees, office supplies, and telephone charges. Quasiregulatory bodies, including the Financial Accounting Standards Board and the International Accounting Standards Board, offer (occasionally conflicting) guidance. But, experts say, following generally accepted accounting rules should be just the start.

"Don't think about accounting just from a financial standpoint," says Gary M. Bolinger, CAE, president and CEO of the Indiana Certified Public Accountant Society, Indianapolis. "If [a project is] important enough to do, it's important enough to measure."

Nathaniel T. Bartholomew points out that the United States has no legal minimum for tracking revenue by separate account but, in general, the sooner you can do it, the better. Batholomew, a partner at Langan Associates, Arlington, Virginia, an accounting firm that does 85 percent of its business with associations, offers this rule of thumb: "If [the project is] 1 percent of total revenue, reporting it [now] could be justified based on your belief that it's a growing part of your revenue picture."

If the project's revenue tops 5 percent of total revenue, he adds, it should definitely be identified separately.

John Evans, AHA's chief financial officer, typically applies two general standards when deciding whether to break out a new account. He advocates separation if the project will be cash-positive from day one or if the association believes the account will be an important or large number someday.

Of course, reason also must apply lest your staff get cross-eyed coding every little receipt. According to the 2003 ASAE Operating Ratio Report, the average association reported that Web advertising accounted for only 0.1 percent of all revenues in 2002-2003. Web ads certainly matter more today, but only recently have they likely cracked the 1 percent "notice me" threshold at the largest associations. And for smaller associations, they may never get there.

Take Maury Astley, CAE, executive director of the Nevada Dental Association, Las Vegas, as an example. He heads a staff of three. And an association member handles the accounts as part of the treasurer's duties, managing the finances with Quickbooks software. Astley doesn't track e-mail advertising revenue nor does he formally track the association's sales by categories-such as members registering online for meetings versus via the mail. But like many small-staff executives, he knows where to get the information should he need it. And this occasional back-of-the-envelope calculation may be all some associations require.

Need-to-know basis

Making sure that the accounts and reality are in sync requires a bit of information gathering, and the ways that associations do this are, of course, varied. At the Healthcare Financial Management Association, for example, product managers typically sit down with the controller to discuss each product's accounting needs.

At the Society of Competitive Intelligence Professionals, Alexandria, Virginia, Paul Brecht examines the monthly financial reports for unexpected bulges in revenue, in part to determine if new breakouts are needed. "It's when you lump things together that you take the chance of missing something," believes Brecht, SCIP's chief financial officer and chief operating officer.

On the other hand, John Evans counts on AHA's product managers to tell him what they need to know. "If there's a return on investment [attached to the product] and somebody's job depends on it, we'll get a call right away," he says.

Evans can't spare the time to monitor hundreds of accounts because he also tracks key nonfinancial indicators. With many associations moving toward the "dashboard" or "balanced scorecard" approaches to management, their focus has broadened to include both cash and nonmonetary measures, such as renewal rates and Web visits.

Attention to details

The current trend of linking finances to strategy underscores the importance of adjusting accounts to keep up with the times. Some say that switching to project-based budgeting has forced them to look more closely at the factors that contribute to each project's income and outgo. Because new projects receive the same treatment as existing ones, innovative types of revenues and expenses get noticed. (To learn more about project-based budgeting, see ASSOCIATION MANAGEMENT, February 2003.)

Albert Sunseri, for one, says moving to project-based budgeting was a revelation for his group. "I'm getting better results with relation to the marginswhich projects are costing more and which are costing less than expected," says Sunseri, executive director of the American Society for Healthcare Engineering, Chicago. Just as important, he adds, "we no longer have these red her-rings in our budget" that look like money-makers but instead wipe out profits because income hasn't been matched up with expenses.

Project-based budgeting also tends to cast more light on what often is an association's biggest expenditure: its payroll. When the Regulatory Affairs Professionals Society, Rockville, Maryland, switched to a project-based format, it installed a program through which staff post timesheets listing how many hours they spent on particular projects. As a result, RAPS has a better idea of how much each activity costs, says Iris M. Rush, CAE, vice president of administration at RAPS and past chair of the ASAE Finance and Business Operations Section.

Even so, the revolution is incomplete: All of RAPS's Web operations arc tossed into the general administrative budget rather than being allocated by category. The moral: Project-based budgeting won't always provide the insight you need if you're lumping together several functions.

The American Society for Healthcare Engineering, for example, considers its magazine, Web site, and e-mail communications as separate products. But within each product area, all types of revenue are lumped together. That ultimately could cause a problem because when you don't distinguish between different types of revenue-such as space advertising and classified advertising-you aren't able to easily compare and contrast across projects. Should ASHE launch another magazine or e-newsletter, Sunseri will have to backtrack and review reams of data to pull out the appropriate numbers for budgeting, benchmarking, or evaluation.

In contrast, when the American Hospital Association wants to see how well a publication is doing, it categorizes and counts up the print display ads, classified ads, e-mail newsletter ads, Web ads, and Web classified ads. Not only can staff see the fruits of their various labors but the association can also compare revenues (and individual performance) across its suite of products.

The National Association of Children's Hospitals and Related Institutions, Alexandria, Virginia, takes a mixed approach. NACHRI's Web site doesn't receive any sponsorship revenue, even when most of the deliverables that led to the sponsorship deal occur through Web ads and links. On the other hand, revenue for want ads that appear on the Web site stays with the Web operation.

A smaller window

In the October 2004 ASSOCIATION MANAGEMENT article "Monitoring Return on Strategy," Andrew S. Lang and Glenn H. Tecker argue that 12 months is too long a stretch between updates to your strategy or your asset allocation. They suggest that controllers can't wait for product managers to realize, after the fact, that something needs measuring.

Charles F. Tate, managing partner of Tate and Try on, a CPA and consulting firm in Washington, D.C., sees this push for timely, accurate, and relevant data as one result of an Enron-inspired demand for corporate accountability. He also thinks it's happening simply because associations want to know more about their businesses.

To ensure an environment of accountability and well-informed decision making, you need a system that collects-and links-as much information as possible. Good news can wait the old saying goes. But for curious executives like Czopek, who wants to know what's driving HFMA's increase in sales, that attitude is something else which needs to change.
[Sidebar]
When deciding what financial information to track, "our belief is that product managers should get any information they want," says Edwin Czopek of the Healthcare Financial Management Association.

[Sidebar]
Similar to the government, associations should strive to update then accounting lines to reflect changes in the wider world.

[Sidebar]
ARE YOU AU COURANT ON YOUR ACCOUNTS?
How much can your account books tell you about new technology-based initiatives? These are the projects, such as an online bookstore, that could change-and probably have already changed-the way your association operates.
If your accounts are up to speed, you should be able to answer questions such as these fairly quickly:
* How much (in both dollars and percent) of your advertising revenues come from e-mail or Web advertising?
* What's the return on investment for your Web site?
* What tech-related data can you use to help forecast staffing needs for the coming year? (For example, are staff members answering more inquiries via e-mail or the Web rather than by phone or mail?)
* What percentage of sponsorship money is parceled out to the departments that made the sponsorship possible?
* What percentage of publication sales comes from your online store?
* What's the cost of fulfilling orders for online sales versus other types of sales (such as phone, fax, or e-mail)?
* How has the cost of delivering documents to your members changed as you began making documents available for download on your site?
* What's the return on investment for your online store compared to other sales methods?

* If tomorrow a board member suggested eliminating your association's print catalog, magazine, or newsletter, would you have the income and expense numbers necessary to make a well-informed decision?
* What percentage of your membership renewals and information updates occur online?
* How many tech-related numbers do you include in the "dashboard" report prepared for the association's CEO or board of directors?

Manufacturing Masters Its ABCs

2010-05-18T14:05:00.002+07:00

Manufacturing Masters Its ABCs; Activity-based costing can help boost profits

Hugh Filman in Toronto. Business Week. New York: August 7, 2000. , Iss. 3693; pg. 86J

Abstract (Summary)
In early 1999, when managers at Alcoa Inc.'s metal-forging plant in Cleveland foresaw a downturn in the aviation sector, one of their key markets, they needed to figure out which of their aircraft products were pulling in the most profits. Alcoa's solution has been a cost-assessment system known as activity-based costing. This analytical approach has been compared to splitting the bill at a restaurant. Where traditional accounting divides the bill evenly between all diners, ABC determines who had the T-bone and who had the burger.

In the high-tech world of aerospace manufacturing, where a few products can account for most of a factory's output, a bad production decision can cause trouble for years down the road. So in early 1999, when managers at Alcoa Inc.'s metal-forging plant in Cleveland foresaw a downturn in the aviation sector, one of their key markets, they needed to figure out which of their aircraft products were pulling in the most profits. The plant's complex processes, varied output, and long product cycles made it tough to determine which lines produced the highest fixed overhead costs. With three- to five-year commitments, ``We had to make sure that we could make money on products,'' says Jeffrey A. Weeks, the plant's aerospace business analyst.

Alcoa's solution has been a cost-assessment system known as activity-based costing, or ABC. This analytical approach breaks down all activities in a manufacturing plant and determines the portion of overhead used to make each product. It's like splitting the bill at a restaurant, says Anthony A. Atkinson, a professor of accountancy at Canada's University of Waterloo. Where traditional accounting divides the bill evenly between all the diners, ABC determines who had the T-bone and who had the burger.

Pittsburgh-based Alcoa isn't the only one learning the ABCs of ABC. Once an arcane research topic, this approach is now the focus of intense study by hundreds of manufacturers. Thanks to the falling cost of computing power, even small companies now have access to powerful ABC software tools. These programs also dovetail nicely with so-called enterprise resource planning software--popular programs that coordinate the flow of data throughout a whole corporation. The ABC approach makes possible far more detailed factory management schemes, giving rise to yet another buzzword: activity-based management (ABM). According to Robert S. Kaplan, one of two Harvard business school professors who popularized the system, this amounts to a thorough reexamination of a whole business--process improvements, customer relationships, budgeting--based on what you learn by using ABC.

With the cost of every product in clear view, managers can perform once-impossible analytical feats. Suddenly, they can understand how scarce funds may have been misapportioned, or how a formerly marginal customer may in fact be a profit spinner. Alcoa employed ABC to capture indirect costs such as machine set-ups, quality control, and packing and shipping. After crunching this sort of information in ABC software developed by Hyperion Solutions Corp. in Sunnyvale, Calif., Alcoa is beginning to make smarter production decisions. Managers can now ask: ``Do we want to be in a line of business, or a particular product line, or do we want to sell off certain assets?'' says Weeks. And while Alcoa is still assessing the complex conclusions of its ABC self-study, it is already using the results to rejigger its prices.

``WHAT IF?'' Companies are also using activity-based management to learn more about each customer's value. With more manufacturers offering highly tailored products, determining the costs of different packages and servicing requirements for customers can be tricky. To help, Hyperion and other providers of ABM applications offer ``what if'' analyses of pricing and production scenarios.

The results can be surprising. One U.S. sports shoemaker, for example, wanted to shift sales from high-volume, low-margin megastores to smaller stores that bought less and paid more, notes Derek Sandison, a vice-president at Hyperion. But the what-if analysis showed the bigger outlets were more profitable. ``Even though the megastores were getting a lower price [from shoppers], they were shipping truckloads,'' says Sandison. In this case, the cost of dealing with small shops--higher numbers of deliveries and more frequent late payments--offset the higher prices they were willing to pay.

Despite its benefits, activity-based costing and management are not for everyone. ``If a manufacturing company has one product and one customer, then I could cost that on the back of an envelope,'' says Hyperion's Sandison. Even for big diversified companies, these programs may be too pricey to implement and maintain. A pilot project can cost from $100,000 to $500,000 for software and consulting, depending on the size, says Jeffrey M. Aldridge, partner in charge of the performance management program at Grant Thornton International in Chicago.

Nonetheless, Aldridge argues that an activity-based management system can generate $3 in savings for every $1 that a company invests. So for manufacturers who must grapple with complex processing operations and a range of products, learning the basics of ABC and ABM may be just what the doctor ordered.

Factoring-When money flows

2010-05-18T12:53:00.002+07:00

FACTORING; When Money Flows - Smoothing the business cycle makes sense; As memories of prompt payment fade into the past, organisations are tapping into factoring to safeguard cash flow.

Mark Story. New Zealand Management. Auckland: Mar 2005. pg. 57

Abstract (Summary)
While most large companies still issue invoices due on the 20th of the following month, many clients know they can get away without honouring payments within that cycle. This has spurred many companies to assume late payment is now the rule rather than the exception. While most large companies still issue invoices due on the 20th of the following month, many clients know they can get away without honouring payments within that cycle. This has spurred many companies to assume late payment is now the rule rather than the exception. At best, slow payment syndrome blocks business growth. At its worst it sounds the death knell for floundering enterprises. Factoring companies are willing to fall in behind the banks (concerning control of a company) as long as they have a security agreement giving them a first charge over the company's debt and sometimes any other assets. At face value most companies could benefit from factoring. But it's a niche product and therefore ideally suited for companies going through particular business cycles. In practice, most firms tend to utilise a factoring option facility for two to three years before reverting to more traditional funding or other non-bank alternatives such as stock and debtors' overdrafts.

In the five and a half years since he joined business financier S H Lock, Jason Williams has seen average invoice payment times drag out from 50 days to just under two months. It makes a mockery of 30-day payment terms.As the company's business development manager, Williams is only too aware of the discomfort many businesses feel when they demand clients pay outstanding invoices in one breath and tout for more business in the next.The dilemma is especially real for owner-operator businesses where the person making the sales and the invoice-chaser are one and the same. While most large companies still issue invoices due on the 20th of the following month, many clients know they can get away without honouring payments within that cycle. This has spurred many companies to assume late payment is now the rule rather than the exception, says Williams. Many business people hold back from chasing up overdue invoices for fear they may compromise the possibility of repeat business. Williams suspects this also explains why most firms are reluctant to invoke a late payment clause when invoices reach past due date.At best, slow payment syndrome blocks business growth. At its worst it sounds the death knell for floundering enterprises. Williams has seen first hand the effect on companies trying to sell goods and services to other businesses on normal trading terms. Many struggle to find sufficient cash to meet business running costs.The strain is especially evident among wholesalers and manufacturers who have to pay once goods are shipped."Lack of cash flow, rather than lack of sales, often prevents companies from developing beyond the initial stages," says Williams.He cites expansion efforts by a typical owner-operated giftware company as a prime example. The banks were reluctant to lend to the company without property security. When the owners eventually secured a bank loan to buy extra stock their growth was a small and part-time affair.The owners had failed to factor into their planning the disproportionate amount of time it would take for them to get paid. Recruitment companies face equally challenging hurdles. Those that fail to pay their temps on time find they simply go elsewhere. "So imagine the benefit of having clients paying 80 percent or more of what's owed 'on delivery'," says Williams. "Access to cash smooths the whole business cycle and allows companies to both grow and ride out the tough times." Most local companies know that factoring options exist. But, unlike overseas where factoring is handled by the banks, in New Zealand factoring needs are met by separate and specialist companies. A notable exception is the BNZ which offers a debtors' financing service of its own. Scottish Pacific Business Finance director David Cooper argues this specialisation creates the false impression that factoring must be lending of last resort.Cooper estimates between 300-500 Kiwi firms use factoring as short-term bridging finance on an ongoing basis. There's no doubt in his mind that non-bank financiers must continue to demonstrate to local businesses how factoring can foster company growth. The average loan has now burgeoned to around $100,000 - a fact that prompts Cooper to believe larger firms are now starting to use factoring as a growth tool. He also believes resistance to factoring is lessening, especially amongst the professional community. How does factoring work? Kiwi firms typically plump for the full-service option. Factoring companies are willing to fall in behind the banks (concerning control of a company) as long as they have a security agreement giving them a first charge over the company's debt and sometimes any other assets. Once this agreement is in place the company cuts an invoice and sends a copy to both its customer and the factoring company. On receipt of that invoice the factoring company immediately provides access to up to 80 percent, and sometimes more, of the value of the invoice. Having collected the outstanding invoice on the due date the factoring company will pay the client company the remaining 20 percent less charges (up to two percent of the total invoice) and interest at bank rates of around 11 percent annually (or a flat rate of around five percent). Based on Williams' calculations, the average cost incurred by companies using S H Lock's full service factoring option is three percent of turnover.Although less popular, some companies opt for a second stream of factoring called invoice discounting or undisclosed factoring. The factoring company still takes a charge over the debt and continues to pay out around 80 percent of the value of the invoice. But the discounting option is not disclosed to the client nor is there any debt collecting involved. Companies select factoring options based on their own financial strengths and weaknesses. Williams notes more mature companies with more robust balance sheets tend to favour invoice discounting, unless they specifically want a third party involved in collecting their invoices. "The companies that worry most about limited cash flow typically lack any understanding of how to get out of the predicament they're in."In Cooper's view, many companies fail to grasp that factoring is a more cost-effective option than simply offering a four percent or more discount for prompt payment. That's because discounts are seldom sufficient inducement to encourage prompt payment. "Even if a client accepts a five percent discount on a $100,000 invoice, the company still has to wait on average around 45 days to get paid," says Cooper. "Whereas with factoring the funds are virtually immediate while the cost is substantially less than $5000."It is possible to offset cash-flow uncertainty by having fewer yet larger clients that are historically good payers. But according to Williams selling into a major chain can be a Catch 22. "Large chain stores are more likely to pay on time but there's always the risk associated with having too many eggs in one basket. Especially if your company, almost by default, becomes an extension of the major chain's business and they unexpectedly have a new buyer who favours a new supplier."Who should consider factoring? At face value most companies could benefit. But, as Cooper says, it's a niche product and therefore ideally suited for companies going through particular business cycles. In practice, most firms tend to utilise a factoring option facility for two to three years before reverting to more traditional funding or other non-bank alternatives such as stock and debtors' overdrafts. "If a company's ledger grows from $50,000 to $200,000 the business can put $180,000 back out the door virtually immediately," says Cooper. "The banks would want further security."An inability to pay debts on time can affect a company's credit rating and may see it relegated to a 'cash only' basis. There are also penalties for directors seen to be trading within varying degrees of insolvency," he says.Cooper claims around 30 percent of his company's clients would have gone out of business fairly quickly or suffered a long and slow death had they not used factoring to free up cash flow. "The impact factoring has depends on how the cash that's freed up is used. Ideally it should be used to fund the fundamentals of the business," he says. "Don't fall into the trap of leaving factoring too late. It's not a cure-all for bad business.

"FEAR OF FACTORINGStill not sure whether factoring is the right option? Scottish Pacific Business Finance director David Cooper advises companies to ask themselves three key questions.1 If we had additional cash in the bank today, how much more product could we import?2 What profit can we make?3 Can we afford to pay a factoring company and still be ahead of the game?Mark Story is a regular contributor to Management.

Accounting for lean manufacuturing

2010-05-18T12:48:00.003+07:00

Accounting for Lean Manufacturing: Another Missed Opportunity?

Kay Carnes, Scott Hedin. Management Accounting Quarterly. Montvale: Fall 2005. Vol. 7, Iss. 1; pg. 28, 8 pgs

Abstract (Summary)
While much has been written in the operations management and engineering fields about the benefits and processes involved in lean manufacturing, very little has been written by accountants about the specifics of adapting accounting systems to better serve lean operations. An evaluation of management and cost accounting texts revealed continued heavy emphasis on traditional absorption cost accounting with only spotty coverage of the accounting techniques needed for lean manufacturing. We propose some reasons for the lack of accounting contributions by practicing accountants and educators, concluding that the career of management accounting faces severe challenges and that university accounting programs do a poor job of preparing graduates for careers in management.

Lean manufacturing aims to reduce waste while providing increased customer value. It seeks to involve all the labor of a company in increasing output, productivity, and quality while reducing inventory, defects, dedicated floor space, cycle time, and the cost of scrap and rework. Lean manufacturing is a process of constant, unwavering attack on waste in all its forms.

Building on the success of processes used at Toyota, those who promote lean manufacturing advocate five fundamental principles:

1. Define value and identify the value stream for each product;

2. Eliminate all unnecessary steps in every value stream;

3. Make the value flow continuously;

4. Base flow on customer pull; and

5. Pursue perfection continuously.2

Lean production combines sophisticated technology and high capital investment with skilled laborers capable of varying task assignments. It allows organizations to introduce new products quickly at reasonable cost while simultaneously improving quality. A lean strategy can reduce inventory levels, saving space and handling costs. Work is often accomplished best by cells of work ers producing a complete product rather than functional departments transferring work in process sequentially along an assembly line. Such reorganization saves time and space on the factory floor and improves product tracking and quality. Inventory at all levels is considered a negative factor to be controlled rather than an asset adding value to the company.

The value stream encompasses all those processes necessary to serve the customer and produce value. It usually must extend further than the factory floor and include even suppliers and distributors. Transparency and cooperation between units within the value stream is necessary if the full benefits of lean thinking are to be achieved.

MANAGEMENT ACCOUNTING

Full absorption and standard costing methodologies arose at the turn of the 20th Century when mass production had revolutionized the manufacturing process and made the United States an economic powerhouse. Production was organized into large, discrete batches with many standardized parts or products. Labor made up 50% or more of product cost, with low-skilled workers considered a totally variable cost. Setup times were high and production runs long. Success in such a system was gained by a stable environment, with each labor unit segmented into hard-and-fast categories of time and pay.

In this environment, an appropriate accounting system maximized work center efficiency by tying most costs to labor and encouraged foremen to keep their center running. Cost accounting faithfully mirrored the organization and economics of the time. Setting predetermined standards for material and labor efficiency was considered both motivational and corrective. The few indirect costs associated with production were assigned to unit product on the basis of the product's labor content. This methodology permitted management to know if each product was carrying its share of overhead and that all costs were being covered by price. The variances produced by such a system allowed management to evaluate and analyze functional and departmental performance. Productivity, efficiency, breakeven, and product costs and margins became the standard by which organizations established and evaluated their internal performance.

In assuming that competitive advantage is gained by improving internal productivity, the system emphasized department-level decision impacts and concentrated on decisions internal to the firm. Departments acted as silos of specialization, and managers competed for bigger budgets, promotions, and bonuses.

In traditional accounting systems, increased volume lowers unit costs. Capital equipment, salaried employees, and equipment setups must be averaged over many units to appear cost effective. Therefore, strategic decisions are focused on volume. Such systems also place major importance on inventory and are geared to finetuning information about the many resources used in measuring and controlling it. Because increases in inventory and costs of ordering and holding don't show up as costs until products are sold, traditional systems might reward managers for overproducing. This problem is exacerbated when bonuses are tied to productivity.

Traditional reports address the efficiency of people, the utilization of machines, and such variances as labor rate and usage, materials price and usage, and overhead absorption. Time and effort are spent gathering data, organizing the report, and explaining the variances. For decades this effort has been considered central to management's understanding of production processes. When processes were stable, competition manageable, and product life cycles relatively long, these monthly or quarterly post-mortem reports served management well. Unfortunately, standard and absorption costing methodologies appropriate to manufacturing processes of the early 20th Century have inherent flaws in today's marketing and manufacturing environment.

DIVERGENCE OF MANAGEMENT ACCOUNTING AND PRODUCTION PROCESSES

Some companies that have considered adopting lean processes have determined that the change would not be cost effective, and others have abandoned the techniques after active resistance from employees and management who felt that the process led to division losses. Organizations may reject potentially profitable manufacturing options for a variety of reasons, including lack of upper management support, poor employee training and other human resource limitations, and resistance to change, particularly changes affecting performance evaluations and pay.3 Some of these behaviors are common to most organizational change. There is strong and growing evidence in the case of lean manufacturing, however, that the failure of the accounting system to properly support the change has been a major factor in management's rejection of new processes.4

Reports from firms that have been successful in implementing lean processes indicate that a change from traditional standard cost accounting practices is crucial. Rather than categorizing costs by department, successful companies organize them by value stream.5 It is necessary to consider, therefore, whether deficiencies in commonly used cost accounting systems have deterred or defeated attempts to adopt potentially profitable production methods.

Fifty years ago, Peter Drucker expressed concern that traditional full-absorption cost accounting negatively impacted strategic and operational decision making.6 Since then, the same complaint has been uttered regularly by those involved in reorganizing business processes to meet the challenges of new production methods.7

Lean processes require information about activities associated with the value stream-procurement, order fulfillment, and month-end closing. Data is needed quickly to manage value streams, constantly identify waste, make each employee accountable for cost reductions at his or her own level of activity, and link all reporting to improvement cycles. Not only do traditional accounting systems not measure many of the needed metrics, but they also report too slowly to be of value in a lean environment.

The apparent failure of some firms to change their accounting systems leads to a chicken-and-egg type question: Do production processes lead to the design of management accounting systems, or do companies set strategy based on the system already in place? The indication of published research seems to indicate the latter.

The production method used by a firm will impact its cost structure and should affect what the company measures and reports, but the reverse may also be true: Embedded cost accounting systems might affect a choice of production system by making some methodologies seem more profitable than others. In this case, instead of acting as a strategic support function, the accounting system could become a hindrance to successful implementation of a superior operational methodology. There is an unfortunate likelihood that upper management may view strategic and operational choices in terms of the information the accounting system is reporting, thereby causing a potentially profitable decision to appear unprofitable.

Successful implementation of lean manufacturing may not require a significant monetary investment up front, but it is likely to create the perception of costliness as inventory decreases lead to higher cost of goods sold. The benefits of smaller inventories, higher product quality, and improved customer satisfaction become obvious only over an extended period of time. A traditional absorption accounting system, with its short-term emphasis, can easily mislead decision makers. To successfully undertake a strategic approach to long-term success, the information system must be changed to reflect long-term performance, and organizational culture must reflect a longer view.

Recent surveys of management accountants report their belief that there has been a change in the role of management accountants from numbers crunchers to business partners.8 Someone reading only these reports would surmise that the profession is alive with new vigor and on the leading edge of developing and implementing improved corporate strategies and processes. Much is made of the increased prominence that internal accountants have in the finance function. Unfortunately, those conducting field studies also comment on the dissatisfaction felt by production managers with the apparent failure of their management accounting departments to develop methods that will aid organizations in making sound business decisions.9 Bernard Pierce and Tony O'Dea found a large preparer-user expectation gap.10 When surveying accountants and production managers in the same companies, they found that the managers were more likely to report deficiencies in the accountants' work than the accountants did themselves. They also found indication that managers are turning to IT departments to create reports their accountants are unable to (or do not) provide.

Integrating production and accounting requires dialogue across functional boundaries. The technical and operating staffs who initiate lean manufacturing are often at odds culturally with those in finance who measure and evaluate the ultimate results. They tend to speak different languages, with each group understanding its specific jargon. Accountants who are willing to adjust to new production methodologies have to mingle with those on the production floor who need the information. Management accountants need to be adaptable and willing to account for rapid variations in activity and processes. Development of local performance measurements allows cell leaders, value-stream owners, and managers to understand and monitor production processes and their improvements.

Just as lean manufacturing attempts to simplify processes and reduce waste, a lean accounting environment should simplify accounting, control, and measurement systems. Measurements should be few and focused only on those variables that motivate lean behavior and bring about continuous improvement. Better ways to understand product and value-stream costs should lead to greater accuracy and improved strategy. Eliminating much of the data now collected can save money and free the time of finance staff to work on more interesting strategic issues.

THE SLOW RESPONSE OF ACCOUNTANTS TO LEAN PRODUCTION TECHNIQUES

There are several themes evident within the lean manufacturing literature that may account for the apparent failure of accounting to change as rapidly as production procedures:

1. Lack of training or understanding of production processes. To keep current with fast-changing operating processes, accountants must combine sound accounting skills, understanding of the business, and the ability to gain in-depth knowledge of the key processes and commercial issues. This comprehension is far broader than what is traditionally expected of accountants.

2. Departmental silos and lack of physical proximity. In many companies, the finance and accounting functions are located at great distance from production areas. Value streams cut across traditional functional departments, but companies have not always made it easy for accountants to interact with operations personnel.

3. A financial statement frame of mind. Those involved in management accounting must eventually tie their numbers to the financial statements. "Bottom line" and historical cost mentality are not only part of their training, they are often that which ultimately determines their reputation and rewards within the organization.

4. Feelings of "professional superiority." In some cases, those trained as Certified Public Accountants (CPAs) or Certified Management Accountants (CMAs) may feel that their education and knowledge is superior to that of those in operations. Maintaining proprietary rights to information produced-particularly if the information is not readily understood-may serve to enhance selfesteem.

5. Enjoyment of complex number crunching and complete accuracy. Those attracted to accounting often thoroughly enjoy the complexities of variance analysis, numerous allocations, and multiple decimal points. They are not attracted naturally to the simplification and speed demanded by lean accounting methods.

6. Fear of failure. Developing new systems in a dynamic environment necessitates the acceptance of potential mistakes and continuous adjustment. Both the culture of the organization and personality of the accountant need to be attuned to such an environment.

7. Inequitable performance reward structures. Often, the performance of the accounting or finance function in traditional control systems is not tied to the performance of business units. An accountant whose benefits are tied to net income, which may temporarily decrease under lean operations, will not be motivated to support or encourage such new operational methods.

8. Fear of downsizing. The basic tenet of lean manufacturing is that anything that does not improve value should be eliminated. This might include much of the data, many of the transactions, and a large number of the reports now being generated by accountants. It is not surprising that some accountants may be hesitant to throw out the complex data collection and manipulation techniques they have developed as well as, possibly, some of their colleagues.

9. Not invented here. As we have noted, there is a lack of research and educational support for new accounting methodologies. Since those in operations management have been responsible for the development of new techniques in production, there seems less incentive for accountants to step in with processes to support the techniques. Consequently, the field is being left to those in other disciplines.

ARE UNIVERSITIES AT FAULT?

The importance of accounting literacy to those who would succeed in business has long been recognized. Thus, accounting courses are a basic requirement in most university business programs, both undergraduate and graduate. The curricula generally begin with one or more courses in financial accounting followed by at least one course aimed at applying accounting concepts to the management function. For students who are not accounting majors, the norm is one quarter or one semester of management accounting concepts.

While the complexity of financial accounting has increased in recent years, the basic purpose and structure of financial statements has remained consistent over several decades. During the 1980s, through the auspices of the Accounting Education Change Commission, an attempt was made to alter the teaching of introductory financial accounting from a preparer's perspective to a user's. The majority of financial accounting texts have implemented this change to at least some extent. The consensus about what topics should be taught at both the introductory and intermediate financial accounting level seems to be fairly well established.

Currently, more than two-thirds of America's accounting graduates work for corporations.11 At about the same time that publicized changes were being attempted in the teaching of financial accounting, the Institute of Management Accountants (IMA) polled a large number of corporate managers about the qualities needed by entry-level management accountants.12 The results of this study did not seem to have the same dynamic effect on the management accounting curricula and texts as those that took place in the financial accounting arena.

Other than occasional calls from the IMA and a special issue of Issues in Accounting Education (May 2000), fewer publication outlets and academic conferences deal with managerial accounting than with financial accounting topics. A report by W. Steve Albrecht and Robert J. Sack points out the rapid changes in the environment of business and gives evidence that accounting programs are not changing very rapidly.13 George Foster and S. Mark Young, surveying managers about the accounting issues most important to them, found that many of the topics of most importance to managers were given little attention in management accounting research.14 This limited attention to the needs of practicing managers seems to apply also to those who write textbooks and/or teach management accounting.

To determine how well management accounting texts have adapted their subject matter to the changes that have taken place in the companies to which such accounting applies, we surveyed the tables of contents from the management and cost accounting texts of leading academic publishers as well as a sample of syllabi from management and cost accounting classes. The findings are only suggestive but open an area for further research.

Our impression of management and cost texts and syllabi is that they are organized around a laundry list of interesting techniques, both old and new. A strong emphasis on full absorption and standard costing forms the backbone of the material. Most texts contain extensive information about overhead allocation and the use and calculations of variances. Although quality initiatives, the Theory of Constraints, value chains, and other contemporary management accounting methods are mentioned in passing, most texts discuss them in a few brief paragraphs or in catchall final chapters near the end of the book. Given the organization of the most popular texts, it was no surprise to discover that instructors were likely to delegate more recent methodologies to the end of the course. Those with teaching experience know that time often runs out before they reach these final chapters. If the concepts of lean manufacturing are thoroughly covered or integrated anywhere in the texts or courses, it is not evident from the sources we examined.

Most business majors will enter firms where at least some attempt is being made to modernize production processes, but it appears that they only learn about improved accounting information methodologies after they leave the university. They are being taught modern operations techniques like lean manufacturing in their operations management and systems courses, but they are not given any guidance in their accounting classes as to how information might be collected, organized, or applied to these techniques. Accounting majors, who study at least one additional semester of cost accounting, will not be much help because cost accounting texts also continue to emphasize the various methodologies of standard costing, variance analysis, and cost allocation in great detail but barely mention procedures that might fit lean manufacturing.

THE LAG IN MANAGEMENT EDUCATION

Additional study is necessary to determine why accounting educators have not responded in a timely manner to changes being made in manufacturing processes. Some possible reasons include:

1. Time devoted to the subject. While financial accounting is often allocated two-thirds of a school year under both the semester and quarter systems, management accounting generally is limited to one quarter. It may be felt that students are best served in the brief time allowed by the straightforward and quantifiable job and standard costing methods, with a little budgeting and breakeven thrown in. This deprives business majors of much understanding of the environment they will enter as graduates. This also fails to explain why so little attention is paid to lean manufacturing methodologies in the courses taught to accounting majors. Cost accounting is often taught in two quarters or semesters. Time spent on the intricacies of cost of production reports and equivalent units might better be spent enlightening future management accountants about more contemporary methods.

2. Faculty training. Few faculty have recent practical experience in production facilities. Faculty internships are infrequent and often not rewarded by university tenure and promotion criteria. Thus academics have no direct knowledge of improved information and production processes. The extensive field work that would be needed to learn about lean manufacturing is difficult for educators to obtain.

3. Research prestige. The exciting research topics accepted by top-tier accounting journals are more frequently in the financial area. Teaching and research in management and cost subjects may not carry the same prestige nor attract the same academic leaders.

4. Importance of professional support associations. The American Accounting Association, the main support organization for accounting academics, has far more sections devoted to financial accounting than to management accounting. There seems to be a perception that the financial area receives more funding and has a higher stature, thus driving research and disseminating information toward improvement of financial rather than management education. The IMA works to increase faculty support, but fewer academics belong to this organization.

5. Silos within universities. The operations management faculty, whose curricula change rapidly, are well aware of the limitations of what is currently taught in accounting. But there is little interaction between those teaching management subjects and those in accounting schools and departments. This situation is exacerbated by the separate accreditation status of leading accounting departments and by promotion criteria that do not reward research in journals outside accounting.

6. Absence of market forces. It is unlikely that students choose to attend particular universities based on the specific content of accounting courses. It is only after they graduate that they might discover that their training is deficient. The global forces that drive other organizations toward change are not as pressing in academia.

7. Rapid changes in manufacturing methodologies. Although first described in the 1980s, lean manufacturing is still finding its way into production processes, with continual adaptations to software and nomenclature. Although texts in the operations management discipline seem able to capture at least some of these changes with each new edition, accounting texts traditionally are slower to adapt.

8. Lack of highly defined terms and processes. While standard costing and variance analysis tend to be well defined and understood both by producers and accountants, lean manufacturing by its very nature must be customized for each company's products and markets. Yet the same might be said for concepts such as breakeven and cost allocation-subjects that are regularly taught in management courses.

9. Lack of theory, complexity of methodology. The accounting systems needed by firms employing lean manufacturing are not as well structured and systematized as the traditional 100-year-old methodologies. Authors and instructors would require greater time and experience more variation in content were they to update their offerings at a faster pace. Pressured to perform many other teaching, research, and service duties, they may err on the side of doing what is easiest.

10. Lack of interest. As mentioned previously, even practicing management accountants seem disinclined to devote as much attention to the needs of the factory floor as operating management feels they should. It is not surprising then that academics tend to teach and write about those topics that they find most interesting rather than those that managers in industry find important.

11.The CPA examination. Until its recent content reorganization as part of computerization, cost and management topics formed a very small part of the exam. Although academics like to state that they do not consider the exam in their teaching, the exam undoubtedly affects curriculum content. The new section devoted to the business environment and concepts holds a promise to include more current topics in management strategy.

INCREASE THE EFFORT TO ADAPT

During the second half of the 20th Century, improvements in engineering and communication led to extreme changes in the way businesses conduct their operations. Globalization and competitive pressures have altered the way products are produced and priced, and the product life cycle has been shortened considerably. It should not be surprising that accounting and control systems designed for mass production are illsuited to this new environment. What does seem surprising, however, is how slow many management accountants have been in adapting to the new realities of lean thinking. Changes in the competitive marketplace drive changes in management philosophy, which should drive changes in management accounting. We contend that unless accountants increase their efforts to develop, implement, and teach accounting methods that better serve business organizations, the occupation of management accounting may soon be seen as irrelevant.

It is rather myopic for universities to deprive graduates of the knowledge base that might improve a firm's competitiveness. Many educational processes have already been taken over by companies that feel they do a better job of preparing their employees than traditional educational institutions. Web searches of the terms "lean manufacturing" and "lean accounting" find a large number of proprietary consulting services and corporate seminars devoted to the topics. Better accounting systems will be created, and companies will adopt them. Management accountants and academics should be leaders in adding value in this area. Unless they increase their efforts, however, they are likely to be passed by as others take over the development of new and dynamic cost and management accounting methodologies.

In recent years, many companies have significantly changed their production strategies. To meet increasing competitive pressures, these companies have moved from producing large batches of uniform product to creating individual products or small batches modified to the demands of individual customers. To be successful in this shift of emphasis, firms have adopted a set of processes called lean manufacturing, a term that seems to have arisen from the work of Eiji Toyado and Taiichi Ohno of Toyota Motor Company.1 Over the past two decades, many companies have implemented lean manufacturing techniques, including concepts such as just in time, the Theory of Constraints, Six Sigma and other quality measures, value-stream management, activity-based management, and target costing.

Changing traditional mass-production thinking to lean thinking requires changes in the ways companies control, measure, and account for their processes. Some companies, when trying to shift to lean manufacturing, discover that their standard cost accounting systems create problems for their lean programs. They often find that the emphasis of traditional standard costing on labor efficiency and utilization promotes nonlean behavior such as manufacturing large batches, building high inventories, hiding waste, and focusing on financial rather than operational performance measures. The new lean environment, however, needs local performance measures that are timely, understandable to those on the shop floor, and, often, nonfinancial.

Historically, measures of accounting and control have fallen within the domain of management and cost accountants. Yet a review of recent accounting literature finds little that addresses the mutual interests of management or cost accountants and those managing operations. While the nexus between lean manufacturing and cost accounting appears to be an area ripe with opportunities for accounting researchers, far more attention to the issue has been paid by those in engineering and information technology. In fact, what has been written in accounting journals often reports a lack of progress by accountants in the adoption of new techniques. Accountants seem to have left the field primarily to engineers and software providers.

In the following sections, we provide brief histories and descriptions of lean manufacturing and management accounting and describe the divide between traditional accounting and current operational practices. We also propose some possible reasons for the failure of both practicing accountants and accounting academics to rise to the challenge.

Financial Accounting Theory

2010-05-18T12:35:00.003+07:00

Financial Accounting Theory

William R. Scott, Fourth Edition (Toronto, Canada: Pearson/Prentice Hall, 2006, pp. vi, 472).

Financial Accounting Theory has 13 content chapters, and several sections containing preface, acknowledgements, bibliography, and index (subject and author index combined). The first edition of the book appeared in 1997. The book's success is indicated by the frequency of revisions, averaging a revision for every three years the book has been in print. As the author has indicated in the preface, the fourth edition has substantial revisions in both contents and topics covered in the book.

Financial Accounting Theory's 13 chapters are well prepared and presented. The first chapter is an introduction. It sets the theoretical framework: both historical and ethical, and their applications to accounting research. Accounting research is approached from two complementary perspectives. The first is theory in research, described in ideal conditions, adverse selection, and moral hazard. The second aspect focuses on theory in practice, which is discussed within the context of standard-setting entities/bodies. The remaining 12 chapters are organized within these two broad frameworks: theory in research and practice of financial accounting.

Chapters 3 to 11 discuss research in financial accounting, while the last two chapters, 12 and 13, are devoted to accounting in practice - standard-setting entities, particularly those agencies in Canada. Chapter 13 has a section on the United States standard-setting bodies: Financial Accounting Standards Board (FASB), and Securities and Exchange Commission (SEC), as well as the International Accounting Standards Board (IASB). The United States and IASB are incorporated as they relate to the Canadian Accounting standard-setting and practices. This structure enables the student and/or reader to have a broader understanding of the Canadian accounting practices as they interface and shaped by the accounting practices in the United States and Europe.

For the instructor, the text has teaching supplements: an instructor resource CD-ROM, which contains instructor's manual; solutions to chapter-end questions and problems; learning objectives for each chapters as well as supplementary references; and PowerPoint® presentations. While Financial Accounting Theory has chapter-end questions and problems, it does not provide the student/reader with a list of suggested readings by chapters, which are relevant if the book is expected to be used in upper-level accounting theory courses or seminars. The book does offer supplementary materials for students, for example, a student CD that has sample exercise solutions for questions and problems included in the book, cases, business practices, examples from standard-settings, and supplementary readings. If it is expected that the book can reach wider audiences beyond students taking accounting courses, then these supplementary materials become relevant. Otherwise, access to these materials will be limited only to students enrolled in accounting courses.

It is obvious that the text is a financial accounting theory book that is suited for a broader audience: students and accounting researchers, as well as practitioners. As an accounting theory textbook, it is appropriate for upper-level undergraduate and advanced M.B.A. classes beyond intermediate and advanced accounting. It can also serve a supplementary reading for doctoral seminars in financial accounting theory classes. The book has been primarily written for students and practitioners in Canada. In this aspect, the materials presented in the book are primarily within the context of the Canadian accounting standardsetting and business environment. Nevertheless, the book can be used as a required or supplementary text in a financial and/ or an international accounting theory course. There has been an emphasis in internationalizing the accounting curriculum. Accounting theory courses have incorporated international and global accounting standards and policies.

Books like Financial Accounting Theory will assist in meeting the demands of instructors who are considering adopting books to use as a text and/or supplementary readings in their accounting theory and seminar classes at both the undergraduate and graduate levels. Whichever adoption method or preferences is used for Financial Accounting Theory, there is no doubt that it serves the needs of instructors, students, and practitioners who are interested and pursuing a career in international accounting.

Getting the Best From an Audit

2010-05-18T12:28:00.003+07:00

Getting the Best From an Audit

C J Kelly. Computerworld. Framingham: May 12, 2008. Vol. 42, Iss. 20; pg. 34, 1 pgs

Abstract (Summary)

An independent information security audit can be nerve-wracking, but this time, the author actually enjoyed it. She guesses it's just a matter of perspective. A bigger factor was that this time around, she was prepared. And she's come to see the audit not as a reproach to her work but as a quantitative affirmation of all the things she's been saying they need to do to keep their data safe. Her idea was to ask the auditor to help her develop documentation and processes for the agency that would ensure a formalized system-development life cycle. The new process addresses the security concerns raised by the report. As a result, they now have a suitable framework with which they can begin doing things differently.

Don't fear the audit. Learn from it. The important thing is that systems should be more secure in the end.

AN independent information security audit can be nervewracking, but this time, I actually enjoyed it. I guess it's just a matter of perspective.

It might help that I've been an auditor myself, and so I knew what the auditor was looking for and what he would put into his report. But that isn't the whole story.

A bigger factor was that this time around, I was prepared. And I've come to see the audit not as a reproach to my work but as a quantitative affirmation of all the things I've been saying we need to do to keep our data safe.

Of course, even quantitative results can be misleading, misguided or misconstrued, depending on the expertise of the auditor. And quite often, what most people will look at is the executive summary. In our case, that was a few pages, backed up by a 700-page technical report. Guess which one of those the higher-ups in state government are going to look at?

The problem is that this executive summary, like most of them, is filled with charts and graphs that grossly overstate our security problems. Not that we don't have problems. We do, and I'm glad to have them out in the open.

In our report, what those charts and graphs showed were the number of high-, medium- and low-risk vulnerabilities and their levels of exploitability. The sheer volume of potential problems could overwhelm the uninitiated.

I need to formulate a response to this, so that as this audit report goes up through the chain of command, those who read only the executive summary will have my comments to refer to. This will be a tough document to craft, because my purpose is to show how the executive summary exaggerates and distorts the actual situation, but I don't want to sound defensive or oblivious to what are real shortcomings.

MEGO GALORE

As for that 700-page technical report, even I could only scan it before I came down with a serious case of MEGO (my eyes glaze over). What I got out of it was that all of the highrisk vulnerabilities are related to our application development environment. And many of these highrisk vulnerabilities would require very little skill to cause serious harm.

This wasn't a big shock. I knew that application development was a problem. But the report was an opportunity to do something about it.

The basic weakness is that developers and programmers often have unpatched systems or have configured their systems so that the application they are working on will work the way they want it to. They give no thought to security matters, as you might well expect.

My idea was to ask the auditor to help me develop documentation and processes for the agency that would ensure a formalized system-development life cycle. The new process addresses the security concerns raised by the report.

As a result, we now have a suitable framework with which we can begin doing things differently. At the same time, we moved the application development team to a separate network segment, off of the production network. That should make it less alarming if the application development systems aren't completely up to date.

There is more work to do in the aftermath of this audit, but we've made big progress. Best of all, the positive outcome is something I wouldn't have thought of without the audit.

So, here's a bit of advice: If you are a security manager, welcome your next audit with open arms. The burdens of playing bad cop all the time and being ignored will be off your shoulders. Let the audit speak for itself- in all its quantitative glory.

Auditing skill

2010-05-18T12:23:00.002+07:00

MENTOR: How good are your auditing skills?

Anonymous. Businessline. Chennai: Oct 6, 2008.

Abstract (Summary)
Hence, the company is justified in including the interest component on the cash credit account attributable to such stocks in the valuation of its stocksc) Dividends are to be paid only in cash. The company is not justified in its proposal to pay dividend by giving cloth at cost price to its share holders. Audit considerationsQ3(a) What are the points to be considered by an auditor under Section 227 (1A)? (7 marks) Section 227(1A), applicable to all audits, requires an auditor to examine the following and offer a comment only if it is not complied with: Where the company makes loans and advances against a security, whether such loans and advances are properly secured and whether the terms of such loans are not prejudicial to the interest of the company or its members. Where certain transactions are represented by mere book entries, whether such transactions are not prejudicial to the interest of the company. Where the company, not being an investment company, sells its investments, whether the sale is not below the purchase price and that the terms of sale are not prejudicial to the company. Whether advances and loans are disclosed as deposits. Whether any expenditure of a personal nature has been debited to the profit and loss account. Where it has been mentioned that shares have been allotted for cash, whether the company has actually received cash. b) What is auditor's lien? (3 marks) Auditor lien is a right of the Q4(a) What are the different methods of substantive procedures?

from BUSINESS LINE, October 06, 2008 State whether the following are true or false giving reasons: (2x10 = 20 marks) a) Internal auditor need not send his audit report to the statutory auditor.

b) Tolerable error is the difference in balance sheet acceptable to the auditor.

c) An auditor has no access to a company's non-financial records.

d) Board of directors can appoint the first auditor of any company.

e) Private limited company, which is a subsidiary of a public limited company, is not included in the ceiling of 20 audits.

f) Cost audit cannot be carried out by a chartered accountant.

g) An income-tax officer cannot add taxable income arbitrarily.

h) Propriety audit is audit of proprietary concerns.

i) Test audit is the other name of test check.

j) Deferred revenue expenditure is capital in nature, hence taken to the balance sheet.

Answers: a) True. Confidentiality is applicable to internal auditors also. Statutory auditor is a third party. There is no legal or professional requirement to submit the report.

b) False. It is the error acceptable between the inferences from sampling as compared to the bulk (AAS 15).

c) False. Section 227 of the Companies Act gives him a statutory right of access to any information, which, in his opinion, is necessary for the purposes of the audit.

d) False. They cannot appoint the first auditors of a government company.

Such an appointment can only be done by the C&AG.

e) True. Any private limited company is excluded from the ceiling of 20 audits f) True. Cost audit can be carried out by cost accountants only.

g) True. Assessment is to be done as per the provisions of law.

h) False. It is an audit in to the justification of expenditure incurred by an officer.

i) False. It is another name of supplementary audit. It is carried out by the C and AG. It is a type of audit, whereas test check is an audit technique.

j) False. It is revenue in nature, having benefits extending beyond the accounting period.

Statement analysis Q2: Give your views on the following: a) During the course of the audit, the auditor comes across a fraud committed by the director of a company, who makes good the loss suffered by the company. The auditor does not qualify the report. (6 marks) b) A company dealing in timber holds its stocks for long durations for seasoning.

The company proposes to include the interest component on the cash credit account attributable to such stocks in the valuation of its stocks. (7 marks) c) A textile company proposes to give the cloth manufactured by it to the shareholders at its cost of production by way of dividend. (7 marks) Answers: a) When an auditor finds a fraud, he should bring it to the notice of the higher authorities. If a director commits a fraud, the auditor should bring it to the notice of the shareholders of the company, the fact that he has made good the loss notwithstanding.

An auditor is governed by confidentiality, which prohibits him from divulging information to a third party, unless he is legally or professionally required so to do.

An audit report is a public document. By qualifying his report, the auditor is communicating with persons such as bankers, tax authorities, etc, who are not the shareholders of the company. Therefore, such qualification in the report would be violative of the concept of confidentiality.

Hence he is justified.

b) AS 16 defines a "qualifying asset" as an asset which requires a substantial period of time before it is ready for its intended use. It does not distinguish between fixed assets and current assets.

In the given case, if timber is to be stored for substantially long period of time before it is ready for its intended use, that is, sale, it also becomes a "qualifying asset".

Once it is a "qualifying asset", borrowing costs expended for it can be capitalised.

Hence, the company is justified in including the interest component on the cash credit account attributable to such stocks in the valuation of its stocksc) Dividends are to be paid only in cash. The company is not justified in its proposal to pay dividend by giving cloth at cost price to its share holders. Audit considerationsQ3(a) What are the points to be considered by an auditor under Section 227 (1A)? (7 marks) Section 227(1A), applicable to all audits, requires an auditor to examine the following and offer a comment only if it is not complied with: Where the company makes loans and advances against a security, whether such loans and advances are properly secured and whether the terms of such loans are not prejudicial to the interest of the company or its members. Where certain transactions are represented by mere book entries, whether such transactions are not prejudicial to the interest of the company. Where the company, not being an investment company, sells its investments, whether the sale is not below the purchase price and that the terms of sale are not prejudicial to the company. Whether advances and loans are disclosed as deposits. Whether any expenditure of a personal nature has been debited to the profit and loss account. Where it has been mentioned that shares have been allotted for cash, whether the company has actually received cash. b) What is auditor's lien? (3 marks) Auditor lien is a right of the Q4(a) What are the different methods of substantive procedures? How are they used? (6 marks) b) What are the advantages of an audit plan? (4 marks) Q5(a) What points are to be considered in an examination in depth? (5 marks) b) What are the precautions to be taken while resorting to a test check? (5 marks) Q6(a) What are the drawbacks of an audit of a small company? (6 marks) b)

What are the considerations for audit of income by the C&AG? (4 marks) Short notesQ7: How do you vouch/verify any two of the following? (2x5 = 10 marks) a) Cenvat credit receivable; b) contingencies; c) write off of bad debtsQ8: Write short notes on any two of the following: (2x5 = 10 marks) a) Computer aided audit techniques; b) audit trail; and c) concept of true and fair.

Audit hasn't found fraud

2010-05-18T12:11:00.003+07:00

Dallas ISD audit hasn't found fraud, but that's not its aim

Kent Fischer. McClatchy - Tribune Business News. Washington: May 3, 2008.

Abstract (Summary)
Two professional fraud hunters, however, were skeptical of Mr. Lowe's assertion, given that the Dallas Independent School District's 2006-07 finances are undergoing a routine "comprehensive audit," not a "forensic audit" in which auditors scrub the books for criminality.

To see more of The Dallas Morning News, or to subscribe to the newspaper, go to http://www.dallasnews.com. Copyright (c) 2008, The Dallas Morning News Distributed by McClatchy-Tribune Information Services. For reprints, email tmsreprints@permissionsgroup.com, call 800-374-7985 or 847-635-6550, send a fax to 847-635-6968, or write to The Permissions Group Inc., 1247 Milwaukee Ave., Suite 303, Glenview, IL 60025, USA.

May 3--When Dallas school officials recently reassured the public that a long-overdue audit of district finances has not turned up any fraud, they failed to mention that their auditors are not specifically looking for fraud.

"No one stole anything," school board President Jack Lowe said at a meeting last week. "There's no money missing."

Two professional fraud hunters, however, were skeptical of Mr. Lowe's assertion, given that the Dallas Independent School District's 2006-07 finances are undergoing a routine "comprehensive audit," not a "forensic audit" in which auditors scrub the books for criminality.

"It sounds like wishful thinking," said James Ratley, president of the Association of Certified Fraud Examiners. "Generally, audit techniques are not designed to detect fraud. Auditors may well have [told district leaders] 'We found no indications of fraud,' but that doesn't mean a whole lot because their purpose is not to look for fraud."

The comments of Mr. Lowe and others came over the last several weeks after trustees received reports on the district's overdue audit. At a meeting last week, district auditor Deloitte & Touche laid out, in broad terms, widespread problems within the district's finance departments.

Deloitte director Reem Samra told trustees that the district lacks an "effective internal control environment," that employees are inadequately trained and that top officials had failed to properly oversee financial transactions. Auditors found these problems everywhere they looked, including financial accounting, grant compliance and anti-fraud programs.

Despite that, Mr. Lowe said he believes "with a high degree of certainty" that there is no wide-scale fraud or theft at the district.

"My question would be: How does he know?" Mr. Ratley asked. "To say that no fraud is present [in that environment] is like me saying that there are no speeders right now on I-35."

Generally, annual audits do not proactively search for fraud. Instead, they aim to verify financial statements, most often by comparing transactions and spending against policies, procedures and internal controls.

Annual audits are not the same thing as intently looking for wrongdoing, said Sandy Alexander, a certified fraud examiner and president of CFO Pros, a Dallas fraud investigation firm.

"Very few frauds are uncovered under the course of an annual audit," Mr. Alexander said. "Most frauds are discovered by whistleblowers."

DISD spokesman Jon Dahlander said Deloitte brought in forensic auditors to examine payroll. The audit team found "a relatively small number of exceptions, all of which have been accounted for." In auditing lingo, an "exception" is a payment or transaction that should not have occurred.

The district did not respond to a request for details on how many payroll problems auditors discovered and how much they amounted to.

Payroll accounts for about $1 billion a year in district spending, roughly 85 percent of DISD's expenditures. That would mean the remainder of the district's spending, roughly $160 million, is yet to be scrutinized by fraud examiners.

Mr. Lowe said the district recently created two new investigative departments capable of conducting fraud investigations. He said he would like those departments -- the Office of Professional Responsibility and a new Internal Audit office -- to conduct fraud investigations for the district.
"We do have an in-house fraud audit team, and I have a lot of confidence in them," Mr. Lowe said.

Protect Your Shop with Back-to-Basics Controls

2010-05-18T12:01:00.002+07:00

SocGen Falls into a Familiar Hole: Protect Your Shop with Back-to-Basics Controls

Val Mulcahy, Carol McGinn. The RMA Journal. Philadelphia: Apr 2008. Vol. 90, Iss. 7; pg. 58, 7 pgs

Abstract (Summary)
Many smaller frauds have escaped the light of public scrutiny either because they fell below the hurdle of media interest, or because they resulted in profits, thus ensuring that the control weaknesses never saw the light of day. It's time for a back-to-basics commonsense approach to trading-room controls. The financial industry has become dazzled by the mathematics of trading, but has neglected to ensure that the rudimentary controls remain in place. At the heart of back to basics is segregation of duties (SOD), the mother of good internal controls. Presented is a back-to-basics punch list of internal controls, including SOD. The list includes: 1. small department/remote offices, 2. weak segregation duties, 3. new products launched without full review, 4. poor training of oversight staff, 5. aggressive or aberrant behavior, 6. absence of transparency/culture of opaqueness, 7. bonus pressures, and 8. culture of greed or arrogance.

Basic controls get results when institutions manage the complexity in modern financial products. At the heart of the basics is segregation of duties.

IT WAS SAD to see Société Générale, another mighty derivatives gladiator, trip over its own shoelaces and fall into a familiar hole in the road. In what may be perhaps the world's biggest financial fraud, this French institution announced that one of its junior traders, Jérôme Kerviel, ran up billions in losses, forcing the bank to raise more capital-and putting the institution's future in jeopardy.

The past decade is littered with celebrated war stories of ended careers and the occasional demise of an institution. The underlying story behind the following institutions' losses is their control failures.

Many smaller frauds have escaped the light of public scrutiny either because they fell below the hurdle of media interest, or because they resulted in profits, thus ensuring that the control weaknesses never saw the light of day.

It's time for a back-to-basics commonsense approach to trading-room controls. The financial industry has become dazzled by the mathematics of trading, but has neglected to ensure that the rudimentary controls remain in place. Institutions have shaped their controls around the mathematics of their sophisticated risk systems, rather than asking the obvious questions, such as:

? Is this person raising internal trades that have not been substantiated?

? Is this person writing trades with counterparties we can't see?

? What else is this trader doing that is flying under the radar of our mathematics?

Why is it, then, that the financial market players and overseers have failed in their jobs? Are the products too complex to be controlled by trained back-office staff? Are the wayward traders too clever? Not at all! The much- praised Corrigan Report on Counterparty Risk Management, issued in 2005, stressed that there is, indeed, complexity in modern financial products, but there remains a need for "time-honored basics of managerial competence, sound judgment, common sense, and disciplined corporate governance." Back to basics gets results.

At the heart of back to basics is segregation of duties (SOD), the mother of good internal controls. No sooner is a new financial scandal uncovered than the hunt begins to discover what element of SOD has broken within the organization. All of those companies that have fallen prey to deadly frauds-and the list is long-ignored basic SOD controls and, as a direct result, were ruined or severely wounded.

Back-to-Basics Punch List

What follows is a back-to-basics punch list of internal controls, including SOD. (These and other controls are discussed in the author's RMA course, Risk Mitigation Strategies for Trading Operations.)

Small Departments/ Remote Offices

Small, not big, is dangerous. Frauds are less usual in a bank's main office or in a department where supervisors and managers watch traders and office staff. But although they are less usual, they are not impossible. Barings blew up in its Singapore office and Daiwa in its New York office. Branch offices or small departments are most at risk, as these units often have less supervision and SOD. Controls tend not to be as tight. There is no second pair of eyes automatically scrutinizing the daily flows.

In the head office there are more people, and the responsibilities of each are outlined more clearly. Well-trained people in central oversight functions, if they are uneasy, should have the professionalism to "cry uncle" and initiate a "pause and reevaluation" of the subject product's operational risk hazards. It's a hard call, but necessary. The oversight and risk management units are accountable, too.

Weak Segregation of Duties

Société Générale (SocGen) disclosed that its trader had breached several firewalls and performed back-office style controls. That ability should be an absolute no-no in any organization. In the day-to-day rush, segregation-of-duty procedures may seem like a hindrance. However, the tone from top management must reinforce these standards and discipline any observed breaches. SOD is a non-negotiable control. Achieving a balance between excessive red tape and effective SOD takes time and requires the judgment of experienced operations managers.

In a small office, it can be difficult to segregate duties because there are not enough people to break down responsibilities. But even in a larger office where there is a slipshod SOD culture, people may not want to bother with the red tape required to complete a transaction. They may know the manual requires certain steps, but they opt to "get this deal out tonight." Or, they may believe a new product can't wait for all of the necessary approvals because profits could be forgone in the fast-moving market. They glide over the traditional segregation of duties.

Segregation of duties must apply to all personnel, especially now that the middle office is increasingly managing derivatives. Critical legacy back-office controls can be subverted by an ill-defined middle office. More staff with highly specialized skills-quantitative, credit, legal, and product knowledge-are working in the middle offices. It is inevitable that there will be high-energy "can do" folks, and that is good for customer service. However, the middle office is a tool of the support function, not a lackey of the trader function. That distinction must be reviewed regularly to ensure the middle-office staff does not act as surrogate traders. They are an integral part of the SOD, and their role is to keep in check the power of the trader. They deserve a higher pay grade than those performing routine operational functions, but they must exercise extra scrutiny. Middle office must not see its role as circumventing legacy operational controls.

New Products Launched Without Full Review

Institutions often try to work around the new product review. Some institutions lack a culture that requires it, while others don't adhere to the reviews. They launch a product and announce it will achieve certain goals. The goals aren't achieved, and the systems the institution hopes to have in place before getting to the next level aren't there. For instance, a pilot project might be approved that permits the back office to manually keep the accounting and risk records while traders do no more than a set limit of trades per month. However, if the product is successful, traders start overtrading, and high volume and proper oversight become a problem on a manual system.

The New Products Committee must perform a follow- up review to make sure systems are in place to accommodate the trades.

That new-product review did not take place at Kidder Peabody when it introduced its forward-dated zero coupon strips. Kidder's accounting system couldn't account for immediate delivery zero coupon securities, and basically the wheels fell off the accounting system.

New products are an important component of a successful trading shop. The challenge is to ensure that all departments, including operations, audit, compliance, credit risk, market risk, and finance, review each new product proposal and express their concerns-even to the point of veto. Even after a product is approved, it must be funded and held to its target performance milestones. Inadequacy of funding or below-par performance must trigger suspension of the new-product authorization until it is corrected. SocGen has not yet said if and when Kerviel's business passed this process.

It can be easy for financial institutions to get seduced by large profits. Staff at all levels of the governance chain may not stop and question the commonsense improbability of the rogue trader's spectacular profits. Baring Brothers, for instance, knew it wanted to get into equities trading in the Far East. Barings had one trader in that region producing incredible profits supposedly out of the low-risk arbitrage of two exchanges in Asia. In fact someone doing some due diligence would have discovered that the huge profits didn't make sense in the declared business model. It's important for managers to question where those profits are coming from and how they are being generated from the lines of business.

Again, a breakeven performance when the whole marketis declining may be a red flag. In Daiwa, for instance, the rogue trader didn't show any losses, although traders everywhere else seemed to have losses for some quarters or even years. That was extraordinary. It was the smoke signal his managers should have seen. When the bottom line is positive, it's hard to ask where the money comes from. Often the trader will claim some secret model that no one can understand as his reason for making money, so his managers stop questioning his tactics. When the auditor timidly raises a red flag or a customer raises a question, as was the case in Société Générale, a trader will hide behind his profits.

Poor Training of Oversight Staff

There's a frantic pace on the trading floor, and new tasks are introduced constantly. Managers must juggle their staff turnover and ensure new staff members receive sufficient training. The key is to staff for excellence. No control protects you better than alert control staff brave enough to raise their hands when in doubt. Recruit, train, motivate, and reward with that goal in mind, and do all that you can to limit turnover. Training should be broad, encompassing the full life cycle of a particular product. It should not be just a quick review with a trader or other back-office personnel for a few hours.

Self-assessment risk reviews are a tremendous tool for staff training. In a self-assessment, you ask all the back-to-basics, dumb questions: Where does the profit come from for that product? There must be a plain English explanation of the business model and the associated risks. It must be communicated to all support and oversight areas. It must be widely understood and accepted. If we know where a profit comes from and we've analyzed it well, then it's easy to see all the risk points.

Self-assessment forces everybody in the support and risk oversight departments to see all the mechanical steps that go into making the profit on a product and to understand the risks that arise from that transaction. Define each risk point and devise an effective control for it. Then use a checklist to determine who is checking this risk and how often and whether they've been properly trained to check it. This knowledge base motivates support staff and encourages the brave to ask the awkward questions.

Aggressive or Aberrant Behavior

The hostile, bullying, harassing, uncommunicative, cliquey, or dishonest trader is often at the center of a fraud. The rogue trader will try to override legitimate controls. Such behavior must be disciplined immediately, and the offender should be dismissed if coaching fails. In addition, further discreet audit reviews of their function should be initiated immediately.

Approaching, coaching, or disciplining a high-performing bully trader may be impossible, even for a senior operations manager. Often, the rogue trader is a bully who overpowers the auditor or oversight officers. By sheer force of temperament, the bully trader can browbeat people into believing his actions are legitimate. The key is not to become embattled. Calmly document and elevate to a level above you so that the bank is well aware of the risks you see.

Neither SocGen's Kerviel nor the trader at Daiwa were bullies, but their work pattern was suspicious. The behavior of both traders should have given cause for special, albeit discreet, audit reviews. The "overworked /too busy to take a vacation" accusation is a tough call in practice. Some trading jobs are hugely time consuming. Options traders are notorious for arduous rebalancing of their books and prolonged back-testing of scenarios. However, only men and women, not accounting records, perpetrate frauds.

Management's role is to keep the rogue trader in check. Top management must set the tone that auditing, compliance, and oversight functions are essential parts of the institution's corporate governance. Even if a trader is making money, he may not be the trader the bank wants. It may be that the trader is making money because he has bullied everybody and they are covering up something. Management must confront the trader when smoke signals appear.

Absence of Transparency/Culture of Opaqueness

Transparency is an environment, not a procedure. Whenever you find opaqueness in an organization, you will find problems. We all dislike revealing our missteps and uncertainties, but secretive management eventually suffocates upward communication channels. Once a product is on the books, there must be full transparency. Risk records and ledgers must be subject to the full rigors of SOD and external confirmation not be kept by one person or front-office staff. Records and performance pertaining to that product should be open to all oversight functions. Mistakes, errors, and most important the "awkward questions" must be investigated and documented and remedial actions taken.

Not only the trader but also the whole organization may foster a culture of secrecy. For example, Credit Suisse, when it was caught in its Chiasso branch losses, didn't disclose its losses. After all, confidentiality is the hallmark of Swiss bank accounts. So when the Chiasso branch manager created a completely fictitious portfolio of investments and set of accompanying books, branch management just told auditors they could not inspect the books. That answer was accepted within the culture. Even when the losses emerged, there was a delay in candor with the regulators. In Daiwa's case, the U.S. Federal Reserve was incensed by the failure of openness. SocGen raises the question again.

If the directors or the senior officers set a secretive tone, that culture filters down and chokes off the channels of communication. It's like blocking a chimney stack, making it impossible for the smoke signals of fraud to be seen.

Bonus Pressures

Usually rogue credit officers and operations officers steal money, whereas traders defraud by inflating their bonus pool. Inordinate bonus payouts should trigger a discreet audit review. The process should review all the asset accounts associated with trading and ensure they have been externally verified, especially for unsettled trades.

It's not easy to ensure that bonuses are fair. Senior management must ask several questions: What profit did the trader make? What percentage will be paid out? What were the origins of the profits? Is it reasonable that Mr. A. or Ms. B. gets paid this bonus after having generated that income? Senior management must understand where that income is coming from before they set any bonus percentage.

Culture of Greed or Arrogance

Our industry holds performance as the highest, if not the only, criterion for success. Moderation in appetite and grace in winning are appreciated, but neither scores any points. Hence, greed and arrogance sometimes spin out of control.

Surely, however, Kerviel seems the opposite of this model. Another form of arrogance was at play. SocGen justifiably prided itself on the outstanding qualifications of its recruits and a heavy emphasis on the power of its mathematical risk control management. It may have been blind to the value of the more mundane control checks that were probably there for the taking.

Conclusion

The industry doesn't have a manual on war stories. Like bridge engineers, we have to look for the failures in past designs before we sign off on each new bridge. Conventional wisdom proclaims that thinking positively earns bigger bonuses than revisiting past failures, but we ignore war stories at our peril. We can't presume that no one will make the obvious billion-dollar mistake.

Segregation of duties and tight internal controls are key. We must ask:

? What are we making money from?

? What are our risks and operational procedures?

? Who's managing those procedures?

Every person in the department must be involved in that self-assessment because every risk should have someone responsible for monitoring it.

Nothing is new in the back-to-basics approach, but sometimes people lack the personal courage, trading experience, or seniority to enforce the basics. Or they may not be properly recognized and credited for raising questions. Don't shoot the messengers who bring bad news. When someone raises a question, it should not be brushed aside because the department is making a fortune. Encourage those who question why a trade happened. Somebody has to raise the question, and everyone should be prepared to say, "We made a mistake."
[Sidebar]
Risk Mitigation Strategies for Trading Operations
This one-day RMA course covers basic operational controls
By Carol McGinn
DESPITE THE GROWING complexity of capital markets, the well-understood, commonsense, and back-to-basics controls are still the most effective. Good control strategies, though uncomplicated, require you to be alert and diligent in your independent monitoring of your institution?s trading operations.
RMA?s one-day course covers basic operational controls and provides practical takeaways that you can immediately apply at your institution. The course also uses a series of case studies and examines the control failures in each so that you can apply lessons learned from these major operations failures.
Course instructor Val Mulcahy says case studies are an excellent teaching tool and ?provide key evidence of the similarities of weaknesses in the trail of war stories.? Two cases from the course illustrate this point vividly.
The first is the case of Nick Leeson, a 28-year-old trader working in the Singapore office of the British Barings Investment Bank in 1995. He lost money in a technical derivatives equity arbitrage business between Far East exchanges. To hide the losses, he began to enter fake and unauthorized trades over a two-year period. In the end, the scandal collapsed the centuries-old bank.
The RMA course covers the lessons learned from this case, including:
* The vital role of segregation of duties.
* The critical need for a culture of control awareness.
* The importance of new-product planning and ongoing control.
* The need for the head office to react to the ?oddball? smoke signals arising out of excessive cash movements to settle margin calls.
Allied Irish Bank?s debacle in 2000 is ?a spectacular litany of all that can go wrong,? says Mulcahy. The bank?s Baltimore office was too small to support the complex trading it permitted. Control staff were underqualified and undertrained, and traders and department heads were too arrogant and extravagant to oversee department staff. A laundry list of violations against just about every core control feature provides several lessons learned:
* Scrutiny is hard work. It means understanding the business, looking at events, asking questions, instituting action plans, and following up for results.
* Trade support and oversight department staff must have industry experience, and their training is paramount.
* Audit staff must be up to the challenge of the business.
* Daily profit and loss must be produced by finance/ operations independently of the traders.
* Reported data must be internally consistent.
* Trade confirmation must be independent and universally applied to all trades, even brokered trades.
* Aged confirmations must be reported to management for action.
"It's crucial to learn how to identify appropriate actions for avoiding control failures," says Mulcahy, "and to develop plans to mitigate persistent operational losses. This course addresses those issues from every perspective, whether you're middle-market trading staff, compliance personnel, or capital markets."
With his background, Mulcahy is uniquely qualified to speak to each of these perspectives. He has more than 25 years' experience in challenging chief financial officer and chief operating officer roles in both the United States and Europe. He has held senior financial and risk management positions at several institutions, including Bank of America, BankBoston, Chase Manhattan, and Chemical Bank, as well as international banks, U.S. securities dealers, a life insurance company, and a major CPA firm.

Mulcahy has in-depth operational expertise in all major domestic and international capital markets products, including U.S. equity and fixed-income securities underwriting and trading, swaps, options, derivatives, foreign exchange, and asset-backed securitizations.
Risk Mitigation Strategies for Trading Operations will be held June 17, 2008, in New York. For more information or to register, contact RMA Customer Care at 800-677-7621.

Inappropriate P-card Practices

2010-05-18T00:34:00.002+07:00

Inappropriate P-card Practices

Courtenay Thompson. The Internal Auditor. Altamonte Springs: Jun 2004. Vol. 61, Iss. 3; pg. 97, 3 pgs

Abstract (Summary)
At a major research university, the internal auditors were tasked with performing routine documentation reviews for the university's procurement card (p-card) program. The lessons to be learned about p-cards from a fictional case study include: 1. Routine audits, although not glamorous, may provide opportunities for internal auditors to identify material control weaknesses in routine processing systems that can have wide ranging impact. 2. The p-card process should have an outlet, by hotline or anonymous e-mail, to allow individuals involved in transaction processing and oversight to report suspected abuse without fear of retribution. 3. Budget pressures may so impact established internal controls that the control is eliminated, resulting in significantly increased risk of fraud.

An understaffed university accounting department gets some much needed help from campus internal auditors and uncovers fraudulent use of procurement cards.

AT A MAJOR RESEARCH UNIversity, the internal auditors were tasked with performing routine documentation reviews for the university's procurement card (p-card) program. Although the audit director was not generally in favor of his department performing routine monitoring, he had agreed to the reviews as a service to the accounting director, whose department recently had been a target of budget cuts.

The accounting department had only one person assigned to review p-card transactions processed through the accounting office. With 1,200 p-cards in staff and faculty hands, the review clerk was responsible for manually reviewing nearly 71,000 transactions totaling more than $11 million from the previous year. The p-card program relied solely on internal control processes in user departments and the monitoring practices of one accounting clerk to ensure the cards were used only for appropriate university expenses.

Previous documentation reviews in other departments had revealed random missing documents, a few instances of card use by someone other than the person to whom the card was assigned, and occasional pyramiding of transactions. (Pyramiding is the use of multiple, or split, transactions - for example, multiple card swipes - in an attempt to break transactions into smaller pieces to circumvent card limits.) These transactions are usually easy to identify with data sorts by vendor and date, or by date, vendor, and accounting transaction number. They are also usually fairly easy to spot by their even-dollar amount and by data extraction that highlights purchase amounts reasonably close to the transaction limit. Despite these occurrences, no evidence of fraud had been identified.

As the current round of documentation reviews was drawing to a close, the internal audit director decided to review one of the university's remote locations that had several p-cards assigned to staff and faculty. His reasoning was that the location had not been visited in recent years by internal auditing, had a history of "creative" accounting related to other transactions, and perhaps was in need of a control-awareness wake-up call.

Using the automated financial system query capabilities, the p-card transactions for the previous year were downloaded, and approximately ioo transactions were selected for document verification. Among those transactions were several suspected instances of pyramiding and unusual descriptions of items purchased.

The audit director scheduled a visit to the remote unit for Tuesday morning. The unit was notified in advance and asked to schedule approximately four hours for documentation verification. Upon arrival, the audit director presented the accounting clerk with a list of transactions to be reviewed and asked the clerk to pull the appropriate documentation. The first receipt document pulled was from a well-known discount store and listed, along with the items that would be used by the university, several children's DVDs and video games. The audit director also noticed several items that were crossed out, with a different description handwritten on the receipt. When queried about the appropriateness of the purchases, the accounting clerk responded that the purchaser had told her the chain's receipt didn't always actually describe the item purchased, and what appeared to be unauthorized purchases were actually different items that were authorized.

The audit director, recognizing that the discount chain's financial success "lived and died" by the accuracy of its inventory control, suspected something was wrong. The director continued reviewing the remaining receipts, identifying an additional 12 questionable purchases, which totaled more than $1,200. he contacted the local chain store manager and verified that "if the receipt says video game, it is a video game," and that the manager could specifically identify each game. After visiting with the manager and identifying all the questionable items, the internal auditor contacted the university police department, as was standard practice, to coordinate a criminal investigation of what was now a suspected p-card fraud.

The auditor identified and downloaded all p-card purchases made by the individual since he had received his card three years earlier and identified multiple suspected unauthorized purchases. The following week, the internal auditor, along with an experienced investigator from the university police department, returned to the unit to review documentation of these transactions and to interview individuals involved. While the auditor reviewed and documented scores of unauthorized purchases, the investigator interviewed staff, and through the senior administrator responsible for the unit, scheduled an interview with the suspect for the following day.

When the accounting clerk was asked whether she had wondered about the appropriateness of the purchases, she became very emotional, commenting that she knew they were wrong, but, "it's a small town and I need my job." After questioning several of the earliest transactions, she had quit doing so. Apparently, management pressured her to ignore the discrepancies because the suspect reported to the dean, and "we don't question what the dean was believed to know about."

The audit director, investigator, and senior administrator arrived for the interview with the suspect the following day armed with the internal auditor's documented evidence of suspected unauthorized transactions dating back three years, just one week after the p-card was issued to the suspected individual. Early in the interview, the suspect admitted purchasing unauthorized items for personal use, but also indicated that many of the purchases were for the university but were being "stored" by him at no cost because the school had limited storage space.

Using a search warrant obtained by the university police department, the audit director and university police removed nearly four van-loads of suspected unauthorized purchases from the suspect's home and personal vehicle. he was terminated immediately.

The total estimated loss from the fraud was more than $60,000, but only $32,000 was considered provable. Many other purchases, though apparently excessive and clearly unnecessary, were not traceable because they could not be individually identified. The suspect was arrested, and the university is currently pursuing the case through the courts.

LESSONS LEARNED

* Routine audits, although not glamorous, may provide opportunities for internal auditors to identify material control weaknesses in routine processing systems that can have wide ranging impact. The p-card process was designed as a pilot program of 30 cards and 15 users and was never truly updated to reflect the growth in the process. As a result, controls that worked for a small program were inadequate for a full-scale program.

* The p-card process should have an outlet, by hotline or anonymous e-mail, to allow individuals involved in transaction processing and oversight to report suspected abuse without fear of retribution. Economic realities often shape actions, and even the most honest people will overlook or ignore fraud if they suspect their job or livelihood will be in jeopardy if they report the suspected abuse. When the tone from the top does not encourage and support ethical actions, fraud can grow rapidly.

* Budget pressures may so impact established internal controls that the control is eliminated, resulting in significantly increased risk of fraud. In the search for efficiency, the first activity to be cut is often the control activity, because practicing good internal controls takes time and doesn't normally contribute to processing efficiency in a budget-conscious environment. This can be a costly decision when control processes become overwhelmed by transaction activity.

* Financial system capabilities must be used to allow detective internal controls to effectively identify and evaluate high-risk transactions. Having one clerk assigned to review all p-card transactions - if the clerk does nothing other than review transactions eight hours a day, five days a week - results in just over one minute per transaction for review. Analysis of buying trends and usage patterns through data extraction and analysis, or periodic system queries, should be implemented to identify potentially fraudulent transactions.

* Individuals responsible for p-card use and monitoring must be continually trained and made aware of fraud risk in card use. Annual refresher courses, including fraud awareness, for all individuals involved in p-card processes should be required. No infraction of p-card rules should be considered minor, and management must be made aware of even seemingly accidental infractions.

* Real consequences for misuse of p-cards need to be formalized and enforced. The tone at the top must clearly convey that fraudulent use of p-cards will be prosecuted. A p-card program without "teeth" to address misuse is a "fraud waiting to happen." Even the best run and most well-controlled p-card program will experience fraud.

* P-card fraud may be indicative of fraud in other areas of purchasing.

P-cards are just one purchasing method. A purchasing card fraud investigation should include review of other purchasing methods available to suspected fraudsters. In this fraud, the suspect was also making unauthorized purchases, totaling many thousands of dollars, through direct-billed purchases and standing (framework) orders, as well as using other individuals' p-cards to which he had access.

Consignment's new clientele

2010-05-18T00:00:00.003+07:00

Consignment's new clientele

Meghan V. Malloy. McClatchy - Tribune Business News. Washington: Sep 14, 2008.

Abstract (Summary)
Sep. 14--Area consignment and resale clothing store owners are seeing an increase in the sales,
and believe a tough economy is only going to continue boosting sales. Milazzo does not run a consignment shop like Hilton and Lemelin-Lastella; rather, hers is a resale store where people are given cash on the spot for their gently used children's clothing, rather than waiting for their cash after their items are sold, as a consignment shop works.

To see more of the Kennebec Journal, or to subscribe to the newspaper, go to http://www.kjonline.com. Copyright (c) 2008, Kennebec Journal, Augusta, Maine Distributed by McClatchy-Tribune Information Services. For reprints, email tmsreprints@permissionsgroup.com, call 800-374-7985 or 847-635-6550, send a fax to 847-635-6968, or write to The Permissions Group Inc., 1247 Milwaukee Ave., Suite 303, Glenview, IL 60025, USA.

Sep. 14--Area consignment and resale clothing store owners are seeing an increase in the sales, and believe a tough economy is only going to continue boosting sales.

Jennifer Lemelin-Lastella, of Sidney, said August was her busiest month, as families tried to shop for the school year on a tight budget. Her store, Luv Bugs, in Augusta, sells consignment clothing and accessories from newborn to size 16.

It was Lemelin-Lastella's first back-to-school season, as she opened Luv Bugs in March.

"Parents were looking for those back-to-school basics, like a pair of jeans, but were reluctant to spend $30 on a pair," Lemelin-Lastella said. "They come here and those kinds of things are affordable."

Melanie Milazzo, of Hallowell, has been in business for almost two weeks. Her Farmingdale store, Back on the Rack, sells clothing for children ranging from newborn to size six. She also sells items from baby cribs and bassinets to dollhouses and sleds.

"I have a six-year-old and a one-year-old at home and I know how quickly kids outgrow clothing, especially when they're young," Milazzo said. "You don't want to just throw those clothes away because they were barely worn, and it'd be nice sell them and make a little money.

"I thought to myself, 'That would be a nice business.'"

While the slow economy was not the reason Milazzo decided to open her resale store on Maine Avenue, she said it certainly isn't hurting business.

"People want to dress their children decently, but they might not be able to run up to the Gap and spend $30 on a pair of jeans for one child," Milazzo said. "Some people just can't afford to do that anymore. And with this winter that we're supposed to have coming, just forget it."

Heidi Hilton, who owns Raggamuffins, a consignment shop with locations in Gardiner, Topsham, Auburn and Lewiston, said the boost in sales this year isn't what has surprised her: it's the clientele.

"This year for back to school we saw a lot of people that one may think wouldn't regularly shop at a consignment clothing store," Hilton said. Her stores sell clothing for babies, children, teens and adults.

She also saw an increase in teenage customers, a group that typically does not "buy from a consignment store and we have seen several this year already."

Milazzo does not run a consignment shop like Hilton and Lemelin-Lastella; rather, hers is a resale store where people are given cash on the spot for their gently used children's clothing, rather than waiting for their cash after their items are sold, as a consignment shop works.

"I think being a resale store helps people out, too," Milazzo said. "People are able to get cash for what they need immediately in exchange for the clothing they bring in."

All three women think sales in the consignment and resale business will continue to grow as Mainers will spend more on heating their homes this winter.

"I've already started selling winter jackets and snow suits," Lemelin-Lastella said.

Because of the spike in revenue and people interested in becoming consignment shoppers, Hilton is moving her Gardiner location of Raggamuffins across the street to a store that is twice as big as her current one.

The new store is expected to open Oct. 1, Hilton said.
In Milazzo's case, customers are also getting a head start on holiday shopping.
In Milazzo's case, customers are also getting a head start on holiday shopping.

"It's September and people have come in to do early Christmas shopping," she said. "I think this is a nice option because they can afford to buy several different gifts for their kids, and the clothes and toys are practically new."

Sold on consignment

2010-05-17T23:49:00.001+07:00

Sold on consignment: Shopping at consignment stores can be like going on a treasure hunt.

Nzong Xiong. McClatchy - Tribune Business News. Washington: Jun 4, 2008.

Abstract (Summary)
With gas prices skyrocketing past $4 a gallon and budgets tightening, dreams of changing your home decor may be on hold for a while. Interior designers, real estate agents and even stage designers for theater productions occasionally will come through looking for special items, consignment store owners say.

Jun. 4--Three years ago, when one of Merryanne Bauer's sons divorced and refurnished his home, she stepped in to help.

She went shopping. However, she didn't shop at only retail furniture stores for all new pieces; instead, she also went to consignment stores.

"I bought two complete bedroom sets from Consignment Cottage" in Fresno, says Bauer, 77, of Fresno.

Then, when a grandson decided to move into his first apartment two years ago, she found things for him at the store, too: a mahogany bed, a buffet, tables and chairs, a couch and more.

"If you wait long enough, you can color coordinate" the furnishings, she says.

With gas prices skyrocketing past $4 a gallon and budgets tightening, dreams of changing your home decor may be on hold for a while. But they don't have to be.

You just might be able to find the things you need to give your home a new look by visiting consignment home-decor stores -- where the prices can be lower and the products sometimes are new, but more often are slightly used.

"When I was trying to get stuff for my grandson, I was in there at least once a week," Bauer says. "You just have to keep looking."

Like-new furnishings

While you might be able to find items that are new, consignment home decor stores typically carry pieces that are used.

The way it generally works is the consignment store agrees in a contract to sell an item on behalf of the owner for a percentage of the selling price.

"If it's a good item and priced right, it'll sell within the first two to four weeks," says Roseanne Guaglianone, the owner of Consignment Cottage. "But the contract is for three months."

While the terms of the consignment vary from each store, if an item isn't sold after a certain amount of time, the owner typically can take it back.

You can find all sorts of things, and a variety of styles, at consignment home-decor stores.

You'll see mirrors, wall art, furniture, bedroom sets, flatware, lighting fixtures and more. You typically won't see any appliances or clothing, though.

Decorating with consignment items is ideal for a couple of reasons. For newlyweds and recent graduates who are just starting out and tight on money, the prices can be more reasonable, say several store owners and customers.

"For young couples and college students, it's a wonderful way to furnish your home," says Diane Wiens, who lives in Madera and has shopped at consignment stores on and off for 15 years. "It's less expensive. You can find some really nice pieces.

"I know you can go to some of these furniture shops that are inexpensive and are brand new. It's going to last maybe two years, but at these consignment stores, they often get items from estate sales. [These older furniture pieces are] put together really nice and designed really well. You'll have a piece that's functional for the rest of your life."

Items at consignment stores "should be cheaper," Guaglianone says. "The things that are at consignment stores, for the most part, they've been in homes for years, and so you can't find them anymore and can't compare to new products out there."

If the person consigning the item remembers what he or she paid for the item, "we try to price it considerably less than what [the seller] bought it for," she says.

If the seller doesn't remember, she and her staff will check to see what similar items were priced at in the past.

Other people are turning to consignment stores, too, for the uniqueness of the things they might find.

"Some of these items have been in families for 20 to 30 years," Guaglianone says. "They're one-of-a-kind items."

Interior designers, real estate agents and even stage designers for theater productions occasionally will come through looking for special items, consignment store owners say.

With many items coming and going on a daily basis, you never know what you might find.

"If you're really looking for unique items to furnish a room, come often," Guaglianone says. "It's always changing. Just because you don't find something today, it doesn't mean you won't find it tomorrow."

On the prowl

Throughout the years, Bauer has found many things for her home, including a mahogany wall shelf and iron wall art with framed pictures of fruit.

She also has given new life to a lighting fixture that she put in her entryway by having it rewired and adding crystal drops and shades.

She has bought some furniture, including a chair she had reupholstered and a semi-circular couch she plans to have reupholstered.

With a creative talent for crafts, she has added more fake flowers to a bouquet she bought at a consignment store. "I liked the vase and could see the potential," she says. She paid about $20-$30 for the original vase display, then added another $30 worth of flowers.

"It was cheaper that it was halfway done," she says.

Wiens has bought gifts for her children from consignment shops, including a set of chopsticks and a rocking chair.

"Sometimes they're funny, sometimes they're really nice," says Wiens, a 51-year-old housewife.

Wiens enjoys visiting consignment shops for the thrill of the hunt. About once a week, she goes by Consign-It Furnishings Sales in Madera, which isn't too far from her home.

"I look at it as fun," says Wiens, who also stops for garage sales and estate sales. "For people like me, it's like a treasure hunt. What am I going to find when I go in? It's exciting.

"What I like to look for are tables, footstools, mirrors, vases, unusual lamps." Among the things she has found and bought is a footstool that still had its original fabric and horsehair stuffing for $39.

Because most things in consignment stores aren't new, Wiens and Bauer will inspect pieces they like for quality.

"When I look at a piece of furniture, you look in the drawer to see if it's dovetail, see if it smells, see if there are scratches," Wiens says.

If the description says a mirror is an antique, she'll give it a lift. "If it is really old, they're really heavy," she says.

Shoppers and owners recommend that you plug in lamps and other lighting fixtures to make sure they work.

Pat Hall, owner of Consign-It Furnishings Sales, carries lamps but offers ceiling-light fixtures less often because it's not easy to test the latter. "I don't know anything about electrical wiring," she says.

Most consignment items will have detailed descriptions on their tags. If they are slightly damaged, the tags often will say sold "as is."

"I make sure ... that everything's fine," Hall says. "I check out the arms or cushions. They wouldn't have rips. If they did, they'd be [sold] 'as is' or go to thrift stores."

Consignment stores have a vested interest in making sure the things they take and re-sell are of good quality, she says. If they don't sell, the stores don't make anything.

Having some knowledge about the worth of an item is helpful, Wiens and Bauer say.

"You have to be up on it a little bit," Wiens says. "If you're not really positive, you can go back." Go home and do some research online on the item. A lot of times, the consignment stores will do their own research on the things that come in and will have antique books on hand to show customers.

For the most part, consignment stores have a no-return policy, so make sure furniture pieces will fit through doors and their destined locations, Wiens says.

If you're not sure if they'll match the rest of your decor, "ask if you can take a piece of it home, maybe a pillow or cushion," Hall says.

If you find something you like but the price is more than you'd like to pay, you can try waiting a week or two. If it's still there, the price probably will go down. Or make an offer. The owner just might take it.
That's how Bauer came to own the semi-circular couch with feather- and down-stuffed cushions.
"It was $1,200," she says. "I offered them $800, and they came back with $1,000."
And now it's sitting nicely in her den.

Practice management tips

2010-05-17T23:45:00.001+07:00

Practice management tips from the '03 AAA meeting

Anonymous. Accounting Office Management & Administration Report. New York: Oct 2003. Vol. 03, Iss. 10; pg. 1

Abstract (Summary)
Sessions at the recent Association for Accounting Administration (AAA) national symposium in Montreal focused on current practice management issues of importance to firm administrators and managing partners. For firms that are considering going paperless, an intranet will be key to the process. About one-third of attendees at the intranet session reported that their firms have begun to perform paperless audits. About the same number are using .pdf tax forms and doing as much e-filing as possible. The partner succession issue is critical, since about a decade's worth of younger talent is missing at many firms. One danger in succession planning concerns buyouts. Many firms still follow the traditional approach which involves a percentage of past earnings times years of business. Firms should expect to see a continuing trend of acquisitions by $4-million to $20-million firms of $1-million to $1.5- million firms with two partners who are tired, find it hard to compete, and no longer enjoy their work.

Two sessions at the recent Association for Accounting Administration (AAA) national symposium in Montreal focused on current practice management issues of importance to firm administrators and managing partners.

The first was one of the small-group breakout discussions for which AAA's conferences are well known. AOMAR attended the session for firms with $2 million to $4 million in fees, but the observations we collected apply to any small or midsize firm.

A second session involved audience questions during a breakfast seminar, which were fielded by industry consultant Allan Koltin (www.pdi-global.com), who was able to shed light on a number of partner-specific concerns.

Highlights from the small-group breakout discussion:

* The importance of intranets. Firms are now learning how to use these effectively, those that are just building their intranets as well as those that are expanding them. And, like many technology areas, the set-up and cultural buy-in will take far more time than getting the technology operational. The tools have become quite simple, especially for small firms, which generally use Microsoft Front Page for their intranet software. A benefit to Front Page is its interface with the Microsoft Office programs.

Your firm can use a single in-office computer to operate the intranet and act as the Web server; in fact, small firms probably won't need to devote a separate computer to this function.

For help with intranets: One firm administrator who consults with CPA firms in establishing intranets is Jim Fahey, firm administrator for Brott Mardis & Co. (Akron, Ohio; jim@brottmardis.com). Another resource is AAA's guide to intranets, which is free to members.

* Going "paperless." For firms that are considering going paperless, an intranet will be key to the process. About one-third of attendees at this session reported that their firms have begun to perform paperless audits. About the same number are using .pdf tax forms and doing as much e-filing as possible.

Attendees advise firms that would like to make this change to start with just a few clients to learn how to do it, and then expand the program. And you needn't invest in an expensive program: You can work with Microsoft Internet Explorer to set up your own files. You can also get software from scanner vendors, although you may find that you have little or no need for high-end scanners. More important than the hardware is the interface.

Also key: Implementation strategy and firm culture. Paperless firms need someone to "own" or take responsibility for the project, to see that it proceeds at an acceptable pace, deadlines are met, and that the new file structure is correct.

* Partner accountability. Firm administrators are always concerned about this issue and it is becoming increasingly important among firm owners as well.

Administrators can do only so much to track operations-partners must accept responsibility if things are to get done, agreed several participants in the session. "This is a cultural issue," noted one firm administrator. You need consensus, a strong managing partner, and a written performance plan. Expect any cultural changes to take "more time than you'd think."

* Budgets for staff appreciation/incentive programs. One firm administrator observed how important it is in a merging firm that has separate locations to use one system to encourage a single culture. Most attendees said their firms had incentive programs for getting new clients, hitting performance goals, and recruitment. But they cautioned that bonuses don't always work as incentives, especially if firm members expect them. If your firm uses bonuses, be clear about their purpose.

In addition to monetary rewards, consider recognizing people's achievements at brief staff meetings at which you can also share information about engagements and other firm data, and morale-boosting programs (contests and trivia games were mentioned as examples).

* Sharing financial information with staff. The firm administrators in the session supported an open-books policy: Staff like to know where the firm stands, and who the achievers are. They expect to be informed about what's going on-it makes them feel part of the team and breeds loyalty.

Partner issues. The breakfast session led by Allan Koltin focused on more partner-related issues, which are no less important to practice management. Key topics:

* Partner succession. This issue is critical, since about a decade's worth of "younger" talent is missing at many firms, Koltin noted. "Now we are beginning to pay the price." The issue has many facets besides finding and grooming talented CPAs to become partners.

"A good succession plan begins the day the account comes into the firm," he asserted. The work needs to become the work of the firm over time, not just the work of a particular partner.

One danger in succession planning concerns buyouts. Many firms still follow the traditional approach which involves a percentage of past earnings times years of business. Koltin urges firms to consider instead the age of the retiring partner's clients-old clients will disappear from the firm long before the payout of the retired partner is complete. He believes that tying the payout to the longevity of the client makes sense financially. However, it can encourage partners to cling to their clients instead of sharing them with the firm-the opposite of what is best for the firm.

The real solution, according to Koltin, is funded retirement, but this is a goal that continues to elude many firms. Until they can accomplish this, a capped payment tied to a percentage of retirement fees and the bottom line is probably the best approach.

* Corporate vs. partnership business models. The profession is moving for now to the corporate model. Koltin says the best managing partners run the firm like a business and treat partners as business partners.

Firms that want to embrace the corporate model will have to do away with one partner having one vote, and requiring a 75% majority to make a change. They'll also need to consider having several levels of partners, including equity, non-equity, and director levels.

* Length of term of service for managing partners. Because managing partners rarely hold the position throughout their careers, firms need to consider how to structure the job. Will the managing partner give up some of his or her book of business to perform the administrative duties? If so, the firm should probably help the person rebuild that book of business after completing the term of service. Moreover, it's important for managing partners to hand over the reins fully to their successors.

Consider having a non-CPA "managing principal" run the firm, Koltin suggests. This can work well for the firm, as long as the partners take what this person says seriously. No matter who runs the firm day to day, partners must not become isolated from decisions made about management and client service issues.

* Valuation of mergers and acquisitions. What are CPA firm practices being sold for now? The one-times-gross-fees traditional measure is still around, Koltin noted. Expect to see a continuing trend of acquisitions by $4-million to $20-million firms of $1-million to $1.5- million firms with two partners who are tired, find it hard to compete, and no longer enjoy their work.

* Value and high billing rates. The most profitable firms set high billing rates for their partners-and they get paid. Koltin proposed a multiplier of utilization times realization. Partners need to focus on what they do to deliver value to set their rates, he said.

* Firm association membership. Today, firms need depth and resources and can get them in the strategic "partners" of a firm association. Also, as an association member, you can learn from others about new areas. In fact, not joining an association and using as much as possible from its offerings causes you to under-serve your clients, Koltin claimed. It also puts you at a disadvantage among larger CPA firms, which are marketing ever more services and core business functions to clients now.

Accounting Firms to Prepare

2010-05-17T23:40:00.001+07:00

Accounting Firms to Prepare Tackle Brazilian Soccer

By Terry Wade. Wall Street Journal. (Eastern edition). New York, N.Y.: Jul 17, 2002. pg. B.9.C

Abstract (Summary)
Many critics, including soccer legend Pele, allege the trouble comes mostly from the top of the country's dozen major clubs, hundreds of minor league teams and the Brazilian Soccer Confederation. Ricardo Teixeira, the head of the confederation, was recently a subject of congressional inquires for allegedly taking part in kickback schemes, which he has denied.

Pro-reform politicians say they are now worried Brazil's latest Cup victory will hurt the push to clean up soccer. When Brazil was struggling to qualify for the latest World Cup, Brazilians were outraged and put Mr. Teixeira under intense pressure.

Mr. [Eurico Miranda] is just one in a string of politicians that worked or serve as club presidents and have come under scrutiny. The senate has asked the public prosecutor's office to take on the investigations of Mr. Miranda, along with Mr. Teixeira and 16 other club or state soccer-federation directors.

SAO PAULO, Brazil -- Undeterred by their profession's recent troubles in the U.S., the world's major accounting firms are ready to tackle a new field: the Brazilian soccer scene.

Though Brazil won an unprecedented fifth World Cup in July, the local soccer scene is in disarray, and its congress is investigating allegations of widespread corruption in the country's pro leagues.

Now, companies including the local units of KPMG and Deloitte Touche Tohmatsu are offering services to the country's professional soccer clubs after President Fernando Henrique Cardoso issued a decree last month to fight corruption by requiring clubs to reorganize themselves as corporations and start publishing financial statements.

For accountants, there is certainly plenty of work to go around. Brazil's professional soccer teams have changed little since they formed in the early 1900s as amateur associations. The reforms aren't just about improving ethics. The changes could also boost foreign investment that Brazil sorely needs.

"Some investors already have had frustrating experiences investing in soccer clubs, and now they fear losing money again in Brazil," said Andre Castelo Branco, a Sao Paolo-based partner with KPMG here. "Now we have to wait to see how the new law is implemented . . . and if club owners have the will to change things," he added.

Though soccer is the most popular spectator activity in Brazil, many clubs are bankrupt, and few people know where all the ticket revenue or television dollars go.

Many critics, including soccer legend Pele, allege the trouble comes mostly from the top of the country's dozen major clubs, hundreds of minor league teams and the Brazilian Soccer Confederation. Ricardo Teixeira, the head of the confederation, was recently a subject of congressional inquires for allegedly taking part in kickback schemes, which he has denied.

The accountants' game plans call for cleaning up the books of Brazilian soccer teams and then structuring new stadium deals that bring in foreigners with deep pockets.

If the reforms work, Alexandre da Rocha Loures, a director at Deloitte Touche Tohmatsu in Rio de Janeiro and a professor at the Fundacao Getulio Vargas business school, projects as much as $500 million in foreign capital will be invested during the next two years for stadium projects in 10 major Brazilian cities.

Services for structuring stadium deals and project finance offer higher fees than traditional accounting. And any new stadium would be well-attended, as eight Brazilian teams rank among the top 20 globally for having the largest fan clubs.

Rio de Janeiro-based club Flamengo, which is struggling to pay its 200 million reals ($70.1 million) in debt, has the world's largest fan club at 30 million and has been home to some of the world's greatest players, including Romario and Zico.

While accountants are eager to restructure Flamengo's operations, their hopes for sweeping changes in the pro leagues ultimately rely on politicians.

Though President Cardoso's decree took effect immediately, it requires congressional approval within the next two months to become permanent law.

Pro-reform politicians say they are now worried Brazil's latest Cup victory will hurt the push to clean up soccer. When Brazil was struggling to qualify for the latest World Cup, Brazilians were outraged and put Mr. Teixeira under intense pressure.

But there are some in congress who tolerate old-style soccer management.

Eurico Miranda, who has denied allegations by the media of using gate receipts from Rio de Janeiro team Vasco de Gama to fund his recent election to congress, opposes reform efforts. "As long as I'm president of Vasco, things will be kept the same," he said last week.

Mr. Miranda is just one in a string of politicians that worked or serve as club presidents and have come under scrutiny. The senate has asked the public prosecutor's office to take on the investigations of Mr. Miranda, along with Mr. Teixeira and 16 other club or state soccer-federation directors.

Luiz Estevao, who was expelled from his senate seat in 2001 for allegedly misappropriating funds for a courthouse construction project, is the owner of Brasiliense FC -- the biggest professional team in Brasilia. And former president Fernando Collor de Mello, who was impeached amid corruption allegations in 1992, launched his political career after serving as the head of the CSA soccer team in Alagoas state.

Despite Mr. Miranda's resistance, the government says it means business.

Minister of Sports Caio Luiz de Carvalho has made it clear that failing to comply with the law can result in jail time for club presidents. That tough stance has accountants preparing for a new growth industry.

Accounting Firms Pledge

2010-05-17T23:35:00.002+07:00

Accounting Firms Pledge to Improve Disclosure Guidance

By Leslie Scism. Wall Street Journal. (Eastern edition). New York, N.Y.: Dec 5, 2001. pg. A.10

Abstract (Summary)
Enron's stock and bond prices plummeted in recent weeks based on media revelations about related-party transactions that the company had referenced in disclosures criticized by some accounting specialists as indecipherable. Compounding problems at Enron are its admitted financial misstatements and billions of dollars in debt hidden for some time in partnerships that weren't consolidated into the financial statements.

NEW YORK -- Trying to shore up their reputation, the Big Five accounting firms pledged yesterday to develop recommendations by year end to improve corporate financial disclosures in some of the areas that blindsided investors in Enron Corp.

The united front by the nation's biggest accounting firms comes as shareholder litigation mounts against Big Five member Andersen LLP. The lawsuits concern financial filings going back to 1997 that Enron last month disavowed. Regulators are conducting a formal investigation of the energy-trading company, the scope of which includes Andersen's audit work for the Houston company. Andersen has said it is cooperating with investigators and studying what happened "to learn important lessons and do better."

The accounting debacle at Enron, which filed for Chapter 11 bankruptcy-court protection Sunday, is the latest in a string of high-profile blowups for the accounting profession during the past several years.

In their news release yesterday, Andersen, KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst & Young specifically promised to develop recommendations to the Securities and Exchange Commission for improved disclosure guidance on related-party transactions, off-balance-sheet "special purpose entities" and issues related to risks of energy contracts.

Enron's stock and bond prices plummeted in recent weeks based on media revelations about related-party transactions that the company had referenced in disclosures criticized by some accounting specialists as indecipherable. Compounding problems at Enron are its admitted financial misstatements and billions of dollars in debt hidden for some time in partnerships that weren't consolidated into the financial statements.

The five accounting firms also said they would work on new ways to improve audit effectiveness, as part of their effort to maintain investor confidence in the accounting profession.

Automated audits

2010-05-17T22:59:00.003+07:00

Automated audits

Tays-Dunphy, Karla. CA Magazine. Toronto: Jun/Jul 1996. Vol. 129, Iss. 5; pg. 36, 3 pgs

Abstract (Summary)
Data transfer is simpler now than it was even a few years ago, and graphical user interfaces have made today's software programs easier to learn and use. Generally, firms first use audit software to automate current tasks, such as the selection of samples from general ledger transactions, accounts receivable outstanding items, inventory items, capital asset additions and payroll. Audit software reduces the time required to select a statistical or systematic sample. Audit software can also be used to help assess valuation and obsolescence. In the receivables area, audit software is used to re-age the accounts receivable outstanding items and compare the results to the client's aging. Audit software is useful not only for large clients of large public practices, but for smaller practices and internal auditors.

IF YOU'VE BEEN DISILLUSIONED WITH AUDIT software in the past, either because data transfer was too difficult or your staff spent hours wrestling with the program, it's time to reconsider. Data transfer is simpler now than it was even a few years ago, and graphical user interfaces have made today's software programs easier to learn and use. More than ever, audit software is a tool that can make your audits more efficient and effective.

For one of our clients (a credit union), we normally spend about two weeks selecting deposit and loan confirmation samples, footing the subledgers and preparing confirmation letters. This year, however, one of our CAs, who had very limited audit software experience, completed it all in one day with audit software -- including transferring the client data to our portable computer.

Doane Raymond decided to use audit software several years ago for a number of reasons: to increase efficiency and productivity; to gain time by automating manual tasks; to perform analysis (such as extensive testing) that would be difficult to do manually; to audit systems for which a traditional paper audit trail was inadequate; to meet the expectations of clients who had invested heavily in technology and wanted their auditors to use it; to provide general audit staff with the most productive tools; and to offer value-added services, such as trends analysis.

Since then, both IDEA and ACL, leading suppliers of microcomputerbased audit software, have introduced Windows-based versions that are easier to learn and use than the former DOSbased programs. In addition, many of our clients now regularly transfer data to their microcomputers from networks and mainframe systems, so data transfer is no longer a problem.

Generally, firms first use audit software to automate current tasks, such as the selection of samples from general ledger transactions, accounts receivable outstanding items, inventory items, capital asset additions and payroll. Audit software reduces the time required to select a statistical or systematic sample - a measurable benefit.

You don't realize how powerful the software really is, however, until you go beyond sampling. In the inventory area, for instance, we use audit software to refoot the inventory file, reperform the extension of quantity times cost, and compare the result to the client's calculation. Previously, a few samples would have been tested manually. Now, with the computer, and in significantly less time, 100% can be confirmed. Audit software can also be used to help assess valuation and obsolescence. Common procedures include extracting all inventory items where cost is more than net realizable value, extracting items that have not been sold in the last 12 months, aging the inventory based on the last sales date, and extracting items with negative costs or quantities. All these procedures would be very time-consuming or impractical to perform manually, especially for large inventory files. For clients whose accounting systems are unable to perform these analyses, we use the audit software to generate reports to help value their inventory. We also use audit software to match inventory test counts to the physical inventory file and then to perpetual inventory. At the same time, we can also check for duplicate inventory tickets.

In the receivables area, audit software is used to re-age the accounts receivable outstanding items and compare the results to the client's aging. We can re-age the entire accounts receivable file, rather than just a few samples. In addition, the software is generally flexible, so that aging periods other than those on the client's standard reports can be used. In instances where a significant number of accounts receivable are selected for confirmation, audit software can be used to select the sample and export the results to a mail-merge file, saving support staff the need to rekey the information.

There are many possible uses for audit software, depending on the type of client. In the case of a charitable organization, for instance, we use audit software to check the continuity of donation receipts and search for duplicate receipt numbers, work orders and bills of lading. For one of our municipality clients, we use such software to generate payroll exception reports, which can include unusually large pays, overtime payments or the largest 20 pays during the year. For financial institutions, we use software to identify loans with unusual interest rates or payment terms, or recompute accrued interest on all outstanding loans -- tasks that used to be restricted to manual test-checks.

In many industries, audit software can be used to extract unusual items (such as repair and maintenance expenses exceeding a certain amount) for further follow-up. The software can also search for all missing sales invoices, based on beginning and ending invoice numbers. It can be used to extract any large debit entries in revenue accounts or to identify related-party transactions; and it can also be used to compare clients' actual balances with budgeted balances, extracting accounts with a large variance for further analysis.

Audit software can be beneficial in non-audit engagements as well. We have used it for analytical procedures, to identify and extract related-party transactions, and to generate reports for clients on inventory obsolescence or other matters. Audit software is also used frequently to import the client's trial balance and then export it into a format supported by our working paper software.

The 1994 CICA Audit Technique Study, Application of Computer Assisted Audit Techniques Using Microcomputers, is a good reference for implementing audit software. (See Appendix A of the study for further examples of audit procedures that can be performed with this software. )

Audit software is useful not only for large clients of large public practices, but for smaller practices and internal auditors. One internal auditor was able to reduce his travel to the branch offices by obtaining branch data in advance and using audit software to look for unusual items and select samples. He then sent this information back to the branch so the supporting documents would be available when he arrived.

Audit software is not just for computer audit specialists, either. At Doane Raymond, all audit staff are trained to use IDEA, the software selected by the firm. Staff learn about the key functions of the software, how to obtain client data, and how to document their work. Such training is necessary to ensure staff learn the most proper and efficient use of the software.

There is a learning curve, especially on the first two or three engagements. Although we are able to obtain net savings in the first year on many of our audits, savings are much more likely in the second and subsequent years. That is because in the first year, it is necessary to spend time rethinking our audit approach. Because of this initial investment, it is imperative that partners be committed to this change. Staff will not use a tool, even one that ultimately makes them more efficient, if they think they'll be blamed for spending too much time in the current year. In such a case, it's much safer for them to do the audit the old way.

With appropriate planning and supervision, however, it's possible to minimize the first-year investment. After providing adequate staff training, you should choose clients who can easily export data from their accounting software (such as ACCPAC Plus). Also, consider selecting smaller clients first, to ensure the task is manageable. And try to target clients who are using the same software or are in the same industry, so you can apply your knowledge from one client to the next.

Consider adding new audit applications each year rather than all at once. If inventory is a high-risk area, for example, start by implementing procedures to assist in checking obsolescence and valuation. Then, the following year, expand procedures to other areas such as receivables or payroll.

It's important to investigate data transfer implications as early as possible. Although the ability to transfer data from a client's system has been a significant barrier to the use of audit software in the past, that barrier has been minimized in recent years. Many of our clients now connect microcomputers to their networks or mainframe systems and download data regularly, in order to manipulate them with spreadsheet software such as Excel and Lotus. The summer season is an ideal time to meet with clients and plan the transfer of their data. (Additional information on downloading and understanding data is provided in appendixes D and F of the study mentioned earlier.)

There are several ways to transfer data between microcomputers: Copy the data to a diskette on the client's microcomputer and then onto the hard drive of your own. For a data file too large to fit on one diskette, use a compression program such as PKZip.

If the data file is larger than 2 MB, you can connect two microcomputers with a parallel or serial cable and then transfer the file. DOS 6 includes a program called Interlnk for such transfers. Other popular programs are LapLink, FileShuttle and Brooklyn Bridge. Or, use Windows 95's Direct Computer Connect to connect two computers. You can also use Windows or DOS backup and restore commands, or a portable tape backup unit.

Small business clients often use accounting software programs on their microcomputers and several of these systems have record definitions included in the audit software. You need to find out the name of the appropriate data file and copy it to your microcomputer.

If the audit software does not contain a record definition for the client's accounting software, determine what export capabilities are available in the accounting software. Most mainstream accounting software can export data in formats such as dBASE, ASCII text or Lotus 1-2-3. If you are using IDEA, the best format is dBASE, since it automatically includes the record definition information in the file.

If the client's software does not have an export capability, it might be capable of printing the desired information in a report format. You may be able to import the report file directly into the audit software or by using a file translation utility such as AutoImport, Monarch or DataImport.

If these methods are not successful, ask the software vendor if he or she can provide the layout of the data files so you can generate a record definition. The vendor may also be willing to develop a program to convert the client's data to a format readable by IDEA.

There are definite benefits to be gained from using audit software in your practice. Not only will it lead to greater efficiency and productivity, but it will enhance your firm's image. Moreover, the software is easier to use than it used to be. If you have ignored audit software for the past few years, it's time to take another look.

The Importance of Data Audits

2010-05-17T22:53:00.001+07:00

Risky Business: The Importance of Data Audits for Content Security

Sue Marquette Poremba. EContent. Wilton: Oct 2008. Vol. 31, Iss. 8; pg. 32, 5 pgs

Abstract (Summary)
Database security is a serious issue that affects every business or organization, and most IT security personnel state one of the most effective means of database security is good database auditing. There are four key categories to database auditing: server security, database connections, table access control, and restricting database access. The federal government and some industries have begun to realize the severity of database breaches and have begun to institute data privacy regulations. Companies are expected to follow these regulations and are regularly audited to make sure they are properly securing their databases. Despite the regulations and governance councils, companies are slow to respond to the need for better database auditing. Not every data breach is caused by criminal intent, but for every accidental breach, there is a disgruntled employee who is looking for revenge or a crime ring eager to make a few thousand dollars selling the information on the black market.

In early July, a Texas man was arrested for allegedly filing more than 160 false tax returns using the Social Security numbers of University of California-Irvine graduate students. The Social Security numbers were reportedly stolen while the man worked for the Student Resources Department of United HealthCare Services, Inc.

In June, a California man was sentenced to nearly 5 years in prison after he was found guilty of hacking into the protected computer system of his former employer, Council of Community Clinics, multiple times, disabling the backup system and deleting files. (He was angry after receiving a negative performance review.) His actions destroyed personal medical records of patients, putting their lives at risk.

This spring, online mortgage loan marketplace Lending Tree, LLC sent a letter to its customers to inform them of a possible data breach caused by former employees providing passwords and access to personal information to other mortgage lenders.

Even members of the Supreme Court aren't safe from identity theft: Justice Stephen Breyer's personal information was made public when someone in an investment firm used peer-to-peer networking and inadvertently provided a gateway to a database. The breach wasn't discovered for 6 months.

Troubling as they are, these stories are just a few of what seems like a never-ending list of companies experiencing data breaches, which can lead to the theft of information ranging from a customer's Social Security number to a corporation's secret designs for a new product.

A 2007 study of 494 IT security personnel conducted by the Computer Security Institute found that, while the numbers are slowly decreasing, 46% of the respondents said their company experienced a security incident in the past year. Fraud caused, in part, by the loss of customer and proprietary data is the number one reason for financial loss within companies (overtaking computer viruses for the first time).

Database security is a serious issue that affects every business or organization, and most IT security personnel state one of the most effective means of database security is good database auditing. Too often, however, data is left vulnerable, partly because companies are more concerned with protecting the network from the outside and invest in technologies such as firewalls to prevent attacks. What gets overlooked is that information from a database is more likely to be hacked by a current or former employee than from a virus injection.

"Essentially, we are guarding the front door, while the bad guys are walking in the back door," says Rick Kam of ID Experts.

THE DATA TRAIL

In order to ascertain risk, companies must track data usage, which is commonly referred to as database auditing. There are four key categories to database auditing: server security, database connections, table access control, and restricting database access.

Server security limits user access to the database server. Database connection involves knowing who has access to a database and how and when it is accessed, while table access control dictates what the user can do within the database itself. Restricting database access refers to protecting the database from outside sources, such as malware that can manipulate code on an internethoused database.

Perhaps the biggest breakdown in database auditing is the lack of governance over user accounts. Too often, when an employee leaves a company or even transfers from one department to another, the person's account isn't closed or changed.

In fact, user access is the number one IT security concern among healthcare workers, according to a study taken at the Healthcare Information and Management Systems Society (HIMSS) 2008 Annual Conference and Exhibition by Courion Corp. Of the 136 people questioned, 64% cited access as their main security issues, while 60% were concerned about passwords being shared between personnel and 52% admitted that orphaned accounts were not properly disabled.

While providing doctors, nurses, and other caretakers easy access to the data they need improves patient care, Kurt Johnson, vice president of corporate development at Courion, adds, "It also opens a whole new concern in the organization to exactly who has access to this information."

There are three phases to a database audit, according to Robert Grapes, chief technologist with Cloakware's data center. "There's the upfront work, the tactical things to be done day-by-day, and the post-forensic or the real audit of what happened on the system," he explains.

The upfront phase involves password issues and who has access to accounts. "While a lot has been done to address password management from an engineering standpoint, we're finding that very little has been done to correct password issues for human administrators who need access to the database," Grapes continues.

So upfront, the idea is to look at who exactly has access to a database and to regularly do audits to account for everyone who has access to the database.

Automated software functions control the tactical daily audits. This can include closing a person's access to the network or changing the fields an employee should have access to, depending on the job duties. The software also dictates when passwords should be changed.

After applications have been run and the database logs have been recorded for the day, the audit occurs. Software, such as Grapes' Cloakware, can be used to record every time the data had been manipulated or a password changed. This information should then be verified on a regular basis to make sure the people working with the database had the authorization to do so.

Unfortunately, financial issues often drive database auditing best practices. It costs money to manage thousands of passwords, Grapes says, yet password management is the best way to protect data.

"Automating the process can improve the security profile," he says. Software, for example, can produce new passwords but not release the new code until the user is ready to log in.

However, if the funds don't exist for automated auditing software, there is a relatively low-tech way to go to protect database information: Make sure that multiple people have access to the database. Too often, companies will assign control to one person, and there are no checks and balances in place.

"In San Francisco recently, a guy was able to lock out an entire system," Grapes says, "and that scenario is not uncommon. One person has all the privileges, like the fox protecting the hen house, and in this case, the fox is able to set up new accounts. Financial institutions are worried about this."

PRIVACY PLEASE

The federal government and some industries have begun to realize the severity of database breaches and have begun to institute data privacy regulations. They include best practice requirements and industry guidelines regarding usage and access to customer data. Financial institutions are currently regulated by the Gramm-Leach-Bliley Act (GLBA), which requires the protection of nonpublic personal data while in storage and implements a variety of access and security controls. Payment Card Industry Data Security Standard (PCI DSS) requires that merchants who accept credit cards follow certain standards of security protection for consumers. The Sarbanes-Oxley Act of 2002 is a congressional response to the Enron and similar accounting scandals and establishes new and enhanced standards for publicly held companies. Perhaps the bestknown privacy effort is the Health Insurance Portability and Accountability Act (HIPAA), which is meant to further protect patient information as more medical records are shared via electronic means.

In addition, the IBM Data Governance Council was formed to create best practices around risk assessment and data governance. The IBM Data Governance Council is an industry group comprising about 50 members representing financial companies such as American Express, Deutsche Bank, Citibank, MasterCard, and others.

Companies are expected to follow these regulations and are regularly audited to make sure they are properly securing their databases.

"IT security is a strategic part of the company, but business people haven't recognized that yet," explains Steve Adler, chairman of the IBM Data Governance Council. "We think that the current methods used for calculating risk need to be automated and a normal part of business."

He says that every individual in an organization needs to be aware of the security risks, which is not usually the case. "There are many people who work in the IT department who are unaware of the security strategy," he says. "There needs to be more operational awareness." Despite the regulations and governance councils, companies are slow to respond to the need for better database auditing. For example, the PCI DSS had a June 30th deadline requiring that web application security testing be upgraded from a best practice to mandatory compliance, yet IT security firms helping with this transition say that only a handful of firms were prepared to meet the requirement, despite being notified of this requirement in 2006.

Rick Kam blames the inefficient database auditing on the natural disconnect between what the executive teams think they are doing for security and what's really happening in the IT and privacy offices.

"There's a tendency to compartmentalize functions," Kam says, "and this has provided easy opportunities to steal information."

THINK LIKE A THIEF

One thing Kam recommends is for organizations to think like a bad guy when protecting data. "We think very differently from crooks," he says. "We think, 'how would a rational person break into the system,' and we invest heavily to protect where we think the vulnerabilities lie. The problem is, the crooks don't view it the same way and will find other ways to access the information they want."

What the company can do instead, Kam says, is bring in a person who can look at database security from a different perspective, such as an auditor hired to investigate fraud risks.

Good training is another vital step toward database auditing. Too often, Kam explains, a person may detect potential fraud early on, such as improper access to certain information, but then not know what steps to take to stop the breach.

Kam has three tips for putting a database-auditing plan into action:

1. Do an information security assessment.

2. Have an up-to-date instant response plan. "Most companies have information security plans and disaster recovery plans, but when they have to respond to lost or stolen information, they scramble like crazy," Kam says.

3. Have an insurance policy to cover the risk. "You have insurance policies to cover employee accidents or other financial loss," he adds. And with nearly half of all companies experiencing a database violation or theft of information, it makes sense to be prepared to cover the costs involved.

Of course, contrary to popular belief, data theft has been around as long as there has been data to steal, and criminals still use low-tech methods, such as stealing mail with personal checks inside or recording credit card information during a restaurant transaction. Computers and the internet have simply provided the bad guys with access to more information stored in one place.

SEPARATE, NOT EQUAL

For that reason, Yuval Ben-Itzhak, CTO of Finjan, Inc., says it is important to segment the data. For a simple database, multiple users may have access to a database, but for each application, each person will use a specific credential to only access the information that is needed.

"The majority of data breaches happen because most applications provide access to all the information in the database," he says. "But once you segment the data, even if it is compromised, the hacker will have limited access to the information."

Encryption is another important and often overlooked tool, he says. Good encryption tools will make information from a violated database useless to a cyber criminal.

Ben-Itzhak suggests companies be creative when it comes to the way they create their databases too. "There's no reason to have all customer data or medical records in one place that's easy to access," he says. Providing different avenues to access the data will better protect it.

He also disagrees with those who say that the costs of better database auditing prohibit companies from making changes. Instead, he says, these practices should be included as the database is being built, that companies need to plan for better security from the get-go. "You don't need to buy other products," he says. "It's a design issue. The developers aren't educated in how to provide security; their job is to provide functionality. And in ignoring security in the design, it becomes a playground for hackers. "

He also recommends frequently checking the information that is in the database. If a customer's information hasn't changed within a specified period of time, it should be considered outdated and removed. "You can't focus on just one element of database auditing," he adds, "or you will end up with a weak link in your security efforts."

COMMUNICATING THE RISK

Customers understand the risks involved when it comes to database breaches, and reports of a breach affect their relationship with the company. According to a study the Ponemon Institute and issued by ID Experts, nearly one-third of consumers notified of a security breach terminate their relationship with the company.

"We found that most people do care about security breach notifications and are concerned," says Larry Ponemon, founder of the Ponemon Institute. "And their concerns are identity theft, financial losses, and the inconveniences that the breaches cause."

Not every data breach is caused by criminal intent, but for every accidental breach, there is a disgruntled employee who is looking for revenge or a crime ring eager to make a few thousand dollars selling the information on the black market. Smart companies realize their reputations and their financial growth depend on ongoing database security.

A' Is For Audit-Proof

2010-05-17T22:46:00.003+07:00

A' Is For Audit-Proof

Stephen McMurray. InformationWeek. Manhasset: Sep 1, 2008. , Iss. 1200; pg. 41, 4 pgs

Abstract (Summary)
The 63% of respondents to the 2008 Strategic Security Survey say their organizations are subject to government or industry regulations. A key piece of compliance is enforcing policies through systems like Active Directory but once set, it's difficult to ensure that rules remain effective -- rapidly evolving technology means infrastructure modifications routinely outpace IT's ability to manage change, leading to gaps between official corporate policy and reality on the ground. Vendors claim new Active Directory compliance tools can gauge policy effectiveness and add value for both IT and the business. Active Directory policy auditing tools fill a niche in the broader category known as governance, risk management, and compliance, or GRC, software. The decision to implement a new utility must be driven by a structured risk management approach. A guiding principle that won't let you down: Policy comes first. The trick is to strike a balance between required business functionality and optimum security settings.

[Headnote]
Could you benefit from an Active Directory security compliance assurance tool? Sure, but policy comes first. By Stephen McMurray

HOW CONFIDENT are you that your systems comply with corporate security policy? Confident enough not to sweat an audit? This isn't a rhetorical question for the 63% of respondents to our 2008 Strategic security Survey who say their organizations are subject to government or industry regulations.

A key piece of compliance is enforcing policies through systems like Active Directory, but once set, it's difficult to ensure that rules remain effective-rapidly evolving technology means infrastructure modifications routinely outpace ITs ability to manage change, leading to gaps between "official" corporate policy and reality on the ground. Add telecommuters and branch offices to this lack of visibility and you have a management nightmare.

The first step to get back on track is to align security guidelines with regulations and deploy Active Directory Group Policies to enforce configurations ... no small feat. Once that's accomplished, IT must still demonstrate compliance. Just defining necessary settings isn't enough-auditors expect you to prove rules are correctly applied.

Vendors claim new Active Directory compliance tools can gauge policy effectiveness and add value for both IT and the business. Misconfigured devices are more likely to have security problems that expose data to exploits or internal misuse. And a relatively small percentage of workstations -usually those with nonstandard settings that allow the user too much control-tend to generate a disproportionate number of virus and spyware incidents.

There's certainly a case to be made for any technology that promises to streamline compliance costs and measurably improve security But as with most compliance software, it's difficult to determine true value amid the clamor of hype. Not all products are created equal, and the last thing you need is another point tool that fails to deliver.

Don't get us wrong-there's value to be found. But to avoid pitfalls that threaten to leave you with a false sense of security and no tangible improvement, lay policy groundwork and examine current capabilities before going shopping.

BIG SELLERS

Active Directory policy auditing tools fill a niche in the broader category known as governance, risk management, and compliance, or GRC, software. From a vendor perspective, GRC products have proved to be a steady source of revenue growth-one that's relatively resistant to the budget cuts that go hand-in-hand with adverse economic conditions. Not surprisingly, then, vendors are moving to strengthen their offerings and rebrand existing products as "compliance solutions." Unfortunately, this fragmented market remains in constant flux as developers scramble to keep up with new technologies. Feature sets vary widely and no two products are alike, making comparisons difficult.

Typically, the big players-think CA, IBM, Novell, Sun Microsystems, and Symantec-push broad suites that aim to meet compliance needs across the enterprise, but Group Policy isn't always addressed. Some packages leave Group Policy management to native tools, while those that include some form of endpoint policy auditing often lack adequate depth. Smaller outfits offering tools specifically for Active Directory tend to provide more comprehensive features in the Group Policy arena; these providers include BigFix, FullArmor, NeUQ, NetPro, and Quest.

Our take: If you're in a large organization with a diverse environment, overarching suites can reduce your product count, but you'll still be forced to supplement them in weak areas. If you just need to plug Group Policy compliance gaps, point tools offer better value.

WAIT... DON'T I HAVE THAT ALREADY?

As larger vendors recognize, Microsoft's Active Directory provides built-in features to enable centralized management of endpoints. So why can't Group Policy, the native AD answer to policy and configuration management, get the job done?

Group Policy is a powerful tool for deploying policy settings-Microsoft has exposed thousands of configuration options in a relatively easy-to-use GUI, and hundreds of additional settings arrive with each new OS version. The underlying technology is fairly robustdefined controls can be applied to users or devices and refreshed at regular intervals.

But any number of issues can block proper Group Policy application, ranging from inadvertent corruption of local security policy files to intentional alteration by those trying to circumvent controls. These events are recorded locally on the desktop or server, so unless you're collecting logs and centrally analyzing them for errors-not likely on workstations, given the bandwidth and overhead required-IT is none the wiser. And event logs are useful only for detecting application problems; they won't validate control settings or report on deviations.

Complexity also is a concern. As policy counts increase, it's easy to make configuration mistakes, either in the policies themselves or in the priority ordering and inheritance that come into play as multiple layers of policies are applied.

"Remember that room in your house when you were growing up where there were two light switches that controlled the same light? One of the switches was always down and the other one was up, and it always felt weird to push the one that was up back down to turn the light on," says John Abraham, CEO of security auditor Redspin. "Group Policy settings in Active Directory are just like that, only there are hundreds, sometimes even thousands, of possible switches. How do you know if the light is on?"

Add another dose of complexity to the mix if you want your policies to include settings for many nonMicrosoft applications. Most organizations are still running the Windows 2003 version of Group Policy, which lacks the ability to easily specify custom registry settings without developing templates.

Help for the most glaring omissions arrived with the release of Windows 2008. One key addition is Group Policy Preferences (GPP), which expands the available configuration options and plugs many of the gaps in older versions, such as the inability to manage registry settings without having to create custom administrative templates. GPP represents the latest iteration of the PolicyMaker technology acquired from DesktopStandard, a leader in Group Policy extensions until it was snapped up by Microsoft in late 2006. Thankfully, the powerful features of PolicyMaker survived the transition intact: Niceties include an expanded set of predefined configuration items that target pain points, such as local account passwords, power options, printers, drive mappings, and environment variables. The best part? It's practically free, and you don't have to upgrade your AD domain to Windows 2008 to begin taking advantage; all that's required is a single Windows 2008 server or Vista workstation, the Remote Server Administration Toolkit, and a small client update deployed to your existing machines.

Advanced Group Policy Management (AGPM) ups the ante with change management, rollback, and improved reporting. AGPM was ported from GPOVault, another Desktopstandard product. Unfortunately, Microsoft has enlisted the tool in its effort to drive adoption of Windows Vista -currently, the only way to get this compelling addition is through the Microsoft Desktop Optimization Pack with Software Assurance. If you can satisfy the licensing requirements, we highly recommend taking advantage of AGPM.

Key areas where even the new Group Policy tools don't measure up: auditing, endpoint validation, and support for non-AD computers. Sporadically connected workstations, such as those used by roaming sales staff or home-based VPN users, also present a challenge, since settings aren't always applied in a timely manner. Reporting is limited to single workstations and must be manually generated for each device.

The upshot: Group Policy can be a powerful weapon in your compliance efforts, but it won't satisfy all requirements.

MANAGE RISK, NOT TOOLS

As tools for Active Directory policy compliance proliferate, effective management will become a challenge. Brian Hayes, CTO of auditor Redspin, says he's seen IT groups buy so much monitoring and reporting gear that they can't manage it. "Sometimes it has the opposite effect of what was intended," Hayes says.

The solution? Apply risk management principles to guide purchasing. The decision to implement a new utility must be driven by a structured risk management approach. Identifying how a tool fits into your portfolio will help avoid "point-product overload syndrome," a malady in which IT administrators become buried in an unmanageable tangle of poorly integrated consoles that provide overlapping or redundant functionality. Maintaining some number of management suites is inevitable, since no single product can address all compliance issues, but proper risk classification can help ensure that your toolbox isn't out of balance.

A guiding principle that won't let you down: Policy comes first. Whether you decide to purchase a suite or use in-house resources, don't overlook higher-level governance issues. Even the best tools add little value if they're not backed up by well-designed security policies that are supported by management. Unfortunately, odds are that you have work to do in the policy area: Our 2008 Strategic Security Survey found that 54% of organizations still don't have security policies in place.

If you aren't there yet, put away your checkbook for now-you need to back up and develop the necessary policy framework. Once your security policy has been defined, it's time to flesh out the technical settings that determine how the policy will be implemented. Be sure to take full advantage of Group Policy features during this process; many organizations don't. If you want measurable improvements in your realworld security posture, you'll need to go much further than simply defining a Screensaver time-out value and applying basic password policies.

CALM THE STORM

There's no way around the fact that hardening servers and workstations will impose limits on user freedom. The trick is to strike a balance between required business functionality and optimum security settings. If your new configuration will significantly increase restrictions on workstations, prepare for the inevitable backlash by confirming management buy-in and clearly mapping technical controls to policy requirements. Risk management principles help here by providing a quantitative way to determine which controls are appropriate.

As for gaining funding for tools, that likely won't be a problem if you're complying with a mandate, but due diligence is still required to get the most from your compliance dollars. Don't neglect the big picture: Map compliance gaps across your systems to determine where the tool fits in your overall risk management strategy. IT shops not under the compliance gun may have a harder time getting approval-CFOs are rightly well-immunized against constant dire predictions of security breaches-so employ a structured approach to demonstrate how your selected product addresses quantified risks. Avoid fuzzy ROI calculations based on hypothetical worst-case scenarios: If management perceives your argument as a bit of a stretch, you'll lose credibility.

Tools alone won't fix your Group Policy compliance woes. But with the proper foundation, the right product can prove valuable in the effort to satisfy auditors and improve endpoint security. While meeting compliance obligations is a worthy goal, gaining confidence that policies are effectively protecting your assets is even better.

Technology As a Tool

2010-05-17T22:42:00.001+07:00

Technology As a Tool for Recruiting and Retaining Staff

John F Heveron Jr. CPA Practice Management Forum. Riverwoods: Dec 2007. Vol. 3, Iss. 12; pg. 12, 2 pgs

Abstract (Summary)
At Heveron and Heveron, CPAs, P.C., the firm has created an environment that requires strong IT skills and adaptability to the continuous changes that occur as each new method evolves. The firm uses data mining software and other tools to improve the quality and efficiency of their audits. It uses Groove collaboration software, a secure file and information sharing tool, which allows Heveron to share information and work together on tools and documents. Staff at Heveron & Heveron, CPAs get continuous training - much of it in-house - through its objectives-focused University of Continuous Professional Advancement. Clients appreciate the extensive use of technology because it allows the firm to perform more thorough, less intrusive audits using their automated tools.

Keeping up with new information technology (IT) is a good way to recruit and retain staff. At Heveron and Heveron, CPAs, P.C., the firm has created an environment that requires strong IT skills and adaptability to the continuous changes that occur as each new method evolves. Managing partner John Heveron, Jr., is quick to tell you that he doesn't think he could even get an interview with his firm these days.

According to John, "What our environment does is attract the right people, show respect for their time, give them continuous opportunities to learn and grow and convince them that it would be a step back to go somewhere else. These circumstances don't work for everyone, but the people who like this type of workplace are the kind of people we want to keep around."

IT is part of firm's core philosophy

Some facts about Heveron and Heveron:

* Total staff of 14, including four partners

* Very strong audit practice; over 65% is audit and attest work, most of which is focused in the affordable housing and nonprofit industries

* Paper-free audits for eight years; has even been asked to beta test some products

The firm also uses data mining software and other tools to improve the quality and efficiency of their audits. There is less paper in its library thanks to the availability of excellent online research and forms services. Staff set up their online services to receive e-mail notifications about their specific area of interest, such as not-for-profit taxation.

As a member of the INPACT America's association of CPA firms, the firm uses Groove(TM) collaboration software, a secure file and information sharing tool, which allows Heveron to share information and work together on tools and documents. Microsoft acquired Groove and has included it in the Office 2007 suite.

Some of the other technologies used by the firm include wired and wireless networking in the field, voice input and computer telephony. The latter tool allows everyone in the firm to instantly see the status of everyone in the office and to track all incoming and outgoing calls for billing and follow-up. The firm also makes extensive use of terminal server, which allows the several staff members with young families to be home for dinner throughout the busy season but keep up with the busy season workload.

Focus on continuous training

Staff at Heveron & Heveron, CPAs get continuous training-much of it in-house-through its objectives-focused "University of Continuous Professional Advancement" (UCPA). Individual training plans start with a review process called preview because it focuses on what each team member will be doing over the coming year and what training, tools and mentoring they need to achieve their preview goals. There is core education for new staff about the industries served by the firm and the technologies they use, as well. More individualized programs are available based on staff needs and desires. Heveron is licensed by the Department of Education as a continuing professional education provider, and they take that responsibility seriously. It allows the firm to use a combination of video, text, online and conference training to get the most appropriate education for each team member. While most of the training is technical, there also is also training in communications-an essential skill for auditors.

Happy staff means happy clients

Happy staff means happy clients, and Heveron's business has been really good. Clients appreciate the extensive use of technology because it allows the firm to perform more thorough, less intrusive audits using their automated tools.

Technology has always been a priority. Back when John, Jr. worked with his dad, John Heveron, Sr., CPA there were computers, essentially bookkeeping machines, and then one of the first IBM PC's available in Rochester. The firms technological proficiency was apparent early on. John, Jr. loves to tell the story of a banker who introduced him to a client simply because he thought they would get along well because each owned a PC! John and his client remain close friends to this day.

The firm doesn't automatically adopt every new technology that comes along. Instead, they go through a process that challenges each one and evaluates how it can help the firm before investing in upgrades.

John Heveron and his partners Michael Desmond, Stephanie Annunziata and Brenda Smith, make a commitment to every person that they hire that they will learn something new every day. They've never been accused of breaking that promise. More importantly, they have been able to put together and retain an extraordinarily strong team.

Auditing desktop applications

2010-05-17T22:35:00.002+07:00

Auditing desktop applications ...even if distributed via SOFTGRID

Derek Melber. Internal Auditing. Boston: May/Jun 2007. Vol. 22, Iss. 3; pg. 42, 2 pgs

Abstract (Summary)
Almost every company is up against the wall when it comes to controlling desktop applications -- licensing, auditing, and maintenance. With new technologies like SoftGrid from Microsoft, all of these procedures are made easier, including the auditing of these applications. SoftGrid is designed to run applications virtually, but with that virtualization, delivery, and management comes the ability to track nearly anything regarding the application that is desired. Application auditing is not the most fun task in the world, that is for sure. However, with SoftGrid, the solutions for auditing and controlling software are more plentiful and useful. SoftGrid can ensure that license compliance is met and will trigger a notification if the company is out of compliance.

Almost every company is up against the wall when it comes to controlling desktop applications. The control that I am talking about is the licensing, auditing, and maintenance of these applications. Even though a company needs these applications to generate revenue, it seems like there should be easier methods to control the applications, from deployment through maintenance. With new technologies like SoftGrid from Microsoft, all of these procedures are made easier, including the auditing of these applications. In an ideal world, the audit mechanism should help or cure licensing compliancy, restrict illegal copying of the applications, and provide robust reporting and analysis of each application. SoftGrid provides a mechanism to solve all of these issues and needs.

The state of the union

Most companies today are scrambling every day to ensure that they are in compliance with software licensing and that the software the company owns is not being illegally copied and taken out of the company. Sure, vendors are taking extra precautions to help restrict these actions, but each step the vendor takes to restrict the application from piracy means one more step in the direction of making the application too complex to operate or maintain.

If your company runs a small to medium Windows network today, you are fully aware of the pain that is required to audit the applications that are running on the desktops in the organization. With such a dynamic array of desktop images and installations, every desktop must be touched in some way. The touch might be manual if a very small shop, or with some reporting mechanism such as SMS or Tivoli. Regardless, these tools provide only an overview of the applications that are installed, leaving a lot of analysis to the administrator or auditor.

May I take your order please?

When it comes to applications, licenses, auditing, and the like, there are plenty of ideal situations that we would like to see. However, instead of thinking about the future and what could be if we had a magic wand, what are some auditing and reporting attributes that seem realistic?

First, there needs to be some mechanism in place to report back which applications are installed and have that compared to the licenses that are available today. The result of this should be some report, e-mail, flag, message box, or the like that pinpoints which applications are out of license compliancy.

Second, the applications need to be protected in some fashion so that standard users cannot just copy them to a USB or external hard drive and take them home. This has gotten better, but there are still some applications, many of them very expensive, that allow this behavior.

Third, it would be nice to know which applications are actually being used. If a user has not used an application in two years, chances are good that the application will not be used for another two years. In these cases, where an application is not being utilized but a license is being paid for yearly, it would be nice to recoup that cost of the application by uninstalling it and stopping payment on that license.

Can you be successful today?

If you dissect the three desires above and apply the concepts to your environment today, does your company measure up and provide these capabilities? Even if you say "yes" or "sort of," I encourage you to read on. There are technologies that will make these tasks easier.

With regard to your company's capability to tackle the first issue above, how well do you know which applications have been installed? Not just "we pushed them out through Group Policy" and hope they are installed, but are actually installed by the end user. Then, how well do you compare the install base to the licensing compliance? If a company does well at any point, this is the point that shines most of the time.

With regard to the second point, pirating applications from work to the rest of the world, how do you measure up? This is extremely difficult to manage and monitor, as some applications can just be copied and moved from point to point. If there is a mechanism in place at your company for this, most likely you have already purchased a high-end application to control such acts.

Finally, do you have any metrics on how often the installed applications are utilized today? If so, I know for a fact that you have spent some "bank" to get this capability. This data is not easy to obtain and is even harder to analyze.

SoftGrid to the rescue!

Of course, with a buildup like this, it is no surprise that SoftGrid can do all of these tasks with ease. SoftGrid is designed to run applications virtually, but with that virtualization, delivery, and management comes the ability to track nearly anything regarding the application that is desired.

First, each application is controlled centrally by the SoftGrid server, so all applications are monitored as they are downloaded and installed. The SoftGrid server can monitor the state of the installed application, indicating the percentage of the application that has been downloaded so far. This is key, as some users might begin the download, start to use the application, then have to leave the network before the entire package is complete. Since every application is controlled through the SoftGrid server, it is easy to check the installed applications to the available licenses. If the licenses are surpassed by the installs, the system can be configured to trigger a notification to the administrators that they are out of compliance.

Secondly, each packaged application on the SoftGrid server has an Access Control List (ACL) associated with it. This controls the use of the application, not only denying anyone from using the application if they are not granted access, but certainly denying them from copying the application for use off of the network.

Finally, SoftGrid is constantly gathering information about the use of the application. Reports can be gathered and generated based on each application, each user and the applications being used, and server usage of the applications. If it is specific application metrics that are desired, the SoftGrid reporting can track start and end times, as well as session duration per application and user.

Conclusion

Application auditing is not the most fun task in the world, that is for sure. Part of the problem with application auditing is that there are no great solutions for the tasks that need to be performed. License compliancy is really just a portion of what needs to be evaluated, and it is not all that elaborate with solutions today. However, with SoftGrid, the solutions for auditing and controlling software are more plentiful and useful.

SoftGrid can ensure that license compliance is met and will trigger a notification if the company is out of compliance. Piracy of applications is no longer an issue, as SoftGrid can control who uses the applications, whether on the network or off. SoftGrid also reports on nearly any metric that is desired to control whether the application is being used or not. Unused applications can save a company thousands of dollars, as the license can be cancelled and the application can be uninstalled. With SoftGrid, the entire world of application installation, control, management, and auditing will be turned upside down.

The route to compliance

2010-05-17T22:29:00.002+07:00

The route to compliance

Arif Mohamed. Computer Weekly. Sutton: Apr 24, 2007. pg. 34, 2 pgs

Abstract (Summary)
"There is no other regulatory or industry compliance requirement that is quite this granular. PCI is unique, but the data you collect in a PCI compliance scan can be useful in meeting many other kinds of audit and assessment requirements - an ISO 27001 certification or a Sarbanes-Oxley audit, for instance," she said.

The security area gets more than its share of red tape. So how do you chart a course that meets regulations without you getting strangled? Arif Mohamed reports

Complying with government and industry regulations is a major concern for IT managers across the board. But few areas of IT get to see as much red tape as security. IT managers are now bound by law to store, backup, encrypt, secure and protect their confidential data, and demonstrate that they are doing this satisfactorily.

Many organisations in the public sector and the regulated industries, such as utilities and legal or financial services, have to demonstrate an information security policy that proves they have a range of steps and measures in place. If these policies are not adhered to, the regulators reserve the right to prosecute.

This happened in February this year, when the Financial Services Authority (FSA) fined Nationwide Building Society £980,000 for failing to have effective systems and controls to manage its information security risks.

The failings came to light following the theft of a laptop from a Nationwide employee's home last year. This urged the FSA to carry out an investigation, during which it found that the building society did not have adequate information security procedures and controls in place, potentially exposing its customers to an increased risk of financial crime.

Margaret Cole, director of enforcement at the FSA, said, "Firms' internal controls are fundamental in ensuring customers' details remain as secure as they can be, and as technology evolves firms must keep their systems and controls up-to-date to prevent lapses in security.

The FSA took swift enforcement action in this case to send a clear, strong message to all firms about the importance of information security."

Afterwards, Nationwide took several measures, including commissioning a comprehensive review of its information security procedures and controls, and increasing security around its accounts.

There are other regulators besides the FSA that require sensitive data to be secured, for example for the pharmaceutical and legal industries, and more recently the retail sector.

The latter has a new security requirement, the PCI Data Security Standard, to ensure that member organisations secure their online transactions and data.

It is based on an initiative by the Payment Card Industry (PCI), driven by MasterCard, Visa and others, to lock down customer data through ensuring that any company that handles credit card payments keeps a tight reign on security.

The PCI requirements look at the fundamentals of IT security, such as making sure that firewalls are only passing traffic on accepted and approved ports, that servers are only running the services that need to be live, or that databases are not configured with supplier defaults, said Diane Kelly, vice-president and service director at Burton Group.

"There is no other regulatory or industry compliance requirement that is quite this granular. PCI is unique, but the data you collect in a PCI compliance scan can be useful in meeting many other kinds of audit and assessment requirements - an ISO 27001 certification or a Sarbanes-Oxley audit, for instance," she said.

"You will be looking at many of the same things. After all, most compliance comes down to things like whether your firewall is correctly configured."

One international standard for security compliance that can be applied across industries is the International Standards Organisation's ISO 17799, known as ISO 27001 in Europe.

This is a formal process that helps an organisation demonstrate that it has a high level of IT security management. It covers 10 major areas, including business continuity planning, physical and environmental security, compliance, personnel security, asset control and security policy.

One organisation that is working towards ISO 27001 is international law firm Norton Rose, which believes that ISO security accreditation will differentiate its from its competitors.

ISO accreditation carries stringent tests for client data and employee security, said Malcolm Todd, head of systems delivery at Norton Rose. He added that the firm is using a range of software products from Attachmate division NetIQ to help achieve ISO security accreditation.

Todd explained that Norton Rose will go through a certification process when it is ready, then face regular audits every six months to a set framework. These checks could cover anything from e-mail tracking to risk analysis, and any staff member can be interviewed about the firm's security policy.

In addition, organisations must adhere to the UK Data Protection Act 1998 if they hold information on members of the public. The act contains eight principles of data protection, including that all data is accurate and, where necessary, kept up to date, that data be kept for no longer than necessary, that it is kept secure, and that it is transferred only to countries that offer adequate data protection.

Then there is the US Sarbanes-Oxley Act of 2002, which affects any UK company that is listed on the US stock exchange. The act requires strict internal controls and independent auditing of financial information to defend proactively against fraud. This carries potentially serious civil and criminal penalties for non-compliance.

As with many of the industry security regulations, software products are available that can help organisations to audit, test and document their security processes.

One supplier that sells a specific on-demand PCI compliance service is Qualys, with Qualysguard PCI. This is a subset of the supplier's Qualysguard on-demand offering that is used by BAA, Novartis and Travelodge to meet compliance requirements.

Another security compliance tool is available from Tier-3, whose Huntsman product carries out enterprisewide threat management and real-time compliance and operational risk management capabilities.

It works by detecting any noncompliant behaviour, establishing an audit trail, reconstructing any security breach event and carrying out forensic analysis. It also has the ability to enforce the security policy.

Other point systems are available from suppliers such as Computer Associates and IBM.

Andy Kellett, senior research analyst at Butler Group, said, "There is an ever growing raft of regulatory rules and hoops to jump through, depending on the business the organisation is in, and some of them cut across the business. For example, if you are in the financial services sector you have to properly comply with the FSA regulations and maybe Basal 2, and if you are a retailer, you may also be responsible for financial data," he said.

"So many security breaches take place, and reality tells us that the average organisation has so many different systems and infrastructures that it needs to protect, that nothing is ever going to be 100% secure."

Kellett said that the starting point for any compliance exercise is to carry out a full audit to understand what information the business holds, what its vulnerabilities are and what elements of the IT systems can be locked down. These include databases, information storage systems and business applications, which could put customers and the business itself at risk.

Following this it is essential to publish a security policy and inform everyone who works in the organisation about what is and is not allowed, said Kellett.

The organisation can automate much of the security activity. So, for example, if the user acts in an insecure way, they could receive an e-mail saying they have been doing something that is not in line with policy, or the system may automatically encrypt a file or lock down the user's file access.

"You tend to end up looking at products that do the monitoring, alerting and protecting of information," Kellett said. This could include managing and locking down the file access rights of individual users, ensuring that particular attachments cannot be sent from e-mails, or even using biometric login systems to secure workers.

At the higher end of the security scale, the organisation could use a military-grade system like Clearswift's Bastion, said Kellett. This can isolate an IT system so that it only interacts with a few other systems that are authorised to do so.

"Clearswift found that the military systems used by the Pentagon were very secure, and that some private firms, financial services and pharmaceutical companies which want to keep their patented medicines properly protected, might benefit from a system where communication could be locked down," said Kellett.

Fire services trial mobile system for safety audits and equipment tests

2010-05-17T22:24:00.002+07:00

Fire services trial mobile system for safety audits and equipment tests

Arif Mohamed. Computer Weekly. Sutton: Mar 20, 2007. pg. 14, 1 pgs

Abstract (Summary)
The 12 fire and rescue services that have placed orders for CFRMIS Mobile are Cheshire, Durham & Darlington, Greater Manchester, Hampshire, Isle of Wight, Leicestershire, Northamptonshire, Northumberland, Nottinghamshire, Shropshire, Tyne & Wear, and Wiltshire.

Twelve of England's 47 fire services are trialling a mobile fire safety system that uses handheld devices and tablet PCs to conduct safety audits. They are expected to go fully live with the system within the next six months.

The system is designed to help fire services meet government targets for auditing and testing fire safety equipment used by private and public organisations, as part of a strategy to make the fire services more proactive in dealing with safety incidents.

Using the system, fire safety officers can download scheduled jobs such as home fire safety checks or fire safety audits to an electronic device, and complete them offline.

Officers can also send information from their handheld devices via GPRS or 36 networks to a central fire safety database.

The client application from software supplier Innogistic Software - Community Fire Risk Management Information System (CFRMIS) Mobile - integrates with a back-end application, also from Innogistic.

This system records each job, the action carried out, and details about individual premises, such as the location of smoke alarms. It uses this information to create audit reports for compliance purposes.

The system can also determine the risk level of individual premises and when they need to be reinspected.

The 12 fire and rescue services that have placed orders for CFRMIS Mobile are Cheshire, Durham & Darlington, Greater Manchester, Hampshire, Isle of Wight, Leicestershire, Northamptonshire, Northumberland, Nottinghamshire, Shropshire, Tyne & Wear, and Wiltshire.

Daniel Ormsby, marketing and business development director at Innogistic Software, said the company has provided the fire services with the CFRMIS back-end application for varying lengths of time.

He said that the mobile logging system would make the services more efficient by making them far less reliant on paper-based manual processes.

"In the past, most of the fire services have done this using paper forms, which they handed to an administrator, but this was inefficient and open to error," said Ormsby.

Compliance Automation

2010-05-17T22:20:00.002+07:00

Compliance Automation

Suzanne Dickson. The Internal Auditor. Altamonte Springs: Feb 2007. Vol. 64, Iss. 1; pg. 27, 2 pgs

Abstract (Summary)
For many organizations, regulatory compliance has become the principle focus of information technology (IT) spending. An effective compliance framework must combine people, business processes, and IT in a way that is integral to the organization's ongoing business strategy -- rather than being a special project. A key challenge organizations face in today's compliance environment is how to tie together all the tools and information to provide a universal view of compliance. Finding and documenting security gaps and exposures is one of the most cost- and labor-intensive aspects of compliance. Just as business performance improvement is an ongoing objective that requires continual attention and effort, regulatory compliance is an unending business process. By using automated tools, internal auditors can help their organization meet complex regulatory requirements more efficiently, improve accuracy, reduce costs, and measure performance improvements from compliance efforts.

Software tools can give auditors more insight into the controls and policies their organization needs to meet regulatory mandates.

FOR MANY ORGANIZATIONS, REGULAtory compliance has become the principle focus of information technology (IT) spending. More money is being spent on meeting compliance requirements than on protecting against security threats and filling business-related needs, according to SecurityCompliance.com, a security research Web site.

An effective compliance framework must combine people, business processes, and IT in a way that is integral to the organization's ongoing business strategy - rather than being a special project. A major component of an effective compliance framework is having a set of IT applications that tracks regulatory compliance automatically. Moreover, IT tools can help groups from all parts of the company leverage compliance-related measurements and controls as a means of identifying and improving inefficient internal business and technology controls on a continuous basis.

A key challenge organizations face in today's compliance environment is how to tie together all the tools and information - across all relevant regulations and a common set of actionable IT controls - to provide a universal view of compliance. Internal auditors can meet this challenge because they have a broader view of the overall stability of the organization's compliance efforts.

AN AUTOMATED APPROACH

Finding and documenting security gaps and exposures is one of the most cost- and labor-intensive aspects of compliance. Some businesses try to leverage homegrown, manual methods such as spreadsheets, hoping to cut costs and implement compliance controls within the required time frame. Although the low cost of implementing this approach is initially appealing, organizations may struggle over time with scalability and reliability. Such manual processes are error prone and often overlook policy deficiencies.

Implementing an automated, consistent, and repeatable process for testing, measuring, updating, and reporting on IT security controls can result in continual performance improvement. Automation can help auditors identify and eliminate deficiencies in such critical areas as customer service, sales, invoicing, and inventory controls; information access, storage, and archive policies; and other processes and supporting technologies. In addition, automated processes can enable auditors to bring together compliance initiatives managed by different groups in separate departments, eliminating duplicate efforts to test and measure the same IT control function across the organization.

Automation can also improve end-user awareness and policy enforcement. Internal auditors should educate information systems users about compliance requirements and policies.

IT TOOLS

With so many different regulations to consider across an entire enterprise, it is nearly impossible to correlate business requirements with regulations and policies without an automated tool set. Internal auditors can use these products to automatically perform tasks such as auditing and examining the IT control environment in real time; developing and publishing reports to measure the effectiveness of IT security controls in meeting standards and regulations; demonstrating due care of compliance; mapping control information to specific policies to recommend improvements to the control environment; and collecting, integrating, and retaining trend analyses and evidentiary information from disparate control mechanisms for audits and documentation requests.

POLICY MANAGEMENT Automated applications enable organizations to define, create, and disseminate policies and track end-user acceptance. Because many organizations are impacted by more than one mandate, a growing number of products map policies to multiple frameworks, standards, and regulations. When integrated with infrastructure assessment software, these tools can supply auditors proof of the organization's policy compliance.

VULNERABILITY DETECTION Identifying IT security risks is made easier through technology that evaluates critical applications and operating systems and intelligently assesses and reports deviations in areas such as password strength, default accounts, user rights and permissions, and vulnerability and patch status. These products automatically identify and prioritize security threats that affect applications, enabling auditors to assess the effectiveness of security policies and recommend ways to strengthen them.

ASSESSMENT Technology tools can help organizations establish, test, measure, and remedy control deficiencies and give auditors a view of IT compliance progress. Assessing and managing IT technical controls is eased by tools that establish baseline configurations for all major operating systems and identify exceptions to configuration standards. Many tools also leverage global networks of Internet activity sensors and security professionals to respond to fast-moving threats.

GOVERNANCE Automated software can streamline governance of a compliance and performance improvement environment. Some tools have compliance assessment and reporting capabilities that integrate data from a variety of sources through a single interface that auditors could use to assess and demonstrate IT policy compliance and identify deficiencies. Some products report gaps in coverage of key regulations and frameworks automatically, while other tools capture and report on user acceptance and waivers to policies.

A UNIVERSAL VIEW

Just as business performance improvement is an ongoing objective that requires continual attention and effort, regulatory compliance is an unending business process. By using automated tools, internal auditors can help their organization meet complex regulatory requirements more efficiently, improve accuracy, reduce costs, and measure performance improvements from compliance efforts.

Experts strike new NHS warning note

2010-05-17T22:15:00.002+07:00

Experts strike new NHS warning note

Tony Collins. Computer Weekly. Sutton: Oct 10, 2006. pg. 16, 1 pgs

Abstract (Summary)
They are worried about new developments such as Accenture's announcement of a withdrawal from its original £2bn NPfIT contract, and a £383m loss at Isoft, one of the programme's principal software suppliers.

ANALYSIS The government has failed in its attempt to quieten the fears of leading computing academics that the NHS's IT programme may be heading for trouble

At the headquarters in Whitehall of the Department of Health on 20 April 2006, senior officials met leading experts in computer-related sciences and welcomed their call for an independent audit of the NHS's £12.4bn National Programme for IT (NPfIT).

Since then, however, the government has made only too clear it does not want any further independent scrutiny of what is the world's largest non-military IT programme.

Health minister Caroline Flint told the House of Commons on 24 May that the NPfIT was "already the focus of regular and routine audit, scrutiny and review", and needed no further examination.

Flint said the programme had been the subject of gateway reviews - assessments by the treasury's Office of Government Commerce. But she said the government had no plans to publish any of these reviews, and ministers have also refused to publish the results of other independent reviews of the programme by internal auditors, or by consultancies such as McKinsey.

Flint said: "We remain confident that the technical architecture of the national programme is appropriate and will enable benefits to be delivered for patients, and value for money for the taxpayer, without further independent scrutiny."

Now the academics have written a second open letter to the Health Committee of the House of Commons because their concerns about the programme have deepened.

They are worried about new developments such as Accenture's announcement of a withdrawal from its original £2bn NPfIT contract, and a £383m loss at Isoft, one of the programme's principal software suppliers.

The academics say that since their first open letter to the Health Committee, they have been in almost daily e-mail correspondence with each other about the NPfIT.

The group has also received private communications from clinicians and technical people involved in various ways with the project.

In an e-mail to Computer Weekly, the group said: "The National Audit Office report [on the NPfIT, which was published in June] did not answer any of our concerns and we increasingly felt that the programme appears to be building systems that may not work adequately, and that even if they worked - may not meet the needs of many health trusts."

It added: "We believe that independent scrutiny is essential, and that the Health Committee is the best body to bring this about."

Members of the group met in London on 28 September and decided that urgent action was needed and that they should write again to the Health Committee and to Richard Granger, chief executive of NHS Connecting for Health, which is managing the IT element of the programme.

The group said, "In keeping with our belief that the NPfIT should be scrutinised openly, we again made our letter to the Health Committee an open letter. The letter has been drafted, reviewed and agreed by e-mail to the whole group."

National programme accepts value of IT audit

2010-05-17T22:12:00.002+07:00

National programme accepts value of IT audit

Tony Collins. Computer Weekly. Sutton: Apr 25, 2006. pg. 4, 1 pgs

Abstract (Summary)

Computer Weekly editor Hooman Bassirian said, "The announcement by Connecting for Health that it accepts the value of an independent audit of the national programme for IT is a significant step forward in helping ensure that the world's largest civil IT project is on track to meet its original objectives and deadlines.

Connecting for Health, the agency that runs the national programme for IT in the NHS, has agreed with 23 leading academics that an independent audit of the scheme could be valuable.

The agency's agreement came when Richard Granger, director general of NHS IT, met academics last week at Richmond House, the headquarters of the Department of Health.

The meeting was arranged at short notice after Computer Weekly revealed that the 23 experts in computer-related sciences had written an open letter to the House of Commons Health Committee asking for an independent audit of the national programme.

In a statement, Connecting for Health said that at the meeting on 20 April "there was agreement that a constructive and pragmatic independent review of the programme could be valuable".

Both parties "agreed to meet again to consider further details of how such a review might best be conducted and its terms of reference".

The agreement was in contrast to the initial hostile reaction to the audit call by health minister Caroline Flint.

Computer Weekly editor Hooman Bassirian said, "The announcement by Connecting for Health that it accepts the value of an independent audit of the national programme for IT is a significant step forward in helping ensure that the world's largest ivil IT project is on track to meet its original objectives and deadlines.

"It would be inappropriate for either Connecting for Health, or any organisation it recommends, to be involved in setting the terms of reference, appointing the independent auditors, or overseeing the research and production of the final report.

"The organisation that is best placed to oversee these activities is the House of Commons Health Select Committee."

A Continuous View of Accounts

2010-05-16T11:53:00.003+07:00

A Continuous View of Accounts
David Coderre. The Internal Auditor. Altamonte Springs: Apr 2006. Vol. 63, Iss. 2; pg. 25, 4 pgs

Abstract (Summary)
In fiscal year 2004-2005, The Royal Canadian Mounted Police (RCMP) performed an audit to assess the appropriateness and effectiveness of the control framework in place to support accounts payable (AP) activities. The overall goal of the audit was to provide reasonable assurance that AP policies and procedures comply with central agency policies and regulations, the control framework effectively supports AP activities, and financial transactions are processed in a way that complies with applicable policies, procedures, and regulations. Continuous auditing supported several of the RCMP auditors' objectives, including identifying and assessing risks and control deficiencies in the AP process, examining trends related to performance and efficiency, and searching for anomalies and fraud. In this audit, continuous auditing contributed to improvements in the AP operation; reduced financial errors and potential for fraud, waste, and abuse; and provided a sustainable and cost-effective means to support compliance with policies and procedures and perform risk and control assessments.

Royal Canadian Mounted Police auditors ride to the rescue of a complex accounts payable function.

N FISCAL YEAR 2004-2005, THE ROYAL Canadian Mounted Police (RCMP) performed an audit to assess the appropriateness and effectiveness of the control framework in place to support accounts payable (AP) activities. As a result of regionalization, the law enforcement agency's AP function is performed primarily by seven AP groups and a network of satellite offices located in five regions across Canada. The function processes almost 500,000 payments for goods and services totaling approximately C $1.5 billion (US $1.31 billion) each year.

The overall goal of the audit was to provide reasonable assurance that AP policies and procedures comply with central agency policies and regulations, the control framework effectively supports AP activities, and financial transactions are processed in a way that complies with applicable policies, procedures, and regulations. Given the electronic nature of the data, the wide variety of transactions, and the large number of AP offices, the audit team planned to maximize its use of information technology to identify and assess risks, test key controls, and check for potential areas of fraud, waste, and abuse. These factors made the project a good candidate for using continuous auditing techniques.

Continuous auditing is a unifying structure that brings together risk and control assessment, audit planning, digital analysis, and other audit technologies and techniques. It supports macro-audit issues, such as using risk to prepare the annual audit plan, and micro-audit issues, such as developing the objectives and criteria for an individual audit. Continuous auditing not only measures transactions against a defined threshold, such as a maximum value, as they are being processed, it also compares those transactions to all transactions over time. Auditors also can use it to compare one set of transactions with another set, such as comparing transactions at one office with another office. These abilities allow auditors to test the consistency of a process by measuring the variability of each dimension.

IN SUPPORT OF AUDIT OBJECTIVES

Continuous auditing contributes to individual audits by supporting the identification and assessment of risk and the development of scope and objectives (see "Key Steps to Continuous Auditing" on page 26). Further, it can be used to determine which locations auditors will visit and to identify specific audit criteria.

During the planning phase of the RCMP's AP audit, auditors used data extracted from the financial and human resources systems to review the operations of regional AP offices before traveling to perform the on-site work. AP personnel in the RCMP's regional offices are responsible for processing a wide variety of transactions, including invoices, purchase card (p-card) expenses, interdepartmental settlements, journal vouchers, emergency salary advances, travel expenses, and relocation claims. In addition, they respond to inquiries from vendors and others within the RCMP, resolve payment issues and disputes, categorize expenses to the appropriate general ledger accounts, and keep the master file of suppliers up-to-date.

The quality of the AP process' design and how well the regional offices execute the process impacts two important areas: supplier relationships and cash management. Control design quality is also directly related to the cost of the AP function; appropriately designed controls will ensure that risks are mitigated at an acceptable and cost-effective level.

Continuous auditing supported several of the RCMP auditors' objectives, including identifying and assessing risks and control deficiencies in the AP process, examining trends related to performance and efficiency, and searching for anomalies and fraud.

RISK IDENTIFICATION

The RCMP's auditors included a variety of risk factors - culled from policy reviews, interviews, reviews of previous audit results, and Internet searches - in the initial risk assessment. The audit compared the performance attributes - cost, quality, and time-based performance measures - of each AP office. Labor cost for accounts payable was the primary cost-based measure. Quality-based measures, which assessed how well the organization's products or services met customer needs, included the average number of errors per invoice. Time-based measures, focusing on the efficiency of the AP process, included the average number of days to pay an invoice and late payment charges. Auditors extracted data from the RCMP's ERP system and imported it into audit software to calculate the elapsed days between the receipt and payment of the invoice and the total of late payment charges.

Using continuous auditing for each AP office, the auditors also determined dollar amounts for each type of transaction. The transaction-type analysis gave the audit team a better understanding of the operations of each office, including how many different types of transactions were being processed. This analysis supported the risk assessment, because operations tend to have greater complexity when more transaction types are processed. The audit also compared the number of correcting journal entries and manually produced checks per office, which indicated additional workload that contributed to the overall level of risk. Using the extracted ERP data, a cross tabulation showing the number and dollar value of each type of transaction for each regional AP office was produced.

Finally, the audit used data extracted from the human resources (HR) database to compare the organizational structure of each office, including reporting relationships, number and classification of staff, length of time in job, retention rates, and training received. The combination of the HR data with the transaction types and volumes helped to identify areas of risk, such as understaffing and lack of staff trained to handle complex transaction types.

Auditors considered the risks associated with the transaction types, volumes, and dollar amounts to determine which types of transactions would be included in the audit. They also used the overall risk assessment to select the locations for on-site audit work.

CONTROL ASSESSMENT

The flip side of risk is control. Control deficiencies can increase risk levels, and unmitigated risks are usually the result of control deficiencies. The audit team reviewed the financial software system to identify key control points in the AP module. Next, auditors used the Internet to research the control rules for that module and used audit software to develop analytical tests to ascertain whether or not the controls were working as designed. For example, audit software was used in one test to compare transaction types processed by each AP clerk to verify that ,separation of duties existed. Additional analyses verified that all invoices over C $5,000 referenced a purchase order, validated that only authorized users were creating or modifying vendor records, and determined whether the goods receipt amount equaled the invoice and contract amounts. Auditors created scripts that enabled tests to be run at any time.

PERFORMANCE TRENDS

Trending data identified performance and efficiency concerns. For example, the audit team used continuous auditing to compare the AP offices, looking at the number and job classification of employees involved in the process and the efficiency of operations. Audit software was used to calculate efficiency measures, including the number of invoices processed per user, number of days and average dollar cost to process a payment, percentage of invoices paid late, percentage paid early, percentage of recurring and electronic funds transfer (EFT) payments, percentage of manual checks, and percentage of invoices for less than C $500. Analyzing trends across years also helped to identify both problems and areas where improvements had been made.

ANOMALIES AND FRAUD

To assist the continuous auditing process, the audit team used brainstorming techniques to identify anomalies and areas of potential fraud. For example, the team theorized that an inadequate separation of duties would permit an AP clerk to create a vendor record, enter a purchase order, and process an invoice to make a payment to that vendor, which could pay a kickback to the clerk. Another concern was that satellite AP offices could process duplicate invoices.

For items identified in the brainstorming session, auditors developed specific automated tests to search for possible fraud, waste, and abuse. Auditors tested for duplicate payments and compared current-year payments to previous years to see if operations were improving. They looked for invoices processed against backdated purchase orders and split purchase orders intended to avoid financial limits. The audit also examined the number and dollar value of invoices going to suspense accounts, where funds are stored temporarily until a decision about their allocation is made.

Finally, auditors ran tests to determine if there were cases where:

* Vendors were created and only used by a single AP clerk.

* The entry user was the same as the user who approved payment.

* The payee was the entry or approving user.

* There were duplicates in the vendor table or vendors with names such as C.A.S.H., Mr., and Mrs.

* Vendors had no contact information, such as phone numbers or addresses.

Although auditors did not discover any instances of fraud, they did identify control weaknesses and instances of noncompliance with policies. In particular, weaknesses in the vendor table and poor controls over the entry of invoices resulted in more than C $100,000 in duplicate payments that were recovered by the auditors.

AUDIT RECOMMENDATIONS

The final use of continuous auditing was to follow up on audit recommendations to determine whether or not management had implemented them and whether they were having the desired effect. During the review, auditors identified data-driven indicators for each recommendation. For example, auditors found that most regional offices processed a large number of invoices of less then C $500. Many studies have shown that the use of p-cards can significantly reduce the costs of processing such payments. The auditors recommended promoting p-card usage for low-dollar purchases and training cardholders to use them appropriately. Six months after issuing their report, the auditors measured usage for transactions under $500 and found that the percentage of p-card payments for low-dollar transactions had increased, indicating that this recommendation was implemented effectively.

Additional tests revealed a reduction in the number of duplicates in the supplier master table, a decrease in the number and dollar value of duplicate invoices, and an increase in the number of invoices referencing purchase orders.

A CHANGE OF THINKING

In this audit, continuous auditing contributed to improvements in the AP operation; reduced financial errors and potential for fraud, waste, and abuse; and provided a sustainable and cost-effective means to support compliance with policies and procedures and perform risk and control assessments. Continuous auditing helped the team to better understand the regional offices. The overview analysis determined that AP was decentralized with no standard processes and that different regional offices processed different transaction types. Auditors also identified concerns in efficiency and effectiveness of transaction processing at certain offices.

As the RCMP discovered, implementing continuous auditing places certain demands on internal auditors. In particular, the audit organization must develop and maintain the technical competencies necessary to access and manipulate data in multiple information systems. If the auditors are not already using data analysis techniques to support audit projects, the audit department will need to purchase analysis tools and develop and maintain analysis techniques. To realize its full benefits, all audit staff members need to adopt the continuous auditing concept. The benefits are substantial and can reduce the time needed to perform audit planning, increase risk and control assessment capability, and allow auditors to a widen their scope of audit activities and use existing corporate data cost effectively and efficiently.