Corporate Governance Corporate governance has attracted considerable attention over the past decades, leading to recommended codes

of practice, conceptual models, and empirical studies. A growing number of empirical studies have demonstrated that good corporate governance contributes to better investor protection, lower costs of capital, reduced earnings manipulations, increased company market value, improved stock returns, and even economic growth. Corporate governance has been seen at the forefront of establishing standards of corporate ethics aimed at reducing unscrupulous corporate practices while preserving a fair business environment. Corporate governance is also increasingly being considered an important part of corporate risk management and the logic is poor corporate governance is viewed as risky, whereas creditors and investors view good corporate governance as a sign of strength in a corporation. Thus, investors are demanding better financial reporting and greater transparency and also demanding more good corporate governance practices. Increasing complexity in business environment and regulation puts pressure on the finance department to improve the financial close and reporting process. The Chief Finance Officer (CFO) needs to make sure that the close is error free and meets regulatory compliance within a given limited timeframe. Thus, it becomes critical that the CFOs need to understand the ways in which people, process, and technology individually and collectively contribute to aggravating or mitigating financial reporting risk for their organizations and determine what changes can be implemented to reduce that risk. The Internal Control Framework Many companies have developed good understanding of their responsibilities relating to internal controls and the need for annual assessment of their effectiveness. It is important for companies to become more transparent by showing the results of the efforts they have made to strengthen their internal control mechanisms, and describing the progress in their compliance and corporate governance. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) developed recommendations for public companies and auditors on ways to prevent fraudulent financial reporting. A generally accepted internal control practice named the COSO Framework, issued by the COSO in the US in 1992. Internal control is defined as a process, effected by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of the following objectives: 1. effectiveness and efficiency of operations; 2. reliability of financial reporting; and 3. compliance with applicable laws and regulations. Consisting of the above objectives, the COSO Framework provides criteria for evaluating internal control and is basically made up of five interrelated control components including: 1. Control environment; 2. Risk assessment; 3. Control activities; 4. Information and communication; and 5. Monitoring.

This Framework also requires an entity level focus and an activity focus. The control environment sets the tone of the organization, influencing the control consciousness of its people, which is the foundation for all other components of internal control, providing discipline and structure. Risk assessment is the identification and analysis of relevant risks to achievement of the objectives, forming a basis for determining how the risks should be managed. Control activities are the policies and procedures that help ensure management directives are carried out. Control activities occur throughout the organization, at all levels and in all functions. Information is needed at all levels of an organization to run the business, and move toward achievement of the entity's objectives in all categories. Communication must take place, dealing with expectations, responsibilities and other important matters. Monitoring is the process of assessment by appropriate personnel of the design and operation of controls on a suitably timely basis, and taking necessary actions. The COSO Framework, which is principles-based, is NOT a checklist and does not imply the same set of controls for every company. To have an effective internal control, a company should implement a mechanism or methodology to accomplish each principle in the Framework. Financial Close and Reporting The Enron collapse in 2003/4 followed by the demise of Lehman Brothers during the financial crisis of 2009 has focused attention more fully on compliance and control. As a result, companies now face the 'perfect storm' of increasing complexity in reporting, broader disclosure requirements, accelerated timescales for producing statutory accounts, and increased scrutiny of their standards of governance, risk and control. Financial reporting can be grouped into three major components:

A variety of accounting personnel responsible for extracting, assembling, aggregating, and analyzing data;

The processes and timelines by which the data are obtained and reported; and The systems that crunch the financial information and distill it into meaningful form. Characteristics of each of the above financial reporting components can be a potential weakness that increases financial reporting risk or a possible strength that reduces financial reporting risk. Accounting personnel of course play a key role in timely and accurate financial reporting and personnel issues affecting financial reporting risk are headcount, training, skills, motivation, teamwork, and effectiveness. Processes and technologies can be implemented to function in an efficient and effective manner. The financial consolidation and reporting cycle, which includes collecting and consolidating financial information from all corporate entities, closing the books, reporting to management, getting auditor sign-off on the results, reporting to regulatory authorities and issuing earnings releases and other statutory financial statements, is highly complex and fraught with myriad potential problems. The continuing intensity of the regulatory requirements, including the sensitive nature of the published financial information result in a great deal of time and effort of key personnel spent in creating, reviewing and validating the filing documents. These requirements are driven by regulatory authorities in an attempt to increase transparency and accountability of financial information. Thus, companies are required to provide increasingly deeper levels of disclosure by reporting their results more frequently but are not being given additional time. More importantly, an increased emphasis on compliance and enterprise performance management has resulted in a higher interest in 'better control' of the closing process as it is a key process underpinning these activities. Financial Reporting Framework In Hong Kong, there are statutes as well as professional rules and regulations to govern financial reporting. Authorities in charge of enforcing of the regulatory framework of financial reporting include:

The Government of the Hong Kong Special Administrative Region; The Stock Exchange of Hong Kong Limited (the Stock Exchange); The Securities and Futures Commission (SFC); The Hong Kong Institute of Certified Public Accountants (HKICPA); and The Financial Reporting Council (FRC). Other mandatory requirements in financial reporting are:

The Companies Ordinance (CO); The Inland Revenue Ordinance; The Rules Governing the Listing of Securities (the Listing Rules) and the Rules Governing the Listing of Securities on the Growth Enterprise Market (the GEM Rules), both issued by the Stock Exchange;

Hong Kong Financial Reporting Standards (HKFRS), a collective term which includes all applicable individual Hong Kong Financial Reporting Standards, Hong Kong Accounting Standards and all interpretations issued by the HKICPA. These mandatory requirements are often cited as the preparation or compliance basis for many financial statements such as .."the consolidated financial statements have been prepared in

accordance with all Hong Kong Financial Reporting Standards, the provisions of the Hong Kong Companies Ordinance and accounting principles generally accepted in Hong Kong ". This kind of declarations or statements can be found in most, if not all, of the relevant corporations applicable to the Hong Kong financial reporting regulatory framework. The overriding requirement on financial reporting under the CO is that the financial statement should give a true and fair view of the company's state of affairs and its profit or loss. Internal Controls Companies are required to maintain proper books of account so as to show at any time a true and fair view of the status of the company's affairs and to explain its transactions. Such books must include details of receipts and payments, sales and purchases of goods, and the assets and liabilities of the company. Internal controls are the policies and procedures that, when implemented effectively and efficiently, help minimize or reduce the impact of risk on a company or business process to an acceptable level. With reference to the COSO Framework, internal control system can be viewed in two layers - the control environment and the control procedures. The former refers to the overall attitude, awareness and actions of management regarding the internal control system and its importance in the corporation and the latter refers to those policies and procedures established to achieve the corporation's specific objectives. The control environment primarily include budgetary controls and internal audit function as a means to strengthen the effectiveness of specific control procedures. Internal control over financial close and reporting includes policies and procedures that:

pertain to the maintenance of records that in reasonable detail accurately reflect the transactions and dispositions of the assets of company and its consolidated entities; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with applicable accounting standards, and that receipts and expenditures are being made only in accordance with authorizations of management and directors

of company and its consolidated entities; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the assets of company and its consolidated entities that could have a material effect on the financial statements. A significant deficiency in one or more of the internal control components that alone or in the aggregate precludes the entity's internal control from reducing to an appropriately low level the risk that material misstatements in the financial statements will not be prevented or detected in a timely manner. Key Control Objectives Accounting irregularities may be viewed at three levels viz. deterrence, detection and investigation. Deterrence involves preventing accounting irregularities from happening. Detection means how the indication and suspicion of accounting irregularities are identified. Once discovered, accounting regularities are investigated and reported to the management. Thus, a corporation may focus at eliminating or minimizing accounting irregularities through implementing effective internal controls.

The key control objectives in respect of the financial close comprise the following:

Authorization and Approval Proper approval of all transactions within the closing process and the final financial statements (e.g. consolidation, elimination, and approved adjusting entries; quarterly and annual financial statements approved by the CFO or Disclosure Committee prior to issuance);

Completeness and Accuracy Timely and accurate recording of all transactions and other events occurred in the financial period; Presentation and Disclosure Items in the financial statements and related disclosures are classified and presented to provide appropriate transparency; Timeliness Closing process must be completed according to schedule to ensure timely external reporting and internal reporting to support business analysis and decision making; Valuation Assets, liabilities, revenues, and expenses are eliminated or valued in accordance with Hong Kong Financial Reporting Standards, Hong Kong Accounting Standards, and Interpretations issued by HKICPA. What Could Go Wrong Following are typical situations of accounting irregularities:

Policies and procedures, which are not clearly established or defined, do not effectively guide accounting personnel regarding how to close the books each month; Regional closing procedures are not uniform from region to region, resulting in inconsistent adjustments, classifications, disclosures, or interpretations of accounting regulations and policies; Existence of multiple systems requiring significant manual intervention to post entries to the General Ledger; Key accounts are not timely and accurately reconciled, rolled forward, or analyzed to identify potential adjustments prior to closing the books; Accounting personnel are not properly trained to execute the closing process consistently and accurately; Accounting personnel do not have necessary skills and experience to complete assigned tasks; Incompatible duties not adequately segregated to prevent inappropriate recording or alteration of accounting information; Unclear accountability individuals do not recognize their ownership responsibilities and rely on the accounting department to confirm account balances and identify potential issues; Unauthorized individuals can access accounting or interfacing systems or such systems can be inappropriately changed such that the integrity of accounting information is compromised; Lack of compromising - merger and acquisition activities demanding an alignment with the acquired company's financial close, consolidation, and reporting process. Financial Reporting Risk At Organization Financial reporting risk can be pervasive anywhere in an organization and can arise from an event or condition, external and internal factors, and decisions and choices made by many within the company. Financial reporting risk may also arise from inaction.

Accuracy Risk Inability to effectively close the books may result in misstatements in financial information used for external reporting and internal decision-making; and also concerns over financial statement accuracy cause stock price to plummet; Communication Risk Issues may arise in financial reporting when everything is filtered through many layers, hands, committees, and approvers as they work their way up the

organizational ladder. The process is slowed; accountability is diluted; and communication

between parties may become muddied and prone to error; Role Risk Poorly defined roles are typically a major red flag as there may be gaps in roles and responsibilities leading to failures to obtain, process, or analyze information. If there are overlapping roles, conflicting information may arise;

Control Risk Failure of applying key control activities consistently and effectively across the key business processes to facilitate the timeliness and integrity of business results; and no internal training to provide an integrated view of how controls need to be performed; Disclosure Risk Lack of clear, concise, and complete disclosures may cause inadequate transparency and adverse actions by the SFC or other external parties; Human Resources Risk Failure to attract, train, develop, deploy, and empower competent accounting personnel may inhibit the company's ability to execute, manage, and monitor key closing activities;

Integrity Risk Dishonest or misdirected employees may carry out activities that are not in accordance with management's instructions or expectations; Organizational Risk Virtually all stages of data gathering, analysis, reporting, and evaluating requires a human interface. Organizations may try to do more with fewer accounting resources. Failure to appropriately organize and deploy accounting resources, and to delegate appropriate authority and accountability to accounting personnel, may result in inadequate execution of the

closing process; Performance Incentive Risk Overworked personnel may err or not complete essential closing activities. Lack of appropriate performance incentives may result in behaviour that is misaligned with management's objectives;

Performance Measurement Risk Lack of defined metrics and the inability to gather relevant information for measurement purposes may impair management's ability to monitor individual, team, and overall business performance; Policies and Procedures Risk Policies and procedures that are ineffective, insufficient, unclear, or outdated may result in poorly executed closing activities, and, as a result, delayed or inaccurate financial reporting;

Reconciliation Risk Failure to consistently and completely reconcile and roll forward key accounts may prevent errors or omissions in accounting information from being detected and adjusted timely; Technology Risk Inadequate or non-interfaced systems that support and enable the financial reporting process may result in inaccurate financial reporting; Timeliness Risk Inability to close the books on a timely basis may prevent key constituencies (external entities or internal management) from receiving the necessary financial information when required. Conclusion In conclusion, improving the effectiveness of the closing process facilitates corporate governance and regulatory compliance. Improving the efficiency of the overall financial close and reporting process can result in cost reduction. As such, management should design and make use of a good internal control system in the aim to achieve good corporate governance for the benefits of the company and ultimately, the shareholders. About the author Dr Fung is currently Senior Lecturer of Caritas Francis Hsu College teaching Accounting and Corporate Management courses. Dr Fung has over 20 years' working experience in corporate banking and has

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