To remedy significant deficiencies and material weaknesses, companies must address root causes.
Key takeaways
People, processes and technology are at the heart of most material weaknesses.
A holistic remediation strategy can help middle market companies address the root causes.
For organizations that must remediate material weaknesses or significant deficiencies in their financial reporting, the stakes associated with addressing their internal control environment couldn’t be higher. In fact, such failures can translate into ballooning audit costs, stress to and loss of key staff, erosion of investor confidence and limitations to future growth.
The first challenge of remediation is that internal control failures rarely result from standalone issues. The root causes tend to be pervasive throughout an environment or business unit. Ultimately, these failures are often masked within an organization’s people, processes, technology and data. Identifying and addressing root causes for material weaknesses are essential both for the health of the business and compliance.
In this article, we’ll explore the potential harms of failing to address the root causes of material weaknesses and how to avoid common remediation missteps and prioritize action items when facing multiple material weaknesses.
The negative impacts of ignoring root causes
Every CFO wants to fix material weaknesses in the most cost-effective and efficient manner. But even the largest of Fortune 500 companies often lack the in-house knowledge needed to tackle remediation holistically. The same is true for growing middle market companies, especially in an era where the number of people seeking accounting degrees is generally declining, according to the Journal of Accountancy.
These resource shortages sometimes cause companies to take a piecemeal approach to remediation. But doing so is akin to treating the symptoms rather than the disease. Often, managing the underlying issues causing material weaknesses is a much bigger challenge than executives anticipate.
When organizations don’t properly address root causes, they often fail to remediate their material weakness in a timely manner.
This creates myriad downstream impacts, including:
Financial issues
Failing to eliminate a material weakness leads to numerous long-term financial challenges, including higher audit, compliance and human capital costs.
Staffing issues
Ineffective processes and controls sap workers’ productivity and morale. They also create stress and overwork, a lack of trust among departments and an increased risk of fraud and impropriety
Scalability and growth issues
A lack of consistent processes and operational effectiveness erodes investor confidence and inhibits growth.
Avoiding the most common remediation missteps
Most organizations believe they’re taking the right steps to remediate their control challenges, but many well-intentioned plans don’t deliver the desired results. This is in large part because a holistic view of the organization’s people, process and technology is required. Three common errors in addressing material weaknesses include:
1. Underestimating the value of people
Changing processes and technology without first considering the talent and training of your existing team can limit success. In fact, when hampered by broken processes and inadequate technology, accounting staff may get frustrated and leave, taking important institutional knowledge with them. At the same time, attracting new talent can be challenging when the accounting environment is fraught. Make training and retaining key staff a priority to help pave the way for the process and technology changes that can address root causes.
1. Implementing new technology alone to fix the problem
Since data is integral to the reporting process, it is understandable that organizations would want to replace outdated legacy systems that are more susceptible to errors. But while implementing a new ERP system or GRC tool may be a component of remediating a material weakness, it also has the potential to create more challenges rather than address the current ones. More technology may be part of the solution, but it is not a silver bullet.
3. Designing new controls on broken processes
Before organizations propose new internal controls, they should first try to find the weaknesses in their existing processes. In fact, there is often an aggregation of control failures that need evaluation. Until all underlying process problems are addressed, no amount of new controls can eliminate risk.
One common challenge is the segregation of duties. When a user has access to more than one process, they may rationalize or feel pressured to override controls. This is especially common in smaller companies with limited staffing. Until this underlying risk is addressed, the potential for control failures remains.
The benefits of a strategic approach to material weakness remediation
There is no one-size-fits-all solution to material weakness remediation. Instead, middle market companies need a third party capable of evaluating their people, processes, technologies and data to find and fix the unique underlying causes.
At RSM, our advisors work with companies to develop strategies that address the root cause of their material weaknesses, strengthen their controls and reduce their risk for future deficiencies.
We take an integrated approach, consisting of:
- Triaging material weaknesses and rapidly remediating simple issues
- Restructuring and consolidating business processes
- Implementing and integrating technology
- Building scalable control remediation and implementation
- Embracing enterprise program management and change management
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