Leveraging Technology to Help Enhance Trust in Internal Controls Amid Rising Material Weaknesses and Resource Constraints

Editor’s note: The following is a sponsored blog post from PwC.

In 2022, the number of material weaknesses (MW) disclosed in a company’s 10-K rose 73% compared to 2021 (2023 Audit Analytics)¹. While a significant majority of that increase can be attributed to organizations that generate more modest revenue, the sharp spike year over year has garnered attention. Numbers coming out of the first quarter of 2023 seem to suggest the trend continues to move in a troubling direction. So, what’s happening out there, and how might organizations buck the trend?

When you double click into MW categorization across various 10-Ks, five top categories emerge:

1. Personnel Inadequacies/Segregation of Duties
2. Financial Close Process
3. IT General Controls
4. Management Review Controls
5. Acquisition and Integrations

We believe that multiple factors can contribute to this current perfect storm:

Changes - ERP Transformations

The upsurge in Enterprise Resource Planning (ERP) systems implementation, and SaaS/cloud migrations specifically, are major contributors to MW. ERP transformations generally involve the integration of various functions, data sources and processes. If these transitions aren’t carefully planned, organizations can encounter challenges in establishing effective internal controls that can lead to MW. If managed effectively, however, we’ve seen many larger clients vastly improve their control environment by leveraging the ERP change event as a catalyst to revitalize controls that may not have been touched for decades. Risk? Opportunity? Turn it into an opportunity.

Resource Constraints

Due to economic volatility, many organizations can face budget limitations, a shortage of skilled personnel and time constraints. These constraints often result in a lack of sufficient resources to establish and maintain robust internal controls, making companies more susceptible to MW. Put simply, the volume, complexity and extent of compliance-related responsibility hasn’t reduced. It may have even increased. Many companies are finding there are less people available to operate and test internal controls, triggering control breakdowns and broader MW.

Complacency

Complacency within organizations is often another contributing factor to the rise of MW. After the initial implementation of SOX regulations, some organizations have become less vigilant in maintaining strong internal controls. Complacency can arise from a belief that existing controls are sufficient –– or from a lack of ongoing monitoring and evaluation of control effectiveness. This trend alone might justify taking a sharper look at your current investment around tech enabling the operation and testing of controls. 

How Automation Can Help Alleviate MW

Automating controls operation and testing offers several advantages that can help address the issues leading to material weaknesses and help reduce overall risk for financial reporting.

1. Streamlined and standardized processes: Automation can eliminate manual and error-prone tasks, helping to provide consistent and standardized processes. Driving more control points inside of your business applications can reduce the reliance on human intervention. Automation can help decrease the risk of control failures due to human error, oversight, or lack of consistency.
2. Enhanced monitoring and continuous auditing: Automated controls enable real-time monitoring of transactions and activities, allowing for immediate detection of anomalies or deviations. This proactive approach can enable organizations to help identify and address control deficiencies promptly, helping prevent material weaknesses from escalating. Earlier identification of control breakdowns can inevitably ward off eventual MWs that resulted in control deficiencies that were detected too late.
3. Robust segregation of duties: Automation supports the enforcement of proper segregation of duties by restricting access-based or defined roles and responsibilities. By helping to avoid conflicts of interest and unauthorized activities, automated controls can strengthen internal controls and help mitigate the risk of fraudulent activities.
4. Improved audit trail: Many of the latest cloud-based ERPs offer enhanced audit trails compared to their predecessors. Detailed audit trails provide holistic visibility into control activities, helping auditors to better assess control effectiveness, identify potential weaknesses and facilitate efficient audits.
5. Increased efficiency and cost savings: Automation can help improve efficiency by streamlining processes, reducing the time and effort required for manual controls. This efficiency gain can allow organizations to allocate resources effectively and focus on value-added activities, while also potentially reducing the overall costs associated with control testing and compliance.

Get ahead of the MW resurgence

The rise of material weaknesses in financial reporting can pose significant risks to organizations and undermine the trust of investors and stakeholders. Understanding the causes of material weaknesses can be crucial for developing effective mitigation strategies. ERP transformations should be viewed as an opportunity to help modernize your controls environment and shift the ratio of manual to automated controls in the right direction.

Leveraging technology to help automate the operation and testing of controls can help increase overall trust and provide a better solution to the challenges laid out above –– enhancing the reliability and accuracy of financial reporting. By leveraging automation, organizations can help streamline processes, strengthen internal controls and reduce the overall risk of material weaknesses, ultimately upholding the integrity of financial information and meeting regulatory compliance standards.

Enterprise Control, a PwC product, is a technology platform built with trusted PwC knowledge that can help you automate the operation and testing of controls. Join us for a webcast on 20 July 2023  to see how you can get ahead of the resurgence of the material weakness.