Call it the year of financial oversight.
The numerous corporate collapses of the past few years, particularly the fall of Enron Corp., have placed the seemingly mundane topic of accounting and financial reporting in the public spotlight. It also has become the subject of countless news articles and of significant legislative policymaking. At the same time, a malaise has settled over the capital markets as other companies disclose generally negative accounting adjustments to their published reports. And a new term, Enronitis, has been coined to describe the destructive effect of these events on the public's confidence in companies and institutions.
While most of the corporate collapses have taken place outside of healthcare, our industry is not immune from Enronitis. The Allegheny Health, Education and Research Foundation bankruptcy demonstrated that healthcare organizations, including not-for-profits, also could be brought down by improper internal controls, accounting manipulation and deceptive financial reporting. As a result, internal-control, accounting and reporting policies are facing increased review, both internally and externally. Additionally, complicated off-balance-sheet financial arrangements, including special-purpose entities, and other unusual transactions and relationships face greater scrutiny. This raised awareness will have profound implications on the interaction among governing boards, healthcare executives-especially chief financial officers-and independent auditors.
Governing boards are ultimately accountable to stakeholders to ensure that proper internal-control, accounting and financial reporting policies and processes are in place. Thus, the role of board oversight and the duties of the audit committee will be coming under increased attention. At the very least, audit committees and boards need to have a working knowledge of accounting and financial reporting rules to fully perform their roles. Relying only on executives and outside auditors won't cut it.
Boards will be demanding that CFOs and other senior managers commit to proper disclosure and ensure that boards are well-informed. They will be questioning management and auditors about the risk of transactions that push the bounds of accounting and reporting standards and other potential risk areas. They will be asking why the accounting policies being used were chosen and how they are being applied. They will be challenging auditors and CFOs to explain any irregularities found in audit reports.
Of particular interest for boards will be full disclosure of affiliated organizations and off-balance-sheet transactions. CFOs should put themselves in the shoes of the readers of the financial statements and consider if the information provided is clear and unambiguous. Also, boards will be asking the auditors about pressure by management to accept less than high-quality financial reporting.
The day-to-day execution of these policies, however, is the responsibility of management, especially CFOs. Financial executives need to embrace open, timely communication with auditors and audit committees, and strive for high-quality, transparent accounting and disclosure. They should be reviewing their organizations' internal-control procedures and be involved closely in key accounting policy and financial reporting decisions. They should examine the accounting of arrangements such as hospital-physician joint ventures and licensing agreements. They need to ensure that estimates and judgments are supported by reliable information and record any identified audit irregularities. Also, they should take a hard stance that business decisions must be based on economic reality.
As a result of the Enron experience, auditors will more aggressively identify key risk areas and approach audits with much more skepticism. A healthcare organization's internal-control system will be thoroughly tested, and complex financial transactions will receive much more scrutiny. Auditors will try to better understand the effects of changes in the business environment on healthcare organizations. They will be more likely to bring in experts with additional specialized knowledge when needed to assist the audit team. To foster increased communication and openness, they will make management and audit committees aware of identified audit differences on a timely basis. CFOs will be required to make much more detailed representations to auditors as part of the audit process. Audit firms then will inspect much more closely these representations, including those on off-balance-sheet financing arrangements in which the organization is or has been involved. The auditors will request more-detailed representations about accounting and financial reporting issues, consolidation, related-party transactions and public disclosure.
There will be greater focus on contractual agreements between audit firms and their clients, including the limitations on liability and indemnity from the client. Audit firms may shy away from using their own auditors to consult on how financial transactions should be recorded and instead retain other consultants. Finally, management letters are likely to be more detailed and more critical of management policies and internal control.
The Healthcare Financial Management Association believes that healthcare organizations have an obligation to provide stakeholders with useful, timely and accurate financial and operational information. This position is grounded in the HFMA's Code of Ethics, in which members pledge to strive for the objective and fair presentation of financial information. It is in the best interest of the industry and the financial management profession to restore trust and confidence in financial information.