Critique of the Usefulness of Spreadsheet Modelling in Financial Accounting and Reporting - Essay Example

GIVING A CRITIQUE OF THE USEFULNESS OF SPREADSHEET MODELLING IN FINANCIAL ACCOUNTING AND REPORTING Table of Contents Table of Contents 2 Spreadsheet modelling 4 Uses of Spreadsheets 4 Five Categories of Spreadsheet Analysis 6 Base-Case Analysis 6 What-If Analysis 6 Breakeven Analysis 7 Optimisation Analysis 7 Simulation and Risk Analysis 7 Spreadsheet Errors 8 Spreadsheets Modelling leading to Financial Crisis 9 Security and Control of Spreadsheets 9 Alternative to use of Spreadsheet Modelling 10 References 12 Spreadsheet modelling A spreadsheet is nothing but a blank table which is composed of number of boxes formed by equally spaced horizontal and vertical lines. Now electronic spreadsheets are available which can be run in personal computers. The boxes in the spreadsheets called cells can be filled with texts and numbers. The values in these cells can be manipulated by the computer using mathematical functions. Combination of the mathematical functions gives rise to further complex formulae. Computer spreadsheets are very much beneficial in manipulating large volume of data very easily and in quickly (Moutinho, et al., 1994, p.26-27). Spreadsheets are very much useful in modelling situations in financial accounting and helps in various decision making processes. Uses of Spreadsheets Spreadsheets are argued to be most frequently used by most of the organisations all over the world. There are many tailor-made tools available in spreadsheets which perform specific business processes (Baker, et al., n.d.). There is an increased popularity in the use of spreadsheets in business concerns. It is so because of spreadsheets being an end user computing platform. The information systems department takes long time to complete the analysis and reporting. Moreover, spreadsheets are easy to use powerful software to do business analysis (Fisher, n.d.). Spreadsheets are used by many companies to assist in the management of information related to critical business procedures. It is done to comply with the rules and regulations of financial accounting and reporting. With the advent of International Financial reporting Standards (IFRS), there is a need for the modifications in the existing system of financial accounting procedures in the organisations. Spreadsheets have thus become an interim option for the organisations before these changes are fully introduced in the accounting applications. Once the spreadsheets are in use in the organisation, the executives feel that the spreadsheets will be replaced by a fully designed new accounting system, very shortly. But in reality, those spreadsheets may be in use in the organisations for a much longer term. Hence it becomes difficult for managers to manage the increasing number of spreadsheets. Moreover, replacing the spreadsheets with the new accounting system can be costly option for the organisations (Baxter, 2006). In the corporate world, spreadsheets are used either for modelling purpose or for operational purpose. Modelling spreadsheets are mainly used for a particular purpose or activity and are used as complex calculators. Spreadsheets meant for operational use acts as a core programme in business by assisting in daily transactions in business. Operational spreadsheets use all types of data, both static and dynamic and also calculations involving those data. Modelling spreadsheets become redundant once the particular task is done with it. Whereas, operational spreadsheets become an integral part of organisational processes and are in use for long term (Baxter, 2006). Five Categories of Spreadsheet Analysis Base-Case Analysis Most of the spreadsheet analyses are done for measuring the results or outcomes relative to certain base case of comparison. A base case can be either the current policy in use or the scenario which is most likely to occur or the best case or the worst case (Powell & Baker, 2010, p.120). This type of analysis can help in answering questions like what would be the expected profit next year if the current policy is followed. What-If Analysis What-If Analysis can be better termed as Sensitivity Analysis, wherein it analyses the changes in key outputs with the changes in inputs. While doing this type of analysis, if it results in an unexpected outcome, it means there is an error or it is a useful insight. It can thus be a part of debugging process. Hence in a what-if analysis, one can either vary a parameter or a decision variable or the model structure itself, to come to a decision. Benchmarking can also be done through what-if analysis (Powell & Baker, 2010, p.120-122). Breakeven Analysis In breakeven analysis, it analyzes the occurrence of a point of interest in particular. It answers questions like, what is the required market share before making a profit. Goal Seek tool available in Excel is a useful tool for doing breakeven analysis. Optimisation Analysis This type of spreadsheet analysis helps to find the decision variables which will result in optimum level of output (Powell & Baker, 2010, p.132). The tool named Solver available in Excel is quite important while doing optimisation analysis. It answers questions like, what would be the allocation of budget to achieve maximum possible profit. Simulation and Risk Analysis This type of analysis helps determining the effects of uncertainties in the form of probabilities on the outputs (Powell & Baker, 2010, p.132-133). Crystal Ball is a tool in Excel which is very important in risk analysis. Almost every managerial decision is guided by some risk factors, so it is an important consideration while doing any analysis. Spreadsheet Errors Errors in spreadsheets can be major concern of organisations. Even a minor mistake in typing incorrect values in spreadsheets can lead to catastrophic results. #VALUE! Error messages are often encountered while using spreadsheets. It is often caused due to mistyping values in cells of the spreadsheets, which corrupt all the dependent cells and files. This type of errors cannot be avoided easily but it can be prevented. Data Validation tool in Excel is quite useful in this purpose. It can be used to prevent users from entering invalid data in the cells, correcting their mistakes and creating an alert message giving a hint about the mistake made by the user (Callahan, 2002). Likewise, spreadsheets can encounter numerous such errors and can go undetected. Errors can occur in different stages of the life cycle of a spreadsheet. It can occur even before the actual spreadsheet is prepared. There may be error in the formulation of the model itself. Errors can occur while making a cell entry or during the testing stage or while it is in use (Powell, Baker & Lawson, 2008, p.131). Spreadsheets Modelling leading to Financial Crisis There are many evidences of malpractices while using spreadsheet modelling in financial accounting and reporting. Organisations encounter considerable losses due to spreadsheet errors. The errors may occur by mistake or may be due to some fraudulent activities by the users. Spreadsheets are often associated with end-user computing (EUC) risk. The problems in the spreadsheets may be in the form of material errors, deficiencies in audit system, fraud cases, etc (EndUserComputing.org, 2010). One such instance of fraud was the collapse of Barings bank in UK. Unauthorised trading by an employee of Barings Bank named Nick Leeson led to such downfall. However, the main issue was how was he able to establish such practice by escaping the organisational control and how the error remained undetected until everything was over. The answer is failure in the control of information system used in the bank (Drummond, 2003, p.93-101). Another such instance is the collapse of Jamaican Banking System due to failure in controlling and managing the use of spreadsheets (Croll, 2009). Hence, use of spreadsheets modelling can lead to dire consequences for an organisation if they are not controlled well. Security and Control of Spreadsheets As mentioned earlier, most of the financial reporting systems by organisations are prepared using spreadsheets. However these spreadsheets are not well controlled by the organisations. With the increasing intensity of rules and regulations requiring a firm control over the financial reporting systems, the spreadsheets need to be further secured and well controlled by the organisations. It requires a different approach towards developing of control in spreadsheets. It should identify and prevent frauds in the use of spreadsheets. End-user development needs more focus by the organisations, since they are quite reluctant and overconfident about the accuracy of the spreadsheets (Panko, n.d.). The information conveyed by the spreadsheets used in financial accounting is mostly used for decision making purposes. Hence, error in the information can cause blunders for the organisations and it may land up in taking a wrong decision base on the spreadsheet data. Use of System Development Life Cycle (SDLC) can be a good practice to increase control over spreadsheets. SDLC is a method of building information systems in a phased manner divided into different steps. It consists of seven to ten steps. Integration of spreadsheet techniques into the organisation applying SDLC can help organisations gain managerial control of spreadsheets (Busbin, Gross & Dillon, 1990, p.101-107). Alternative to use of Spreadsheet Modelling As discussed earlier, spreadsheet errors can prove to very much costly for an organisation. Lot of companies are giving away spreadsheets and looking for better alternatives which are far more secured and cost effective. Demand-driven manufacturing practices are leading towards this transition. One such example is the company named See’s Candy, who completely changed their spreadsheet modelling to a single platform for its various activities like inventory management, packaging, etc provided by JRG. It was quite cost effective for See’s Candy (Schwartz, 2005). SDLC model which is human-centred as well, can be a good option for developing a human-centred information system and help in successful running of businesses (Zhang, et al. 2005, p.532). References Baker, et al. (no date). Spreadsheet Risk, Awareness and Control. [Doc]. Available at: http://www.mba.tuck.dartmouth.edu/spreadsheet/product_pubs_files/SSrisk.doc. [Accessed on March 24, 2012]. Baxter, R. (2006). The Role of Spreadsheets in Today’s Corporate Climate. [Online]. Available at: http://www.theiia.org/intAuditor/itaudit/archives/2006/january/the-role-of-spreadsheets-in-todays-corporate-climate/. [Accessed on March 24, 2012]. Busbin, J. W, Gross, E.P. & Dillon, T. (1990). Improving Spreadsheets Control for Sales Managers through the use of the Systems Development Life Cycle. Journal of Personal Selling and Sales Management, [Online]. Available at: http://www.jstor.org/discover/10.2307/40471393?uid=3738256&uid=2129&uid=2&uid=70&uid=4&sid=47698797822567. [Accessed on March 24, 2012]. Callahan, T. (2002). Block That Spreadsheet Error. Journal of Accountancy, [Online]. Available at: http://www.journalofaccountancy.com/Issues/2002/Aug/BlockThatSpreadsheetError. [Accessed on March 24, 2012]. Croll, G. J. (2009). Spreadsheets and the Financial Collapse. [Pdf]. Available at: http://arxiv.org/ftp/arxiv/papers/0908/0908.4420.pdf. [Accessed on March 24, 2012]. Drummond, H. (2003). Did Nick Leeson have an accomplice? The role of information technology in the collapse of Brings Bank. Journal of Information Technology, [Pdf]. Available at: http://www.palgrave-journals.com/jit/journal/v18/n2/pdf/1990185a.pdf. [Accessed on March 24, 2012]. EndUserComputing.org. (2010). Enterprise Spreadsheets & the “Titanic Effect” – Do we have a problem? [Online]. Available at: http://endusercomputing.org/tag/spreadsheet-fraud/. [Accessed on March 24, 2012]. Fisher. (no date). Spreadsheets and Business. [Ppt]. Available at: http://fisher.osu.edu/~schilling_1/spreadsheets/sld002.htm. [Accessed on March 23, 2012]. Moutinho, L. et al. (1994). Computer Modelling and Expert Systems in Marketing. London: Routledge. Panko, R. R. (no date). What we know about spreadsheet errors. [Online]. Available at: http://panko.shidler.hawaii.edu/ssr/Mypapers/whatknow.htm. [Accessed on March 24, 2012]. Powell, S. G. & Baker, K. R. (2010). Management Science: The Art of Modelling with Spreadsheets. (Ed. 3). USA: John Wiley and Sons. Powell, S. G., Baker, K. R. & Lawson, B. (2008). A critical review of the literature on spreadsheet errors. Decision Support Systems, [Pdf] 46. Available at: http://mba.tuck.dartmouth.edu/spreadsheet/product_pubs_files/Literature.pdf. [Accessed on March 24, 2012]. Schwartz, E. (2005). Demand-driven manufacturing: Burn those spreadsheets. [Online]. Available at: http://www.infoworld.com/t/data-management/demand-driven-manufacturing-burn-those-spreadsheets-144. [Accessed on March 24, 2012]. Zhang, P. Et al. (2005). Integrating Human-Computer Interaction Development into the Systems Development Life Cycle: A Methodology. Communications of the Association for Information Systems. [Pdf], 15(1). Available at: http://aisel.aisnet.org/cgi/viewcontent.cgi?article=3151&context=cais. [Accessed on March 24, 2012]. Read More