In order for any kind of business to strive, to keep track of its finances, and understand its financial standing, carrying out a balance sheet substantiation is important. The balance sheet is a financial record of a business’s assets, liabilities, and equity. The process of balance sheet substantiation is one that ensures all the elements and total balances reported in the company’s balance sheet are up to date, accurate, and correlate with other financial records of the business.
What is balance sheet substantiation?
Balance sheet substantiation is a financial accounting process whereby a sole proprietorship, partnership, limited liability company (LLC), or corporation confirms that the records of its finances which include its assets, liabilities, and equity as contained in its primary accounting record system tally with the transaction records and balance held in a supporting subsystem of record or held in the same primary accounting record. Balance sheet substantiation is also referred to as balance sheet reconciliation.
The primary accounting record system could be Enterprise Resource Planning (ERP) general ledger, SAP, Oracle, or any other accounting system that is used by the company. An Enterprise Resource Planning (ERP) general ledger contains the financial reports and budget information from all departments that make up the business. SAP is an enterprise resource planning (ERP) software that incorporates key business functions. Oracle is a multi-model database management system commonly used for data warehousing (DW), online transaction processing (OLTP), and a mix of both DW and OLTP database workloads.
Balance sheet substantiation includes multiple processes aimed at ensuring that all transactional entries or balances of accounts are well reviewed, in agreement (balanced), and certified in accordance with the business provisions. Apart from comparing the total balance on the company’s balance sheet with its other internal and external financial records, it also involves checking individual transactions to ascertain why and how each transaction was completed. All this is done to ensure that each transaction has been properly recorded and classified and that everything that needs to be on the company’s balance sheet has been effectively captured.
Businesses generally carry out a balance sheet substantiation to aid with the reporting of their financial standing and drive their regulatory reporting obligations. The balance sheet substantiation ensures the integrity of the company’s balance sheet and is an important step in business account management, financial reporting, and preparation for both internal and external audits.
Carrying out a balance sheet substantiation is an important aspect of closing monthly, quarterly, and yearly accounting periods, thus, it is mostly carried out within these periods. It ensures that the company’s accounting department, owners, and other stakeholders have a clear view of the business’s financial standing at the time. A well-substantiated balance sheet is also a key tool used by investors to ascertain if a business is worth investing in and is also used to evaluate the company’s creditworthiness.
Generally, the balance sheet substantiation is done manually by manual monitoring and reporting, the use of spreadsheets, and emails. But the recent advancements in technology have brought about the use of modern technology in the balance sheet substantiation processes. Software solutions have brought about a level of automation that has aided in standardizing and enhancing the process. Large corporations with a lot of personnel involved in the balance sheet substantiation process or who have a high volume of accounts use these software solutions to drive up efficiency, improve transparency and shorten the time spent on the balance sheet substantiation process.
Balance sheet substantiation in simple terms
Balance sheet substantiation is the process of rechecking the balance sheet records to validate their accuracy. The balances of the various balance sheet segments as well as all individual entries are checked to ascertain their correctness when compared with the data from other financial records in order to detect and correct inconsistencies or omissions.
The essence of balance sheet substantiation is to ensure that the company’s financial records are well classified and properly recorded in the balance sheet because doing this helps the company to track its financial standing and ensure they have accurate financial reports.
The balance sheet substantiation process is can be done monthly, quarterly, or yearly.
See also: Common stock in the balance sheet
Framework for balance sheet substantiation
Carrying out an accurate balance sheet substantiation ensures that a business has properly accounted for and recorded all transactions in the right place. Listing assets, liabilities, and equity in the supposed order.
Assets are resources that bring positive economic benefits to the company which includes all its tangible and intangible assets such as fixed assets, prepaid expenses, cash, accounts receivable, and inventory. Liabilities include all short-term and long-term liabilities, these are all the things the company owes customers, debtors, vendors, employees, and others. They include wages, taxes, accounts payable, deferred revenue, customer deposits, and notes payable. Equity or stockholders’ equity is all earnings from investments into the business. This includes share capital, paid-up capital, and retained earnings.
The framework that is used for balance sheet substantiation includes:
- Make sure that all assets, liabilities, and equity as recorded in the balance sheet are certified.
- Ensuring each account is properly assigned so as to be put through a workflow. This should include the person responsible for the preparation and review of the balance sheet; when it is due and the category it falls into.
- Applying risk ratings to each account so as to know which particular accounts to focus on whenever further balance sheet reconciliation.
- Using software systems to run an automatic reconciliation.
- Passing on any accounts that have been flagged by the software system for further manual investigation.
See also: Assets and liabilities differences
Balance sheet substantiation challenges and solutions
When it comes to carrying out a balance sheet substantiation, the company’s accounting team is riddled with some challenges that make the process cumbersome and could also result in inaccuracies. We shall discuss these challenges and their possible solutions below.
- Inadequate timing
- Human inaccuracies
- Application errors
Challenges of balance sheet substantiation
Although there have been huge improvements in the balance sheet substantiation processes, it still has some challenges which we shall discuss below
Carrying out a balance sheet substantiation in the shortest time possible is an impressive feat but when speeding up the process hinders proper substantiation, then, it becomes a challenge. When an extremely short time frame is allocated to balance sheet substantiation, it makes the company rely more on estimates about its financial standing. In most cases, these estimates are accurate thereby exposing the company to cases of attempts to manipulate numbers that could lead to fraud.
A lot of companies rely on using manual reporting, spreadsheets, emails, and other workflow systems to aid with the balance sheet substantiation process. The reliance on manual reporting gives room for human error and other inefficiencies that could arise based on the combination of familiarity within the substantiation team as well as blind faith in each other skills. Misallocation of items can also pose another challenge.
Although spreadsheets are easy to operate, they require that the team correctly configure and manually populate them. This is often done by sourcing data from the various financial records of the company. If any item is not accurately entered, it adversely affects the end result.
All of these can bring about making assumptions about the integrity and accuracy of the balance sheet substantiation results. Hence resulting in poor results at the end of the balance sheet substantiation.
With the recent advancements in technology that have brought above the use of various applications for balance sheet substantiation. Although these offer some ease in the process, they offer little efficiency gains around the manual efforts required in entering the data. Errors could also arise from miscoding. Point solutions may also suggest ways of addressing certain issues which may not fit with your business need and thus, require more manual effort. As such, these could combine to result in more waste of time and inaccuracy in the end result.
Solutions to the balance sheet substantiation challenges
- Longer timing for substantiation
- Automating some of the processes
- Using the right application
Longer timing for substantiation
Although most companies carry out balance sheet substantiation monthly, quarterly and annually, they do not give the financial team that does this substantiation enough time to properly carry this out. If the substantiation process can begin ahead of time to avoid rushing it in order to meet up with the reporting deadlines, it will go a long way in ensuring that the balance sheet substantiation is properly and accurately done.
Automating some of the processes
In order to reduce human errors, there is a need to automate some of the processes. Automation can aid in cutting down costs, free up the accounting team to focus on more value-adding activities, saves time, eliminate errors arising from blind faith in teammates, and also prevents the manipulation of numbers that could lead to fraud. Once the substantiation process is automated, transactions and balances from various financial records can be easily matched and any discrepancies can be easily further investigated by the accounting team. The team should also commit to continuous improvements and transparency to mitigate any human errors that may arise.
Using the right application
When choosing balance sheet substantiation applications to use for your company, it is important to choose those that closely match your business sector and offer options that match your balance sheet substantiation requirements.
Carrying out a balance sheet substantiation is fundamental to ensuring that your balance sheet records are accurate and can be trusted. When the balance sheet substantiation is not properly done and the errors get picked up by external auditors, it can negatively impact the company’s reputation and also erode the trust of investors and other stakeholders when it becomes public knowledge.
Since the balance sheet gives a summary of the company’s financial health, its substantiation must be taken seriously and done accurately to avoid errors. To help increase accuracy, automating some of the processes is important. Furthermore, without the balance sheet substantiation, auditors will not be able to the balance of the company’s balance sheet which could lead to misrepresentation and other negative impacts on the company. To avoid this, the balance sheet substantiation should be accurate and readily accessible to auditors. Additionally, the balance sheet substantiation information improves transparency, helps reduce risks, provides assurance on the company’s financial statements, and gives management the right tools for decision-making.Last Updated on October 4, 2022 by Nansel Nanzip Bongdap