Jim Hunt: Why don’t we just dive right in and talk about the Five P’s. Let’s identify them first and then we’ll drill deep on each one. So what are the five PS of compliance?
Julio D: So I think it’s good to give a level set of the talk track that we’re trying to achieve here because I think it’s important Jim, to really give the audience a feel to why compliance and how some companies look to compliance as a necessary evil. I think the new thinking, especially we at Bramsol see compliance as a competitive advantage and we really feel that competitive advantage gives you through the lens of compliance because it enables companies to have confidence that the information coming through to all investors for that company is accurate.
Julio D: It’s accurate. It’s in accordance with all the laws and regulations, so therefore an investor, myself or you, Jim, you can go on, look at a public company’s numbers because we know they now comply with all the regulatory standards and you can make your own decision whether you want to invest in that company or not. Simple example of revenue recognition. We know there have been substantial changes in the last five years for revenue recognition. Well, once you know that a company has complied with the new standard, you can feel comfortable. I could make a educated decision whether I want to invest in that company or not. The same time you say with leasing with all the regulatory new compliance standards that have come out in the last five years. Now, with that level set, if we go into the five PS of compliance, we can really see why these things are very important.
Julio D: There’s really five issues or five standards when we talk about the five P’s, which are Policies, Procedures, Processes, Proof and People. So Jim, I don’t know if you want to just take a step back and understand how this all encompasses from a holistic perspective. But if you look at the first P, it’s all about your counting policy. So what is the accounting policy when it comes to compliance? Well, every company has to comply. We talked about revenue recognition, lease accounting. There’s a policy that you now have to create. So people like myself, well I used to work at a company where the new revenue recognition standard was coming out and as a result the executive team asked me: we need to create an accounting policy that’s going to ensure compliance for the new revenue recognition standard. How do we do that?
Julio D: You have to first understand what the new standard is saying. So basically for revenue recognition, it was a four step model. ASC 606 but under ASC 606 it’s a five step model that you have to look at revenue recognition in a very different way. So when it comes to policy, what companies have to do as your first step is you really have to say, okay, here’s what the new policy says and here’s how it compares to what the standard says from the regulatory board of FASB or IASB. Here’s the five step model for revenue recognition or whatever the standard says. And then you now have to interpret that and apply that. So your company’s processes, which is our second step. But before we go into the process, let’s understand what the policy actually means. So I’m going to take what the regulatory body has said and I now I’m going to apply it to my own company’s standard policy setting. Now, every company has its own business process and generate revenue recognition in various and different ways. You may have an oil company pulling oil out of the ground versus Amazon selling something online. Now, the whole point of that is each company was developed based on that standard. It’s all one accounting policy to deal with. That’s new revenue recognition standard or any accounting standard for that matter. So usually as a process you basically take your standard and then you apply it to your own company’s business process and then you usually document that in an accounting policy document. This accounting policy document usually would go to your executive management team and usually it’s signed off by a chief financial officer because he or she is now saying based on the new standards, we are now going to follow this new accounting policy so that we are in compliance with the new standards.
Julio D: So when the CFO goes on the investor calls for public companies or is audited by an external auditor, the first question they will ask them is have you complied with the new standard? He would say yes. And obviously being an auditor, the next question would be, well show me. And this accounting policy document will be the evidence of the set up for following this new standard.
Jim Hunt: So the policy step in the five Ps is really taking regulatory change, the mandate, understanding it, understanding how we have been doing things in the company and updating that baseline policy so that it’s compliant and that it guides what the company’s going to do and then that kind of feeds into the next two steps for sure – the procedures and processes.
Julio D: Right. So the policy is a guiding light for the company. Any company, every company, should hopefully have some policy to understand how it goes about following its accounting operations, following the accounting policies and procedures. So when you think about that policy, the policy is a document. It’s sort of a theoretical document that is, that is in line with an accounting standard. The process now is the application of that theoretical document into the company’s operations. If you think about what a process is, if I am recognizing revenue based on a time based mechanism, which is I have a subscription and I get billed $10 every month. The process of recognizing that is now every month based on the new accounting policy, I am going to, or I am allowed to recognize revenue on a monthly basis, which is in line with and in compliance with the new standards.
Julio D: Compare that to a leasing implementation of the new lease accounting standards where you’ve set your accounting policy and now your business process is whenever there’s a expense item over a certain threshold, there is now a new business process. I have to now look towards my new accounting policy based on leases as to whether I have complied with the new standard. So in a month of expense, I now have to say is this expense related to the new lease accounting standards? Does that make sense to you, Jim?
Jim Hunt: Yeah. Yes, it does. Here’s a question. Maybe you can clarify for our listeners the processes and procedures. Is one more software solution oriented and the other is more people oriented directing them on what they’re going to do?
Julio D: Yes. So you know, think about compliance. Compliance can be done in various mechanisms. You can comply with a policy manually, you can comply with a policy using a system. And we always recommend as best we can to always use a system because of the flaws of us humans and the flaws of using manual processes. So the procedure now comes into play because the procedure is the desktop manual of the process, which comes from the policy. So the procedure is the actually how to do something. So if you take a specific example of revenue recognition for a company that is selling bottled water, the procedure is when the invoice comes in, we have to look at what are the shipping terms of this shipment of bottled water. If the shipping terms are delivery Cod, basically I can recognize revenue as soon as I deliver to that location. If the shipping terms are free on board, it means that I can recognize revenue once I deliver it to that location where it is going to be shipped.
Julio D: So even though you have now complied and you have a business process to say this is what I need to do in my process, the procedure tells me when I shipped that bill of goods for my bottled water, I now have to look to what are the shipping terms as a procedure in my accounting operations, which you can now distribute world wide so you can have a consistent level of policy, accounting, standard documentation and process by saying everybody who is shipping our goods out, the procedure now is to look for the shipping terms to ensure that I’ve complied with a new standard. So it’s really a nice layering of starting with the policy at the top, going on into the process and then really looking at the desktop procedures into how do I execute this compliance initiative from top down.
Jim Hunt: So those are essentially the three stages of implementation of policy over an umbrella framework, the processes which involved software and other mechanisms to enable you to implement that policy and the procedures which as you say like the desktop manual which is the how-to piece for people who are actually going to be implementing and running the processes.
Julio D: It’s very important because a lot of the breakdown in compliance initiatives, especially multinational environments is that companies create a great policy at corporate HQ, but it’s never filtered down into the business process and therefore the staff assistant sitting down in Africa or Asia who is 5,000 miles away from corporate doesn’t actually understand what his or her part of responsibility is to ensure compliance. I think a lot of companies always have to remember that it’s very important that once you have this great policy that you can show, you really have to show how to implement it and the implementation of those accounting policies and procedures is really in the desktop procedures. That has to be now certain throughout the organization. We always say, if you take a look at leasing, you can have a great lease policy at corporate, but who really is the person who is implementing the lease policy?
Julio D: What we find is, based on all the implementation projects, it is the person who is driving the forklift, the person who’s sitting down at the warehouse, or in the logistics department. Why is that? Because that person is the first line of defense. When somebody says, we have a thousand shipments, we need to order a new forklift. Well guess what, that forklift rental could and most probably will impact your lease accounting policy. And then the question arises, should we capitalize this lease expense for a forklift? So you can see Jim, that it’s great to have an accounting policy at corporate, but if you don’t filter this down into how to desktop procedures at each location within a company, it could fail very quickly.
Jim Hunt: Right. And it also brings to mind for me is that it’s easy to let rest on your laurels and think you have completed it. The policy development team, they might say, “okay, we’re done”. And then the processes, let’s assume that that’s on IT. So the IT department implements software in the greatest processes you could ever think of. But unless you have the next step of procedures to tell the people all around the world how to use those processes, then you really are getting nowhere. You might have a great capability under the hood, but if you haven’t talked to the person who has to drive the car, it’s not going to go anywhere.
Julio D: Actually that’s a nice segue, segue Jim, into the other two Ps, which is really where the rubber hits the road when you think about it, which is basically Proof and People. So, if you take People first, People really means, how has your organization circulated this information to everybody who needs to know about these regulatory changes?
Julio D: So while somebody sitting down at corporate needs to know all the nuances of the new standards and how it affects the company’s operations, the People aspect of it is really the training for everybody that needs to be involved in the compliance initiative. So when we talk about people, my example I just gave you, which is the person sitting down at the warehouse in Asia, and you may say to yourself, well, how does the person sitting down in the warehouse who is just basically, you know, renting the fork lifts or anything, the truck 5,000 miles a week, how is he or she actually involved in compliance of a new accounting standard? What I would see tremendously and exactly what I just said, is you have that person, and like you said, Jim, you have this great glossy policy at corporate but then the person who really needs to enforce the policy is the person sitting down in the warehouse and he or she is our first line of defense when it comes to initiatives.
Julio D: And we all know compliance is no longer a necessary evil, but it’s really a competitive advantage. So it’s very important that when it comes down to the people, the question is how do we roll out the training? So in my, in my personal experience when I was rolling out the new ASC 606 rules, we had four offices all throughout the world. I went to Asia, I went to Africa, I went to Latin America and we had two day intense trainings. We started with the managers and then we rolled it down to all the accountants and the assistants and like I said, a lot of times people miss the non-accounting staff and what people don’t realize is the non accounting staff, the operation staff in any accounting rule out of new regulations, they are the ones that usually are the first line of defense. The accountants typically receive the information from operations, so it’s very important that the accountants, even though they have to know a little more nuanced information that the operational teams have to really understand what is the new regulation about, why are we doing it and what is my role in this compliance initiative?
Jim Hunt: Yes, you just said the magic word I was going to ask you about which is the “Why?” It’s really important in bringing the people on board, especially the operational people on the front lines, to have them understand the “How”. Obviously if they don’t understand the procedures, that’s the goal of the training. But if you give them the context of the “Why”, this new change to compliance, you don’t have to give them chapter and verse on every paragraph in the policies, but it really helps people adopt the change if they understand why change is occurring.
Julio D: I think also too more importantly is if you think about motivation and trying to have a consolidated concerted effort in a compliance initiative, once people understand that their roles, even though they work in a warehouse or they have a lower level assignment or job responsibility. Once they understand that they are very important piece of this compliance puzzle, they become more motivated to actually help enforce that compliance. And I think it’s very important, especially in a multinational environment where you have far flung operations, especially decentralized operations, that those people understand how important they are in the whole scheme of the company-wide compliance initiative. And I think it’s, it’s been proven that once people understand that they are part of this initiative and like you said, the why of it, they become much more motivated and much more involved. And to help the organization to comply with that initiative.
Jim Hunt: Excellent points, all. We have about three or four minutes left today and we have one big P left and that is Proof. And that’s going to go to documentation, reporting, disclosures and auditing.
Julio D: Yes sir. So, you know, you can do the four Ps really well, but if you don’t have good documentation and evidence to prove that you’ve done these things, it really isn’t worth anything. Because if you think about it, your auditors are going to come in and they’re going to say, okay you’ve complied with these new regulatory standards or compliance initiatives, so prove to me that you’ve done this, show me how you’ve done this. And that’s why you start with these accounting policies. You have your process change map and then you go as down to your desktop procedures about this compliance initiative. And then so therefore you have this proof that we started at the top and we’ve gone down all the way to the end to the execution of this compliance initiative and that proof is really the key to all, because as they always say, if you haven’t documented it, in the accounting world, you haven’t done it. So it’s very important. You don’t want to go through all that process and expense and effort of training people and then you have not documented it because an auditor, his only way of validating that, you know Julio went to Africa to do training, he went to Latin America and a CFO signed off on the documentation is a trail of evidence that’s going to show step one to step 50 and that will really give them that comfort level that okay, ABC company has complied with this initiative of a new regulation, a new accounting standard or any new business process as you go.
Julio D: Documentation is clearly very important. But just as one more thing, Jim, from, from a proof perspective, not only do you have your external auditor requirements, but it’s a good business practice for companies, you know, as they move forward. The thing people don’t realize is things change. People leave companies. So if I took a company public or took a company through a new accounting regulation and all the information is in my brain and I haven’t documented anything, if I get a better job tomorrow and I leave all that information goes away. So it’s not just a compliance initiative. When we talk about compliance, we talk about it being a competitive advantage where you’ve now documented it as a best business practice. You can just say, okay, I’m leaving tomorrow, here’s all the processes, here’s all the documentation for the new person coming in, so therefore it’s a nice flow of transition as well.
Jim Hunt: Really good point. And it brings up another question I was going to ask about. We started off by talking about essentially public companies and investors and so on. And I want to be sure we bring up the point that these five Ps don’t just apply to public companies. They apply to private and to other organizations because even if you don’t have investors, you have lenders, you have partners, you have, regulators depending on what industries you’re in, and you need to be able to prove compliance to those people as well.
Julio D: Excellent point. Because as we know, most private companies, they have debt agreements and debt agreements require a certain amount of compliance initiatives, so it’s an excellent point. These five Ps, Jim, they’re really not for public or private. They for all companies, and again moving away from companies have to do this. It’s more of companies are wanting to do this because it also gives them, the last thing I want to say before we leave is it gives them a competitive advantage because: what happens if you document all your business processes, you have desktop procedures in all your key critical areas of operations? Can an executive team do more with that? Of course they can. They can manage their business better. And that’s what we talk about using compliance to ensure competitive advantage and give them a step up on their competition. That’s the key from a non-accounting perspective. It’s improved process efficiencies that you get from doing these exercises in every critical process.
Jim Hunt: Excellent point for the wrap up. And just a final note: it really relates back to the Bramasol mantra of Comply, Optimize, Transform because, if you comply right and you consider things like the five P’s and you’ve put all that foundation in place, then you’ve laid a solid foundation for optimizing and as you go forward for transforming the overall organization.
Julio D: Absolutely. Jim.
Jim Hunt: This has been great. Julio, thank you for your time today. I’m sure the listeners will get a lot out of this and I look forward to our future sessions.
Julio D: Thank you very much. Have a wonderful day.