Companies with third-party suppliers, business partners or vendor relationships that are based on the concept of "self-reporting" lose millions of dollars each year because of insufficient controls over such business models, says a new report by KPMG LLP, the audit, tax and advisory firm.

“The Self-Reporting Economy: A Matter of Transparency and Trust” outlines how corporate risk has grown unnecessarily in a burgeoning $300 billion "self- reporting" economy in which each business partner provides the other with pertinent financial and other information used to measure activity, such as sales-volume figures. Poor internal controls and oversight cause the majority of self-reporting information to be wrong, causing companies to lose millions in potential revenue, the report says.

In one instance, KPMG reviewed a gasoline service station company to find that it had overpaid for fuel supplies because its supplier inadvertently had not instituted a preferred-client discount. The service station company recovered tens of millions of dollars, said Robert S. Pink, a partner with KPMG's Risk Advisory Services practice. Another example involved an audio- components company that audited one of its distribution partners and found a significant under-reporting of sales, costing it $35 million.

"Companies with these relationships often find it difficult to control them effectively, because they are exposed to the weaknesses in the reporting processes and business ethics of the business partner," Pink noted.

"Misreporting financial or other information in these relationships is usually not deliberate, but often the result of management's wrongly interpreting complex agreements, unclear lines of responsibility, computer system weaknesses, or just plain clerical errors, causing certain aspects of the reporting between the companies to be inaccurate," said Pink.

Further raising the stakes, most companies do not realize the number of self-reporting relationships they have or how they can extend well beyond the obvious royalty or licensing agreements into every facet of their supply chain. Yet, with expanding global competition, shrinking profit margins and spiraling costs, companies continue to enter new collaborations based on self- reporting, the KPMG report adds.

"The accuracy of reporting, together with a sense of mutual trust among partners, is especially important in the current climate of intense regulatory scrutiny, because deficiencies in reporting could signal lax internal controls, contrary to new U.S. laws for corporate accountability," added Pink. "A weak reporting link adds risk unnecessarily."

Companies that have effective corporate-governance safeguards, however, can protect against self-reporting risks by business partners, according to the KPMG report. Some measures companies may consider are:

  • Conduct a comprehensive review of a prospective partner's internal controls before entering into a self-reporting relationship;
  • Determine if there are sufficient two-way communication and ongoing reporting mechanisms and controls to help ensure effective contract management and compliance;
  • Involve all parts of the company in managing the performance of self-reporting relationships.

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