AccountingTools

August 07, 2019

The Fast Close, Part 5 (#20)

August 07, 2019/ Steven Bragg

In this episode, we discuss how issuing a comprehensive financial statement package prolongs the time required to close the books. A better approach is to use a two-stage release of information, where the core financials are issued at once and everything else is issued later. Key points discussed are noted below.

Earlier, I talked about how shifting closing work into the preceding month and centralizing accounting operations in one place can seriously reduce the amount of time needed to close the books. This time around, I’ll cover how the structure of the financial statements themselves can cause problems with the speed of your close.

The Trouble with Comprehensive Financial Statements

If you issue just the basic set of financial statements at the end of the month, then you’re in a distinct minority. It’s great if you can do this, because you finish all of your accounting transactions, press a few buttons, and your accounting software spits out the reports you need. Unfortunately, most of us have to issue additional reports. These may be a reconfiguration of the existing reports, usually the income statement. The most common change I’ve seen is different groupings of the results of corporate divisions, sometimes splitting them out by themselves, and sometimes clustering several divisions together. This may be because a manager runs several divisions and wants to see their results in one income statement, or perhaps because management wants to sell off a cluster of divisions, and so wants to present their combined results to a buyer. Whatever the reason for the special income statements, you’ll certainly be spending more time assembling and presenting this information.

I’ve been dealing with special income statement layouts for years, and I find that the best approach is to use the report writer in my accounting software to create any income statement that management wants, if I think they’ll keep asking for it month after month. Even if it’s a one-time request, I still try to create it with the report writer, because the alternative is to use an Excel spreadsheet, and it’s much easier to make a mistake in that.

Now, creating a special income statement is the easy part of a financial statement package, and it really doesn’t take that much extra time. The problem is when managers start asking you to include operational information in the financial statement package.

This causes all kinds of trouble for several reasons. First, operational information, such as inventory accuracy, or the order backlog, is created in other departments, and they may not be too accurate in compiling this information – so you may be including incorrect information in the financials, and that may cause delays if management wants you to fix the errors and then re-release the financials.

The second problem with operational information is that it may be delayed – and I mean really delayed. This happens because a different department is compiling the information, and they may not be in much of a rush to do so.

A third problem is that operational information may be used to calculate bonus payments. If that’s the case, managers all over the company may pounce on this information as soon as the financials are released, and you end up defending metrics that were compiled by somebody else – and doing it right when you’re trying to clean up from the close.

Use Delayed Information Releases

So – what do you do with operational information? Your best bet is to separate it from the basic financial statements, and release it on some other day, preferably a couple of days later. By doing so, the departments supplying this information have more time to get the information right, and the accounting team knows the financials will not be delayed because of missing operational information.

Better yet, I prefer to issue operational results once a week, instead of once a month. That way, managers are usually more than happy to split off the operational results from the regular financials in exchange for more frequent information.

The other problem with the financials is that top management sometimes wants you to release a different set of financial statements to each manager. For example, this could mean that the marketing director gets the basic financials package, as well as the expense statements for just the marketing department. If you run into this problem, and you can’t persuade top management otherwise, then try to just issue the core financials to everyone, and delay the release of any additional financials until the next day.

By now, you’ve probably seen a common theme in these recommendations, which is to only release the basic financial reports that come with your accounting software, and delay the release of any other information.

This means that you have a two-stage release, with a primary focus on basic financials on day one, and everything else on a later date. This obviously sounds simple, but it’s easy to gradually get into a trap of issuing more and more information with the financial statements package, until the sheer volume of the release eats up an extra day of your closing time. In short, be vigilant – and report less necessary information separately.

Related Courses

August 06, 2019

The Fast Close, Part 4 (#19)

August 06, 2019/ Steven Bragg

In this episode, we discuss how the centralization of the accounting function can be used to enhance the closing process.

In the first three episodes in this series, I talked about how to shift closing work into the preceding month. This massively reduces the amount of work you have to complete on closing day, and it’s the best single way to speed up the close. However, there are plenty of other closing techniques. In this podcast, I’ll cover the use of accounting centralization to increase your closing speed even more.

The Problem with Multiple Divisions

If you want to achieve a fast close and you have multiple divisions with their own accounting staffs, then you’re already going to have a hard time. This is because the corporate accounting staff has to wait for the division staffs to complete their close, and then load those results into the corporate accounting system, and then fix any errors caused by the other divisions. At this point, you’re lucky if only a week has gone by – and the corporate accounting staff hasn’t even started its closing process yet.

And furthermore, if there’s no interface between the accounting systems used by the outlying groups and the corporate accounting staff, then the company must either manually re-enter the closing data submitted by each division – or it has to purchase a mapping software package that automates the process. Even it you automate this mapping chore, someone needs to monitor it to make sure that the divisions don’t change their account structures without telling anyone.

To make matters even worse, each division may have its own set of procedures and chart of accounts, each of which are little bit different from everyone else’s. Because of this, some groups process transactions in different ways, which can result in more errors, and also possibly transactions being recorded in different accounts.

And to make matters even worse, you now have queue times and wait times at the local divisions for closing activities, which are piled on top of the queue times and wait times of the corporate accounting staff.

If you’ve inherited this kind of a system, there are no easy solutions. You could try to impose exactly the same chart of accounts and procedures on every division. But – each one will think that their approach is better, and fight you over this kind of standardization. In addition, once you get everyone standardized, the common accounts and procedures gradually start to change all over again, so you have to go through the same standardization mess a few years later.

The Need to Centralize Accounting Functions

The much better long-term solution is to centralize all accounting functions – and I mean every last one of them – in a single location. By doing so, you now have complete control over the chart of accounts and the procedures used to process transactions. And you can eliminate all of those duplicate queue times and wait times. And better yet, you can concentrate all of the accounting staff and managers in one place, where they’re much easier to manage. Along the same lines, you can also pick the best of this reduced group of managers to assist in the closing process, which results in fewer errors and a faster close.

To expand on that last point, let’s say you have five divisions, and the accounting department of each division assigns three people to the closing process, plus you have five more people at corporate headquarters. That means you have twenty people getting their hands on the closing process. And that is twenty people who can make a mistake, or be out sick for a few days, or otherwise occupied – all of which either causes errors in the financials or delays the close. Now, let’s say you centralize all of the accounting in one place. This means you may have to add one or two people to the closing team at corporate headquarters, which brings your total up to maybe seven. That’s still just a third of the amount you had before, and that smaller group will be much easier to manage.

Another advantage of centralization is that all accounting transactions are now stored in a single accounting database, so if the closing staff locates what appears to be an error, they can research it and fix it themselves. This is much faster than passing an inquiry back to the accounting department of the division where the error originated, so that they can research it whenever they have some spare time.

If you centralize accounting, it may also be possible to take advantage of workflow software.

This is software that tracks the status of work within the accounting area, so you can see exactly who is working on a closing activity, and this obviously makes for tighter management of the process. On the other hand, if accounting is spread out in many divisions with many different systems, you almost certainly will not be able to install a company-wide workflow management system.

Problems with Accounting Centralization

The main problem with accounting centralization is the massive systems upheaval you go through when all transaction flows shift away from the divisions and into a single location. Now, you can go for the high-risk approach and do a complete switchover on a single date. This presents the risk of a major system meltdown and all kinds of issues with not paying suppliers, not applying cash receipts, and certainly not issuing financials any faster. As an alternative, you might want to consider using a gradual centralization where you roll out one process at a time. This could mean centralizing payroll first, and then the payables process, then cash application, and so on. By doing so, any meltdowns will be much smaller meltdowns, and your conversion team will learn from its mistakes as it goes along.

Additional Thoughts

Now, how does centralization apply if you only have a single accounting location to begin with? You can still use it, because now you focus on reducing the number of people involved in the closing process. As a general rule, having fewer people involved results in a faster close, because you eliminate the risk that work will not be done or completed improperly due to miscommunications. This does not mean that all closing work should be shrunk down to the point where just one person handles everything. Instead, there will be an optimum number of employees who should be involved, and you can usually tell when you reach that point, because shrinking the headcount below this level actually results in a lengthening of the close.

As a final note, consider the need for centralization when you acquire other companies. This is a great opportunity to shift all of the accounting departments of the acquirees straight into your centralized accounting function. An acquired company expects changes to be made when they are bought, so fulfill their expectations and do the deed right away. If you wait until later to centralize, then it becomes politically more difficult to make the change.

I think that gives you a reasonable overview of how centralization impacts the fast close.

Related Courses

August 05, 2019

The Fast Close, Part 3 (#18)

August 05, 2019/ Steven Bragg

In this episode, we discuss more closing activities that can be completed prior to the end of a reporting period. Doing so can greatly increase the speed with which financial statements are created.

Interest Expense

First, let’s talk about interest expense. If you have debt outstanding, you probably have a really good idea of exactly how much is outstanding throughout the month, as well as the amount of the interest rate. So. If you expect no changes to the debt balance during the month, either up or down, then you can easily calculate an accrued interest expense well before the end of the month. And even if you do expect some changes to the debt balance before month-end, you can usually figure out what the changes will be if you have any remotely accurate cash forecasting system in place. So, in most cases, you can accrue an interest expense figure that should be pretty close. My company has debt, and I usually accrue the expense about a week before the end of the month.

Accrued Vacation Time

Next up, let’s try accrued vacation time. A lot of people don’t even bother to accrue any changes to this amount until the end of the year, because they don’t think that it changes very much. The balance usually stays pretty steady if your company doesn’t experience much employee turnover, and if employees are fairly reliable in using up their excess vacation time. If this is the case, then great – review it well before the end of the month, and maybe make some small accrual adjustments now and then.

Ah, but. What if your staff is not so reliable in using up their accrued vacation time? This means that the accrual will keep going up over time, and possibly pretty fast. The best way to get the calculation under control is to change your vacation policy to a “use it or lose it” policy.

My company allows only a 40-hour vacation carry forward into the next year, which makes it really easy to accrue vacation time – we just calculate a 40-hour accrual for everyone, and make a few minor adjustments if employees have even less time left to roll forward.

By using this approach, we cap the upper end of the dollar amount of the accrual, so the risk of being off by a substantial amount is nearly zero. So, with this “use it or lose it” policy, we don’t worry too much about having an incorrect vacation accrual, and we usually review it several days before month end.

Accrued Contractor Fees

Here’s another one. What about accruing for the services of any contractors that you may have working for you? This could happen if you outsource a lot of departments, or if you operate under a contractor rebilling model; that’s where independent laborers work for you, and you rebill their hours to your customers. In either case, you could be talking about a pile of expenses that need to be recorded with a high level of accuracy.

One of our divisions operates under the second scenario, where several people are contractors for short consulting projects. To accrue their hours in advance, we give them access to the company’s timekeeping system, and make absolutely certain that they keep their hours up-to-date. Then at the end of the month, I offer to pay them the very next day if they can get all of their hours recorded in the timekeeping system by the day. This allows us to accrue for their time before the closing crunch begins. It’s usually just about the last accrual that we do before the end of the month.

Account Reconciliations

OK, here’s one final item to consider. It’s possible to complete your reconciliation of the asset and liability accounts before the end of the month. What I’m talking about here is verifying the detailed contents of each account, to make sure that what is in each account is what’s supposed to be there.

I’ve run across a lot of people who swear that this is not an area you can complete early, because changes are being made to these accounts right through closing day. However, here are a few arguments in favor of doing this work early. First, if you do all of the other advance closing steps that I’ve been talking about, there’ll be far fewer changes to these accounts on closing day.

Second, doing account reconciliations a little early allows you more time to research why each entry was made into each account – and that means you’ll can take your time to ensure that the contents of each account should actually be there.

Now, if you were doing this on closing day, you’d be flying through it as fast as you could go, and would probably make some mistakes that could screw up the financials. In other words, it may actually be more accurate to reconcile accounts early.

And third, you can still reconcile the accounts on closing day, just to make sure that any late entries ended up in the right accounts. However, by doing most of the reconciliation work early, I usually see only a small number of reconciling items left to review. In fact, we don’t bother to reconcile accounts on closing day, because we haven’t seen a problem in this area in a couple of years. Instead, if we make some late entries to an account, we just include them in the next month’s account reconciliation work.

Well, that covers many of the closing activities that you can shift into the preceding month. If you decide to take this approach to your close, make sure that you create a closing checklist, where closing work is divided up into the period before closing day, and during closing day. I have one, and I use it as a check off list for the close, usually starting about ten days before the month closes.

So far, I’ve covered the shifting of work out of closing day. It’s the single best way to improve your closing speed. But this doesn’t mean that we’re done with the fast close. Ah, no. There’s quite a ways left to go before you reach a one-day close. For the next podcast, I’ll talk about how centralizing some accounting functions will also improve the speed of your close.

Related Courses

August 04, 2019

The Fast Close, Part 2 (#17)

August 04, 2019/ Steven Bragg

In this episode, we discuss a number of closing activities that can be completed prior to the end of a reporting period. Doing so can greatly increase the speed with which financial statements are created.

Last time, I talked about several activities that you could shift out of your closing day activities and into the last few days of the preceding month. I covered payroll accruals, bad debt reserves, error corrections in the financial statements, and depreciation – all of them are things you can do before closing day.

In this podcast, I’m going to talk about more of the same thing. There are a lot of closing activities that you can complete early, so I plan to touch upon a number of them, both now and in the next podcast. After that, I’ll move on to other ways to create a fast close.

Review Rebillable Expenses

So, to jump right back into the examples, another task you can complete early is to review all expenses that you plan to rebill to your customers. This is a pretty common occurrence in companies that bill staff time to customers, because there are sometimes travel & entertainment expenses that customers are expected to pay.

If you wait until closing day to include these expenses in your customer invoices, you’ll probably be in for a rude surprise at least once every close, because some of the expense information is incorrect – usually because the expense is charged to the wrong customer, or in the wrong amount, or there are no backup receipts or incorrect receipts. Whatever the reason, it’s best to fix all of these problems before closing day arrives. Also, since employee expense reports tend to arrive really late in the month, this is usually an activity that you’ll have to deal with late in the day at the very end of the month.

Accelerate Commission Calculations

Here’s another activity you can accelerate – how about commission calculations? This is not something you can completely knock off before the end of the month, since some invoices won’t be done until closing day. But there’s no reason why you can’t complete the bulk of the commission calculations at the end of the month. This gives you time to make a leisurely review of the calculations and commission splits. That way, you only have to account for a small number of additional commissions during closing day.

Review Billable Hours

For a third possibility, consider doing a review of all employee hours that are supposed to be billed out to customers at the end of the month. It’s pretty common to see some incorrect hours, or missing hours, or hours that are charged to the wrong customer. If you wait until closing day to check this information and then finds mistakes, you’ll have a really hard time closing the books fast, because you’ll spend hours tracking down employees to get them to revise their billable hours records. And this can become a major problem when those employees are traveling or away on vacation.

My company takes this to an extreme. We dig into all billable hours records at the beginning of each week for the preceding week, and we hound employees until every last one of them has entered correct time records. We do that every week without fail, for three reasons. First, we get employees into the habit of entering their time on a regular basis, so we have fewer problems at the end of the month. Second, employees tend to forget what they worked on if they only enter their time at the end of the month, so it’s more accurate to record hours more frequently. And third, this means that only the last few days of the month are at risk of not being entered by the end of the month.

Complete Portions of the Financials

A fourth possibility for you is to complete some parts of the financial statements before the month is over. This does not usually mean the income statement or balance sheet, since these documents will change based on additional information you enter on closing day. No, what I’m talking about is operational reports. These will vary by company, but they usually include some kind of statistics. In our case, I enter such information as headcount, bad debts incurred, customer loss ratios – things like that. This is also a good time to review any spreadsheets you may be issuing with the financials, just to make sure that your dates and formulas are correct. I also like to create a separate subdirectory for each month’s reports, which I also do in advance. So, when it comes to financial statements, there are a lot of small things you can do in advance, though you probably cannot actually complete any reports.

Conduct Online Bank Reconciliations

One more possibility is to do on-line bank reconciliations. Most banks now have your transaction information available on-line, so sign in each day and reconcile your bank accounts. By doing this, the only reconciliation work left for closing day is for just the last day of the last month, which should be about 1/20th of the usual work load, since you’re only reconciling one work day instead of the usual 20 or so working days in a month. And also, this is just good business practice. When you reconcile every day, you can catch all sorts of unusual cash flows, both in and out, that you otherwise would not have seen until the end of the month – so it’s a really good control. We’ve been doing daily bank reconciliations every morning for every bank account, and we’ve been doing it for years. This is not just for the fast close – it’s simply a good idea.

Related Courses

August 03, 2019

The Fast Close, Part 1 (#16)

August 03, 2019/ Steven Bragg

In this episode, we introduce the concept of the fast close, where the financial statements are produced on a vastly accelerated basis, usually in a single day.

First, I’d like to point out my background in this area. I’ve been issuing financial statements for about 20 years now, and noticed early on that producing financials took a painfully long time. In many cases, it took us a month to issue financials, so we were right back at it the next day, doing the next month’s financials. Since doing the financials all the time meant that we were not doing other things, this struck me as being a waste of time. Also, in a few cases, we had a financial crisis on our hands and didn’t even know it, since it took so long to find out how we had done.

Over a number of years, and with several different companies, I figured out on my own how to shrink the closing interval to just one day. There really have been no guidelines anywhere about how to do a fast close, so I gradually built up a list of what worked (and what did not work). The result is that, for quite a few years now, I’ve been putting out 16-page financials for a multi-division company in one day. For the year-end financials, we always schedule two days to close the books, just because the books will be audited, and we want to be extra careful. However, even then we almost always finish up on the first day, and we’re pretty much sitting around twiddling our thumbs on the second day. So, that’s my background on this topic.

Define the Fast Close

Also, let’s define the fast close. It means that you can release financial statements really fast, preferably in a single day. I suppose an alternative possibility is to have a “faster close,” which means anything quicker than what you’re doing now, though slower than a single day. There is also something called a “soft close,” which means that you don’t really issue a full set of financial statements – instead, you just pull statements from your accounting software without going through all the accrual and reconciliation steps that are normally needed for a complete close.

What you get is financial results that are not entirely accurate, but the effort required to get there is pretty minimal.

The soft close is most commonly used by public companies who only have to release quarterly results, so they run a soft close on the other 8 months of the year, just to get an idea of what kind of results they’ll be reporting at the end of the next quarter.

The Need to Spread Out Closing Activities

Now, the single most important solution to the whole closing process is fairly simple, once you define what the problem is. The main closing problem is that you have to jam way too many closing activities into too small a time period. So, with that problem definition in mind, the solution is – to move closing activities out of the closing period. What I mean is, rather than trying to complete perhaps 30 closing activities on the first day of the month, just figure out which items really need to be done on that day, and shift most of the other activities out of that one day.

I’m going to give a bunch of examples on this topic. First, let’s say that you always wait until closing day to create a payroll accrual for unpaid wages from the preceding month. This one can be difficult, because you want to wait for all timesheets to be submitted, so you can create a really accurate wage accrual. However – most of those wages can be easily predicted, since most everybody works an 8-hour day, and you already know which days from the end of the last month have not yet been paid through the payroll system. So… multiply the number of wage earners by 8 hours per day, by the number of unpaid days, and there is your wage accrual. No need to wait until after month-end to calculate that.

Now, you may not like to do this, since somebody will probably work a few hours more or less than the average during those unpaid days. Sure. Absolutely. But by how much will you be off? Probably by not very much at all. And if you want to be more accurate by estimating a little overtime for those people who usually work it – then fine, add it to the accrual. My point is, that the wage accrual is not that hard to calculate with a fair degree of accuracy before the month has closed. One time, I created a wage accrual three weeks in advance, and then compared it to what the actual expense was, and I was only off by a few percent – and certainly not enough to make much of a difference in the financial statements.

Here’s another example. What about the bad debt reserve? A lot of people adjust it on closing day, based on their review of the aged receivable balance on that day. Great, that’s one approach.

But it takes up precious time during closing day, and don’t forget that the goal is to move everything possible out of closing day. So, why would your reserve be any less accurate if you updated it a few days early? After all, it’s a reserve – it’s not intended to be absolutely accurate, and you are allowed to be a little bit off. So – work with your credit manager, and make your best guess. Chances are, your best guess a few days early will be about the same as your best guess on closing day.

Here’s a third example. The real fear of most controllers is that they complete the financial statements on closing day, and then find out that they contain some errors. And those errors take up a lot of time to investigate and correct. So. Why not review the financials for errors a few days early, and fix them as soon as you find them? By doing so, only the transactions entered in the last few days of the month still might contain errors, and that should vastly reduce the amount of error fixes you need to take care of on closing day. And another point on this – if you spot an error in the financials a few days early, this is not a rush period, so you can relax and take your time to properly fix whatever caused the error. By contrast, if you spot an error on closing day, it’s very likely that you’ll blaze through the investigation as fast as you can, and quite possibly throw on a short-term fix that doesn’t really halt the underlying problem. So, earlier problem resolution gives you better solutions. And on top of that, you just took a lot of difficult work out of closing day.

Here’s a fourth example. What about depreciation? Most people like to wait until all accounts payable have been recorded for the month, and then figure out which ones are fixed assets, and then record their depreciation. I don’t do it that way.

Instead, I record depreciation a day or two before the end of the month, based on two sources of information. First and most important, I use all accounts payable that have been recorded so far in the month. This means that I may miss a fixed asset for which the bill arrives in the last day or two of the month. The second source of information cover this problem, because I also use the purchase order that we issued from our capital budgeting system for any fixed assets that should arrive before the end of the month. Between these two sources of information, I can create a pretty accurate depreciation number before the month is even over.

And furthermore, what if I miss the depreciation on a new asset, or miscalculate the amount? Well, think about this for a minute. A typical asset is depreciated for a minimum of three years, if not longer. So, even if my depreciation calculation is off, then – worst case – I’m only off by 1/36th of the total asset amount. And, if this kind of error occurs, I can correct it at my leisure at any point during the following month. Quite honestly, I can’t even remember when I’ve needed to make such a correction, because the system works pretty well, and the depreciation figure is accurate.

Related Courses

How to Audit Fixed Assets

August 02, 2019

Controls for Fixed Assets (#15)

August 02, 2019/ Steven Bragg

In this episode, we discuss the controls associated with fixed assets. The primary controls over fixed assets really cover three main topics, which is acquiring and disposing of them, as well as in-house security. I’ll start with acquisition controls.

Acquisition Controls

The most basic acquisition control is that the initial approval for a fixed asset purchase comes through the annual budgeting process. Even though the budgeting process may be done many months before there’s any plan to actually purchase an asset, you need to plan as far ahead as possible. The reason is that a company may have only a limited pool of money available, so all possible acquisitions need to be reviewed together. That way, managers can figure out how to allocate funding.

Now, let’s say that there’s a sudden need for a fixed asset, and this need appears after the budget is finalized. Well, now there may not be enough cash available to pay for both the new asset and the other assets that were approved earlier as part of the budgeting process. In this case, the most common control is to make it really hard for the new asset to be approved. This usually means that even a small request is bumped up to a very senior-level manager for approval, and there has to be a really good reason why it’s needed right now, rather than in the following budget period.

Getting back to that budget approval process, there’s usually a fairly lengthy capital request form required. The person requesting the asset has to fill out the reason for the purchase, some sort of discounted cash flow estimate, and probably an itemization of exactly when cash flows are expected – both inbound and outbound. I prefer to have a simpler form for small asset requests, just so you don’t waste the time of the managers who have to fill out the forms.

The discounted cash flow estimate in the application form is going to use a hurdle rate that’s at least as high as the corporate cost of capital.

You can consider this to be a control, because if the project’s cash flows are discounted at the hurdle rate and it results in a negative discounted cash flow, then this should tank the request. After all, a company needs to at least earn back its cost of capital on new funds invested, or it’ll eventually go out of business.

Another control over the acquisition of an asset is to guard against any purchasing shenanigans. One ploy is that employees could buy assets and sell them to the company, then steal the assets, and sell them right back to the company again. You can spot this by always entering the serial number of each asset in the fixed asset master file, and then running a report sorted by serial number, so you can see if there are any duplicates.

Of course, this also means that you have to lock down access to the fixed asset master file, so no one can alter the serial numbers.

Another control over fixed asset acquisitions is to have a second person review all additions to the fixed asset master file. The reason is that a typo or a misclassification in that file can have some consequences that’ll impact the financial statements. For example, if an asset is entered in the wrong asset category, its depreciation period might now be too short or too long, which impacts profits. Along the same lines, if its location is entered incorrectly, then good luck finding it the next time you do an audit.

Also, it helps to compare all the additions to the fixed asset master file to the approved capital request forms. It sometimes happens that employees go completely around the capital budgeting process, so this is a good way to spot when that happens.

Here’s another control. When a new asset comes in, if you can’t find a serial number on it, or it’s written on a label that could fall off, then create an identification tag that uses some kind of durable material. It doesn’t have to be made of metal, but consider using a laminated plastic tag that’s really hard to rip off. Then enter the tag ID number in the fixed asset master file. By doing this, you make sure that every asset is clearly identified.

Asset Security

Now, once your assets are approved and bought and their locations are recorded, always make someone responsible for them. This means that you create a list of all the assets that each manager is personally responsible for, and send the list to that person once every quarter.

If you really want to lock down this control, then also list “asset responsibility” in their bonus plans. If you do that, managers will definitely keep an eye on every asset in the company.

You can even go a bit further with the manager responsibility angle. Another control is to make any department from which an asset is stolen replace it with their own funds. Since they very likely have other uses for that cash, you can bet that department managers will take asset control really seriously.

If managers are going to be held responsible for assets, then they will insist on another control, which is a formal transfer document that both parties sign when an asset is shifted over to another manager. This is a good way to make sure that asset moves are being properly tracked.

That should give you a pretty good idea of controls you can use for fixed asset acquisitions. Now let’s switch over to security controls, and there are only a couple of these. First, restrict access to any parts of the company where you have expense assets that someone could easily pick up and walk out with. These days, that usually means locking the access doors to the admin offices, because of all the expensive computers in there. You might also want to restrict access to the tool crib, since tools can walk off the premises as well. Really large machinery doesn’t require much access control, for obvious reasons – if anything, I’d be quite impressed if someone could make off with some production equipment that weighs a few tons!

Another security control is to attach a radio frequency identification tag to each asset that could be stolen, and then install detectors near all of the building exits. Then, if someone walks out with a fixed asset, the alarm goes off – just like if you steal clothes from a retail store.

There’s one more control that sort of falls into the security category, which is doing an audit of all fixed assets. This doesn’t keep assets from being stolen, but at least it will tell you after the fact if anything is missing. Some companies do these audits on a rolling basis, so that only a few people need to be involved on a part-time basis, while others make a big production out of an annual audit where everything is counted in one day. Take your pick here, though I prefer a rolling audit, since the counting process tends to be more relaxed, and that means that it’s also more thorough.

And by the way, it may make sense to review the depreciation periods and salvage values being used during the audit process, at least for newer assets. If you review this information for a new asset just once, it’s not too likely that it’ll ever change again.

One more piece of this auditing process is to also review assets to see if their value has been impaired. There are some accounting rules that say you have to write an asset’s net value down to its impaired value as soon as it’s been impaired. However, this can be a lot of work, so I suggest doing an impairment review only on the most expensive assets.

Asset Disposals

Let’s switch over to a third category of asset controls, which covers asset disposals. The control that everyone seems to miss is just reviewing assets to see which ones you no longer need. If there are any, then sell them. I’ve seen more companies that just park assets off in a corner and never try to get any cash for them, so they’re basically throwing money away.

Another fixed asset control – and a really good one -- is to require the use of a disposition form before any asset can be sold, or donated, or junked or whatever the case may be. This form needs to be signed by a manager-level person. The reason for this control is to keep employees from selling off assets without anyone knowing about it. Managers really don’t like it when an asset disappears from the premises without their approval.

And one final control. Once an asset is sold, always make sure that the cash receipt from the asset sale matches the amount of cash actually received. Employees sometimes sell company assets and then keep the proceeds. I’ve even seen a company owner do this – though I have no idea why, since he took home all the profits anyways. Maybe it was the excitement of stealing his own money.

Here is my view of fixed assets. In a lot of cases, capital spending proposals are for the wrong assets, because managers want to increase the capacity of areas of the company that are not really the bottleneck operation. So… the company spends a lot of money on fixed assets, and profits don’t go up at all. Therefore, I strongly recommend focusing a great deal of attention on the need for more assets, before even worrying about controls for acquiring and disposing of them.

One other point is that a lot of spending these days goes into technology assets, which depreciate really fast. In these cases, having a lot of disposal controls doesn’t make much sense, because the assets are essentially worthless after just a couple of years.

Related Courses

Fixed Asset Accounting

Fixed Asset Controls

August 01, 2019

Controls for Payroll (#14)

August 01, 2019/ Steven Bragg

In this episode, we discuss the controls associated with payroll. This is an area in which fraud is more likely to occur because of such activities as buddy punching and the use of ghost employees, so controls are unusually necessary. Key points made in the podcast are noted within the following general classifications:

Manual System Controls

Verify that all time cards have been received from employees by matching them to the employee list
Verify all hours worked, and especially overtime, with supervisors
Gain proper approval for all pay rate changes
Have a second person verify all payroll calculations
Have recipients sign for their paychecks, to ensure that payments are not going to ghost employees
Compare cashed paychecks to the list of distributed checks, to see if additional checks were issued
Compare the addresses on employee checks, to see if more than one check is going to the same address
Look for double endorsements on checks, which are an indicator of ghost employee arrangements

Cash Payment Controls

Have recipients sign for the amount of cash issued to them
Use a bill and coin requisition form, with approvals, to request the cash to be used for payments to employees

Computerized System Controls

Use a smart time clock to eliminate the need for manual approvals
Have supervisors manually override the smart clock to allow overtime selectively
Install biometric clocks to eliminate buddy punching
Install a surveillance camera over the time clock to foil buddy punchers
Review the payroll register for errors
Use variance reports to detect incorrect payments
Review self-service entries by employees and managers for errors
Install limit checks on self-service screens to control the date entry process
Email all payroll changes made back to the people requesting changes, to ensure that the changes match their intentions
Install extra controls over direct deposit change transactions
Do not use deposit slips for direct deposit information (use a cancelled check instead)
Look for duplicate pay-to bank accounts, which can indicate ghost employee transactions
Limit access to the employee master file, and keep a log of changes to it
Compare the company phone list to the payroll register, to see if anyone was excluded from a payroll, or if ghost employee payments are being made

Related Courses

Optimal Accounting for Payroll

How to Audit Payroll

Payroll Management

July 31, 2019

Controls for Accounts Payable (#13)

July 31, 2019/ Steven Bragg

In this episode, we discuss the controls associated with accounts payable. There are many possible controls that may be used, but the accountant needs to be aware that employing all of them could seriously reduce the overall efficiency of the department. Key points made in the podcast are noted within the following general classifications:

Manual Controls

Install three-way matching for larger expenditures
Institute a duplicate invoice search
Store unpaid invoices by date, to ensure that those items to which early payment discounts apply will be paid on time
Roll out negative approvals, to streamline the invoice approval process
Store blank check stock in a locked location, to prevent theft
Restrict access to the signature plate
Maintain a log of all checks that have already been used, to spot illicit removals
Review supporting documents before signing checks
Limit the number of check signers to a small number of rigorous signers
Never sign blank checks
Perforate cancelled checks, to keep them from being submitted for payment

Computerized Controls

Conduct automated three-way matching
Automatically scan for duplicate invoices
Lock down access to the supplier master file, so that no one can alter pay-to addresses
Track changes that have been made to the supplier master file
Adopt a standard naming convention for suppliers in the supplier master file, to prevent the creation of duplicate supplier records
Scan the supplier master file for duplicate supplier records
Compare supplier to employee addresses to see if there are any matches
Install the positive pay system

Electronic Payments

Install an ACH debit filter to restrict deductions from a bank account
Minimize the amount of cash in the checking account to cover just current liabilities, to minimize the risk of large additional charges being made against the account
Install password access to the electronic payment software
Have the bank call the CFO or controller for verbal approval of large electronic payments
Review repetitive payments on a regular basis, to ensure that they are still valid

Related Courses

Optimal Accounting for Payables

Payables Management

July 15, 2019

Collection and Cash Receipt Controls (#12)

July 15, 2019/ Steven Bragg

In this episode, we discuss the controls associated with collections, cash receipts, and petty cash. The main concept is to avoid cash-related controls by keeping cash off the premises, usually by encouraging the use of ACH payments or payments into a bank lockbox. Key points made in the podcast are:

Collection Controls

The collections staff is not allowed to handle cash receipts, since this presents a temptation to steal the cash and use credit memos to cover up the theft
The collections staff can only create credit memos without approvals that are relatively small; all others require management approval
Management approval is required to assign invoices to a collection agency, because of the significant collection fees charged

Cash Receipts Controls

Two people open the mail, to reduce cash and check pilferage
The mailroom staff creates a list of all cash and checks received, of which it retains a copy
The mailroom staff endorses all received checks as being for deposit only
The cash receipts clerk matches all checks entered into the accounting system to the list provided by the mailroom, to look for anomalies
Compare the bank deposit slip to the cash receipts journal, to see if the courier removed any cash or checks
Force the cash receipts clerk to take vacations, which may uncover instances of lapping fraud
The cash register clerk gives a receipt to every paying customer, so the customer can compare the receipt to the amount paid

Petty Cash Controls

Don’t use petty cash at all
Assign responsibility for the petty cash box
Document all disbursements from the petty cash box
Audit the petty cash box
Place a contact switch under the petty cash box, so that an alarm will sound if the box is taken

Related Courses

Credit and Collection Guidebook

Optimal Accounting for Cash

July 13, 2019

Controls for Billing (#11)

July 13, 2019/ Steven Bragg

In this episode, we discuss the controls associated with billing. The key points made in the podcast are divided into three parts, which are for manual systems, computerized systems, and general controls.

Manual Billing Controls

Verify prices being billed against a standard price list
Proofread larger invoices prior to mailing, to minimize errors
Have the originating salesperson verify invoices, to spot errors
Verify any unusual payment terms
Verify the applicable sales taxes being charged
Stamp each envelope with “address correction requested”

Computerized Billing Controls

Print and review the invoice preview report to ensure that all items to be billed are accurate
Reduce access to the billing software, to minimize the risk of fraudulent billings

Controls for All Types of Billing Systems

Segregate the billing and collection duties, to keep anyone from falsely issuing a billing and then collecting the related funds

Compare contract prices to what is being used for the prices on the most recent invoices
Monitor customer complaints regarding invoices
Issue month-end statements to customers, to see if they can spot any errors
Compare the quantities shipped to the quantities invoiced
Clean up the invoice format to make it easier for customers to read
When entering an invoice into a customer’s online payment system, print the confirmation page to verify that it was entered
Segregate credit memo creation from the cash receipts function
Require approvals for the creation of larger credit memos
Charge credit memos against salesperson commissions, so that they have an incentive to investigate the memos
Audit a selection of credit memos

Related Courses

Credit and Collections Guidebook

July 12, 2019

Controls for Shipping (#10)

July 12, 2019/ Steven Bragg

In this episode, we discuss the controls associated with shipping. This process begins with a verification that customer credit has been approved, proceeds to picking from stock, and ends with packages being prepared for delivery to customers. Key points made in the podcast are noted below.

The primary goals of the shipping function are that you ship exactly what customers ordered – and nothing else, and that you absolutely, positively make sure that you bill them for whatever was delivered. Our controls need to support these two goals.

Controls Over Deliveries

There’re several controls that can help us with the delivery goal that I just mentioned. First, let’s make sure that nothing is shipped that should not be shipped. An obvious control is to verify that the sales order has been stamped or flagged by the credit manager, which signifies that the credit department is OK with the order. If the shipping department uses a common database with the credit department, then simply printing the daily shipping list should automatically exclude any orders for which credit has not been approved. And, you could back this up with a standard policy which states that no orders are released without the prior approval of the credit manager. If properly enforced, that policy is sometimes useful for putting the fear of God into the shipping manager.

There can also be an occasional audit to compare credit authorizations to what was actually shipped, just to make sure that this control works.

A second control is that, as soon as the picked items arrive in the shipping area, compare the sales order to the picked items to make sure that they match. If some items were not in stock, then you complete a three-part backorder request form for the missing items.

One copy goes to the order entry staff for follow-up with the customer, while another copy goes to either the purchasing department or production scheduling department to either order or create the missing items, and the shipping manager retains the final copy, along with the sales order.

A third control to support this goal is to investigate the reasons for product returns from customers, since these returns may include items that were incorrectly shipped.

Controls Over Billing of Shipped Goods

Now, we turn to the goal of making sure that all shipped items are billed. This goal is near and dear to the heart of every accountant, since it’s highly embarrassing to not issue an invoice for a shipment. The main control for this goal is the proper use of a bill of lading. When an order is shipped, the shipping staff prepares a three-part bill of lading. One copy goes with the shipment, one stays in the shipping department, and one copy – this is the important one—goes to the accounting staff. The accounting staff uses this bill of lading as a trigger to create an invoice, which we’ll get to in the next podcast.

Another control is to complete a daily shipping log that contains a summary of every shipment sent out. The accounting staff can compare this log to what they actually invoiced to see if any shipments were missed. If the shipping department is fully computerized, then the shipping software should create this log automatically.

A special situation arises when a company is not actually shipping anything itself – instead, a supplier is sending the goods straight to the customer -- this is called drop shipping. The company sends a copy of the sales order to the supplier, who sends a copy of its bill of lading to the company when it delivers a shipment to the customer. In short, this is like having a long-range shipping dock. The primary dangers are that the supplier never receives the customer’s order (and so never ships it), or that it ships the order but never sends a proof of shipment to the company’s accounting staff. We guard against both the first and second risk by investigating old open customer orders for which we’ve never issued an invoice to the customer.

These are an excellent indicator of problems somewhere in the drop shipping process, though of course they could just mean that the supplier has not gotten around to making a shipment yet. Another control is to match the supplier’s billings to the company to the company’s invoices to the customer. If the supplier’s invoices contain items not in the company’s invoices, then the company has missed an invoicing opportunity somewhere.

Another special situation is when a customer uses an evaluated receipts system. This is when they pay their suppliers based on what they receive, not what they’re invoiced for. In fact, they don’t want to receive an invoice at all. Instead, these customers usually want to have a special label printed and attached to any deliveries sent to them.

These labels always include the customer’s authorizing purchase order number, and probably some additional information about the contents of the shipment. If the label is not attached, then the company isn’t paid. Consequently, a double check of the label before these shipments are sent out is a very useful control. Also, if each label contains a unique identifying number, then the shipping manager can run a report from the computer system that shows which unique label was attached to each delivery. If there’s no unique number listed on the report, then you know that a label was not printed.

Here’s my view of shipping controls: it’s best to use an integrated computer system to the greatest extent possible, since this area will otherwise be overloaded with paperwork, and that interferes with the efficiency of the department. By using computers, the shipping staff can easily verify credit approvals, print labels and bills of lading, and electronically issue shipping notifications to the billing department. Without computers, the process is much slower and more likely to suffer from errors.

Related Courses

July 11, 2019

Controls for Production (#9)

July 11, 2019/ Steven Bragg

In this episode, we discuss the controls associated with production. A major concern in this area is that the production staff is in the business of manufacturing goods, so any controls imposed on them will reduce their production efficiency. Consequently, controls generally need to be built into the production system, with little user interaction, or require the services of a separate group of people from those engaged in production. Key points made in the podcast are noted below.

The Need to Minimize Controls

Today’s topic is controls for production. Now, production employees are in the business of building products, so if you ask them to do anything else, like fill out forms or count things, they’ll be distracted. The result is that the controls are performed poorly, and because the employees are distracted, this may also have a negative impact on their regular production work. Therefore, it’s best to install production controls that don’t bother the production staff. This can mean that control work is only done by non-production employees, or that controls are installed in processes around the production area, but not within it.

What to Control in Production

What are we controlling in production? We want to make sure that the right orders are being produced, and that the materials and staff are available to manufacture those orders. To ensure that the right order is produced, the standard control is to issue work orders from a master production schedule, which is maintained by the production planning staff. A production routing instruction sheet will be attached to the initial parts kit when it departs the warehouse, and the materials handler will shift it from work station to work station in accordance with the work sequence listed on the routing instruction.

The production planning staff monitors the flow of orders through the production process. Though there are some automated methods available to conduct the monitoring, the most common approach is to have the production planners tour the plant and manually verify the status of each order. Conversely, the automated approaches are to either have each workstation operator log in the arrival and departure of each production job on a computer monitor, or RFID tags can be attached to each order, and monitored based on the signals the tags emit. The use of RFID tags is still exploratory, so I don’t recommend that approach until the technology has settled down a bit more.

Ideally, all the parts are used, production is completed, and the resulting finished goods are returned to the warehouse.

Unfortunately, it’s not quite that simple. We’re still going to have problems ensuring that the correct materials and staff are available to produce those goods.

One problem at the beginning of the production process is that the picking staff in the warehouse may not have properly picked all of the parts. To detect this, a logical control is to have the materials handler compare the picked parts to the parts listed on the pick list, to make sure that they match.

Next, what if the warehouse staff picked exactly what was listed on the pick list, but it was not what the production staff really needed? This problem is caused by an incorrect bill of materials. There are several ways to control this issue. First, lock down access to the bill of material file in the computer system, so that only authorized people can access it. Second, audit the bills of material, and have all problems corrected. The target bill of material accuracy level, by the way, should be at least 98%. And third, investigate whenever the production staff has to request extra parts from the warehouse, or if they return unused parts to it – both are indicators of an incorrect bill of materials.

A different problem that can occur anywhere in the production process is that the routing document is incorrect, and doesn’t properly include all production work steps. This is important, since the problem jobs must be jammed into the backlog of work stations that are not even expecting the work, which can cause some major backlogs. To fix this problem, audit the labor routing records, and shoot for a target accuracy level of at least 95%.

Also, as was the case for bills of material, always lock down access to the labor routing records in the computer, so that only an authorized person can access them.

Yet another problem is the occasional production of scrap. An allowance for scrap is sometimes included in the bill of materials, but if the allowance is too small, then the job will run out of materials before the required number of units have been completed. There are several ways to ensure that scrap levels are correctly recorded.

One is to have the production staff fill out a form that itemizes how much of which item was scrapped. Then a data entry person collects the forms and enters the scrap information into the computer.

It also helps to prenumber the scrap forms and track down any missing forms. However, as I mentioned earlier, you generally want to keep paperwork away from the production staff. Also, they have a tendency not to report scrap, because they don’t want to be held responsible for making the scrap. So, we need some alternative ways to collect scrap information. One is to have the production staff dump all scrap into collection bins, and then a data entry person adds it all up at the end of the shift and records the amount of scrap. A less organized approach is to periodically sweep through the production area and collect any scrap or finished goods that are left lying around, and then record this information.

There are other issues that need controls, such as labeling goods for rework, or pulling inventory out of production for a quality review, but you get the general idea that unusual transactions that remove materials from the production flow must be reported as fast as possible.

Material Requirements Planning as a Control

For those of you with some experience in manufacturing, the production flow that I’ve been talking about is based on a material requirements planning system, or MRP for short. An MRP system is a push system, whereby a production schedule plans out how many units will be produced, and what materials will be required to produce it, and then controls the entire process of ordering materials and shepherding them through the manufacturing process.

Now, the problem with an MRP system is that it requires massive amounts of accurate information in order to correctly plan the production process. To ensure that the MRP system works, there need to be lots of controls to verify that the data entering the system does not screw up the works.

Just-in-Time Systems and Production Controls

A way to reduce the number of controls is to use a just-in-time system. This approach is based on the pull concept, which is that finished goods are only manufactured when there is actual demand for it. A signaling device called a kanban is used to notify upstream workstations of the quantity needed, and those workstations produce until the order represented by the kanban has been filled. Then they stop working. Some other features of a just-in-time system include very small lot sizes, short lead times, frequent supplier deliveries, and a strong focus on reducing equipment setup times.

The just-in-time system is very attractive from a controls perspective.

First of all, lot sizes tend to be quite small, so scrap is discovered by the downstream workstation almost at once, before the upstream workstation has had much time to create more of it. This means that scrap levels will be minimal, and so there’s not much need for a control to count scrap.

Second, there’s little need to count incoming inventory, either from the warehouse or from an upstream workstation, because it’s usually slotted into bays in a standard-sized container that’s easy to count with just a glance. So, this eliminates the need for a quantity verification control.

Third, work-in-process inventory doesn’t stay in the manufacturing area for very long, so there’s no need to track inventory as it moves from workstation to workstation within the production area. Instead, just count the amount of finished goods as they come out of the production area.

The main area in which controls are needed for a just-in-time system involves suppliers. They’ll be making lots of small-quantity deliveries, possibly several per day, and it’s not efficient for the receiving staff to inspect and log in each receipt. Instead, the location of controls need to shift upstream to the supplier itself, where the company’s industrial engineering staff pre-certifies the ability of each supplier to deliver the right quantities, on time, with good quality, and directly to the production area. This may also call for the use of a supplier performance scoring system.

In short, a just-in-time manufacturing system requires far less control than a traditional MRP system.

Parting Thoughts

Here’s my view of production controls: The overriding concern in production is to stay out of the way of the production staff. Their job is to manufacture goods. This means that any attempt to have them fill out forms, conduct counts, or do anything even remotely associated with a control will almost certainly reduce their level of efficiency. Unfortunately, an MRP system requires a lot of paperwork – it needs to be notified of any transactions that are even remotely out of the ordinary. On the other hand, a just-in-time system is designed to be essentially self-controlling. And that means that discrete control functions are minimized, and the production staff can get on with the business of production. Obviously, I like the control environment for just-in-time manufacturing.

Related Courses

Inventory Management

July 10, 2019

Controls for Inventory (#8)

July 10, 2019/ Steven Bragg

In this episode, we discuss the controls associated with inventory. This is a massive area that encompasses many controls, so we split them up in the episode into controls for inventory storage, inventory costing, and inventory handling. The point is made that inventory is really a liability, since it puts the company at risk of inventory obsolescence, requires significant resources to track, and involves a large working capital investment.

Inventory Storage Controls

Fence in the warehouse and lock the gate in order to minimize pilferage
Restrict warehouse access to authorized personnel
Tie the pay of the warehouse staff to inventory record accuracy
Be orderly in regard to how inventory is bagged, boxed, and stored
Implement cycle counting, including investigations of any errors found
Conduct a weekly audit of inventory record accuracy, post the results in the warehouse, and pay bonuses based on it

Inventory Costing Controls

Schedule a periodic obsolete inventory review
Run the “where used” report to see if any on-hand inventory is not being used on products
Conduct a quarterly lower of cost or market review, to spot valuation problems early
Lock down access to the bill of materials and labor routing records, to keep them accurate
Track the identifications of anyone who alters inventory records
Monitor the period-end cutoff of inventory counts, using an on-site person
Compare monthly overhead charges on a trend line to spot anomalies
Conduct a periodic detailed analysis of the cost of goods sold to search for unusual entries
Run a report that shows any inventory items with negative unit balances
Run an extended inventory valuation report and look for unusually high or low values
Compare per-unit costs on a trend line to spot anomalies

Inventory Handling Controls

Enforce rapid data entry for inventory moves
Update the bill of material records as soon as changes are made to product designs
Always pick from inventory using a copy of the original customer order, to ensure that picks match what was actually ordered

Related Courses

Accounting for Inventory

Inventory Management

July 09, 2019

Controls for Receiving (#7)

July 09, 2019/ Steven Bragg

In this episode, we discuss the controls associated with the receiving function. This is a key area, since received goods need to be logged into the system properly in order to notify everyone that they are available for use. In addition, proper receiving assists the payables department in processing payments to suppliers. Key points in the podcast are noted below.

The Segregation of Duties

The first order of business is to make sure that the purchasing and receiving functions are segregated. Otherwise, someone in purchasing can order something, run down to the receiving dock to pick it up, and then take it home – which means that the company pays for it, and no one realizes that fraud has just been committed. So, by having a different person receive goods, the company can be sure that the received items are properly stored or dispositioned within the company – and not taken home.

The Receiving Process Flow

Besides the splitting of duties, there’s also a strict process flow used by the receiving function to ensure that there is a proper level of control. The first step in the process is when the purchasing department sends a copy of each issued purchase order to the receiving department. The receiving staff files all unreceived purchase orders by supplier name, which makes them easier to locate later on.

When a delivery arrives at the receiving dock, the staff uses the purchase order number marked on the shipment to reference the purchase order document. The staff then uses a standard receiving inspection checklist to review the delivery. This checklist can include such items as inspecting the shipping container for damage, proper labeling, product quality, quantity, and the date and time of delivery. They should initial each item on the checklist as they complete it, and make note of any problems. If there are problems, they usually contact the buyer who issued the purchase order for further instructions, which may involve storing the goods to one side for further review.

If the shipment has not been authorized by a purchase order, then the receiving staff should be authorized to reject the delivery. However, since this may cause all kinds of problems with rush deliveries that were authorized with a verbal purchase order, the receiving manager may spend some time trying to track down the recipient before rejecting the delivery.

In any case, the receiving department should always charge the buyer’s department a stiff inter-departmental charge for this service, since buying without a purchase order is a clear control breach, and is also a pain for the receiving staff to deal with.

If the shipment is acceptable, the receiving staff must identify and tag every item received with the correct part number, and then enter the part number and quantity received into the computer system. From the perspective of the materials manager, who needs to know what materials are in stock for production, this is the single most important control in the receiving process. It’s just not acceptable to put items on the shelf without first identifying and recording them. Even if the receiving manager claims that there’s too much material clogging the receiving area and he or she has got to move it into warehouse storage, the answer is always the same – tagging and logging come before storage. If necessary, the receiving staff can be supplemented with more employees to eliminate the work backlog. Under no circumstances can unrecorded inventory be stored in the warehouse, since it’s extremely difficult to locate it again. There. I think I’ve beaten that control point to death.

To continue a bit further with this concept, a key control is to make sure that all data entry happens as soon as possible. The best approach is to have suppliers attach bar coded identification tags to all deliveries, so the receiving staff simply scans the bar codes into the computer system and their data entry work is done.

If the receiving system is still paper based and there’s no computer in sight, then a different approach is needed. Receiving employees are not always hired for their data entry skills, so it may make sense to have a data entry clerk whose primary task is logging in receipts. This may call for manual entries to inventory card files, which – though primitive – are still in use. If so, the clerk should also complete a receiving log, which is a daily summary of all receipts. This log should include the date, the name of the supplier, third party delivery firm (if there is one), and the contents of each delivery at a summary level. If the receiving department enters this information into a computer system, then there is no need to maintain a separate receiving log, since the computer can automatically generate the report.

Why bother with a receiving log? It provides a good summary of daily receipts, which can be used by the accounts payable staff at month-end when it is trying to determine if there are any receipts in inventory for which it has not yet received a supplier invoice. If there are, then it uses the receiving log to assist in creating an expense accrual for the missing invoices. Of course, a fully integrated enterprise resources planning system will automatically locate any receipts for which there are no supplier invoices, and take the additional step of figuring out the price of these items from the related purchase order – this gives the accounts payable staff all the information they need to create a month-end expense accrual without ever bothering to look at the receiving log. Unfortunately, ERP systems cost a few million dollars, so most of us use other approaches to calculate the month-end payables accrual.

The final step in the receiving process is for the receiving staff to make a copy of the bill of lading, keep the copy for future reference, and forward the original to the accounts payable staff, who will match it to the supplier’s invoice and an authorizing purchase order before paying the invoice.

That’s it for the basic receiving process. However, receiving is also subject to a number of variations that are common enough to address as well.

Customer-Owned Inventory

One special case arises when a shipment contains customer-owned inventory. This happens when customers want to have some of their parts included in a custom-designed product. It can also happen when suppliers send consignment goods to the company that are to be sold by the company. In either case, the company does not own the goods, and should not record them as company-owned inventory, since this would greatly inflate the value of its inventory, thereby also falsely increasing its reported profit.

The best fix for this issue is to have the purchasing staff assign a special purchase order number to each incoming item that the company is not actually purchasing – perhaps it begins with an unusual letter, such as “Q”, that tells the receiving staff not to assign a part number to the order that is also used by a company-owned part, thereby avoiding the accidental assignment of a cost to the item. In addition, the unique purchase order code tells the receiving staff to put the inventory away in an area assigned to customer-owned or consignment goods, which is another way to ensure that this inventory is properly segregated and therefore not counted as company-owned inventory.

Yet another control over this issue is to put a special identification tag on each item, perhaps color coded, so there is no way an inventory counter will later identify it as being company-owned.

Customer Returns

Here is another special case, and one that’s even more common. What if customers return goods to the company? How does the receiving department accept it, or should it accept these returns?

The answer is that it should not accept returns without a formal authorization from the customer service department. I have had an interesting experience in this area where unrestricted returns almost bankrupted a software company that I worked for early in my career. Our sales were to large retailers, who realized that we had no returns policy, and immediately commenced shipping back massive quantities of a few poor-selling products. We hired a CFO who soon realized that this was a make-or-break problem. He had the receiving department reject all product returns unless they included a return authorization number – each of which was issued by him – personally. And I can assure you that he did not issue very many. The sales agreement with the retailers did not allow them to return unsold products, so he solved the problem with this control.

Returning from the example, the receiving staff obviously needs to have an up-to-date list of all return authorization numbers that have been granted, including – and this is important – the exact quantity and types of items for which a return is being granted. Otherwise, customers have a bad habit of returning more than was authorized, and may continue to do so for some time.

Cross-Docking

Let’s cover another common receiving situation, which is cross-docking. This is when items are delivered into a warehouse receiving bay and immediately shifted to another outbound truck, where they are shipped out again. Cross-docking almost certainly involves a high-volume environment where the materials handling staff has no time for transaction data entry. If materials handlers are still required to do data entry, they will almost certainly make mistakes. To avoid this issue, there are three possible controls for keeping data entry out of their hands.

One solution is to require complete bar coding of all incoming loads, so each pallet can be scanned as it leaves one trailer and enters another.

This approach requires a great deal of coordination with suppliers, but is certainly a common approach.

A second option is to have suppliers send an advance shipping notice to the company, detailing the exact contents of each truckload. As long as this information is accurate, the receiving staff simply logs in the identifying trailer number, the computer matches the trailer number to the advance shipping notice, and presto! The entire truckload is automatically entered into the company’s warehouse management system. This is very nice, but it does require accurate advance shipping notices from the supplier.

A third option is more old-fashioned, which is to have the materials handlers do nothing but handle materials, and assign full-time warehouse clerks to the entry of all incoming and outgoing transactions. This approach tends to result in the most errors, but also requires minimal automation.

Deliveries to the Production Line

And finally, here is one more special case – what if the company has no receiving function at all, and instead allows suppliers to deliver goods directly to the production line? This scenario almost never arises unless a company is using a just-in-time manufacturing process where inventory levels are kept so low that all arriving deliveries are used immediately in the production process. The key control is for the company’s engineering staff to visit each supplier location and certify the accuracy of their deliveries. If they pass, then they are allowed to make deliveries without going through the receiving process. A secondary control that is built into the system is that the company’s production process will shut down if parts are NOT delivered, while excess deliveries will be immediately obvious, because they will be piled up on the shop floor. A third control is to have an ongoing supplier report card system set up that tracks on-time delivery, as well as the quality and quantity of deliveries. If a supplier’s score drops too low, then they receive a re-certification visit from the engineering staff.

Parting Thoughts

Here is my interpretation of receiving: Inspections tend to be haphazard when a large number of deliveries are received at once, since the receiving manager is more concerned with getting deliveries properly identified and stored as soon as possible. Consequently, it’s better to rely upon other means of determining delivery problems, such as supplier pre-certification, than to rely upon the receiving staff to do inspections. Also, there can be a real problem with the transfer of receiving information to the accounts payable staff, with some paperwork never reaching the payables department at all, or very late. When I eventually reach the payables control lecture, I’ll talk about methods for automating and even eliminating this transfer of information.

Related Courses

July 07, 2019

Controls for Expense Reports (#6)

July 07, 2019/ Steven Bragg

In this episode, we discuss the controls associated with expense reports. These reports have historically been reviewed by the accounting staff in detail, even though few errors are ever found. There are more streamlined ways to deal with expense reports, as discussed in this episode. Key points in the podcast are noted below.

How Expense Reports Have Been Handled

Expense reports are the summarization of a variety of expenses paid for by employees, and for which they want reimbursement. The trouble is that none of the items paid for by the employees were initially approved by an authorized person, so the company is faced with the problem of sorting through the mess to figure out which expenses are valid, and which will be rejected.

The old fashioned control approach to expense reports is to review 100% of the receipts submitted, in excruciating detail, then go back and forth with employees and supervisors about what expenses will be allowed or rejected, and eventually reimburse an amount that is suspiciously close to the total amount shown on the original expense reports. In other words, after all that review work, most companies pay the full amount of every expense report submitted.

There has to be a better way to control expense reports. There is. Actually, there are several approaches.

The Partial Expense Report Review

First -- a much less expensive alternative to the full report review is the partial review. This means that only a few expense reports are fully reviewed, but if errors or possible cases of fraud are found, then the person submitting the expense report will be subjected to a full review from that point forward. Even better, it makes sense to review their expense reports for the past few years to see if there’s been an ongoing problem. In addition, it’s very useful to inform all employees that expense reports are being spot checked, which should prove to be a sufficient deterrent for most people to submit accurate expense reports.

Have the Company Directly Pay for More Expenses

Another approach is to keep as many expenses as possible from appearing on employee expense reports; since the largest expense item is almost always reimbursement for travel expenses, it makes a great deal of sense to route all travel through a booking person within the company, who can coordinate the approval of employee travel before any bookings are made.

Of course, the company pays for all travel directly, rather than through employee expense reports. The result is that inappropriate travel can be stopped before it occurs, while the total dollar amount of expense reports submitted declines drastically. The problem here is that many people like to make their own travel arrangements, and will resent having the company do it for them.

Use an Automated Expense Reporting System

Yet another approach is to create or purchase an automated expense reporting system, into which employees enter their expense information. This approach avoids the use of manual or spreadsheet-based reports, which tend to be full of errors, while also allowing for the imposition of travel policies at the point of data entry. These rules keep employees from entering expenses that’re not allowed under company travel rules. Examples of such software packages are those produced by Concur and Extensity.

Create a Travel Policy

Another approach to expense report controls is the travel policy – this policy defines exactly what expenses are allowable and (more importantly) not allowable, as well as the penalties to be imposed for breaking the rules.

Parting Thoughts

Here is my interpretation of employee expense reports: Conducting a 100% review of all expense reports is wildly inefficient, and rarely even begins to pay back the cost to review them. Consequently, an occasional audit will be sufficient. Furthermore, it’ll quickly become apparent which employees are causing reporting problems, and which ones submit such squeaky clean expense reports that they can safely be ignored. Also, requiring centralized bookings will not only improve controls, but also presents the opportunity for lowering travel costs by centralizing with a small number of travel suppliers. Keeping tight control over whether travel occurs at all is the best way to control expense reports, since this can save thousands of dollars by preventing a trip entirely. Conversely, most other expense report controls are more focused on saving just a few dollars here and there.

Also, smaller companies can get by just fine with expense reports that are submitted on spreadsheets, despite the occasional errors that will creep into these reports. On the other hand, companies dealing with hundreds or thousands of expense reports will find that more automated expense reporting systems will be cost effective.

Finally, travel policies should certainly be issued on a regular basis, but in reality few people look at them, so they’re most useful as a partial deterrent.

Related Courses

Expense Report Best Practices

Payables Management

July 07, 2019

Controls for Purchase Orders (#5)

July 07, 2019/ Steven Bragg

In this episode, we discuss the controls associated with purchase orders. Purchase orders are an excellent control over purchases, though they are time-consuming to produce, and so are usually confined to more-expensive purchases. Key points in the podcast are noted below.

Why We Use Purchase Orders

I’ll start with a question: Why do we need purchase orders? Because it is useful to have someone with a considerable knowledge of product prices and ordering systems who can channel a company’s flow of purchases, rather than having every employee buying anything they want. The result should be lower prices and purchases from a relatively small group of qualified suppliers.

Primary Purchase Order Controls

There are four primary controls involving purchase orders. First is the mandatory purchase order authorization. This means that the purchasing staff must issue a purchase order for every purchase made by a company. By doing so, someone trained in buying is reviewing every purchase made. However, since purchase orders are very labor intensive to create, we need to devise several ways to reduce the burden on the purchasing staff. One is to allow small purchases, which inherently don’t require much oversight, by using procurement cards instead of purchase orders – I covered the controls for them in Episode 4. Another approach is to issue a blanket purchase order that covers all purchases for a specific item or commodity group for a relatively long period of time. Yet another alternative is to pre-approve certain suppliers for purchases, and allow employees to requisition items directly from those suppliers by using electronic catalogs.

This brings us to the second primary control. The purchasing staff should not be put in the position of authorizing a purchase, since they are not responsible for the expenses of each department whose employees want them to create a purchase order. Instead, we require employees to complete a purchase requisition form, which must be approved by their department manager. By doing so, the department manager is taking responsibility for each purchase, and understands that the cost of this purchase will be charged against his or her department’s budget.

The next primary control is to reject deliveries if there is no purchase order. After all, employees will purchase by the easiest and quickest means possible, and purchase orders are neither quick nor easy.

To ensure that they follow the purchasing rules, the receiving staff must reject deliveries if there is no authorizing purchase order number. This causes all kinds of grief if an item is rejected that is also desperately needed somewhere in the company, so a common alternative is to set such receipts aside for a short time while authorization can be affirmed. More on this issue in a moment.

The final primary control is to match supplier invoices to authorizing purchase orders. This will be dealt with in greater detail when I get to controls for the accounts payable function, but, in short, the accounts payable staff should match all supplier invoices to the quantities and prices listed on the authorizing purchase orders, and follow up on anything that does not match.

Secondary Purchase Order Controls

There are also a number of secondary controls for the purchasing function.

As I just noted, it may not be prudent to reject an unauthorized delivery, but having the receiving staff spend time tracking down who ordered the item outside of the normal purchasing rules is essentially enabling the person who broke the rules. There needs to be a penalty for this type of behavior. A good one is to charge that person’s department a stiff inter-company fee, such as $1,000 per incident, which should get the department manager’s attention, and keep this situation from arising again.

Here is another secondary control. If the purchasing system is a manual one that uses paper purchase orders, those purchase orders are the equivalent of gold – steal a few and you can authorize all kinds of purchases. To prevent this, prenumber the purchase orders, lock them up, and track the numbers to ensure that none are missing.

If the purchasing system uses a computer, then access to the purchasing database can also result in the unauthorized issuance of purchase orders. In this case, be sure to use password control to restrict unauthorized access to the database. This should also include the immediate cancellation of database access privileges for all employees who are leaving the company.

Whether purchase orders are created manually or through a computer, a useful control is to periodically examine all old open purchase orders. They may contain authorizations to purchase a few residual items that were never received, or may relate to entire orders that were never received. In either case, some investigation may reveal that these orders are no longer needed, so they can be cancelled.

And finally, the internal audit staff can also provide control over the purchasing process. For example, they can review purchases made by the purchasing staff to see if prices are unusually high; this may be a sign that a purchasing person is being paid a kickback by a supplier in exchange for ordering items at an excessively high price.

A separate controls issue is the use of a computerized materials management system. These systems can automatically issue purchase orders based on projected production requirements. Such systems remove a considerable burden from the purchasing staff, but there is a risk that the system will issue incorrect purchase orders, usually caused by incorrect information somewhere in the production database. As a control over this problem, it is customary for the purchasing staff to either review all automatically-generated purchase orders before flagging them for release, or at least review any orders involving unusual items or quantities.

Parting Thoughts

Here is my interpretation of purchase orders and related controls: They’re a strong control over purchases, but they are not necessary in several situations, where are as follows:

The expenses of a service-intensive company mostly relate to payroll, so the minor amount of other expenditures may not call for the use of purchase orders.

Purchase orders are a pain to create, so it is best to avoid them for small dollar purchases by using procurement cards instead. Similarly, any cost of goods sold purchases should be requisitioned by a materials management system. Therefore, only purchases falling out of these two areas should involve manually-created purchase orders.

Conversely, if a signature plate is used instead of a check signer, then the only real control over purchases is the purchasing department, which should insist on the use of purchase orders, subject to the restrictions I’ve just noted.

Related Courses

Purchasing Guidebook

July 06, 2019

Controls for Procurement Cards (#4)

July 06, 2019/ Steven Bragg

In this episode, we discuss the controls associated with procurement cards (also known as credit cards). These cards are a great way to minimize the use of purchase orders, so it is useful to not impose too many controls on them; a reduced volume of controls will tend to encourage their use. Nonetheless, some controls are required, as noted in the following discussion.

Purchasing is really accomplished using two alternative methods. You can go out and buy materials on a credit card, or in this case we’re calling it a procurement card, or you can order it through purchase orders. So in this episode, I’m talking about procurement cards, and in the next episode, I’ll be talking about purchase order controls.

How Procurement Cards are Used

Now the procurement card is a credit card that’s used to buy small-dollar items without prior authorization. They’re a very good technique for reducing the amount of paperwork in the purchasing department, and in terms of volume, it can be used in up to about a quarter of all purchasing transactions. The dividing line for where you use procurement cards versus purchase orders is rather vague. It can be just a few hundred dollars, or it can be tens of thousands of dollars, and the decision really lies with the purchasing manager, who needs to decide which dollar limit is the most cost-effective.

The intent behind procurement cards is to avoid as much paperwork as possible. So similarly, you really want to reduce the amount of control over procurement cards to the extent practicable, which is going to depend upon the extent of use of those cards. Because if you put too many controls on it, people will begin to say that it’s actually easier to use purchase orders. Though frankly, given the amount of bureaucracy surrounding purchase orders, that might take a bit of doing.

Primary Procurement Card Controls

Nonetheless, as I go through these control points, please keep in mind that you don’t have to install all of them.

These controls fall into two categories. The primary controls for buying with a procurement card are as follows:

First of all, make anyone using a procurement card enter each receipt they make into a purchasing card transaction log, because they could lose the receipts.

Then, when the monthly card statement comes in, make them reconcile that transaction log to the card statement, to ensure that all items purchased and listed on that card statement are correct.

If they have a missing receipt, have them fill out a missing receipt form. This in particular should be reviewed by a supervisor, because this is a fundamental area in which someone could commit fraud by “accidentally” losing a receipt – and then buying something for personal use.

This missing receipt form should identify the item on the monthly statement, and identify what it is. The supervisor should sign off to certify that this is a legitimate business expense on behalf of the company.

Now if someone using a procurement card also elects to contest an item, then they should fill out a line item rejection form – which can also be monitored by the procurement card manager. This form identifies which line item is being disputed, and why. Such as, it wasn’t an authorized purchase, it was already billed by the supplier, they didn’t receive it, and so on.

And then assemble everything – the receipts, the transaction log, the missing receipt form, item rejection form, the monthly statement, and give it to a supervisor for approval.

After being approved, this then goes to the accounts payable staff for payment.

Given the number of items in this primary control group, involving reconciliations and assembling forms, and cross-verifying information, it doesn’t hurt to make people use a standard reconciliation checklist, and sign off on the checklist when they’re done – just to make sure that everything has been completed.

All of this may seem like a lot of work. And if you only have one or two procurement cards, it may not be necessary. However, if you’re dealing with dozens, or conceivably hundreds of procurement cards, then these are really very fundamental controls that are needed to maintain an adequate level of control over the process.

Secondary Procurement Card Controls

In addition to those basic controls, there are a number of secondary controls for using procurement cards. And as I mentioned earlier, you don’t need to install all of them, because keep in mind that you want an efficient procurement card program, as well as a sufficient level of control, so this is really a balance.

The first one is to have a procurement card orientation meeting, after which you hand out cards to those who are designated as recipients. By having this meeting, you can run them through all of the policies involving those cards to make sure that everyone clearly understands what is expected of them.

Another control – and an obvious one, and which many people use, is to restrict purchasing by dollar amounts per day, grand total amounts per month, types of purchases, various limitations along those lines, and that will vary by the types of restrictions available through the bank that’s offering the card.

Another control is, the program manager – this is the person who’s in charge of the entire procurement card program – is the only one allowed to approve changes in spending limits. You can’t simply have a local manager call the bank and demand a higher spending limit.

And if there are really high spending limits, then the change approval authority should be bumped up to an even higher level – possibly vice president level.

Another control is to prohibit any cash advances on procurement cards, thereby locking down anyone’s ability to take cash directly out of the till.

Another control is to have users sign an agreement, which itemizes any sanctions to be imposed on them if they misuse the cards. Now there may not even be a good legal basis for going after people if they misuse cards, but by signing this agreement, it does set an expectation with the card users.

Another control is to track card expenditures on a trend line. By person. What this does, is you can see if there’s any unusual blip in a person’s expenditure pattern, which may indicate some kind of fraudulent use.

Another control is to investigate any purchases made for cost of goods sold items. The reason this one is important – actually very important to the engineering department in particular – is that if a company already has an automatic purchasing system, such as a material requirements planning system, or MRP system, the MRP system itself should be issuing all purchase orders as needed. So if there’s a sudden need to buy something on a rush basis with a procurement card instead, this probably means that there’s an error somewhere in the supporting bill of materials database for the MRP system, which someone should investigate and correct, so that it doesn’t happen again in the future.

The Procurement Card Program Manager

Now let’s talk a bit more about this program manager. This is someone who has a number of responsibilities related to the procurement card program, which could involve a great deal of purchasing dollars. One item they do is to investigate anyone requesting a card. This could involve background checks, and potentially even bonding, though it’s rarely used in this instance. Another job function for the program manager is to monitor disputed charges. If there are many procurement card users, it’s very likely that those disputing a few charges here and there will forget about them or not have to follow up on them, whereas a single person in charge of monitoring all of these charges can do so fairly efficiently.

This person can also monitor card usage for unusual expenses, and they can also monitor orders for replacement cards that were lost or stolen to make sure that the replacements come in in a timely manner.

Also, they’re responsible for retrieving cards from departing employees and canceling those cards.

And another control to think about is that the program manager is probably the one ordering procurement cards from the bank, but perhaps someone else should be assigned the role of receiving those cards. This ensures that extra cards are not acquired and then used for incorrect purposes.

Procurement Card Policies

And finally, there are a number of policies related to procurement cards, and it makes sense to go over these at the procurement card orientation meeting. Some of them may seem painfully obvious, but nonetheless it does make sense to go over them, and also issue to all card users a document that itemizes the policies.

Certainly one policy is that cards are never for personal use. Another policy can state the limits on card spending, while another policy is to not split a large purchase into smaller dollar amounts in order to stay under a purchasing limit – and that one happens all the time.

Also, the procurement card is not to be used for capital purchases. Capital purchases generally involve a whole different acquisition program that follows a very different set of approvals, and so should not be acquired with these cards.

Also, the procurement card is not to be shared with anyone. After all, only one person was authorized to use it, and only one person was investigated to ensure that that person was appropriate for the use of the card. You share it with someone else, and suddenly all of those controls have been circumvented.

Also, be timely in completing monthly reconciliations. The accounts payable staff will love you if you do this. One of the biggest problems with procurement card programs is getting the card users to submit their monthly reconciliations in a timely manner.

Another policy is to be timely in reporting lost cards, so the old cards can be cancelled as soon as possible, which reduces the company’s risk of having things purchased without authorization.

One more item. Do not receive cash back for credits. All credits must be run back through the card. You don’t want employees accessing cash through their cards for any reason whatsoever.

Related Courses

Purchasing Guidebook

July 05, 2019

Controls for the Credit Department (#3)

July 05, 2019/ Steven Bragg

In this episode, we discuss the controls associated with both a manual and computerized credit department. The main control points and related topics noted in the episode are noted below.

These controls can be dealt with in terms of increasing levels of sophistication. At the lowest level of control usage, you don’t really need the credit department at all, because the whole thing is a gigantic control. Very small companies usually exclude it from the order process flow, so they automatically accept orders from all customers, and don’t worry much about bad debts.

Credit Applications

However, after a while a business starts to see a few bad debts. And when that happens, the typical reaction is to issue a credit application if orders are fairly large, and to not bother with a credit application if orders are relatively small. When this happens, employees will just go to the local office supply store to buy a block of standard credit application forms and that’s what they give to customers.

Approval Stamps

Now that’s not a sufficient control, because what you also need is a credit approval stamp. Someone needs to review completed credit applications, decide whether or not to grant credit, and if so, then stamp a copy of the sales order –you may recall the sales order from an earlier episode. The credit department keeps one copy of the stamped sales order, and sends another copy to the shipping department. The shipping manager is not allowed to ship anything unless that credit approval stamp appears on the sales order.

If anyone tries to add a fake approval stamp to the sales order, well, the credit department has kept another copy of the sales order. And, if a question arises about a sales order, then they can pull it out and compare it to the sales order copy being held by the shipping manager. To make sure that this control works, the sales orders held by both the credit department and shipping department should be locked up, which makes it very difficult for someone to illicitly stamp both copies.

And finally, at this very elementary stage of control, you need one policy, which is – don’t ship anything unless there’s a credit approval stamp on the sales order. This policy needs to be drilled into the shipping manager.

Credit Policy

Now, moving up to a bit larger order volume, you need to develop more standardized rules for which credit applications are accepted, and which ones are rejected. This requires a very formalized credit policy, which needs to contain several key items. First, it should outline a collection goal. For example, it could say that bad debts can be no more than 2% of sales. Or, perhaps from an efficiency perspective, it specifies how many collections employees are allowed per thousand customers, or perhaps it lays out a collection target, such as the number of days sales outstanding. Whatever this goal might be, it needs to specify the performance expected of the credit department, and itemize precisely how credit is to be granted, so there’ll no longer be any variation involved in determining who gets credit, or not, and how much credit is granted.

In addition, they need to have a supporting policy, which mandates a review of the main credit policy at least once a year. This supporting policy is intended to compare the existing credit policy to the company’s current financial and operating position – such as its product margins, strategic direction, general economic conditions, the actions of competitors, and so on.

The reason you need this review is that, for example -- a company may have an innovative product with a high profit margin, and since the profit is so large, they can afford to grant easy credit, and if there are bad debts, they can be easily absorbed. But over time, pricing pressure from competitors may shrink those margins, and that means a much tighter credit policy is necessary to meet the changing conditions.

Procedure Training

Another control you need with this increased order volume is regular staff training in credit procedures, with the intent being to standardize credit granting as much as possible, so there’s no variation by person.

Credit Application Analysis

And a final, fairly minor procedural item, though one that’s quite necessary, is to investigate unanswered questions on the credit application. Early on, when credit applications are being used mostly as an afterthought, this tended to be ignored. But now, with higher transaction volume, you want to lock down the process, and so – in addition to the policies and procedures and training, you have to make sure that the credit applications are totally completed, every single time.

Credit Limits

Now, let’s add a level of complexity to the credit function, and add computers to the mix. This happens when transaction volume increases to the point where credit can no longer be handled manually. The first control should be built into the accounting software, which is a field for a credit limit. If you fill this in for every customer, then the computer system will tell you whenever a customer is exceeding its credit limit.

Also, there’s no longer a need for a credit stamp on the sales order – this is partially because there’s no longer a sales order, because it’s been automated. It’s also because there should now be a credit approval flag in the system. To set a credit approval flag, any person with the proper password can enter the accounting software and flag a specific order as being approved for payment. And if it is flagged, then that order should now appear on the daily shipping report, since that report should only list orders ready for shipment if their credit flags have been set.

If the credit flag has not yet been set for an order, then that order won’t even appear on the shipping report, so the shipping manager won’t ship it.

Additional Credit Controls

Besides these basic credit controls, there are a few others to consider. You shouldn’t necessarily install them all, since that could become burdensome, but they are things to think about if you want to create tighter controls for a computerized credit system.

First, you can create a report that itemizes all customers that comprise the top 20% of your sales. And since that’s where most of your credit risk is concentrated, that’s where you might want to conduct a new credit review for every customer, every single year.

Another control is to review credit levels if a customer skips payments. This is a very difficult thing to spot with a manual system, but it’s very easy to notice with a computer system.

Another possibility is to review credit levels for all customers issuing NSF checks, which is not sufficient funds checks, and in this case – again – very easy to spot with a computer report.

Another option is to review credit levels if a customer stops taking early payment discounts.

So there are a few extra controls to consider.

Now, an additional level of sophistication with a computer system is to use it to access credit information over the Internet. I personally use Dun & Bradstreet’s Business Information Reports. And you can also have a credit rating agency notify you by e-mail when a customer’s credit rating drops, or when some other credit-related issue arises.

If you want to use a bit more technology, consider either posting your credit application on your web site, or e-mailing it to customers. Better yet, set up an electronic form on your website, so they can enter credit information directly into your computer system.

If you really want to get fancy, and spend a great deal of money on programming, you can set up automated rules-based decision tables to evaluate incoming customer orders. These tables can be very sophisticated, but on a basic level, what you’re looking for is something that will scan incoming order and if it’s from an existing customer, then it’ll continue with additional processing. If not, it’ll shunt the information off to a real person for manual review. However, if it is from an existing customer, and if there’s been an order within the past few months, the system will continue with its automated review. If not, and the customer has not placed an order in quite some time, then it can be shunted off again to a real person.

And then, finally, for that limited subset of customers falling within the first two criteria, it can automatically flag them as being approved if it fits within a specific credit limit – perhaps anything under a few thousand dollars.

That’s a really simple rules-based decision system. These systems can become very complicated, and should they be – if you have a lot of customers, and you can’t possibly review them all manually. You’ve simply got to find a way to let the computer system help you out, and a decision table is a good way to do that.

Related Courses

Credit and Collection Guidebook

July 04, 2019

Controls for Order Entry, Part 2 (#2)

July 04, 2019/ Steven Bragg

In this episode, we cover the full range of controls associated with a computerized order entry function, mostly dealing with controls for electronic customer orders. The main control areas noted in the episode are noted below.

Initial Order Approval

To begin, you can get a verbal or written purchase order from a customer, and you manually enter it into your accounting computer system. In this case, you still need to verify if an approved buyer has given you the order. This control is usually skipped for old customers, but if the customer is a new one, this might be a useful control step.

Data Entry Review

The next control is one to ensure that the information on the customer order is the same information that was input into the computer system – in this case, you’re guarding against data entry errors. This may sound like an archaic control, but it’s necessary if you have new or poorly trained order entry staff, or if customer orders are extremely complicated.

Once the order is in the computer, the computer can automatically match the order quantity to your inventory records, so you can tell the customer if you have enough inventory on hand to fulfill the order. The problem for many companies is that the inventory records may be inaccurate, which leads to incorrect delivery promises to customers. Fixing that problem calls for some inventory controls, which we’ll get to in a later episode.

Match Order to Prices

Another control is to link the computerized order to your on-line price books, so that the computer tells you if the price being entered is incorrect. Unfortunately, there may be special pricing deals that cannot be monitored automatically with a price book. In that case, you still need a manual control to review these prices with the sales manager.

Issue Confirmation

With a computerized order entry system, there’s no longer a need to generate a five-part sales order, as was the case with a manual order entry system. Instead, order information is distributed throughout the company through the computer system. However, you still need to send a confirmation back to the customer, which could be a printout or an e-mail notification. In either case, the order entry system should be able to provide this notification for you.

Additional Scenarios

Now, what if there’s an up-front credit card payment that occurs at the same time as the order placement? This usually happens when a customer places an order through your web site store. For this type of order, you can skip several controls. First, there’s no need to verify that the customer exists, because the buyer just paid you up front, which eliminates your credit risk. Second, there’s no need to conduct any price matching, because they’re paying based on the prices you posted on your web site, so there’s no way the prices could be inaccurate.

Another type of order is when electronic orders are coming in, such as an electronic data interchange transaction. These orders usually drop directly into your accounting system, so there is no data entry, and therefore no need for a data entry control point. Also, there’s usually no need to verify the buyer, because electronic orders normally come from very long-term business partners, and the arrangement between the two companies is so tight that you know who’s authorizing these orders. In many cases, the order placement by the customer is coming straight from the purchasing module of their computer system, so there’s no buyer involved at all.

You may want to insert a control point here if the order is unusually large, because it’s possible that the computer system at the other end incorrectly created a really large order. This control is usually just a flag or report that appears when a maximum order quantity level is exceeded.

A control you do want here is a confirming electronic message going back to the customer. This is a standard feature for electronic data interchange transactions, and this tells the customer that their order information has arrived at your computer.

Also, price verification is probably unnecessary, because electronic orders are usually based on very large, long-term, master purchase order arrangements where both parties know exactly what the prices are. If you want to be careful – sure – you can always match it up against your pricing file on a spot check basis. But, it probably is not necessary.

Evaluated Receipts Controls

Finally, what about order entry if you’re in an evaluated receipts situation? Evaluated receipts is relatively uncommon, unless you’re in a fairly large company, or if you’re dealing with a large company that has such a system. Evaluated receipts is when the customer issues you a purchase order, you put the purchase order number on the delivery going to that customer, and then when it arrives at the customer, they enter that purchase order number into their computer system, and the purchase order number is automatically matched up against the original order in their system – and they pay you based on that information. They don’t need an invoice at all. So in this case, an additional control is to set a flag in the order entry system when the customer order is received, which is to not print the invoice and also to trigger the creation of a special shipping tag which itemizes in a bar coded format the purchase order number, and any additional information required by the customer.

This may also call for a periodic audit review to verify that evaluated receipts customers have that flag set up in their customer master file records.

Comparison to Controls for Manual Systems

Now, if you compare the controls I’ve itemized for computerized order entry systems to the ones I described in the last podcast for a manual system, you’ll find that some controls are no longer needed. One is that you don’t need any pre-numbered sales orders, since there are no longer any sales orders. Also, there’s no need to lock up any unused sales orders, for the same reason.

On the other hand, computerized systems also require some new controls that you never see in a manual system. One is password access. It’s useful to have order entry people log into the system with a unique code, so that you can track which ones are committing the largest number of data entry errors. Another control is to add data entry validation routines to the computer system, so that the computer will reject incorrect entries being made by your data entry staff. Validation is good for spotting incorrect prices, addresses, or unit quantities.

A fancier control is to use workflow management software to route any unusual billing terms to a manager who has to approve them before the order can be processed. However, that requires additional software that is not normally found in an order entry system.

Order Entry Policies

Some policies are also needed. One is to verify customer existence if an order is placed that exceeds a specific dollar amount. Another policy is that special price discounts must be approved by management if the discount exceeds a certain level.

Related Courses