AccountingTools

August 19, 2019

Metrics (Asset Utilization) and New 2007 Accounting Standards (#30)

August 19, 2019/ Steven Bragg

In this episode, we review upcoming new accounting standards, as well as some of the better metrics relating to asset utilization. Key points discussed concerning new accounting standards are:

Conceptual Framework Project; could be at the top of the GAAP Hierarchy
Business Combinations; acquisition method
Fair Value Option
Earnings per Share; to converge with IFRS standards
Income Taxes; to converge with IFRS standards
Nonprofit Accounting
Post-Retirement Benefits; implementation guidance
Subsequent Events; cleanup issues
Emerging Issues Task Force; changes to its approval process
Securities and Exchange Commission; Staff Accounting Bulletin 108

Key points relating to the metrics for asset utilization are:

Sales per person; can be adjusted by using outsourcing or part-time employees
Need to look at asset utilization on an individual basis to see impact on bottleneck operations
Repairs to fixed assets ratio; fixed assets are stated at gross, and intangible assets are excluded
Accumulated depreciation to fixed assets ratio; increasing trend shows preponderance of old assets; might also still have old assets on the books that have already been dispositioned
Breakeven point; useful for understanding maximum possible profitability, as well as the margin of safety; can be used to view the impact of new fixed asset purchases on the breakeven point

Related Courses

GAAP Guidebook

August 18, 2019

Metrics (Cash Flow) and Excel Risk Mitigation (#29)

August 18, 2019/ Steven Bragg

In this episode, we review the ways in which Excel spreadsheets can fail and how to mitigate these risks, and also discuss the essential metrics relating to cash flow. Key points discussed concerning Excel risk mitigation are:

Excel is useful for rapid system construction.
It is possible to set up data validation in Excel, but this feature is rarely used.
A general failing is the high degree of company-wide access to Excel spreadsheets.
A user can have a false sense of security when using Excel, not realizing the ways in which it can issue false results.
The best risk mitigation approach is to identify the most critical spreadsheets in the business and focus on improving them; review for complicated formulas that are likely to fail.
There are spreadsheet problem detection products on the market that can be applied to Excel.
Use the Excel feature to view all formulas; makes it easier to peruse them.
Look for hard coded figures within a range of formulas; more prone to error.
Investigate cells containing high-dollar values.
Conduct data analyses for large data sets within a spreadsheet.

Key points relating to the metrics for cash flow are:

Always use a few cash flow measurements as a basis of comparison to other metrics.
Cash flow return on sales; shows the amount of cash generated as a percent of sales.
Cash flow return on assets; less subject to manipulation than return on investment metrics.
Fixed charge coverage; use it to see if most of a firm’s cash flow is used to pay for its fixed expenses.
Cash to current assets ratio; a high proportion of cash indicates a high level of liquidity.
Cash to current liabilities; provides a very conservative view of cash requirements.
Cash flow to debt ratio; see if there is sufficient cash flow available to pay down debt obligations.

Related Courses

Excel Formulas and Functions

Introduction to Excel

August 16, 2019

Metrics (Liquidity) and a Review of Accounting in 2006 (#28)

August 16, 2019/ Steven Bragg

In this episode, we review the key accounting events during the past year, and also discuss the key metrics for liquidity. Key points discussed concerning accounting events are:

Enron and Worldcom jail terms were handed down.
There were a series of stock option manipulation frauds.
The SEC issued new compensation disclosure rules.
FIN 46 was issued, involving off-balance sheet reporting requirements.
Issues with the existing lease and pension accounting standards were discussed.
The industry dealt with ongoing complaints about the requirements of Sarbanes-Oxley section 404, pertaining to systems of control.

Key points relating to the metrics for liquidity are:

The current ratio is not a useful indicator of liquidity, since it includes inventory, which is not liquid.
The quick ratio is better, since it removes inventory from the calculation.
A comparison of sales to assets can be plotted on a trend line; the proportion should be about the same over time.
The days of working capital ratio indicates the amount of working capital needed to support one day of sales.
The accounts receivable collection period indicates the average number of days during which an invoice is outstanding, before it is collected.
A comparison of sales to inventory can be plotted on a trend line, to indicate the ongoing investment level of a business in inventory.
The accounts payable days measurement can be plotted on a trend line to highlight any changes in payables duration.
The risky assets conversion ratio shows the percentage of low-value assets on a company’s balance sheet.

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August 14, 2019

Metrics (Inventory) and the Risk Assessment Suite, Part 2 (#27)

August 14, 2019/ Steven Bragg

In this episode, we delve further into the risk assessment suite, and also describe the most useful metrics for inventory. Key points discussed relating to the risk assessment suite are:

It was created in response to high-profile audit failures.
It requires a more robust understanding of the client, its risk management practices, operating environment, strategy, and competitive factors.
The client will likely be required to complete a questionnaire pertaining to the preceding items.
There is a new focus on auditing the financial statement presentation and disclosures.
The auditor will need to ask more questions about a client’s internal controls.
It requires consideration of a client’s internal controls as part of an audit.
More attention must be paid to the risks of material misstatement of financial statements.
Link the audit program to an increased need to address the risks of material misstatement.
Work by the client to assist the auditor can reduce fees; it may also be possible to reschedule the audit to assist the auditor.

Key points discussed related to metrics for inventory are:

Inventory turnover is useful for seeing how much inventory is needed to support sales.
The proportion of old inventory on hand is needed to call attention to the need to eliminate inventory. The percentage of returnable inventory is a more specific variation.
Inventory accuracy is needed by the purchasing and picking staffs, and reflects inventory record accuracy.
Inventory availability is needed to see if there is a problem with delivering to customers on time.
The percentage of warehouse utilization is needed to plan for additional investments in warehouse space.
The cubic volume of warehouse space used is useful for adjusting the warehouse racking systems to accommodate more inventory.

Related Courses

How to Conduct an Audit Engagement

Inventory Management

August 13, 2019

Metrics (Payroll) and the Risk Assessment Suite, Part 1 (#26)

August 13, 2019/ Steven Bragg

In this episode, we give an overview of the risk assessment suite, and also describe the most useful metrics for the payroll function. Key points discussed relating to the risk assessment suite are:

The cost of audits for a public company can be three times the cost of audits of privately-held companies.
There is a disparity between the need for higher levels of assurance arising from audits and the pressure on auditors to keep their prices down.
The risk assessment suite revises auditing standards to make audits more comprehensive.
As a result of the risk assessment suite, audit planning will likely start sooner, so audits will also start sooner, and auditors will be more inclined to finish all audit work while still in the field.

Key points discussed related to metrics for payroll are:

Use the number of manual paychecks cut per 1,000 payees
Use the number of W-2c forms issued per 1,000 payees
Use an error summarization system to self-report payroll errors, and then issue an aggregated report by error type.
Use payroll outsourcing costs by month, divided by the number of payees; track on a trend line.
Use the total payroll department cost divided by the total number of payees; track on a trend line.
Use the number of W-2 forms downloaded by employees, divided by the total number of payees; useful when posting W-2 forms on a central site, where employees can readily access them.

Related Courses

How to Conduct an Audit Engagement

Payroll Management

August 11, 2019

The Fast Close, Part 10 (#25)

August 11, 2019/ Steven Bragg

In this episode, we cover improvements to the billing process, and make final comments about the fast close. Key points discussed concerning billing are noted below.

The Closing Issues with Billing

I’ve saved billing to be the last item I cover in these discussions on the fast close, because most people tend to leave it for last. When you start a fast close project, billing is not usually considered a problem area, because it doesn’t really take that long to complete. Instead, people like to focus their attention on the really massive issues, like improving inventory accuracy. But once they get past all of those other problems, billing is still waiting there, totally unimproved and hogging a large chunk of the closing day.

The main issue with billing is that you really can’t eliminate it entirely on closing day. More than likely, there’s been a fair amount of shipping right through the end of the preceding day, and that’s just going to take some time to process. However, there are some ways to improve the situation.

Issue Invoices Early

First, issue invoices as early as possible. This means completely flushing out every other invoice related to shipments made earlier in the month. There’s absolutely no excuse for waiting until closing day to complete invoices that could have been handled a few days before.

Also, issuing invoices as early as possible also means having someone stay late on the last day of the close in order to create invoices based on any shipping documents sent in by the shipping department up to that point.

First thing the next morning, send someone down to the shipping dock to verify everything that was shipped the day before, and to bring back any remaining shipping documents. Get someone working on these last invoices as soon as possible.

Put Resources on Invoice Issuance

However, even being organized like this is not enough. There may be such a volume of invoices to be created that it still takes a bunch of hours. If so, you should assign practically everyone to do invoicing during the morning of the close. In addition, give each one of them their own laser printer, so they can more efficiently create invoices. Not having them walk to a central printer can save a surprising amount of time.

Do Not Retype Information

Another time-saving trick is to not retype a lot of information from supporting documentation onto an invoice. Instead, enter on the invoice something like, “See attached” or “As per the attachment,” and then staple the supporting documentation to the invoice. Or, if you’re copying from an electronic document, try to cut and past the information into the invoice, rather than manually retyping it.

Use Special Invoice Templates

Also, we’ve all run across those painful customers who want invoices issued to them in a very specific format – or else they’ll reject the invoice. The slow and painful approach is to manually create exactly what they want, no matter how much time it takes. However, if the customer is going to be around for a while, consider creating a special customer invoice template for them, so that the special formatting becomes a routine billing issue.

Additional Comments

In addition, don’t keep waiting to create an invoice if there’s a chance that its contents may change in the near future. If you wait around for more accurate information, it may not arrive for weeks. A better alternative is to at least create the invoice, so the revenue is booked, and then modify it after the fact – if that’s even necessary.

And finally, if you send out month-end statements, don’t do it right in the middle of the close. That’s something that can easily wait a day or two, so just schedule it for some other time.

So, some final comments on the fast close. Your primary goal is to shift work out of the closing day, so the most effective change you can make is to shift closing work forward into the preceding month. Another comment is that the fast close does not require much money – you don’t need fancy accounting or workflow management software. In fact, you don’t really even need a consultant. But if you do hire a consultant, get one with a good industrial engineering or process analysis background. That kind of skill is useful, because the fast close is entirely about process improvement, and not at all about accounting.

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August 11, 2019

The Fast Close, Part 9 (#24)

August 11, 2019/ Steven Bragg

In this episode, we talk about the techniques that can be used to improve the closing process for payroll. Key points discussed are noted below.

Payroll involves a couple of closing activities that can really slow down the close, but you can get around one of them with a procedural change and the second one with a systems change.

Commission Calculations

The first item is commission calculations. It tends to be one of the absolute last items to do in the close, because you have to wait until all invoices are completed before you can figure out which person has earned a commission. And on top of that, your commission structure may be really complicated, perhaps with commission splits, overrides, bonuses, and so on. Because of all the complexity, you do an initial calculation and then send it to the sales manager for a review, which may not come back for a day or two.

There are some ways to get around these problems. First, the quick and dirty – and least accurate -- approach is to figure out the historical commission percentage of sales in each month, and just book an accrual for the commissions to be paid, based on your total sales. This only works if the commission structure is really simple, because most of the time, the complexity of the commission system could result in a very different commission percentage every month.

A better approach, and the one that I use, is to calculate commissions the night before the end of the month, so I’ve included almost every invoice, and then tack on the few remaining invoices that have to be created once the month is over. At that point, I book the commission accrual, even though no one has reviewed the calculations yet. My reasoning here is that the commission I’ve booked is almost certainly going to be very close to the final corrected number. Usually, the only changes I see after that point involve who gets the commission, not the amount of the commission.

In short, these changes allow me to finish off the commission accrual on closing day in less than an hour.

Unpaid Wages Accrual

Now, the second activity that can slow down the close is the accrual of unpaid wages. This is mostly a problem for companies with lots of people who are being paid on an hourly basis. In the worst case scenario, these employees fill out manual time cards, which require all kinds of reconciliation time, as well as time to track down missing timecards. If you have a labor-intensive operation, this may even be the chief bottleneck that gets in the way of a fast close.

Here’s how you get around the problem. As was the case with commissions, I’ll first bring up the idea of a quick and dirty – and less accurate -- solution, which is to assume that everyone works a standard number of hours per day, so you accrue this amount, and don’t even wait for the timesheets to arrive. And, as was the case with commissions, this is not such a good idea for a lot of companies, because the hours per person may vary a lot.

The approach I use is to require everyone to enter their time in an internet-based timekeeping system, which automatically summarizes all of the accrual information for me. A key part of this approach is to issue constant reminders to employees before the close, so they know they have to submit their hours. In addition, we are very pushy about getting all employee hours entered every single week. By making a big deal of this all the time, we’ve really trained employees to submit their hours on time, every time. Of course, there will always be a few employees who haven’t recorded their hours for the last few days of the month, but at that point, I feel a lot more comfortable accruing for just a few hours of unrecorded time.

Now, what if your employees don’t have internet access? You can set up computers on the company premises, so that they can enter their time. Or, you can set up computerized time clocks that automatically upload all employee hours into a central database, and that basically gives you the same information that would have come from an internet-based system.

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August 09, 2019

The Fast Close, Part 8 (#23)

August 09, 2019/ Steven Bragg

In this episode, we discuss how to improve inventory record accuracy, which can have a massively positive impact on the speed of the close. However, the improving inventory record accuracy is a prolonged process that will undoubtedly take months, and consume the time of the best warehouse workers. Key points discussed are noted below.

Inventory closing is a monster problem for companies that don’t have good tracking systems, and it’s a complete non-event for those that do. This is because the closing difficult almost always stems from tracking the physical quantity of goods on hand, not the cost of the inventory. So, I’m going to focus on how to achieve really excellent inventory record accuracy.

But first, be aware that if you suffer from poor record accuracy right now, you’re doomed to keep on having a slow close for several months to come, because improving your accuracy is a slow process – as you’re about to see. Just keep in mind, there is no magical way to suddenly have 98% accurate inventory records. This is a slow and methodical process.

Let’s see how it works.

Install inventory Tracking Software

The first step is to install a good inventory tracking software package. Most accounting packages already have one, so I won’t get into this part too much. The main software feature you’re looking for is the ability to record a storage location for each item of inventory, and preferably multiple locations for a single inventory item. If you don’t have this, then go look for different software.

Create Rack Locations

Next, you need to create unique rack locations. This means that you designate the first aisle as A, then B, and so on. Within each aisle, you need to number every rack. A common system is to designate the first rack on the left as rack number one, then the first rack on the right as rack number two, then the second rack on the left as rack 3, and so on. Within each of those racks, every level should be numbered. So for example, the fourth bin up in the second rack of aisle C would be designated with the location C-2-D. You need this level of very precise location codes in order to know where all of the inventory is located.

Lock the Warehouse

Next, you have to lock down the warehouse. This may sound medieval, but you really have to do it. I have never seen a warehouse with perfect accuracy that did not fence it off. The trouble is not that employees walk off with inventory, but that they have a bad habit of taking it off the shelf to examine it, and then putting it back somewhere else, which makes it really hard to find.

Consolidate Parts

Next, consolidate parts. The usual warehouse has the same part stored in several locations, which is OK is you have a good location tracking system. But we’re not there yet, so keep each item in one place while you get things organized.

Assign Part Numbers

Now is the time to assign part numbers to every part in the warehouse. A key point is to only use the most senior warehouse staff to do this, because anyone else is extremely likely to assign the wrong part numbers, which will cause all kinds of problems down the road.

Verify Units of Measure

Once those numbers are assigned, Make sure that the units of measure are correct. Where possible, mark the correct unit of measure right on the inventory item, so there’s no mistaking what it is. When someone uses the wrong unit of measure, it’s amazing how incorrect your quantities will be.

Pack the Parts

Next up, pack the parts. This means that you should count loose parts, then seal them up in boxes or bags, and write the count quantity on the box or bag. This makes it much faster to count inventory when you get to cycle counting, which I’ll talk about in a minute.

Count and Load the Inventory Data

Next up is the big weekend project, which is to count all the inventory items, and enter the numbers into the inventory tracking software. And the key part is, you enter this information along with the location codes. The data is not going to be completely correct, but cycle counting will take care of that over the next couple of months.

Cycle Count

The next step is cycle counting. This means that the most experienced warehouse staff will count a small quantity of inventory every single day. When they do a count, they don’t just correct any errors they find – they also spend some time tracking down why the error occurred, and then they fix the problem. By going after the underlying problems, you’ll see a nice, steady rise in the inventory accuracy percentage over several months.

Audit the Inventory

And speaking of that inventory accuracy percentage, send someone from the accounting department down to the warehouse once a week to do a spot check of inventory accuracy. The best way to report this information is to post it on a white board in the warehouse, and preferably by aisle. When you assign specific warehouse staff to each aisle, and then measure accuracy by aisle, this is a really good way to find out who is good a t cycle counting.

However, be warned, a high level of accuracy can simply mean that an aisle contains lots of slow-moving inventory items, so whoever is doing the cycle counts actually has a really easy time of it. Conversely, if you have an aisle with really high inventory turnover and the accuracy is still high, then you’ve got a fantastic cycle counter in charge of that aisle.

Issue Bonuses

Finally, reward the staff with bonuses as the accuracy levels gradually go up. This shows them that accuracy really matters – at least, it really matters to you, since it’s pretty to close the books when you have no idea if the inventory number is even close!

My experience with improving inventory record accuracy is fairly extensive – I’ve taken the accuracy level to about 98% for four different companies. Based on that experience, my key tip is persistence. Accuracy will not be achieved overnight, and it can also drop really fast if you don’t pay attention to it. So – do a few inventory audits yourself, and personally hand out bonuses to the warehouse staff – and keep doing it over and over again.

If you follow the approach I’ve just outlined, then you’ll eventually just print out the inventory reports at the end of the month and not even question their accuracy. This area can truly become a non-event, but it takes time.

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August 09, 2019

The Fast Close, Part 7 (#22)

August 09, 2019/ Steven Bragg

In this episode, we discuss how the payables function can be streamlined, so that the time associated with it as part of the closing process is minimized. Key points discussed are noted below.

Payables is one of the larger logjams that gets in the way of a fast close. A lot of controllers – whom I would call overly cautious -- prefer to wait several days – sometimes up to a week – for every last supplier invoice to come in before they continue with the close. They do this because they’re afraid they’ll miss a large invoice and thereby report too small an amount of expenses in the income statement.

There are several ways to get around this problem, and which should allow you to close payables in just a few hours. The solution revolves around your comfort level with not waiting for supplier invoices.

Record Accruals

Your first (and best) solution is to create an accrual based on what’s come in at the receiving dock, and for which you have purchase orders. You can then merge this receiving and pricing information together to create an extremely accurate accrual. It’s usually best to create a custom computer report that generates this accrual automatically, so you don’t make any mistakes. And for that matter, a computer report also requires much less time to create.

OK, that was the easy accrual, since it was based on the receipt of hard goods. What about other supplier invoices for which you don’t have hard evidence of receipt, like services? There are a couple of solutions. One is to create a contract summary file that itemizes all payments that the company is contractually supposed to make each month. Then compare it to the invoices that have already come in, and accrue anything remaining.

Another option is to track supplier billings on a trend line, and simply accrue the average amount that is likely to arrive in the mail. But -- use this one with great caution, because the actual amount may vary lot from the average. In most cases, I choose not to use it at all, since larger invoices are your main area of concern – and those are almost always covered by contracts or purchase orders that will give you better accrual information.

Obviously, the solutions I’ve just mentioned involve lots of accruals, and that may not be something that you’re comfortable with, since accruals can be inaccurate. If so, I suggest starting only with those accruals that are based on hard receipt information and supporting purchase orders, where your accrual is bound to be right – probably to within a few dollars. Once you’re comfortable with that system, work your way down into other accruals that may be less accurate, until you reach a level of discomfort.

At that point, you’ll almost certainly have reduced your payables closing time by a fair amount. If you ever want to address the accruals topic again, there’ll always be a few more accruals to investigate.

Minimize Invoice Approvals

Now, there are some other problems with the payables system that can delay the close. One of the worst involves the approval of supplier invoices. Some companies send out invoices for approval before they log the invoices into the payables system, so the close has to wait until the various managers fish the invoices out of their in boxes and approve them and send them back to the payable staff. This can take weeks. A much more streamlined approach is called negative approval – this involves logging in all invoices as soon as they arrive, and then sending a notification to the approving manager that the payable staff is going to pay it unless they hear otherwise. Realistically, they almost never hear from the managers, and everyone is happy. Best of all, payables can be processed a whole lot quicker.

If you want to push this concept a step further, consider reducing the number of approvals needed, so it’s only for items that are really large and which don’t already have an authorizing purchase order.

Pay Based on Purchase Orders

Another technique for streamlining payables is to pay based on the information in the purchase order, rather than the supplier invoice. Under this approach, the computer system automatically sets up payments as soon as goods are received, so there’s no need for a supplier invoice at all. This system is called evaluated receipts, and it’s not available on most smaller accounting packages, so it’s really only option if you have a large ERP system, like Oracle or SAP.

Use Procurement Cards

A completely different approach to streamlining the payables system is to not use it all! Instead, bypass the whole thing for smaller purchases and use procurement cards to buy all of the low-cost items. This involves a whole different set of procedures and forms and training, but on the other hand, it really reduces the payables workload, and so makes it easier to close the books.

Use a Web Portal

And speaking of completely different approaches, consider that the main problem with the payables close is waiting for supplier invoices to work their way through the postal system to get to your company. So… how about skipping the postal system entirely? You can set up a web page on your company’s Internet site, and have suppliers enter their invoices directly into your computer system. This might seem a little demanding, but you could promise to pay them a few days early in exchange.

Parting Thoughts

Out of all the preceding suggestions, the main one is to use more accruals rather than waiting for supplier invoices to arrive. If you do that, there’s no reason why you can’t close the payables function in a few hours.

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August 07, 2019

The Fast Close, Part 6 (#21)

August 07, 2019/ Steven Bragg

In this episode, we discuss how the use of journal entries can be altered in order to improve the closing speed. The general concept is to only create journal entries for larger amounts, ignoring all smaller ones that will have a minimal impact on the financial statements. Key points discussed are noted below.

The Journal Entry Problem

People don’t normally think of journal entry management as impacting the fast close, but it can – and usually in a negative way. The problem is that people tend to use too many journal entries, and they don’t exercise much control over them. This leads to several ways in which the close can be delayed.

For example, you may have a nitpicky controller who insists on creating entries for all kinds of accruals, even ones for tiny amounts. The intention in this case is to create an absolutely perfect set of financial statements. However, what people forget is that the financials are not perfect, and in fact they are more of an opinion regarding the financial status of a company at specific point in time. If you create dozens of tiny accruals, the result is probably not going to be appreciably more accurate, because there are too many estimates involved. Instead, it’s much easier to use a small number of large accruals, and skip everything else.

So how do you tell when a journal entry is needed? There is no perfect approach, because what constitutes a material entry will vary by company. However, your best bet is to simply schedule an accruals review perhaps once a quarter – outside of the closing period, of course – and decide if any accruals that used to be material have shrunk to the point where you can safely eliminate them. Or, to use the old saying, “when in doubt, leave it out.”

Reduce the Number of Journal Entries

Reducing the number of entries helps the close in several ways. First, the general ledger accountant has to monitor far fewer entries, and so can use the saved time to help with other parts of the close.

Also, this reduces the risk that someone will forget to reverse the entries in the next accounting period, if that’s required. Also, if the accrual is being parked in an asset or liability account for some time, then this means there are fewer accrued amounts to monitor in those accounts.

Now, earlier, I referred to how companies don’t exercise much control over their journal entries. This involves a couple of issues. First, there may be no standard list of entries to make, so for example you may have a wage accrual in one month but not in the next – and this gives you inconsistent results in the financial statements. Another issue is that no one person may have been assigned control over the journal entries, so that the same entry might be made by several people. If duplication occurs, then you have to spend time locating the problem and reversing the extra entry – and this will slow down the closing process.

Enhance Journal Entry Controls

How do you fix these control problems? It’s really simple. First, assign responsibility for journal entries to just one person, or as few as possible, and lock out anyone else from being able to make entries in the computer system. Next, create a standard list of journal entries that have to be completed, and set up standard journal entry templates for them in the accounting software. By taking these steps, you ensure that exactly the same entries are made every time, and in the same format. Also, when you use journal entry templates, the software normally allows you to set a reversal flag, so the entry will automatically reverse itself in the next reporting period, if that’s what you want. This avoids the really irritating problem of sometimes forgetting to set an entry for reversal, and then having to investigate and correct the problem later on.

Use Recurring Entries

Another way to make the journal entry creation process even easier is to set up a few of them as recurring entries that will automatically run in each period. These are used in cases where the amount of the entry won’t change much from period to period. A good example of this is depreciation, where you could even ignore the entry for a few months and let it repeat itself, and then review it maybe once a quarter and correct it as needed. One point about recurring entries is that they are usually set to expire at some point in the future, so scan the monthly list of journal entries in the system, just to make sure that they’re still running.

Define Accounts

If you have a number of divisions with different charts of accounts, you might run into a problem where different divisions assume that an account is used for different things, so you end up having to investigate the amounts being fed into the corporate general ledger. This can also cause a lot of inconsistency in where numbers are stored from period to period. If this is a problem, you might consider creating a brief definition for each account. Or, even better, only create a definition for the accounts that tend to confuse people, so the definitions list will be nice and short. Even better, try to build the definition right into the account name, or re-write the name to make it more understandable.

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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.

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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.

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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.

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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.

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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.

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