Bragg's Laws of Accounting (#173)

In this podcast episode, we discuss three human conditions that relate to accounting problems. Key points made are noted below.

Bragg’s First Law

Expenses will continue into the future unless acted upon by an outside force. This is a major cost management point, since expenses tend to recur unless specific action is taken to stop them.

Bragg’s Second Law

When financial statements are stretched to make the numbers, future results always decline. The reason is that reserves are reduced in order to generate current profit figures, and then have to be replenished in later periods, which reduces profits in those periods. This can result in shareholder lawsuits for misrepresenting profits.

Bragg’s Third Law

The quality of financial statements begins to degrade as soon as they are perfect. This is because the error-tracking functions of the accounting department are dismantled once perfect results are achieved, leaving room for new errors to cause problems in the statements. This is a particular problem when the underlying systems evolve, since the revisions may contain flaws that result in more errors being introduced into the financial statements.

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Cost Management Guidebook

Accruals and Deferrals (#172)

In this podcast episode, we discuss the use of accruals and deferrals. Key points made are noted below.

The Use of Accruals

An accrual is a journal entry used to recognize an expense or revenue item in the current period, while a deferral is a journal entry that pushes out recognition to a later period. I already talked about this somewhat in Episode 21, which was about streamlining the use of journal entries so that you can close the books faster. My main points were to avoid immaterial journal entries, use a standard set of journal entries, and use standard templates when making entries. And that’s a good start. I’d like to flesh out the topic with some additional points.

Accruals and Deferrals for Revenue

My first point is how to deal with accruals and deferrals that involve revenue. This is a really sensitive topic with auditors, especially when you’re moving around revenue numbers right at the end of the year, when they impact the annual financial statements. Two suggestions here. First, if you’re going to take an action that will increase the reported amount of revenue, think long and hard about it before doing so, because you’re absolutely going to be investigated by the auditors. And second, document the entry to death, with detailed justification for why you increased the revenue figure. When in doubt, don’t do it.

Now, what about the reverse concept with revenue, where you elect to defer revenue recognition into a later period? This is nice and conservative. But – the situation usually arises when the company receives an advance payment from a customer, where the entry is a debit to cash and a credit to a liability account. If you make this entry, will the amount of the liability trigger a covenant breach on any loan agreements? If so, you might want to make management aware of the situation.

Accruals and Deferrals for Expenses

Now let’s switch over to expenses.

First up is compensation expense. If there’re a lot of hourly employees, it’s likely that you’ll have to accrue a large expense for unpaid wages at the end of each month. Depending on the number of these employees, compensation expense may be the largest accrual entry, month after month. Since it’s the biggest, it’s the most likely to be audited – in detail.

And that means you’ll need to be extra careful with the entry. The issue most likely to be screwed up is what’s not in the entry – which is payroll taxes. In many cases, the accounting staff only thinks about the unpaid wage figure itself, and forgets to accrue for any payroll expense. So have a standard calculation spreadsheet, and make sure there’s a built-in formula that includes payroll expense.

Another problem with accruing unpaid wages is the nature of the supporting spreadsheet. It may contain a listing of each hourly employee, and you then add in the hours that each person worked that were unpaid. The trouble is, you have to remember to add to the spreadsheet any new employees – which is easy to forget. One possibility is to note on the spreadsheet a reminder to add new staff. Or, avoid the whole problem by having the payroll system automatically generate the cost of the accrual.

A topic related to compensation is the accrual of vacation time. The standard approach is to set up a spreadsheet that lists the unused vacation time of each employee, multiplied by their hourly wage rate. The total is the vacation accrual. There’re three problems with it. First, you need to add a payroll expense accrual; otherwise, the expense is under-reported. Second, put a note in the month-end closing procedure to check for pay raises. If anyone received a raise, transfer that amount into the spreadsheet, so the total vacation expense is increased.

And third, there’s the issue of use it or lose it vacation time. Under this concept, a company terminates any accrued vacation time if employees haven’t used it by the end of the year. In a fair number of cases, they allow employees to transfer a small number of hours forward into the next year, but not the full amount. If you have this rule in place, the goal is to ensure that there’s a correct vacation accrual at the end of the year, when the books are audited. That means there’s an upper boundary on the amount of the vacation accrual in the preceding months, which is the maximum number of hours that can be rolled forward into the next year.

If you don’t use this cap in the calculations, you end up with this wildly fluctuating vacation accrual in the preceding months that’s really high in some months when everyone is earning vacation but not using it, and dropping catastrophically, usually in the summer, when everyone uses it.

Now, if compensation expense isn’t the biggest accrual, it’s likely that the largest one is going to be accruals for supplier invoices that haven’t arrived yet. This is usually a cost of goods sold item, and it can be a hefty accrual, especially if the company is closing the books fast, and isn’t waiting for late invoices to arrive.

I can’t emphasize enough just how easy it is to screw up this accrual. There needs to be a good system in place for figuring out which invoices haven’t yet arrived, which needs to encompass both goods and services. That’s hard for services, since you can’t find the information in the receiving log. And in addition, this accrual has got to be automatically reversing. Otherwise, the expense sits on the books until someone decides to reconcile the balance sheet accounts, which may not happen for months.

So how do we make the supplier invoices accrual work? At the simplest level, if you keep running into late supplier invoices that aren’t included in the correct reporting period, and these amounts are material, then you’re just going to have to extend the closing period – maybe for a week or more, until all of these invoices arrive.

Long term, the solution is to figure out which suppliers submit invoices late, and then work through a procedure for estimating the amount of each of these invoices in advance. The result may be five or ten – or more – different estimation calculations. It’s pretty much going to be a case of how much work do you want to go through to estimate supplier invoices, versus the benefit of closing the books faster. It’s your call.

Here’s another accrual that causes trouble – employee benefits. We’re talking about medical insurance, life insurance, dental, disability, and so on. Insurers want to be paid before the period to which the insurance applies. That means the company has to defer recognition of these payments until the following month, so the initial entry is a debit to a prepaid expense account.

Deferring an expense is a little unusual, at least in comparison to the bulk of the journal entries made, so the accounting staff is more likely to get it wrong – and this is a problem, since the benefits expense can be a large number. To get it right, set the default expense account for all benefits suppliers to the prepaid expenses asset account. That means the initial recordation is not to an expense.

Then, when it’s time to close the books, have a specific closing step that requires someone to examine the prepaid expenses account to make sure that the correct benefits amount has been moved to the benefits expense. And on top of that, have a specific review step for the accounting staff, where they check the contents of the benefits expense account in the preliminary income statement, just to make sure that the correct expense amount was recognized. This is a bit of a pain, but if you don’t do it, there’ll undoubtedly be times when there’s no benefits expense recognized in one month, and double the amount in the next month.

And a final comment on accruals is not to wait until the end of the year to recognize depreciation expense. If you do that, there’s a massive lump of expense at the end of the year that may offset a lot of what might have looked like a pretty good year-to-date profit. It’s better to manage the expectations of company management by including a portion of the depreciation expense in each successive monthly income statement, so there’re no surprises at the end of the year.

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Collection Controls (#171)

In this podcast episode, we discuss the controls that can be applied to the collections function. Key points made are noted below.

The Need for Collection Controls

The main issue with collections is that receivables can become stale really fast, so you need to stay on top of them. To do this, you need three controls. The first one is a clear dividing line that defines when a receivable is considered to be overdue. As soon as a receivable hits this date, you must take action to collect the receivable. In a lot of organizations, there’s a tendency to not take action for too long, so customers get a free ride for a couple of weeks past when they were supposed to pay.

Types of Collection Controls

Sometimes the delay is due to indifference about collections, but sometimes the excuse is that the collections staff starts making calls early, and is told that the check was just put in the mail. So this means the collection staff just wasted its time contacting customers. But is that really the case? What the collection staff actually did was post a notice with customers that the company follows up on all receivables that are even slightly overdue, which sets the tone for the next customer payment. And for that reason, I advocate setting that dividing line just a couple of days after the receivable due date.

The second control is to make sure that every overdue receivable is assigned to someone. This is the responsibility of the collections manager. So as soon as a receivable hits that dividing line that triggers collection activity, it has to be formally assigned to someone. Otherwise, it’s just going to hang there, and nothing will happen.

A common method for assigning customers to the collections staff is to always assign the same customers to the same collections staff. By doing so, collectors gain some familiarity with customers, and can build up relations with them over time. To an extent, this makes collections work more efficient. But on the downside, collectors may start to sympathize with customers, and allow them some payment delays. If this appears to be happening, rotate customers among different collections staff.

And the third control is to make sure that continual pressure is placed on the customer to pay. From a management perspective, that means placing continual pressure on the assigned collections person to engage in collection activities. Sounds simple, but it requires active management.

You cannot let any receivable sit quietly for any period of time. Instead, there needs to be a barrage of collections work going on.

You can only achieve this level of active management of the collection staff if there’s a good record keeping system in place. Ideally, the collections people record what they did with each overdue receivable in a central database, so the collections manager can skim through it and see if anyone requires a little push.

It’s possible that you could impose a standard progression of collection activities on the collection staff, such as always starting with a dunning letter and then going to a phone call. I don’t like that approach, though. The reason is that an experienced collections person knows which buttons to push with each customer, and so should be allowed to do so. They can take any steps they think are necessary to collect a payment. If you still want to impose a standard progression of collection activities, at least confine it to the least experienced collections staff.

In short, the basic theme for collection controls is to take action early, and don’t let up.

Now, there’re some other controls involving collections. The main one is credit memos. We issue a credit memo to offset an invoice that’s not going to be paid, or at least not paid in full. The credit memo is created in the accounting system and then offset against an overdue invoice, which cancels out the invoice. The trouble is that credit memos can be an easy way out for the collection staff, and could be a source of fraud.

For example, a collections person is having a hard time collecting from an annoying customer, and just wants to get rid of the blasted receivable. So he creates a credit memo, and – poof – no more collection problem, because the invoice just went away.

The other issue is fraud. If a collection person also receives cash payments from customers, this person could pocket the payment and create a credit memo to offset the related invoice.

These issues bring up two possible controls. One is to keep the collection staff well away from any customer payments.

Your best bet here is to use a lockbox system, where payments are sent to the company’s bank, and never even enter the accounting area. The other control is to lock down access to the credit memo creation module in the accounting software, and require manager approval before a credit memo can be created.

However, there is a limit to having the credit manager approve every single credit memo, since a lot of credit memos are for really small amounts, usually because a customer short paid a very small amount on an invoice. If this is a problem, allow the credit staff to create small credit memos without any further approval from a manager.

Another control that makes sense is to have a feedback loop to the credit department. The collections staff is on the back end of the credit granting process, and so it has to collect credit that someone else granted. If the collections staff can’t collect on a receivable, the credit manager needs to know about this right away, so that any further credit is shut down. A possible extension of the concept is to give the collections manager the override authority to shut down credit for a customer, no matter what the credit manager may say. That’s a bit extreme, but may be worth considering.

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Treasury controls (#170)

In this podcast episode, we discuss the controls relating to treasury activities. Key points made are noted below.

The Need for Treasury Controls

There’s a key difference between the treasury area and every other part of the company, which is that just one transaction in the treasury area can potentially bankrupt the company. For example, an employee is authorized to wire funds on behalf of the company, so he wires all of the company’s excess cash to his bank account in the Cayman Islands. And that’s it, the company is toast.

Preventive Controls

So in this case, the system of controls has to focus on preventive controls much more than detective controls. Since the company can be wiped out by just one case of fraud, you have to prevent fraud from ever happening, which calls for what might appear to be some pretty oppressive preventive controls. Such as requiring multiple approvals for every wire transfer. Or having the bank call the company president for confirmation before any wire transfer is processed. Or only issuing wire transfers from a separate bank account, which is only funded with enough cash to pay for each specific wire transfer. These are all preventive controls.

Another preventive control that a lot of companies don’t think about is to install a debit block on the company’s bank accounts. This means that no outsider can use an ACH debit transaction to remove cash from an account. Or, if you have a supplier who insists on being paid with an ACH debit, set up a separate account that’s designed to handle the ACH debits, and only fund the account with enough cash to pay for the expected amount of these debits. That way, if a fraudulent debit hits the account, the company won’t lose very much money.

Detective Controls

These controls are designed to keep the company alive by avoiding large improper cash transfers. Now this doesn’t mean that you don’t bother with any detective controls. A detective control is designed to catch a problem after it’s already happened – which in this case is like locking the door to the henhouse after the fox has made off with your chickens. Nonetheless, a detective control can at least point out situations that you can guard against in the future with more preventive controls.

So some detective controls that might help are to conduct a daily bank reconciliation, and to have the internal audit staff review the trail of authorizations for all wire transfers.

Investment Controls

So far, we’ve only been talking about controls related to electronic transfers of cash. But what about controls for the investment of funds? It’s quite possible that the treasurer can invest excess cash in funds that are really risky, or not very liquid. If they’re risky, the investment value can decline – a lot, and the cash is lost. Or, if the investment isn’t liquid, the company may have to wait a long time to get its cash back.

It can be difficult to outright prevent these types of investments. But you can at least make it quite clear that the company only invests in the safest possible investments. One option is to have the board of directors approve a policy that states exactly which types of investments are allowed, and possibly which ones are not allowed.

Another option is to have an investment procedure that requires the treasury staff to make sure that the period of an investment doesn’t exceed the forecasting period of the cash forecast. By doing so, you ensure that all investments are limited to the period of time over which you can predict the need for cash.

OK, another option is to go bureaucratic and create an investment form that has to be filled out and approved, possibly by several managers. By doing so, the worthiness of an investment can be examined in advance. And, since they’re signing off on the investment, they’re also becoming responsible for the outcome.

A final thought is to not actively engage in any investment activities at all that require the manual movement of funds. Instead, you could enter into an arrangement with the company’s primary lender to roll over all available cash into overnight repurchase agreements. This is automatic, and the investment is very low risk. On the other hand, you won’t earn much of a return on overnight repos.

Now, another treasury area that may be in need of controls is borrowings, especially in the area of the line of credit. One issue is to make sure that the bank’s records of the amounts outstanding and the related interest expense match those of the company. It’s quite possible that they don’t, since a loan payment could have been credited against the loan account of some other customer of the lender. Or, the lender may be charging a different interest rate than the company agreed to. I’ve seen both. To guard against this, conduct a detailed monthly reconciliation of the lender’s loan statement to the company’s loan liability account.

Another problem, which I’ve seen multiple times, is that a company has an asset based line of credit, and the amount of assets available as collateral on the loan drop so far that some of the loan must be paid back – usually unexpectedly. This can cause quite a scramble at the company, possibly to the point where it runs out of cash and may even go out of business.

To keep this from happening, there should at least be a monthly comparison of the outstanding loan balance to the borrowing base associated with the loan. Better yet, do this comparison as part of the weekly cash forecast, so management can see in advance if there’s a risk of having to pay down a loan in the near future.

And one more control over loans is to have the treasurer sign off on each loan repayment or drawdown. By doing so, someone can cross-check that there’ll actually still be enough cash on hand after a loan repayment is made. Or, that a loan drawdown is actually justified. Otherwise, a company might find itself with either too little cash or paying interest on too large a cash balance.

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Controls for Petty Cash (#169)

In this podcast episode, we describe a range of controls for petty cash. Key points made are noted below.

The Need for Petty Cash Controls

Petty cash is easy to steal, and so requires the use of several controls.

Possible Petty Cash Controls

You could eliminate petty cash entirely and replace it with corporate credit cards or an employee reimbursement system.

Reduce the number of petty cash boxes being used.

Limit individual petty cash transactions to a maximum amount, with all other reimbursements going through accounts payable.

Reduce excess cash balances. Ideally, each petty cash box should be drawn down entirely about once a month.

Force some types of transactions over to accounts payable, where they are more visible to management. Examples are employee advances and reimbursements for parking tickets.

Bolt the petty cash box into a drawer or just use a locked cash drawer; otherwise, the entire box may be stolen.

Ensure that petty cash plus receipts equals the total authorized amount for each petty cash box. Use unscheduled audits to enforce this, which may include additional spot training.

Give petty cash custodians a training class on how to use it, and also put a laminated petty cash procedure sheet in each petty cash box.

Write all petty cash receipts in ink, so that they cannot be altered.

Track who is being reimbursed the most; could indicate who is submitting duplicate receipts for reimbursement.

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Accounts Reconciliation (#168)

In this podcast episode, we discuss the accounts reconciliation process. Key points made are noted below.

The Need for Accounts Reconciliation

What we’re talking about is making sure that we have complete documentation that backs up the balance in every account.

The one account that everyone reconciles is the cash account, but you can find bank reconciliation procedures all over the Internet, so I won’t deal with that here. The real question is, what’s the account reconciliation process for all of the other accounts.

So first, let’s talk about why this is important. If your books are audited, the auditors will want to see the detail for all of the accounts that roll up into the balance sheet. If something doesn’t belong in an asset account, they make you charge it off to one of the accounts that rolls up into the income statement, which usually means that your profits will take a hit. And, they’ll want to make sure that all liability and equity accounts are properly compiled.

This means that the balance sheet accounts need to be reconciled at least once a year, just before the audit begins. This can be quite a frenzy, with all kinds of nasty little discoveries of items that should have been charged to expense months ago. The result is usually a delayed start to the audit, and a bunch of unexpected charges to the financial statements at the last minute.

This trouble comes from not managing the process properly. And there are some things we can do about that.

Accounts Reconciliation Best Practices

My first suggestion is to keep all of the small stuff from ever appearing in the balance sheet to begin with. This means setting up a threshold level. If you have a justifiable asset to record below that threshold, don’t do it. Just charge it to expense.  I usually make this point in regard to fixed assets, but it can also apply to prepaid assets.

Second point. If there’s an account that has an automatically-generated detail report behind it, then the balance in the detail report absolutely always match the total for the related general ledger account. There’re no exceptions.

This means the receivables aging report matches the grand total for the trade receivables account, and the payable aging report matches the grand total for the trade payables account. This makes it super easy to reconcile these accounts, because you know there aren’t any journal entries mucking up the account. If you have a justifiable reason for using a journal entry on either of these accounts – don’t. Instead, park it in some other related account that’s chock full of journal entries, and which you have to manually reconcile anyways.

Third point. If you have a default flag in your accounting software to make a journal entry a reversing entry, then set the default to a reversing entry. This way, any entry you make automatically flushes out of the system in the next reporting period, so it won’t be hanging around in your accounts for months. You can always turn off the reversing flag for specific entries, but try to keep it to a minimum.

Fourth point. Get rid of the really tiny accounts that only contain a couple of transactions a year. Dump them into a larger related account, so you can reconcile fewer accounts. The main exception is when you need to segregate this information for reporting purposes. Otherwise, dump the small accounts.

Next point. Set up a checklist item in your closing procedure for reconciling accounts. The intent is to have a reminder that you’re supposed to do this as part of every close. Now – do you actually have to reconcile every account as part of every close? No. Most of the accounts still have balances that are so small that there’s hardly any activity in them, so review them maybe a couple of times a year. But there’re some major accounts that you never miss. That means cash, trade receivables, fixed assets, trade payables, and equity – at a minimum.

Also, the auditors probably have some hot button accounts that they dig into in far more detail than you’d think possible. You know which ones they are – just think back to which accounts they examined in the last audit. Always flag these accounts for ongoing reviews.

Next is the timing of the reconciliations. You don’t actually have to reconcile an account as part of the closing process. In the middle of the close, you have people running around the department with their hair on fire, and the controller looking like the grim reaper – there might be just a tiny amount of pressure.

And when there’s too much pressure, you’ll skip a few reconciliations, and the next thing you know, it’s the end of the year again, and now there’s all kinds of unresolved issues in the accounts.

So instead, think about doing a nice, leisurely account reconciliation around the middle of the month.  This means you’re reconciling to the balance at the end of the preceding period, so you’re not bothering to reconcile the current period. But the main point is to look for items that just don’t belong anymore. Flush those out as soon as you find them.

Also, if you do mid-month reconciliations, you don’t necessarily have to reconcile every account every month. Instead, have a schedule of which accounts you’re going to review in each successive month.

And yet another point is to have a schedule for all of these account reconciliations. If you don’t put them on the department schedule, there’ll always be reasons to delay them in favor of something else. For example, consider putting maybe a single account reconciliation at the top of your schedule for each day, so the recon gets done first. Another option is to figure out which is the slowest day of the entire month – like maybe a day when there’s no payroll to process, no inventory counts, no collections activity – whatever – and block out a good chunk of time for reconciliation work.

A key point in all of this talk of scheduling reconciliations is to do it when you have sufficient time, and when there’s not a rush. If you can do that, it’s much more likely that you can dive deep on an account and really make sure that everything belongs there.

And one final point. Consider maintaining a separate schedule of the contents of an account for each reporting period. That means you don’t keep revising the same detail backup information. Instead, there’s a record in place of how you justified each account balance in each reporting period. That gives you a really good history if you ever need to go back and see what was going on earlier in the year.

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Changing Careers into Accounting (#167)

In this podcast episode, we discuss how a person outside of accounting can transfer his or her skills into the field. Key points made are noted below.

How to Transfer Skills Into Accounting

The basic question is, how does someone in a different field transfer their skills into accounting? This is really more of a career planning question, and so I wouldn’t normally address the topic – but an awful lot of people are asking it. Given the amount of interest, I’ll give it a try.

First, we have to attach some assumptions to the question. The context seems to be that everyone started off going down a different career path, so they have training in something else. They don’t like what they’re doing, or perhaps they were laid off, so now they want to give accounting a try.

Age-Related Restrictions

Next, let’s point out the restrictions on trying to jump sideways into accounting. First, a formal accounting degree can take up to five years of college. If you’re a little older, with a family to support, it’s probably difficult to impossible to get that training. The next restriction is that the auditing firms tend to hire people who are pretty young, and right out of college. So if you want to get into auditing and you don’t fit that profile, good luck. And to make matters worse, some of the larger companies prefer to hire from the audit firms, so you’re not going to be targeted by these firms.

So these are some barriers to getting into accounting. So, we need to find some alternative paths. Let’s take a look.

Working for a Smaller Company

The first alternative is getting a job with a very small company, like a startup. Their founders may not be too picky about qualifications, as long as you’re willing to take a cut in pay, and do work that covers more than accounting. So, for example, if you have skills in purchasing, you could head up that area, and volunteer to supervise accounting, too. Over time, senior managers might fork over a controller title to go with all of that responsibility.

But the trouble with the small company approach is that small companies tend to grow. And when they do, they may hire auditors to do an audit, and the auditors may point out that the accounting staff is kind of underqualified – at least on paper. So this approach may work initially, but gets riskier over time. Still, it gives you the job you want for a while, and you can use that time to pick up some additional training or certifications.

Working in a Specialized Area

The second alternative is to get a job in a specialized area of accounting that relates to what you already do. For example, if you already do purchasing, get a job in payables. Or if you work in the warehouse, get a job doing inventory valuation. Or if you do engineering, there might be a home for you in cost accounting. Or if you do sales, perhaps there’s a way to shift that experience over into calculating commissions. Now, this is a bottom-up approach. Once you’re in the department, it’s up to you to work up through the management levels.

Working in Rotating Positions

A third option is to find a company that makes a point of rotating its staff through a bunch of positions. You see it sometimes in restaurant chains, airlines, consumer goods operations – it just depends on how senior management wants to run the company. If you’re lucky enough to be accepted, make it known that you’d like to eventually take a turn in accounting. Of course, the downside of this approach is that you’ll eventually be moved through accounting and on to something else. Still, this is the type of operation where not having a perfect resume is less of a problem.

When Your Educational Background is Weak

Another variation on the initial question comes from a couple of listeners that are currently controllers or CFOs, but they’re nervous about their ability to shift jobs because they never piled up the credentials to begin with, and now a lot of years have gone by.  I know some of these people personally, and they’re totally competent. The trouble is that they stayed with one company for a long time and worked their way up from the bottom without getting formal training or certifications.

This is a really scary place to be. They’re a little older, their resumes are a bit weak, and so they’re not sure about how the marketplace will view them. And to make matters worse, they’ve been with their current employers for so long that their pay is well above the industry average, so a job with someone else is almost certainly going to require a pay cut.

In this case, I point out that you currently have a job in the accounting field, so stay there as long as it takes, while you fill the resume holes. That may mean multiple years of night courses at college, but if you’re serious about it, then get going now, and stick with it. You may be doing this for a long time, but having a solid resume means you can break free from your employer with a lot more confidence, and hopefully get a pay raise out of it, too.

In most of these cases, if a company is looking into going public, you might be screwed. Even if you’ve made it into the accounting department and it looks like you have a successful new career, your lack of training and certifications might stop you cold. When a company goes public, advisors are going to recommend that management bring in a real pro with perfect credentials, just to impress the investors.

Parting Thoughts

So in short, getting into the accounting field from some other profession is not that easy, especially if you’re coming at it from a position of minimal accounting knowledge. If you’re already in the field but have a weak resume, you may do pretty well within your current company, but can’t go elsewhere. Though I’ve made some suggestions that might help, there’s really no quick and easy workaround. If you want a solid career move that you’re planning to stick with for a long time, nothing beats getting a formal degree and perhaps a certification, too.

This may all sound a bit gloomy, but on the other hand, there’re a lot of job opportunities in accounting, and that’s not supposed to change, so it can be worth the effort to get in some extra work to either make the switch into accounting, or to bolster the position you already have.

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Whose Accounting System to Use in an Acquisition (#166)

In this podcast episode, we discuss whether to allow a purchased company to operate its own accounting system, or to require it to use the parent company’s system. Key points made are noted below.

Components of an Accounting System

This is THE question if you’re running the acquiring company’s accounting department, because it impacts a bunch of issues. First of all, let’s define what an accounting system means. It’s not just the accounting software, which is the mistake that everyone makes. There’re also the accounting policies. For example, what if the acquiree capitalizes all assets over $5,000, while the acquirer capitalizes everything over $10,000? That’s a difference in systems, and each policy variation creates different results in the financial statements.

Here’s another one. What about the forms that are being used? A form is really a data entry sheet. You take the information from the form and put it into the computer system. So what if you’re collecting less information in one company’s form and more on the other? That means the computer systems contain different information for the same transactions.

And another systems issue is procedures. What if one company has a tight set of closing procedures that can close the books in one day, and the other company doesn’t. Or, what about controls? The acquirer might be publicly held, and so has great controls, while the acquiree is privately held, and doesn’t have any discernible controls at all.

And, we’re not done yet. What about the definitions of accounts? One company might define accounts receivable as just trade accounts receivable, while another company might define it as also including all receivables from employees. If so, you can’t even compare the line items in the financial statements, because they contain different information.

All of these items are part of the overall accounting system. And I bring them up to point out that this really isn’t just a computer software question. In reality, some aspects of the two company’s accounting systems are probably going to have to be combined.

The Need for Consistent Policies

Just to have some consistency in what the companies are jointly reporting, you’re probably going to combine accounting policies. And the auditors may insist on using a fairly similar set of controls. And the definitions for the accounts should be reasonably consistent. So that’s probably the minimum level of accounting systems that need to be combined.

Differences in Process Flows

But beyond that, the situation is much less clear. Let’s look at it from the perspective of how the two companies operate. If they’re in fundamentally different industries, the entire process flow for transactions could be different, which means that both procedures and forms are different. If so, don’t try to shoehorn the accounting systems of the acquiree into those of the acquirer. The two organizations are simply too different. Instead, buy some consolidation software, and map the results of the acquiree’s financial statements into those of the acquirer, and get on with life.

Accounting Systems from a Strategic Perspective

Also, let’s look at this from a strategic perspective. If you want to completely switch an acquiree over to the parent company’s accounting systems, it takes time. It can take a lot of time. So, what if the parent is a serial acquirer? The management team has figured out how to buy the same type of business over and over again, and it’s buying a bunch of companies every year. If so, and you’re trying to switch everyone over to the parent’s accounting system, it can be pretty tough to keep up the pace. In this situation, you really only have two choices. Either invest in several integration teams that are constantly on the road doing integration work, or – and much more likely – you just let everyone keep their own systems.

Now let’s take it from a different strategic perspective. The parent company is really careful about its acquisitions, and only does so at long intervals. In this case, you have the time to conduct a full integration, so this is more of an option. However, the parent company may be achieving really fine results with its acquisitions because it promises to leave the management teams alone. If so, even though you could integrate the accounting systems, you probably should not do so.

Now in this latter case, you still need to roll out the minimum level of systems integration, which was the account definitions, and policies, and probably the controls. But that would be it.

OK, here’s another strategy issue. What if the parent company is buying up other businesses with the intent of making money from the deals by cutting expenses as deeply as possible? In this case, a key part of the plan might be wiping out the local accounting departments, and shifting all accounting to a central processing center. This is the ultimate level of systems integration, and it takes a fair amount of work. But in this case, there is no choice. Senior management is essentially mandating that you will shut down all local accounting systems.

My Personal Viewpoint

So that’s my general view of how to handle the accounting systems of acquirees. And of course, that’s all theoretical. In terms of what I’ve actually done, I always leave the existing accounting staff in place, because I want local expertise on-site. I also impose common definitions, policies, and controls. I do not mess with localized procedures and forms, since the acquiree’s accounting staff might have good reasons for coming up with them. And also, I really don’t care. It doesn’t matter that much if there’s some divergence between companies in how a process operates. And the same goes for forms.

Enforcement of Accounting Systems

Which brings up a major point, which is how oppressive do you want to be in enforcing exactly the same systems in every subsidiary? That means sending in an internal audit team to conduct investigations, which is expensive. And it means conducting enforcement activities to bring local staff back into line. Which is annoying for everyone involved. I prefer to let local staff do their own thing, within reason. As long as their error rates are low and they close their books on time, I let them do what they want.

Oh, and there’s one other item – I always require everyone to use the same accounting software. That way, all transactions are recorded in a single database, and we can close the books faster. That also means that I don’t allow too many changes to the corporate system. We have the same account structure for all subsidiaries, and there has to be a really good reason to change it.

But – what I do is based on having had a number of acquirees over the years that were roughly in the same industry. If I’d been dealing with radically different subsidiaries, I certainly would have let them operate their own software, and we just would have used consolidation software.

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How to Set Up an Accounting Department (#165)

In this podcast episode, we discuss how to install accounting practices in a company that doesn’t have any policies and procedures. Key points made are noted below.

A lot of us run into this problem. You might be with a start-up company that initially doesn’t have an accounting function at all, or maybe you’re getting into a situation that’s a complete mess. So where do you begin?

Cash Tracking

You always begin with cash. Because if that’s screwed up, the company will fold, and nothing else matters. So you have to understand cash and set up systems around cash. That means scratching together some kind of a cash forecast. Initially, if there’re no supporting systems, or they stink, you’ll just have to cobble something together, to see if there’s enough cash to keep going for the next couple of months. If not, you have other problems. But if the cash situation is OK, the next step is to take a hard look at the problems you had putting together the cash forecast. Maybe the aged receivables report is unreliable, or maybe not all of the payables seem to be recorded in the books. Or maybe you’re not sure about the repayment terms on a company loan. Whatever there is, write it down. This becomes the first part of your checklist of activities.

Calendar of Activities

Next, create a calendar of activities, and mark on it when you’re doing the next cash forecast. Probably in about one week. When you do the next forecast, upgrade it a bit by addressing one of the items on your checklist. And keep doing that. Eventually, probably in three or four months, you’ll have created a pretty acceptable cash forecast. And you did it, because you followed a calendar that forced you to repeat the activity, and a checklist, that forced you to upgrade the activity.

Credit Enhancement

So far, we’re only monitoring cash levels. The next step is to take an active role in improving cash. We do that by addressing credit and billings and collections. Credit goes first.

Credit is like a spigot. If you open the tap and credit pours out, you might have a hard time collecting all the money that customers owe. So the first step is to take a hard look at how credit is being granted.

In a loose accounting organization, they pretty much give credit to everyone. If so, see what the impact is. Does the company have a lot of bad debts? If so, with which customers? And under what circumstances was the bad credit handed out? If you can get the answers to these questions, you’ll probably find that one or two very specific credit rules need to be set up to handle bad debt problems. If so, formalize just those rules. In other words, only formalize the rules that are really needed. Don’t take a bunch of policies and procedures from an accounting book and force them on the department. If you’re just starting out, you don’t have time for all of that bureaucracy. Instead, focus on just what matters to get credit under control. Then write down in your checklist any remaining credit issues that you want to address the next time around, and mark down a date in the calendar to do it – probably in a month or so.

Collections Enhancement

Next up is collections. Review the aged receivables report and see what’s way overdue, and why it’s way overdue. If there aren’t any problems, then guess what? Move on. There are no policies or procedures to mess with. Again, we’re initially setting up systems just to correct existing problems. If there are no problems, don’t mess with it. But if there is a collections problem, figure out a possible change in collection activities, like bringing in the sales staff to help. Then make a note in your calendar to check back in a couple of weeks to see how it worked. If it did work, you might have a new procedure for the collections staff to use. If it didn’t work, no procedure is needed.

Billings Enhancement

Next up is billings. Have someone compare product ship dates to billing dates. If there’s a big differential, the billing process needs to be tightened up. To do that, install a policy that billings have to occur within one day of shipment. Guess what, you now have an official policy. Put it in the accounting manual, and then surprise the billing staff in a couple of days by checking in again. Without a doubt, they won’t be billing on time yet, because they didn’t believe you. This is a good time for a fire and brimstone speech, followed by more follow-ups to see if they’re billing on time. And of course, the follow-up is listed in your calendar.

So you see where this is going. Setting up a properly structured accounting department is not a matter of dumping a pre-written policies and procedures manual on the accounting staff. Instead, install just what’s needed, and then keep following up to make sure the changes stick.

And then if it appears that another change is needed, incrementally create one more policy or procedure, and make sure that that one sticks, too.

Accounts Payable Enhancement

So let’s keep going with our structuring process. A fun one is accounts payable. In a really unstructured department, the staff just accepts all invoices, no matter where they come from, and pays them without a lot of cross checking. Believe it or not, that’s not a bad starting point, if the goal is to keep suppliers happy. And it just might be. Chances are, duplicate payments and fraudulent payments are a pretty small part of the total.

Nonetheless, start working on a single improvement to payables. The obvious one is to have the payables software do an automatic match on invoice numbers, which flags something that’s already been paid. Another one might be to use negative approvals, where the accounting staff is going to pay every invoice unless an approver says no. Whatever the case may be, install just a single improvement change, and lock it down with repeat attention.

Payroll Enhancement

Another area is payroll. The main issue, of course is to make sure that everyone is paid the correct amount and on time. So look at the complaints coming back from employees, pick a good juicy problem, and analyze it to death. For example, if paychecks aren’t reaching an outlying location on time, set up a procedure to send the checks by overnight delivery service. Whatever the improvement may be, establish it, create a procedure, and make sure it’s followed.

Financial Statement Enhancement

And finally, there’s the financial statements. Sure, you can shoot for producing financials in one day, but you’re not going to do it. At least, not for quite a while. In this case, the first target is to produce accurate financial statements. Once you’ve reached that goal, then work on compressing the time line. To do this – again – work on one improvement each month, and get it right before moving to the next one. For example, if the closing entries are perpetually screwed up, create some journal entry templates in the accounting system, and spend a month or two making sure they’re exactly what you want. Then lock down the templates and move on to the next project.

General Concepts

Now, I can’t begin to tell you how to set up an entire accounting department in a seven minute podcast.

And I realize this is an important issue for people who’ve just walked into a mess, and have no idea where to start. But what I’ve tried to do is lay down some general concepts to follow. Which are:

Organize the cash situation first. Then organize the value that accounting adds to cash flow, which is credit and billings and collections. Then work your way through the department, and organize the items most desperately in need of change. And “organization” means a highly tailored approach that installs just the most crucial policies and procedures. And then beat on the accounting staff to make sure that everyone is following the new rules.

Then do a continuing series of passes through the department, to clean up less important items. Now, unfortunately this approach also means that you may end up reacting to crises. So, for example, if a large bill was paid twice, that suddenly becomes your number one issue. That’s fine. If the loss was that big, maybe it should be your number one issue. But after a while, you’ll have set up enough structure in the department that any remaining crises are going to be pretty small.

And that’s it – that’s how I would go about setting up a properly structured accounting department. You’re basically adding layers of policies and procedures, and when there’s no need for any more, stop. That means the department focuses on just the structure it needs, and ignores any extra bureaucracy. If the situation changes, then maybe you’ll incrementally add on a little more structure. But don’t overdo it.

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Wage Surveys, Specialty Certifications, and the MBA Degree (#164)

In this podcast episode, we discuss several topics relating to accounting certifications and the MBA degree. Key points made are noted below.

This episode is a continuation of the discussion in Episode 162, which was about the CPA and CMA certifications. As you might recall, I pointed out that I’d probably receive hate mail from people who hold the CMA certification, because I didn’t think that certification was all that useful. That’s not quite what happened. I got an e-mail from someone who really hated the CMA. And he raised some additional points, which seemed worth addressing in a separate episode. So here we go.

Wage Surveys

First point. The Institute of Management Accountants is the group that sponsors the CMA certification. They issue a salary survey every year that shows how much more money a holder of the CMA certification makes over someone who doesn’t have the certification. That one survey alone probably gets people thinking about taking the test for the certification. But before you buy the study guide, consider that a person who gets any certification is pushing harder for job advancement than someone who doesn’t. So in way, getting any certification at all is a self-fulfilling prophecy, because this type of person is bound to earn more money over the long term. So you might want to discount any salary survey that shows how you’ll make more money if only you earn such and such a certification.

Specialized Certifications

Second point. What about specialized certifications? For example, there’s the CIA certification, which stands for certified internal auditor. And there’s the CISA, which is for Certified Information Systems Auditor. And there’s the EA, which is for Enrolled Agent, which relates to taxation. And, for that matter, you also have the Certified Financial Planner, and Certified Fraud Examiner, and Certified Financial Manager. And so on. Are any of these worthwhile?

It depends upon how you approach how you’re going to use them. I do not recommend a shotgun approach, where you go into a frenzy of test taking and sit for every possible exam. Instead, the better approach is to figure out exactly what you want to do with yourself, and then specifically target the certification that makes the most sense.

I can bring some personal experience to this one. Back in Episode 162, I mentioned that I had both the CPA and CMA certifications. That’s not the whole story.

I only mentioned those two, because they were most relevant to the point I was making. Actually, early in my career, I picked up seven certifications – and it was in shotgun style. I just sat for every possible exam. The intent was to be qualified for everything, so my resume would look better. It didn’t really work out that way. No one ever commented on all of the other certifications, so I eventually let them all expire.

And here’s a story to consider. One of those other certifications was the Certified Internal Auditor. It’s usually considered the third most important accounting certification, after the CPA and CMA. So one day I received a call from someone else living in Colorado who had all three certifications.  She was calling to let me know that there were now three of us in the entire state who had the big three certifications. The main thing to take away from that call was that only three people in the entire state thought it was important enough to load up on certifications. No one else bothered.

So my advice with specialty certifications is to make very sure about what you want, and target your efforts on just one or maybe two of these certifications.

And speaking of the CIA certification, I was flying back and forth to another city while studying for the test, and carrying this big training manual with me that said CIA on the cover. You wouldn’t believe how many people asked if I was training to join the Central Intelligence Agency.

Getting an MBA

OK, third point. What about getting an MBA? That’s the Masters in Business Administration. A lot of job postings require either an MBA or a CPA. That’s pretty stupid, since the MBA curriculum doesn’t remotely cover the same information that the CPA covers. The MBA covers all kinds of non-accounting issues, like business law, and management theory, and marketing. So someone who issues a job posting like that isn’t thinking through what they’re asking for.

Still, if you’re looking for a more advanced job, like controller or CFO, it’s fairly likely that you’ll see an MBA requirement on the job posting. What do you do? It takes a couple of years to pick up an MBA degree, and it’s pretty expensive. I’ll answer this one from personal experience. Yes, I have an MBA. I’m fairly sure it led to my getting my first controller job, so it definitely was worthwhile for me. And that controller position led to a couple of CFO jobs in a row, so I’d have to say it was very worthwhile.

But that doesn’t mean the MBA is right for everyone. For example, if you’re in the public accounting profession and you intend to stay there, then just having the CPA certification is really enough. In that area, the CPA is king, and any other qualification doesn’t really matter that much. The MBA is more useful if you want to be a controller, or CFO, or a management consultant – and that’s because what they teach you in the program can actually be put to good use in those jobs.

Another consideration is the quality of the school from which you earn the degree. The general thinking is that you should try to get it from a top 20 business school, since the school’s name recognition then goes along with the degree. I agree with that, but with a provision thrown in. After all, it may not be possible to be accepted into one of those programs, and they’re all incredibly expensive. Instead, consider a really good regional college that has good name recognition in that area. So if you continue to work in that area, the degree still gives you some name recognition.

Drawing from personal experience, my MBA is from Babson College. It’s a really good school just outside of Boston in the United States, and it has terrific regional name recognition. It’s not usually listed in the top 20 business schools, but it probably is in the top ten business schools in that area. Getting the degree from Babson definitely helped me get my first job out of college, because all of the auditing companies recruited there.

I don’t recommend any of the other MBA programs. There’re huge numbers of people who have the MBA degree, so you’ll just be one in the crowd, unless there’s some kind of name recognition associated with the program.

Another thought on the MBA is that it doesn’t do much to your starting pay if you earn the degree and then get a starting job in the auditing industry. I know, because I got an MBA and then went straight to work for Deloitte & Touche. All of the new hires swapped their starting pay information, and it turned out that the pay differences for people having only bachelor’s degrees, versus those with master’s degrees was just a couple of thousand dollars.

So, in summary, I still think the MBA is a good idea, but only the right MBA.

Basically, the name brand of the school from which you get the degree is more important than you might think. Also, the degree is only of practical use if you intend to either go into management or consulting.

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The Chart of Accounts (#163)

In this podcast episode, we discuss ways to fine-tune the chart of accounts. Key points made are noted below.

Characteristics of the Chart of Accounts

The chart of accounts is the listing of all the accounts you use in the general ledger. If you use accounting software, which is most everyone, it’s quite likely that the software suggests a standard account structure for you. When new types of transactions come up, you probably add an account in which to store the related information. For a lot of accountants, that’s it – the chart of accounts is pretty much a non-issue.

But maybe it should be an issue. If the chart of accounts is structured incorrectly, it can require a lot of extra work. For example, let’s say the company controller likes to track expenses at a really detailed level, and so creates an amazing number of accounts. So instead of just having an office supplies account, there’re now accounts specifically for the copier machine, and another one for paper supplies, and so on. That’s what I call a deep chart of accounts – there’re a lot of accounts.

And also, what if the controller decides to have a longer account code structure, just in case? For example, a small company may only accumulate expenses for the company as a whole, in which case you can get by with a three-digit code. But if you add a department code, then the account code expands to five digits. And if you add divisions, then the account code becomes seven digits. That’s what I call a wide chart of accounts – each account has a lot of digits.

The worst possible case, of course, is when the chart of accounts is both deep and wide, because the accounting staff has to remember so much more information in order to record transactions. This difficulty shows up in several ways.

For example, the accounts payable staff has trouble remembering which accounts to charge expenses to, which means that they end up in one account this month, and in another account the next month. And that makes it impossible to track accounting balances on a trend line, since the numbers are constantly moving around among different accounts, and departments, and even divisions.

An issue with having a deep chart of accounts is that it’s more difficult to create financial statements. Whenever you create a new account, there’s a risk that the report writer in the accounting software won’t include the new account in the financials. And that means the financial statements will be wrong, and you’ll have to access the report writer and figure out what happened.

And yet another issue with both a wide and deep chart of accounts is setting up suppliers with a default account. The standard approach to dealing with suppliers is setting up a default account to which all purchases from that supplier are charged. This is a good idea. But if you get it wrong, which is way more likely with a complex chart of accounts – then every subsequent transaction with that supplier will also be wrong – at least until someone figures out the problem and fixes the default code.

Here’s another issue with a deep chart of accounts. The company’s outside auditors will be buried with accounts that they have to audit. And if they have to conduct more audit work, then the audit fee is going to increase.

Chart of Accounts Best Practices

So what can we do about this? Obviously, simplicity is crucial. First of all, the shortest possible account code structure is always best, since the accounting staff has fewer numbers to potentially enter incorrectly.

Second, and speaking of numbers, think about setting up the departments and divisions with an alphanumeric code instead of a numeric code. For example, department 01 becomes department AC, for the accounting department. This is much more obvious for the accounting staff to remember.

Third, shut down the minor accounts. There tend to be a lot of accounts that just don’t contain much information. For example, there may be a property taxes account that only gets used a couple of times a year. Or, you may have something like an office supplies account that gets used a lot, but the total balance is really small in comparison to the major accounts.

In this case, consider shutting down some accounts. The main criterion for doing so that you’re not using the information. In other words, if you see a variance in an account and yet you still don’t take action to eliminate the variance, then there’s not much point in having the account.

This concept can be taken to an extreme. To cover all of the expenses, you could have just one account for the variable cost of goods sold, one account for allocated overhead, one account for compensation of all kinds, and one account to accumulate every other type of business expense. That’s four expense accounts. Now, I point this out just to get you thinking. Very few organizations will really shrink their chart of accounts down that far. It isn’t really possible, since some accounts are needed to accumulate information for tax returns. And some managers have a hot button expense that they like to track, so by God there’s going be an account for that item. Whatever.

Nonetheless, you can see how far you could scale things back. A more realistic approach is to do an annual review of the chart of accounts that’s pretty harsh. Make the staff give you good reasons to keep accounts. Otherwise, they’re gone. The accounts, not the staff.

I only suggest doing this at the beginning of the fiscal year, for a couple of reasons. First, it’s no longer possible to compare periods. For example, the old financials might have a separate line item for payroll taxes, while this information is consolidated into a single compensation line item in the new financials. If so, the report writer has to match up the accounts properly, so that the financial statements show payroll taxes in the compensation line item both for the old year and the new year – that’s assuming that you issue comparative financials that cover more than one year.

Another problem is the comparability of information for the auditors. They like to compare expense account balances from last year with this year, to see if anything unusual occurred that needs to be investigated. But if you changed the account structure, this is kind of hard to do. So you need to warn the auditors about changes in accounts.

Because of these issues, it could be better to only make a modest number of account reductions in each year, so this becomes a pretty long-term project.

And there’s one more issue, which is keeping tight control over the chart of accounts going forward. There’s always somebody in the organization that wants to create another account, so they can store information, usually for an analysis or reporting project. If so, your initial reaction should be to turn them down. Once a new account is in the chart of accounts, it’s tough to get rid of it. Instead, tell the person to store the information separately, maybe in a spreadsheet.

Usually, the information being requested will end up being for a really short period of time, and then they don’t need the information any more. And you just saved yourself from setting up another account.

The same advice goes for subsidiaries. Everyone gets the same chart of accounts. The only waiver should be if a subsidiary operates in a different industry, and so really does need to accumulate information in a different way. Otherwise, subsidiaries tend to go wild with new accounts, and before you know it, there’s a massive tangle of accounts. This also means that acquired companies need to shift to the chart of accounts of the parent. This is a hard conversion, but it’s a good idea in the long run.

So in short, reduce the number of accounts, and don’t use many numbers in the account structure. That means the chart of accounts is narrow and shallow.

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The CMA and CPA Certifications (#162)

In this podcast episode, we discuss the need for accounting certifications, and whether the CMA or CPA certification makes more sense. Key points made are noted below.

How the Certifications are Used

Just so you know, CMA stands for Certified Management Accountant. This is a certification maintained by the Institute of Management Accountants. There’re a number of other certifications you could compare it to, but the only one that really matters is the CPA certification, which stands for certified public accountant.

And also, I’m fairly qualified to talk about this subject, since I’m currently a CPA, and used to be a CMA – I let the certification lapse a number of years ago – which might tell you something about the direction of this conversation.

Whether to Obtain a Certification

But first, why have any certification at all? That’s simple enough if you’re going to be an auditor, because you have to be certified as a CPA at some point, which is usually defined as when you’re promoted to audit manager. That requirement is pretty clear, and that why the AICPA, which sponsors the certification, claims to have 386,000 CPAs as members.

Now the situation is quite a bit different if you’re not an auditor, and instead are working in industry as an accountant. In this case, the question really is, at what point does some sort of certification requirement show up on a job description? So for example, if you go online and look up the job descriptions for a bookkeeper, or a cost accountant, or a general ledger accountant – basically any staff job – you won’t find too many that say the person should have any kind of certification.

The situation changes when you look at job descriptions for controllers. Pretty much all of the job descriptions out there state that a person applying for this type of job should have either a CPA or CMA certification. This is not a minor point, because the same job descriptions are used by everyone who hires a controller. When a controller job is posted and you send in your resume, they’ll mark you down if you don’t have one of these certifications. It doesn’t mean you’re automatically written off, but it does mean that you won’t rank as high as someone who does have a certification.

So having a certification is essentially a case of checking the boxes to make sure that you fulfill all the requirements for a management position. Now this doesn’t mean that having a certification is a top priority. Relevant job experience is always going to come first. After that is your education, and then maybe a certification is third in importance.

In addition, once you get some seniority as a manager, having a certification on a resume becomes a bit of an afterthought. When someone is looking to hire a senior controller or CFO, they’re looking for other things, like a deep knowledge of public company reporting, or being able to raise funds. So the use of a certification is more relevant for someone who’s just trying to break into the management ranks.

So let’s say you want to become a controller, and maybe eventually a CFO, and you’ve decided to fulfill that basic requirement and pick up a certification. Which one should you get? Well, if you used to be an auditor, just keep up you CPA certification, and that’s all you need. If you never had the chance to take the CPA exam or fulfill the two-year experience requirement as an auditor, then by default your choice is to take the CMA examination.

That covers the basics. But there’s more to this topic. First, which of the certifications is perceived to be better? That would be the CPA certification, and for a couple of reasons. And yes, I know I’ll get some hate mail from people who have the CMA certification. Anyways, the first reason is the marketing budgets of the organizations that sponsor these certifications. The AICPA sponsors the CPA exam, and they have a massive marketing budget. That’s why so many people have heard of the CPA certification. The IMA is much smaller, so they just can’t get the word out as effectively about the CMA certification. The second reason is that you have to be a CPA to be an auditor, so way more people go to the trouble of getting certified, and then maintaining the certification.

So by comparison, there’re 386,000 CPAs, and only 30,000 CMAs. I’m really not trying to knock the CMA certification – this is just the reality of the situation.

Another issue in regard to certifications is whether it makes sense to pick up both certifications.

If you do, the usual path is to sit for both exams as close together as possible, since some of the subject matter – not all of it – is the same. You certainly can, if you want to spend the extra money for the two examinations. In addition, keep in mind that each of these organizations charges a large annual fee to maintain your certification, and each one has continuing professional education requirements.

So it’s not just about trying to pass two examinations in a row. You also have the ongoing expense – and time – associated with maintaining the certifications. And that’s why I dropped the CMA a long time ago. I didn’t feel like paying the fees and taking the extra hours of continuing professional education. And frankly, I didn’t feel that having both certifications on my resume helped all that much. In short, my advice is that you don’t receive much incremental benefit from having both certifications.

Now here’s another thought. What about taking both examinations but not fulfilling all of the other requirements to actually be certified? Maybe you don’t have the experience requirement, or don’t want to pay the annual fee, or don’t want to spend time with all of that ongoing training. What you could do is state on your resume that you’ve passed one or both exams. That at least proves you have a lot of very specific accounting knowledge. I think it’s a good idea, and it’s certainly better than saying nothing at all about a certification.

So, in short. I suggest that you go after just one certification, with the CPA having priority over the CMA. If you’re just finishing up college it doesn’t hurt to sit for both exams, since your knowledge will be fresh, and you’ll have a better chance of passing both. If you’re a really senior manager already, obtaining a certification may not make much sense. But if you’re trying to get into a management role for the first time, having a CPA or CMA certification is a good idea.

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When to Write a Procedure (#161)

In this podcast episode, we discuss when to write an accounting procedure and when to avoid doing so. Key points made are noted below.

Characteristics and Usage of Procedures

The core issue is, do you write a detailed how-to-do-it procedure for every conceivable activity in the department? On the plus side, this is a really good training tool if you have a lot of inexperienced new hires, and they just don’t know how processes work. It’s also good from a controls perspective, because auditors like to see that there’s a written procedure in place, and that you’re following what the procedure says. It also tends to improve the consistency of processes.

Those are the good points. Then we have a lot of downsides. Systems are constantly changing, so you have to spend time updating whatever’s been documented, as part of the process of changing the systems.

Also, if you decide to write a massive number of procedures, that’s going to take a lot of time by either senior staff or consultants. Either way, there’s a fairly large cost associated with it. And on top of that, updating the procedures is expensive.

The next problem is issuing updates. If you have lots of people who use the procedures, and especially if they’re in multiple locations, you may have to send out either complete replacements for the procedures manual, or a lot of minor updates to three-ring binders. In the latter case, the recipients have to keep swapping out the old pages and putting in the new pages. So the updating process requires a lot of time by the people using the procedures.

Next issue. Just sending out an update to a procedure isn’t enough, since you can’t really expect people to figure out the exact nature of the change. Instead, there needs to be training that goes along with the written procedure. Again, we’re racking up a lot of cost and staff time.

But we’re not done yet with procedure problems. The next issue is rigidity. If every last conceivable process step has a written procedure for it, then bureaucracy sets in. This means there’s a specific, approved way to do everything. By default, that means every other way is not allowed.

The end result tends to be way too much reliance on a massive procedures manual, where the response to every question is – I don’t know, let me go look that up. And by the way, the largest complete set of corporate procedures I’ve ever seen was three feet thick.

And speaking of bureaucracy, a massive set of procedures also calls for a full-time staff to support it. Which does not strike me as being a very good idea from a cost perspective.

And one more issue with bureaucracy is that the use of best practices pretty much disappears. Instead of thinking of better ways to conduct a process, a written procedure just locks it in where it is right now. And that means the efficiency of the department stops improving.

When to Create Procedures

By now, you may have figured out that I’m not exactly advocating having a lot of procedures. Instead, you need to figure out that fine line between too many procedures and too few. So here are a few guidelines to consider.

First, is a process highly repetitive? If so, you need a procedure, because every transaction should be completed in exactly the same manner, and a procedure can control that. Otherwise, there’ll be just enough variation that the auditors will call you out on having processes that aren’t being followed consistently.

Second, is there a significant risk of loss? For example, something like a wire transfer. Even if the volume is low, a single screw up could cost a lot of money. In this case, write a procedure. And again, this is exactly the place where an auditor is going to look for a procedure, and they’ll expect the procedure to be followed perfectly, every time.

Third, what’s the nature of the business? If you have a highly repeatable business, like a retail store, then most processes should be handled in the same way in all locations. This is one of those cases where having a fairly large procedures manual is expected.

And fourth, is the process really complex, with many steps? If so, even an experienced person could screw it up, so it makes sense to have them walk through every step, every time, just to make sure that they get it right.

And that pretty much covers the cases where you need procedures. In all other cases, I suggest that you do not have formal, written procedures. And by avoiding procedures, you’re also giving the staff a certain amount of leeway, which may result in some imaginative thinking about how to do things better.

So in summary, in most cases, you should have a relatively small procedures manual that only covers the most high-volume, risky, or complex processes. This allows you to easily swap out the manual when there’s a procedural change, with minimal staff time and not much expense. And it also means that you avoid getting bogged down in those dozens or hundreds of minor processes that really don’t impact the department or the company all that much.

Related Courses

Accounting Controls Guidebook

Accounting Procedures Guidebook

The Soft Close (#160)

In this podcast episode, we discuss the nature of the soft close and how to do it. Key points made are noted below.

Characteristics and Usage of the Soft Close

The soft close means that you close the books at the end of each reporting period, but not with all of the usual closing steps. You might even skip nearly all of the closing steps, and just go ahead and print the financial statements. Now, obviously, if you skip a bunch of closing steps, you’ll save loads of time, but the financials will also be less accurate. The question you need to ask yourself is, under what circumstances does it not matter that the financial statements are a little off? Let’s work through this.

First of all, we’ll assume that your company gets its financials audited at the end of each year, so those year-end financials will require a complete closing process. OK, that still leaves 11 months of financials for which you could use a soft close.

Next, a publicly held company gets its financials reviewed at the end of each quarter. So for these companies, you still could use a soft close for eight months out of the year. Well, that’s not bad. You could save a bunch of time on your closing process two-thirds of the time. And that’s the worst case.

Now, how much time can we save with a soft close? There’s no hard and fast number. Instead, think of this as a continuum, where you could have no closing steps whatsoever, but a high risk of inaccuracy at one end, and at the other end, you have lots of closing steps and a low risk of inaccuracy.

You need to decide how much risk you want to have in the financials. This isn’t a qualitative judgment, where you just make a wild guess as to how many closing steps you can avoid. Instead, take a look at the size of the adjusting entries that you’ve made as part of the closing process for the past couple of years. Chances are, only a couple of them are really large. Everything else is so puny that you could either skip them entirely, or just copy the same entry for multiple months.

Soft Close Techniques

Let’s go through some examples, so you can see how this works. First, how about depreciation. It changes a little from month to month, but not much.

What you could do is load a standard depreciation entry into the accounting software, and set it to run automatically for the next six months. At the middle of the year, it’ll probably be off a bit, so check the underlying depreciation calculations, and set a revised entry to run through to the end of the year. Then adjust the year-to-date figure to actuals, so the full-year results will be accurate.

Here’s another example. The allowance for bad debts. You could go through all sorts of analysis to guesstimate what the allowance should be on a month-to-month basis, but let’s face it. This is a reserve account. That means you can never get it exactly right. So don’t try – or at least, don’t try every month. Instead, record a reasonable bad debt expense each month, to load up the reserve account, and then let it run for a while.

However, this doesn’t work if you have a small number of large invoices outstanding, because if even one of those is a bad debt, your allowance could be way off. So it depends on the circumstances. If there’re lots of small invoices, adjusting the allowance at long intervals is probably fine.

Here’s another possibility. What about the wage accrual? If the company has mostly salaried employees, who cares about the accrual? It’s just not for that much money. On the other hand, if practically everyone is paid on an hourly basis, you could seriously screw up the financials by not including the accrual. It just depends on the circumstances.

Let’s keep going. What about commission accruals? A lot of controllers go through this incredibly painful process of calculating the exact commission owed to every salesperson before they close the books. Why bother? If the overall commission percentage doesn’t change much, then just accrue the overall percentage of sales as commission expense, and get on with life.

And here’s a favorite for controllers – what about overhead allocations? In most companies, the amount produced in each month doesn’t vary much, and the overhead cost pool doesn’t vary much. So why allocate overhead at all? You could skip what is sometimes an amazingly convoluted exercise, and just wait until the auditors show up at year end, and then do it once.

And here’s one you may struggle with. What about account reconciliations?

Any reasonably cautious controller wants to know what’s in every single balance sheet account, because it’s possible that some of those balances should be charged to expense. Well, you don’t have to reconcile all of them. Instead, look through the accounts, and decide which ones are so small that even if they’re completely wrong, will correcting them really impact the financials all that much? Chances are, you’ll only have a couple of accounts left that really require a reconciliation. The others can all be checked at much longer intervals.

Now, I’ve just pointed out that you can drop or at least scale back a bunch of closing activities that some controllers would consider religiously important. I only consider one closing activity to be absolutely mandatory. And that activity is to print a preliminary version of the financials, and scan it for anomalies. There’re bound to be a few, and those will require an investigation – though only if they’re large enough. A small variance isn’t going to bother anyone, so don’t worry about it. Chances are, the small stuff will probably self-correct in the next month’s financial statements.

Now, all of this may sound like an awfully laid-back way to deal with what is, realistically, the most important product of the accounting department. True enough. But it can also save a bunch of staff time. You need to make the decision to adopt a soft close or not. And if you do, then keep in mind that you still need to conduct a full and very detailed close – just at longer intervals. By doing so, any minor problems can be found and corrected before they become so large that they’re causing major errors in the financials.

So in short, the soft close can be a major labor saver – but you need to figure out for yourself just how much of a soft close you can tolerate. It might be the elimination of just a few closing steps, or you could strip away most of the closing process, in exchange for a bit more variability in the results that you report. It’s you call.

Related Courses

Closing the Books

The Soft Close

The Year-End Close

The Liquidation Basis of Accounting (#159)

In this podcast episode, we discuss the details of the new liquidation basis of accounting. Key points made are noted below.

When the Liquidation Basis is Used

Liquidation basis accounting is basically about preparing your financial statements in a different way if the business is about to be liquidated. The official term is, “when liquidation is imminent.” You can consider “imminent” to mean when it’s unlikely that the business won’t be liquidated, or that liquidation is being imposed on the company – such as through an involuntary bankruptcy. And by the way, liquidation means the business is shutting down and paying off its creditors. Liquidation does not mean when a business is being acquired. Otherwise, a lot more companies would be using this.

Presentations Under the Liquidation Basis

Hopefully, you’re not in an imminent liquidation situation. But if you are, the basic rule of presentation is to include in the financials the amount of expected cash proceeds from the liquidation, and the expected expenditures needed to settle all remaining liabilities. This means the accounting is different from what you’d normally see in a couple of areas.

First, you can recognize any assets that had not previously been recognized, but which you expect to either sell in liquidation, or use to pay off liabilities. And that means you can recognize internally generated intangible assets – which would not normally be the case. The main point is that you can only recognize these items if they’re actually worth something in liquidation. And only when you’ve also accrued expected disposal costs for the assets.

Another point. In liquidation accounting, you’re measuring assets at the estimated amount that you can sell them for – which may or may not be their fair market value. If the liquidation is a bit of a rush, this could mean that the estimated selling price is less than fair market value.

Also, and this is no surprise – you’re supposed to accrue every expense that you expect to incur as part of the liquidation – such as legal fees. What is surprising is that you’re allowed to accrue the income you expect to earn during the liquidation period.

For example, let’s say there’s a plan to completely shut down a plumbing business in one month. You should estimate the amount of income expected from the remaining customer orders, and accrue that income right now. And yes, this means the business is recognizing income before it’s earned the income. This goes against GAAP in a big way, but then liquidation accounting no longer assumes that the business is a going concern. Instead, the main focus of attention is – as the name implies – to see what the company is worth in its liquidated state.

Now these rules changes don’t mean there’s a complete accounting free-for-all, where you can completely recast the balance sheet. In particular, you’re not allowed to anticipate being released from a liability until the release actually happens.

Another point is that you don’t discount disposal costs to their present value, and there’s no discounting of any accrued income. And that’s because there’s really no point. If the entire business is about to be liquidated, it won’t be around for very long, so the amount of any discount should be immaterial.

So, what if the company doesn’t liquidate just yet, and in fact drags along for a few reporting periods? Well, in each period, you’re supposed to remeasure the assets and liabilities and adjust them in the accounting records to their liquidation values as necessary.

And of course, you have to disclose all of this – the plan for liquidation, measurement assumptions, when liquidation should be completed, and details about the income and costs that you’ve accrued.

Additional Statements to Present

There’re also a couple of new statements to present. There’s the statement of net assets in liquidation, which shows the net assets available for distribution at the end of the period. There’s also the statement of changes in net assets in liquidation, which is just what the name implies – it shows only the changes in net assets during the reporting period.

Parting Thoughts

And finally, the liquidation basis has had a few references in the accounting literature in the past, but this is the first it’s been directly addressed. And it’s only been referred to in passing in the international standards. My guess is that this is not the last we’ve heard of the concept, and that more will appear in the international standards, too.

Related Courses

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Intercompany Accounting (#158)

In this podcast episode, we discuss the mechanics of intercompany accounting. Key points made are noted below.

• Intercompany accounting is a subset of consolidation accounting.

• It involves the accounting for transactions between entities that are owned by the same parent, usually with a payment arrangement.

• An intercompany account is used to identify these transactions.

• There must be intercompany entries on the books of the companies on both sides of a transaction, which is easier to enforce when they use the same software.

• The managers of assets received from another company tend to argue for lower asset values, to minimize subsequent depreciation and write-offs.

• Both entities need to agree in advance on what to record for the intercompany entry.

• Regulators could challenge outstanding receivables as capital contributions, if they are not settled.

Related Courses

Business Combinations and Consolidations

The Senior Accountant (#157)

In this podcast episode, we discuss why the senior accountant title should not be used, and how to replace it. Key points made are:

When you’re in public accounting, it’s pretty universally accepted that an introductory auditor position works on things like confirmations and bank reconciliations, and then you move up to inventory and equity accounting as a senior-level auditor. So if you switch to another auditing firm, they can tell from your title what you’ve been doing.

How to Become a Senior Accountant

That’s not true in the private sector, where there’re three different ways to become a senior accountant. One approach is just seniority based. If you’ve been with a company long enough, you get the senior accountant label. Or, if you’re supervising people, you’re considered to have that title. Or, if you’re a real specialist in a certain area, then you receive the same tag. So you could be classified as a senior accountant if you’ve been with the company for maybe 10 years, or if you supervise the collections team, or if you’re the designated general ledger accountant.

Problems with the Senior Accountant Title

I don’t like these reasons. Any of these reasons. In fact, the basic problem with the senior accountant title is that it can mean so many things that it’s essentially meaningless. And therefore, you shouldn’t use it. Here are my reasons.

First, if someone simply has a lot of seniority but not enough skill, this is really a pay grade adjustment, not a title change. There’s no reason to ever alter someone’s title if the underlying skill or training level hasn’t changed.

Next, if someone supervises staff, then say so. They might be an accounts payable supervisor, or a collections supervisor. If so, call them a supervisor, not a senior accountant. If you call someone a senior accountant who’s really a supervisor, you’re doing them a disservice, because they have to explain on their resumes how that title translates into what may be quite valuable supervisory experience.

And then there’s the specialist. If someone is a specialist in inventory, then call them the inventory accountant. Or if they do nothing but general ledger work, then call them the general ledger accountant. It’s specific, so there’s no question about what a person with a more specific title is supposed to do.

So what if you have employees who all have the senior accountant title, but who individually received the title for a different reason. One of them has been with the company a long time, another one is a supervisor, and another one is a payroll specialist. Well, there’s no way to compare the positions. So for comparative purposes, the title is useless.

So when can you call someone a senior accountant? There’re two circumstances. One is when you add it onto a more specialized title. So someone with a lot of inventory experience could legitimately be called a senior inventory accountant. It reflects a superior level of knowledge.

The other situation is in a small department where you have several accountants on staff who are multi-purpose – each one may be involved in any number of activities. In this case, you could use the senior title to differentiate the most experienced of this group, without going so far as to designate them as a supervisor or an assistant controller. Realistically, this should be called a general accountant, senior grade.

But I can’t think of any circumstances at all when you’d just call someone a senior accountant. It’s too vague and tells you nothing about the position. So, the recommendation is to abolish the title. Instead, if someone is a really good specialist, add “senior” to the front of their title. If they supervise, then say so. And just having lots of years on the job doesn’t qualify someone for any special title at all.

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Accountants’ Guidebook

Changes in CPE (#156)

In this podcast episode, we discuss changes to the continuing professional education rules, and how they will impact the CPE industry. Key points are noted below.

CPE Requirements for CPAs

If you’re a certified public accountant, then you need to earn at least 40 hours of CPE per year. If you’re not a CPA and don’t plan to become one, then you can tune out this episode right now. But if you are a CPA or want to become one, this discussion contains some information that you likely did not know about.

But first, some actual advertising. We’re now offering on-line CPE courses. So if you go to accountingtools.com/cpe, there’s dozens of CPE courses listed, which you can take on-line, and at your own pace. And that includes taking an on-line test and receiving a completion certificate by e-mail. So if you need CPE, go to accountingtools.com. There’s also a link to the CPE at the top of every page on the site.

The Governing Body

Now, getting back to the topic. The governing body that sets the standards for CPE is NASBA, which stands for the National Association of State Boards of Accountancy. NASBA has changed some of the rules regarding CPE recently, and this is going to cause a ripple effect through both the CPE industry and the publishing industry.

What I’m going to talk about isn’t something that you’ll see anywhere else, because I may be in the best position to see the impact of what NASBA has done. I deal with the CPE distributors, and the course developers, and NASBA, and one of the big publishing houses, so I have a pretty broad view.

The first change is that NASBA no longer allows a book to be the basis for a course. In the past, a CPE distributor bought accounting books in bulk from the major accounting publishers, and hired local CPAs to develop course materials for the books, like course objectives, and question and answer segments at the end of each chapter, and of course the final exam.

Ramifications of NASBA Rule Changes

But because NASBA wants a course to look like a course, and not like a book that’s been adapted into a course, you can’t take that type of course any more. This has way more ramifications than you might think. First, some of the distributors are still issuing courses in book form, which is now illegal.

If you buy a course and they send you a book with some extra course materials attached, you need to buy your CPE somewhere else.

Second, the CPE distributors who were offering books as courses just had their business models destroyed, so they’re scrambling to find new content that’s structured as an actual course. If they don’t succeed, they’ll probably go out of business, so expect some consolidation in the industry.

And third, the CPE distributors are no longer buying books from the publishing houses. Since I see book royalty statements from both the publishing side of the industry and the CPE distribution side, I estimate that roughly a third all accounting book sales for books that are also sold as courses have now disappeared.

This means that the publishing houses now have a drop in sales that they never expected. And because sales have dropped so low, they’re now activating a clause in their contracts with authors, where they switch to print on demand, rather than printing in large batches of books. This has a major implication for the authors of accounting books, because the royalty for print on demand books is only 5%, versus 15% for books printed in batches. So the accounting book authors are having their royalties cut by two thirds, in those cases where book sales are low. I’m now seeing the 5% rate take effect in as little as two years after the publication date. And that drives authors out of the book writing business.

This means that you’ll still see authors writing one or two accounting books, but then they’ll stop writing, once they understand how low their royalties will be. And overall, this means there’ll be fewer accounting books being published.

Also, because book sales go down, there’ll be very few second editions of any books coming out. At this point, I would expect only very established books with a long history to still go into multiple editions.

Changes to the CPE Standards

Now, let’s go back to those NASBA changes. They’ve also ratcheted up the standards for what has to go into a CPE course. This involves some very specific use of course objectives that have to be reflected in the final examination, and a table of contents, and an index, and a glossary. These aren’t massive changes, but they require more work by someone who’s developing a course.

So if a course developer had been planning to make money by publishing a book and issuing a course, now the book publishing avenue doesn’t look very profitable, and it takes more time to create the course. The end result is probably going to be fewer people wanting to create courses, because the profit just isn’t there.

On the other hand, there won’t be any real impact on existing courses, since it’s not that difficult to retrofit a course to the new standards. So you’ll still see the old courses, just not as many new courses.

And here’s another NASBA change. When a course was developed, a CPE distributor used to put it into what they called pilot mode and made it available for free to their customers for a short period of time. The customers were supposed to take the course and render an opinion on how many CPE hours should be assigned to the course. Once the distributor had this information, it stopped the pilot phase and started selling the course based on the number of hours recommended by the testers.

This meant that some CPAs were getting their CPE for free. NASBA has now created a word count formula that CPE distributors can apply to a course, and they can determine the number of CPE hours from this formula. That means they don’t need the pilot mode anymore, so there’s no longer a need to offer free courses. I’ve noticed that a few of the CPE distributors still offer course pilots on their websites, but you should expect this to go away fairly soon.

And in case you’re wondering how many people were taking pilot courses for free, it was a decent number. Usually about 20 people pounce on these courses when they’re in pilot mode, and that’s at each of the distributors.

Competitive Pressures

And another issue that I alluded to earlier is that the number of CPE distributors will probably decline. At first glance, it appears fairly easy to get into the CPE market, but there’re several barriers to entry. First, NASBA is amazing slow at certifying anyone to offer courses. Also, if a distributor wants to offer courses, the annual NASBA fee is pretty high, and you also have to maintain an infrastructure for taking on-line courses. And, if you’re issuing course catalogues, there’s the cost to buy CPA mailing lists, and printing and mailing the catalogues.

So it isn’t that easy for a new course distributor to turn a profit. This means I’d expect some churn at the low end of the market, as people try to get established as distributors, and then fail.

And also, there’s some pretty serious price discounting by some of the CPE distributors, to the extent that the better course writers refuse to do business with them. And that means course writers are starting to refuse to distribute their courses with anyone but the established companies. And that means a new player can’t even attract any content to offer to CPAs.

So, in short, expect fewer CPE courses in the future, and fewer accounting books, and not so many CPE distributors. It’s not a pretty picture, but that appears to be the direction in which we’re headed. And the reason for these changes was essentially an interest in tightening the standards so that higher-quality courses would be issued. The result may not be quite what was intended.

Reporting of Other Comprehensive Income Reclassifications (#155)

In this podcast episode, we discuss the new accounting standard for disclosing the effects of a reclassification of other comprehensive income. Key points made are noted below.

Rules Change for Other Comprehensive Income

This episode is about a new accounting standards update that’s called “reporting of amounts reclassified out of accumulated other comprehensive income.” The update number is 2013-02. This is a minor update, but since a lot of organizations report other comprehensive income, I thought it might be useful to bring up the change.

The rules change basically says that, if GAAP requires an entire amount to be shifted from other comprehensive income to net income, you have to report the effect of the reclassification on the line items into which the amounts have been shifted. Also, in cases where the amount reclassified does not go directly into net income, you now have to cross-reference other GAAP disclosures that describe these changes. So, for example, if a reclassification goes into the balance sheet, you’d have to cross-reference the disclosure. The reason for requiring this information is so that someone reading the financial statements of a business fully understands the effect on the statements of these reclassifications.

All of this information was already required to be disclosed, but it was scattered around in the financial statements. Now, the information is assembled into one place.

Also, the disclosures are required for all financial statements issued by a publicly held company, and for the annual financial statements of privately held companies.

That was the overview. Here are a few more detailed points.

You have to present the information separately for each component of other comprehensive income. Also, you can present the information on either a before-tax or an after-tax basis. And also, you can present the information either on the income statement, or as a separate disclosure in the notes to the financial statements.

If you choose to present the information on the income statement, it’s presented in parentheses next to each line item that’s affected. This also has to include the aggregate tax effect of the reclassifications on the income tax line item.

An example of this type of presentation would be a parenthetical disclosure next to an expense line item that says, “Includes $10,000 of accumulated other comprehensive income reclassifications for net losses on cash flow hedges.” That’s a pretty bulky form of presentation that can clutter up the income statement, so I’d suggest not using it, unless you’re only including this type of information for just one or two line items.

If you choose to present the information in the notes to the financial statements, then present it for each component of other comprehensive income, along with subtotals for each component. In terms of readability, I think you’d do better by disclosing this information in the notes.

So for example, the header for the footnote disclosure might be called “Reclassifications out of Accumulated Other Comprehensive Income.” The first column in the table might have a subheading for gains and losses on cash flow hedges, with individual line items for things like interest rate contracts and credit derivatives. And then you could have additional subheadings for things like unrealized gains and losses on available-for-sale securities, or maybe a separate classification for insignificant items.

Then the second column contains the numbers for each of these line items, and a third column lists which line items in the income statement are affected.

And that covers the new accounting standards update. Overall, I don’t think they should assemble this information in the income statement, since it really will clutter up the presentation. Aggregating everything into a footnote disclosure could put some useful information in one place, and the tabular format is a good way to present it - but this is not what I’d call critical information for the users of financial statements.

Related Courses

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Managing in Financial Adversity, Part 4 (#154)

In this podcast episode, we discuss the things not to do when a business is confronted with a period of financial adversity. Key points made are noted below.

How Not to Deal with a Bad Financial Situation

In the first three episodes, I talked about how to correctly handle situations where a company’s financial situation declines. And that leaves room for one more episode about how not to deal with a bad financial situation. What I’m going to describe this time, you’ve probably seen or will see at some point in your career. I know I have.

Doing More With Less

The first way to not deal with bad finances is the concept of doing more with less. Also known as firing a bunch of people and spreading the load among the remaining lucky few. From the viewpoint of management, the remaining few are lucky, because they still have jobs. But because management didn’t redesign the business to pare away parts of the company, the work load can be enormous. And that leads to some bad effects.

First, there’s no longer any corporate culture. Because the work day is longer and the work load is larger, there’s no time for employees to mingle. And there’s no time for company-sponsored events. In short, all of those subtle reasons that make a work place enjoyable go away, which increases employee turnover.

Second, there’s employee burnout. Work days get longer, and weekends become work days. After a while, people start making mistakes because they’re always rushed. Efficiency improvements disappear, because no one has time to think about installing best practices anymore. And, employees are more likely to become sick, but they need their jobs, so they come to work anyways. For all of these reasons, productivity declines.

But we’re not done yet. Some of the extra work is being dumped on people who don’t know how to do the work, because the people who used to specialize in that work have been let go. And there’s no time or money to conduct training in the extra work. This means productivity goes down and error rates go up. And, because the remaining employees know they’re not doing a good job on these new tasks, their morale goes down.

Eventually, the best employees will find work elsewhere or shift into different careers.

That means the “A” level employees are gone, which leaves the B and C grade employees behind to run the business. And that means the productivity level declines even further.

So. The end result of just laying people off and spreading work among the remaining staff is burnout and lack of initiative, which leads to bad morale, reduced productivity, and losing your best employees. And yet, this is what managers do all the time. They call a staff meeting and look sorrowful, and declare that everyone has to pitch in together to pull through the crisis.

If the only thing a manager can do is a great sorrowful imitation, then they’re going to get what they deserve, which is a failed company. As I’ve been saying in the first three episodes of this series, a smart manager should very carefully reconfigure a company so that it can operate normally at a reduced level of expenditure. And that does not mean laying lots of extra hours on the remaining staff.

The Impact of Fairness in Cutbacks

Another scenario is when management decides to be “fair” to all parts of the company in a financial downturn, and decides to require the same percentage of expense cutbacks all over the company. This is another mistake, for a couple of reasons.

First, some department managers are better than others at controlling their expenses, so a tightly-run department could be devastated by a mandatory expense reduction. Meanwhile, someone who’s been very loose in managing another department may find that it’s quite simple to accommodate a cutback, since there’s so much excess spending already going on in the department.

And, a side effect of this situation is that managers learn to maintain a buffer of excess expenditures that they can unload during the lean times. And that means the company is maintaining too high a rate of expenditure all the time.

Second, some parts of a business are more important than others. Do you really want to impose a mandatory, across-the-board cutback on areas like R&D, or sales? If they’re driving revenue growth, that could be a really bad idea.

And we have one final scenario, where you think that the financial downturn will be a relatively short one. In this case, what may appear to be a prudent and humanitarian decision is to spread the pain around the entire organization, and impose a temporary pay cut on everyone.

This approach may actually work if there’s a reasonable expectation that the situation will improve soon. In that case, paring back wages allows you to retain talent, and it can build trust with employees. The problem is that it doesn’t work very well if management is simply hoping and praying that sales will improve. There may be no basis for such a belief – the industry may not be cyclical, so sales probably won’t come back. In this case, cutting back on wages has a couple of negative effects.

First, it means the sole method by which management is dealing with the crisis is by cutting wages. That isn’t exactly proactive. From a competitive perspective, it’s not good, because the management of a competitor may be reacting differently. They may be restructuring their business model, so they can really pound away at their competition – which, of course, will make matters even worse for the first company, which simply imposed a pay cut.

And the second negative effect is that no one knows how long the pay cuts will be in effect. So, if sales don’t increase, and time goes by, then look for the A level employees to leave the company. And maybe to go work that more proactive competitor that I just talked about.

So imposing an across-the-board pay cut is not always a good idea. If you’re going to impose one on an organization, then at least set up a mandatory review date that’s not too far in the future – like a month off. When that date arrives, make a realistic assessment of the situation, and decide whether to prolong the pay cuts to another review date, or to take more decisive action.

My main point in all of these discussions about dealing with financial adversity is that it takes quite a bit of analysis to understand exactly where costs can be reduced. In most cases, a broad reduction in expenditures is not warranted, and it may damage the company.

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