Accounting in a Startup Company (#181)

In this podcast episode, we discuss the unique issues associated with the accounting in a startup company. Key points made are noted below.

The Inconsistent Pay Problem

The accountant is one of the few people in the company who knows its cash position, and so may be asked not to cash a paycheck if cash levels are getting low. This is done in order to hide the cash situation from other employees.

Don’t get into a startup situation as a manager unless you’re willing to accept some pretty inconsistent pay. Also, minimize the amount of monetary sacrifice that you’re willing to make, because you may not make much money out of the deal. If you’re not in a financial position to take these kinds of risks, then it may make more sense to work for a larger business.

The Pressure to Fudge Financial Statements

The company president may put pressure on the controller to fudge the financial statements to create better results, which brings up major ethical concerns. This can be a significant concern, since entrepreneurs are more willing to bend the rules - including the accounting rules. When this happens, assume that the president will keep on pushing to see how far he can bend the rules, so the best approach is to shut him down at once with hard adherence to the rules. Also, call in the auditors for a backup opinion. Further, try to be pleasant when dealing with management, so that you can break the news gently that you won’t cooperate.

Dealing with Unrealistic Expectations

The management team of a startup company is usually very optimistic, which places additional pressure on producing financial results that match their inflated budget figures. In addition, their bonus plans create an incentive for them to create inflated revenue and profit results. The accountant needs to talk managers down to more realistic expectations, to reduce the pressure to fudge the financial statements. This starts with hard push back when the budget is produced, to focus on what is actually possible.

Ethical Concerns

In the wild and loose environment of a startup business, expect ethical issues to arise frequently - perhaps as much as once a week.

When the startup environment is simply too toxic, then the accountant needs to resign and look for work elsewhere. Otherwise, there is a risk of association with whatever fraud that the company may eventually commit.

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Training and Motivation (#180)

In this podcast episode, we cover getting the best out of staff, which training to focus on and how to deal with those people who just want to keep doing the same thing. Key points made are noted below.

Training Needs by Position

The accounting department requires lots of training for people at the top of the department hierarchy, and much less for those beneath it. For example, a tax manager needs a lot of ongoing training. Conversely, a billing clerk requires much less training. Therefore, classify each position in terms of the amount of training needed, and act accordingly.

Dealing with Employee Needs

Many employees do not want to change, which is entirely acceptable. These people deal with less grief, less travel, and have more personal time. The manager needs to honor this decision by employees. These people probably do not want to be promoted, and so should not be.

Separate out the achiever group from the mass of employees, and focus primarily on their needs. As for everyone else, they do not like change. Accordingly, use pilot projects that are run by achievers and staffed by everyone else, give them enough money to ensure success, and support these projects for as long as it takes. Doing so enhances the skills of everyone on a project team.

When to Upgrade the Staff

When there no hope of altering the department at all, then completely modify a major process and staff it with new people. The whole point is to upgrade the staff. Only have your achievers interview candidates for these new hires, to ensure that the best new people are brought in.

When employees are really refusing to go along with changes and they have been with the company a long time, they need to leave the company as soon as possible. The reason is that they have a large amount of influence within the company. Otherwise, changing anything takes forever.

Wholesale staff replacements are usually needed. Otherwise, a gradual staff overhaul results in new hires behaving just like the existing staff.

Dealing with Deadline Problems

When people cannot meet deadlines, consider altering their jobs to avoid the need for deadlines. For example, take a person away from producing financial statements and move her into cost accounting instead.

Related Courses

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The New Revenue Recognition Standard (#179)

In this podcast episode, we discuss the new revenue recognition standard. Key points made are noted below.

Nature of the New Standard

This is a principles-based standard, rather than a rules-based standard, which means that it includes general principles for how to recognize revenue, and you are supposed to use your own judgment in figuring out how to apply the concepts.

This standard applies to both GAAP and IFRS, so it is essentially the new worldwide standard for revenue recognition.

The Five-Step Approach

There is a five-step approach for revenue recognition. First, they assume that a transaction with a customer is being to be based on a contract, so you have to link a contract to the customer.

The second step is to list the performance obligations in the contract, which means the goods and services that the seller is selling to the customer. If you can’t identify a performance obligation, then you can’t recognize any revenue.

The third step is determining the transaction price that’s built into the contract. If the amount to be paid is variable, then set the price at the amount most likely to be paid. When setting the price, do not go so high that there will probably be a significant reversal of the cumulative amount of revenue that’s already been recognized.

The fourth step is to allocate the transaction price from step three to the performance obligations that were identified in step two. The main rule is to allocate the payment amount that the seller expects to be entitled to when it satisfies each performance obligation. One guideline is to allocate based on the standalone selling price of the individual goods and services in the contract. If there are no standalone prices, then you can estimated it. Another option is the residual approach, which involves applying the total price to everything in the contract that does have a standalone selling price, and then assign whatever is left to the remaining performance obligations.

The fifth step is the actual recognition of revenue, which happens when the customer gains control of the goods or services, such as taking title, or accepting the goods, or when the seller has the legal right to be paid.

Additional Points

To deal with a customer’s right to return goods, the seller has to record an asset based on the right to recover products from any customers who have demanded a refund. So, this is an accrued asset, where the offset is a reduction of the cost of goods sold.

It is quite possible that the new standard will not impact the accounting for many organizations at all, especially retailers.

To deal with the new standard, be very consistent with your contract terms; otherwise, you will need to do a separate revenue recognition analysis for each contract. Also, be very precise about the wording used for performance obligations in the contracts, so there is no question about when an obligation has been completed. In addition, only analyze changes in variable consideration at longer intervals, in order not to waste too much time on it. And finally, create a system for documenting standalone selling prices, which makes it easier to allocate prices to individual performance obligations.

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Segregation of Duties (#178)

In this podcast episode, we discuss how to handle the segregation of duties in a small business. Key points made are noted below.

The Need to Segregate Duties

The segregation of duties involves keeping one person from performing every task in order to reduce the risk of fraud. For example, one person could create a fake employee in the payroll system, pay the person, and keep the payment. If there were two people involved in this process, then one person could perform the initial payment processing, while someone else approves the payments - thereby reducing the risk of fraud.

Options for Segregating Duties

The segregation of duties can be quite difficult when there are few people in the accounting department. In this case, there is no perfect solution. Any outcome will inconvenience someone, or cost more, or involve an increase in the risk of fraud.

One option is to segregate duties by bringing in someone from outside the department. However, this person is not familiar with accounting processes, and takes the person away from his regular work. If you do this, only assign the person a simple task that he will readily understand.

Also set up a backup person, in case the first person is out of the office. This involves additional training. Do not assign an excessively junior person to the backup role, since they may not be willing to speak up about issues that they find.

Schedule accounting activities well in advance, so that the outsider who is helping out on segregated tasks can include accounting tasks in his schedule. This reduces the need for a backup person.

You could pay an outside accountant to come in periodically and assist with segregated tasks. Would probably be someone from a bookkeeping or CPA firm. This can be expensive, and they may only be able to assist at longer intervals.

You could alter procedures to minimize the need for segregation of duties, such as by having customers sent their payments to a lockbox at the bank - so there is no cash receipts handling within the firm.

A final option is to accept the risk of fraud and not segregate duties at all. If so, at least try to segregate tasks when there is a risk of losing a large amount of money.

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Accounting Controls Guidebook

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Freight In and Freight Out (#177)

In this podcast episode, we discuss the accounting issues related to freight in and freight out. Key points made are noted below.

Accounting for Freight In

Let’s start with freight in. This is the shipping and handling cost of bringing goods into a company. There’re a couple ways to deal with it. You’re allowed to include it in the cost of inventory. If you follow that path, some freight in cost may end up being capitalized into the month-end inventory. That means it won’t appear in the cost of goods sold until the related inventory items are eventually sold. That could work if you want to delay expense recognition.

Another option is to charge it straight to expense as incurred. This works pretty well if the amount of freight in is relatively small, and it reduces the amount of work involved in figuring out how much freight cost is included in the ending inventory balance. On the other hand, this could result in charging a bit more to expense up front than would otherwise be the case.

I come down pretty hard in favor of charging off freight in right away. Yes, it accelerates expense recognition a bit, but for most companies, the amount of expense involved is pretty small. The main reason for an immediate charge off is to keep freight in from mucking up the inventory records. It’s just one more item that gets loaded into the bill of materials or allocated through overhead, and one more item that the auditors need to be aware of when they examine the year-end inventory balance. And on top of that, you have to factor freight costs back out when doing a lower of cost or market analysis.

So, in short, I suggest charging freight in to expense as soon as you receive the invoice from the freight company.

But. There is one case where you might not want to do that, and that would be in a business with seasonal sales. Let’s say you produce goods all year long, but only sell them during a high season, like during the summer or the winter holidays.

If you were charging freight to expense all through the year, you’d have these odd looking financial statements that have a small amount of cost of goods sold in every month, but no offsetting sales, because sales only occur during the prime selling season.

In this case, you might have to capitalize the freight in cost, just to avoid questions from investors and lenders about why there’s this weird expense showing up in the income statement.

Accounting for Freight Out

And then there’s freight out. This is the shipping and handling cost required to deliver goods to customers. And, as was the case with freight in, there’re a couple of ways to account for it.

The basic method is to charge freight out to expense as soon as you incur the cost. A possible issue here is the timing of the recognition. Under the matching principle, all costs associated with a sale are supposed to be recognized in the same period as the sale. But, with freight out, you may not receive an invoice from the freight company until the next month, which means that the expense recognition is incorrectly delayed.

Given the amount of expense involved, a lot of companies don’t bother to accrue the expense in the correct period. They just wait for the freight invoice to arrive, and record it in whatever period that happens to be. I would say that accruing freight out in the proper period is more of a pain than it’s worth. You’d need to match up every shipment with every freight billing to see which shipments haven’t yet been invoiced by the shipping company, and estimate what the invoice should be, and then create an accrual. And to make the decision even easier, I’ve never heard of an audit firm that forces its clients to accrue for unrecorded freight out.

Another issue with freight out is what to do if you re-bill the freight charge to the customer. The choices are to either treat the billing as a form of revenue, or to offset the billing against the freight out expense.

Freight out billings to customers should only be treated as revenue if doing so is the primary revenue-generating activity of the business. It seems like a strange business model if that’s how a company turns a profit. Instead, you would normally offset freight billings to customers against the freight out expense line item. This should result in a pretty small freight out expense.

There may even be cases where the freight out expense is negative, if the amount billed is routinely higher than the amount of the expense.  If so, that’s fine.

Another issue is where to report both types of freight expense in the income statement. Both should definitely be in the cost of goods sold. I’ve heard an argument that the cost of freight out should be listed in the sales department, but that just makes no sense. Freight is clearly a direct cost that’s associated with a product sale, so it has to be in the cost of goods sold. It doesn’t relate to the daily operations of the business, and so it shouldn’t be included in the sales department, or for that matter in the general and administrative area.

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Accounting for Freight

Expectations for a Staff Accountant (#176)

In this podcast episode, we discuss the expectations for a staff accountant when you are the manager. Key points made are noted below.

Focus of the Staff Accountant

This may sound like a simple question, but it actually gets to the root of how to advance in your accounting career. Some people seem to stay buried in their original jobs for decades, while others move on pretty fast. For example, I know two people who started as accounts payable clerks. One is still there, thirty years later, and the other is a partner at Deloitte. What was the difference?

The Ideal Staff Accountant

Well, I’ve managed people for many years, and developed some pretty strong opinions about this issue. My first point, and the most important one by far, is that a staff accountant is hired to assist his supervisor with a problem that the supervisor has. Therefore, the staff accountant’s main focus in life is to make sure that the supervisor’s problem goes away. There’s nothing better for a boss than to hire someone into a position, and then never have another problem come out of that area.

So what does this mean? To start with, it means the staff person doesn’t require any re-training. They’re trained just one time, they take notes, and then they know how to do it. If there’s a problem, they figure it out on their own or ask a co-worker. The supervisor is involved in re-training as little as possible. So from the staff person’s perspective, this means taking what may be some verbal work instructions and translating them into a procedure. And then updating the procedure to make sure that you’ve got the process down perfectly.

If a staff person can do this, the view of the supervisor is that he was able to hand off a problem, and then the problem disappeared. At this level of expertise, a supervisor will look upon you as a good employee, but that’s not good enough to be promoted.

My second point is in regard to errors, and it relates quite a bit to the first point. A really competent staff person does not create errors, and also knows how to correct and prevent errors.

This means that when you create an error or find one, you spend the extra time to figure out how it appeared in the first place, you can fix it, and you know what kind of a procedural or other change is needed to make sure that it never happens again.

To reach this point requires that a staff person has a deep knowledge of their work. They don’t just have that procedure written down that I talked about in the first point. In addition to that, they know why each step in the process exists. They know why there are controls, what information is entered into the accounting system, what constitutes an error, and so on. At this level, a staff person is a complete and total expert in what he does. In fact, in some companies, if you asked a manager about the difference between a staff person and a senior staff person, they might say that a senior staff person is someone they’d trust to fix mistakes. In other words, a junior person creates errors, and a senior person fixes them.

So in the first two points, we’ve progressed from having a solid knowledge of work tasks to having a comprehensive knowledge of the entire process. And at this level of expertise, a staff person can expect some advancement within the department, but it’s not good enough to be promoted into a management position.

Which brings us to point number three. After knowledge comes improvement. A really awesome staff person is someone who takes their knowledge of the system and recommends improvements. And this should be ongoing, with a stream of changes going up to the supervisor all the time. If you can do this, the supervisor’s view is that he originally hired you to take away a problem, and now not only is the problem gone, but the whole area has improved.

A further point here is that the improvement suggestions have to be well-considered. That means knowing how to implement a change, and knowing what the effects of it will be. It’s quite likely that a supervisor will ask the person making a suggestion to go ahead and do it. So you have to be prepared to do so, and to get it right the first time. At this point, you’ve proved complete competence, and you can be relied upon to advance the state of the department. If you can reach this level of ability, the supervisor is going to recommend you for a management position.

Reaching this third level can take time, but some people dive into the work so fast that they can blaze right through the clerical aspects of accounting in no time at all. That’s why you see some people linger in jobs for years, while others are on the fast track right from the start. Usually, from the supervisor’s perspective, someone who is ready for promotion to management is incredibly obvious, simply because no one else in the department is trying.

The trouble is that so many people never get past the first point. They don’t fully understand what they’re doing, and they never wrote down their work instructions to begin with, so they’re always causing problems. Which leaves supervisors wondering if they need to find a replacement, not whether these people can be advanced.

This brings up the question of why someone can’t get past that first point, and I think it comes down to their level of interest in the job. If they don’t really want to be a staff accountant, or they find some element of their job to be annoying or not very interesting, then they don’t delve into it enough to make sure of how it works, and they certainly don’t try to improve anything.

If this is the case, my advice is that no job is completely perfect, but even so, you still have to be competent at all of it. I went from staff accountant to chief financial officer in about ten years, and I can assure you that there were annoying aspects to every job I had along the way, and that includes the CFO job. But I still went ahead and learned about the annoying parts.

So there you have my expectations for a staff accountant. There’re a lot of accounting managers who listen to this podcast, and with any luck, they’re all nodding right now, saying yes, that’s what I need from my staff – right there. Either that, or they’re simply nodding off.

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Goodwill Amortization (#175)

In this podcast episode, we discuss the new accounting standard for the amortization of goodwill for privately-held companies. Key points made are noted below.

The Nature of Goodwill

We have a new standard in Generally Accepted Accounting Principles, which is number 2014-02. This is about a different way to account for goodwill. Goodwill occurs in an acquisition, and it’s the difference between the price paid and the amount of the price that can be allocated to the assets and liabilities of the acquiree. So if you pay a high price for an acquisition, there’s going to be a lot of goodwill asset sitting on your balance sheet.

Previous Goodwill Accounting

Up until now, everyone had to do a periodic impairment test to see if the goodwill should be written off. The feedback that users were sending to the Financial Accounting Standard Board is that goodwill impairment testing is a pain in the butt. I happen to agree.

New Goodwill Accounting

So they’re now giving us an alternative. This alternative only applies to privately held entities. It doesn’t apply to publicly held companies or to nonprofits. There’s a project in the works to examine the same issue for those entities.

And the alternative is – to give you the option to amortize goodwill on a straight-line basis over a ten-year period. Or, if you can prove that a different useful life is more appropriate, you can even amortize it over fewer than ten years.

The one catch is that you still need to conduct impairment testing, but only if there’s a triggering event indicating that the fair value of the entity has dropped below its carrying amount. And, you can choose to test for impairment only at the entity level, not for individual reporting units.

Since the ongoing amortization of goodwill is going to keep dropping the carrying amount of the entity over time, this means the likelihood of an impairment test is going to decline as time goes by. And since impairment testing is only at the entity level, there’s even less work involved in whatever amount of residual impairment testing there might be. If you’ve ever been involved in impairment testing, you’ll realize that the large reduction in testing work will be awesome.

I suppose sort of a minor additional catch is that, once you elect to amortize goodwill, you have to keep doing so for all existing goodwill, and also for any new goodwill related to future transactions. So that means you can’t selectively apply amortization to the goodwill arising from just specific acquisitions.

And then we have some reporting requirements. On the balance sheet, you’d present the amount of goodwill net of any accumulated amortization and impairment charges, which is fairly obvious. This is the same logic we use in presenting fixed assets. And in the income statement, goodwill amortization is presented within continuing operations, unless it’s associated with a discontinued operation – and in that case, you present it with the results of the discontinued operation.

So what’s the real implication of all this? First, if a privately-held company has engaged in any sort of acquisitions activity, it’s probably built up a fairly substantial amount of goodwill. It’s quite possible that the goodwill asset is the largest line item on the balance sheet. Since goodwill doesn’t really mean much, this massive number tends to reduce the usefulness of the balance sheet. And, since impairment testing is a pain, I’d expect a lot of controllers and CFOs to be sitting with their company presidents right now, explaining why it would be a really great idea to start amortizing away all of that goodwill.

But – if you do that, there’s going to be a whopping amortization charge that offsets profits for a long time. As a reaction to that, I can see all of these private companies starting up campaigns to educate their investors and lenders about what they’re going to do, and how reviewing the income statement now means subtracting out the effects of amortization.

And it’s quite possible that all of this amortization is going to send people running for the statement of cash flows, since this is the least affected of the financial statements. The basic message is going to be, ignore what you see in the income statement, just look at how our cash flows are doing.

A minor additional factor is that this is just one more reason why smaller publicly-held companies might choose to go private. They may have built up a lot of goodwill assets while they were publicly-held, and now they have the chance to flush it out, but only if they go private.

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Figuring out Undocumented Processes (#174)

In this podcast episode, we discuss how to gain an understanding of the controls and processes of a business when there are no written ones in place. Key points made are noted below.

How to Manage the Documentation Process

This is important for a controller, since controls and processes are precisely what you’re responsible for. So, how do we go about doing this?

There is an easy solution. If the company has been audited in the past, it’s possible that the outside auditors have already done an analysis of processes and controls, and they can walk you through them. And provide a commentary about which controls don’t seem to work too well. So that’s your best way to go about it. But what if there’s no audit?

Well. In the typical organization, there could be a couple of dozen processes that the accounting department is involved with, so it could take a long time to figure out how they all work. So your first step is to prioritize. Which process needs the most attention?

To be blunt, it’s the process that’s most likely to get you in trouble if it doesn’t work right. And most of the time, that’s going to be customer billings, since not getting invoices out on time, or doing them wrong, is going to impact cash flow. So we’ll use the customer billings process as an example.

Example of Process Documentation

The first step is to interview the most senior person who handles billings. Use the interview to document how the process is supposed to work. Then go back over your preliminary procedure with the person, and see if you got it right. Then watch them do an actual billing, and see if it matches what you have in the procedure.

This gives you a rough understanding of how the process works. And – the documentation should include controls. So – take a look at the controls that you’ve been able to identify and see if there’s anything missing. If you think there might be, go back to the person you interviewed, and see if the missing control actually exists, but you just didn’t write it down the first time.

At this point, you probably have a reasonably accurate procedure, and a decent grasp of the controls. But that doesn’t give you the in-depth level of knowledge that’s expected of a controller. In addition, there needs to be a system in place for spotting screw ups. For example, an invoice isn’t priced correctly, or no sales tax was charged, or the customer won’t pay because an item was billed that was never delivered.

You can obtain this extra knowledge by keeping an eye on adjustments that flow through the billing system, like credit memos, or invoices that are written off and replaced. When you investigate these items, they’re good indicators of where the process is breaking down. Then make a note of the issue, and revise the process to fix the issue.

And that’s how you gain an understanding of controls and processes.

Areas to Investigate

So, what are the main areas to investigate? It’s going to vary by the type of business, so for example the processes for an insurance company will be quite different from the ones used by a casino or a restaurant. But at a minimum, you’ll need to focus attention on the big three processes, which are customer billings, accounts payable, and payroll. Once you have an understanding of those three, the next biggest process and controls mess is probably in the recordation of inventory. And after that, look at the two areas that involve cash, which are cash receipts and wire transfers.

That usually covers the main processes that can get you in trouble.

Now let’s take this from a different direction. The person who suggested the topic asked if you could understand controls and processes by looking at the chart of accounts and financial statements. My answer for the chart of accounts is no – the types of accounts used don’t tell a whole lot about processes. Accounts are just the buckets in which you store information.

The financial statements, on the other hand, can offer some clues. If the recognition of revenue and expenses in the financial statements seems to jump around a lot from month to month, that probably means the processes for recognizing revenue and accruing expenses are not being followed – if there’re any processes for closing the books at all.

And that brings me to the one other procedure that can get the controller in trouble, which is closing the books. If the financial statements aren’t reliable, then the underlying processes need to be documented and cleaned up. And that can take a long time. I talked about how to close the books back in episodes 16 through 25, and few more times since then. You might want to go back and listen to those episodes.

The Priority of Documentation

What I’ve outlined here really isn’t that difficult. The problem is that a new controller has a lot to do, and may not get around to these familiarization activities for a while. That can be a big mistake, since a basic knowledge of accounting processes is considered fundamental for a controller. If a few months go by, and you still don’t know how the systems operate, senior management is definitely going to think that you’re incompetent. And that means figuring out controls and processes should be completed early on, no matter how hard it might be to jam in the work.

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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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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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