Spreadsheet Errors (#193)

In this podcast episode, we discuss how to deal with spreadsheet errors. Key points made are noted below.

The Nature of Spreadsheet Errors

You rely on a spreadsheet for a long time without really figuring out how it works, and then one day you realize that there’s a flaw, and it’s been churning out incorrect numbers all along. This is a wee bit of a problem if you’ve been using those numbers for journal entries, since that means the financials are wrong, too.

The worst case I ever saw was a small company that had been using an incorrect spreadsheet to figure out how much overhead to allocate to their inventory. When the auditors came in at year end, they threw out almost all of the inventory asset, which wiped out the company’s net worth. So there you go. This sort of thing can be critical.

So why do we create complicated spreadsheets? Some of the time, it’s because the accountant who created them was incredibly detail-oriented, and so he just kept on expanding and expanding it, and next thing you know, it’s a full-time job to maintain a spreadsheet. The person might even take pride in having created one of the seven spreadsheet wonders of the modern world. Unfortunately, that’s a pretty common personality trait in the accounting profession. It’s just the way we are.

Justifications for Complex Spreadsheets

I can think of only one situation where a really complex spreadsheet might be justified, which is if it contributes toward billing a customer for more money. For example, there might be a cost reimbursement contract, so the more cost you can allocate to a certain customer’s job, the better. And that might require some complexity. I once ran across someone whose entire job was using massive spreadsheets to allocate the overhead costs from an airline reservation system, so that the company could bill the supporting airlines as much as possible for it. OK, I can go with that as a justification, but I certainly wouldn’t want to have that job.

So let’s just say that there are a few good reasons for spreadsheet complexity, and a whole lot of reasons to have simpler systems. Let’s go with option number two, and see what we can do with it.

Spreadsheet Best Practices

Now, the worst case of spreadsheet errors is probably going to occur when a different person takes over a spreadsheet. This would be a good time to force the new person to dig right through the spreadsheet, figure out how it works, and then present it to someone who’s more experienced. Until they can defend the spreadsheet, they’re considered to be temporary in that job, because they don’t know how it works yet.

You could go a step further, and force them to write up the essentials of the spreadsheet in a document. That document can then go into the department’s procedures manual, which would be great if the auditors ever need information about spreadsheets.

The problem with that advice is that someone only reviews a spreadsheet at long intervals – when there’s a job change. To compress the review process a bit more, put a spreadsheet review on the department schedule at pretty long intervals – maybe once every year or two, and do it during a slow part of the year, so it won’t be skipped.

When scheduling these reviews on the calendar, pay particular attention to any spreadsheets that directly impact the financial statements. In other words, if a spreadsheet has the potential to really screw up the company’s numbers, review it before the end of the year, so that no spreadsheet errors end up in the year-end financial statements.

Another option is to require a complete spreadsheet review whenever you want to make a formula change to a spreadsheet. That means documenting what you want to change, and having someone else inspect the alteration to see if it does what you want it to do. This is quite a bit like a software coding project, where there’s a team review to go over code – except in this case, it’s a spreadsheet.

And another thing. When you want to change an existing spreadsheet, copy the old version to a separate worksheet, and then make adjustments. That way, if the new spreadsheet doesn’t work, you still have the original to fall back on.

When doing any of these reviews, take a hard look at the inputs to the spreadsheets. There’s a good chance that the report the information came from has changed over time, because no one told the person who wrote the report that it was being used as input to a spreadsheet. So if the report changes, that screws up the spreadsheet. And by the way, that also means adding information about spreadsheet inputs to that write-up of the spreadsheet that I mentioned earlier, that goes in the procedures file.

Now, these detailed reviews are way too extensive if you apply them to every possible spreadsheet, since every accountant on the planet has a few dozen of them, if not a few hundred. The point is to conduct a deep investigation on just the really massive or complicated ones. If a spreadsheet is only a simple list, then don’t bother with it.

I’d also like to make a case for the complete avoidance of complicated spreadsheets. When you dig into most types of accounting, there isn’t that much of a need for these types of spreadsheets. For example, keep cost allocations simple, because – why not? Does a slight refinement of an allocation really result in any actionable information? Probably not.

So. When all of these types of reviews I mentioned are going on, part of the dialog should be whether a spreadsheet is needed at all, or at least whether it can be simplified. Accountants being accountants, we all love complexity – but this is one case where I’m not sure we should.

My final word on the matter is that spreadsheet errors aren’t usually considered to be critical – until just after you realize that they’ve been feeding you incorrect results. So the usual approach to spreadsheets is to ignore them, and then have a crisis review, but of only the spreadsheet that was screwed up, and then everything returns to normal – until the next spreadsheet explosion. If that’s the way you want to manage it, just be aware of the downside.

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Cycle Counting (#192)

In this podcast episode, we discuss how to install and use a cycle counting system. Key points made are noted below.

Interim inventory observations are just a physical count of the inventory that happens at any time other than the end of the year. You do an interim count when the inventory record keeping system isn’t giving you accurate results. That could mean there’s a perpetual inventory system in place that really stinks, or there’s a periodic inventory system, and that’s not designed to have accurate inventory records in the first place.

What to Do With Inaccurate Inventory Records

So basically the issue is that the inventory records are inaccurate, and what to do about it. There’re three options. You could guess at the ending inventory balance, which would be based on an extrapolation of the historical ending inventory figures for the past few months. This is generally a really bad idea, because it doesn’t account for all kinds of inventory write-offs that might have occurred, like obsolescence, or theft, or excessive scrap. So estimates of inventory tend to be too high, which means that the reported profit figure is too high.

Your next choice is to conduct a physical inventory count. If you’re going to do this, make them as infrequent as possible, for a couple of reasons. First, you have to shut down the warehouse to do the count. Second, the count involves staff time, and possibly on a weekend, so there’s also the cost of overtime. And third, the result isn’t necessarily all that accurate. The reason is that the people doing the count may not work in the warehouse, so they don’t correctly identify the inventory, or they miscount it.

Even so, there may be no choice, if you don’t want to take the risk of guessing at the ending inventory balance, and there’s no cycle counting system in place yet.

Which brings us to the third option, which is cycle counting.

The Nature of Cycle Counting

In short, cycle counting involves having the warehouse staff do a count of just a few inventory items every day. If they find a mistake, they correct it in the inventory records, so that the records match what they physically see. And on top of that, any error triggers a discussion about why there was an error, so there’s an ongoing investigation into the causes of record errors.

Over time, the number of underlying reasons for record errors goes down, which means that the accuracy of the inventory records goes up. To the point where there’s really no need to do a physical count at all. So that’s the brief view of cycle counting. I’ve installed the system in several companies, so I’ll add some additional thoughts about it.

The most important issue is that the basic record keeping system has to be a perpetual system, which is the one where the inventory records are constantly being updated for incoming and outgoing inventory items. And, the records have to be updated really fast. There can’t be a backlog of transactions that haven’t been added to the inventory records yet.

Otherwise, you get a situation where a cycle counter finds an error, and corrects the database to match what he found, and then the warehouse clerk records a transaction in the system that should have been recorded the day before, and now the inventory records are wrong. So to get around this problem, I suggest giving portable terminals to the warehouse staff, so they can update the records as they move inventory.

The next issue is how to select items for a cycle count. There’re a lot of ways to do it, like counting more valuable items more frequently, or counting items that are scheduled to be needed in production, so you can spot shortages in advance. My approach is the simplest of all, which is basically to start in the lower left hand corner of the aisle furthest to the left, and end at the upper right hand corner of the aisle furthest to the right. And that’s because it’s the simplest. The warehouse staff can do this themselves. Just put a piece of red tape at the spot where they stopped counting the day before, and count another small piece of real estate the next day, and move the red tape forward a bit to mark the new ending spot.

This approach is not fancy, but it’s not subject to much error – unless you lose the piece of red tape.

And actually, I’ve modified the basic system, so that we keep high-turnover items in one aisle, and have the best cycle counter count that aisle over and over again. That keeps any shortages from developing.

How to Do a Cycle Count

Now, how to do a cycle count. Figure out which block of real estate to count, and run a report from the inventory system that lists all of the items in that block. Then take the report over to the cycle counting area, and match everything on the report to what you see on the shelf. That covers half the work. Then you trace everything on the shelf to what you see on the report. The second step is needed to see if anything has been moved into a bin but not recorded in the inventory database – which is really common.

The next issue is figuring out when to do cycle counts. And the answer is, at the beginning of each shift. Once the flood of work hits the warehouse later in the day, it’s a real struggle for the warehouse staff to do cycle counts, so don’t put the pressure on them. Just get it done in the first few minutes of the day.

Another point is to assign the warehouse staff to specific count areas, so when you find an error later on, there’s no question about who’s responsible for it. That way, you can get a competition going among the warehouse staff, which gets pretty intense if you start handing out cash bonuses each week for who has the most accurate area.

The next thing to do is a weekly accuracy audit of the warehouse. This means comparing the inventory records at random to the physical inventory, and then posting the accuracy scores in the warehouse. This really matters to the warehouse staff, especially if they’re being paid bonuses, which I totally recommend.

In terms of progress, it’s pretty slow. The initial accuracy level might only be 10 or 20 percent, and it’s a long ways from there to 100% - which you might never reach. I usually declare victory in the upper 90% range, which could be anywhere from three months to a year down the road.

The Effects of a Cycle Counting System

But the nice part when you get there is that there’s absolutely no need for a physical count. If you were to do a physical count at that point, the accuracy level of the records would actually decline, because of the errors that creep into a physical count.

When the system is really working well, we’ve just printed out an inventory report and handed it to the auditors at the end of the year, and told them to go check our numbers. There was no physical count at all. The funny part was that the warehouse staff knew the records were perfect, so they trailed along behind the auditors – just to gloat when they couldn’t find anything wrong.

So, in short, the ultimate solution is definitely cycle counting, but it might take a while to get there. In the meantime, guessing at the ending inventory balance can be a career-limiting move, so it’ll probably be necessary to do some physical counts. The pain of doing those counts might provide a little extra boost to get going on a cycle counting program.

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The Elimination of Extraordinary Items (#191)

In this podcast episode, we discuss the new accounting standard that eliminates the separate reporting of extraordinary items in the income statement. Key points made are noted below.

The Prior Treatment of Extraordinary Items

The rule used to be that you had to separately identify an extraordinary item in the income statement, net of tax, after income from continuing operations. It was intended to strip away all extraneous items from the core operating results of a business, to see how well it was really doing. An extraordinary item was something both unusual and infrequent, and typically involved a large loss.

The Elimination of Reporting for Extraordinary Items

By eliminating this reporting requirement, we are showing a more comprehensive picture of outlier transactions that still impact a business. Realistically, we should be putting more items into the body of the income statement, to show the full range of financial results. This means adding back the results of discontinued operations, and putting fewer items in other comprehensive income.

This change in the accounting standards does not apply to IFRS, since the IASB never adopted the separate reporting of extraordinary items in the first place.

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The Intern Experience (#190)

In this podcast episode, we discuss the auditor intern experience. Key points made are noted below.

Intern Work Periods

Winter interns work from January through March, while summer interns work from June through August. Internships last a minimum of eight weeks, and may run to 11 weeks.

Intern Activities

Interns are treated as regular staff, and are expected to prepare work papers, perform procedures, and respond to review notes.

Winter interns typically work on year-end audit engagements, while summer interns are more likely to work on benefit plans.

Interns work on lower-risk cycles, such as auditing cash, fixed assets, and employee compensation. Could assist with revenue testing.

Converting Interns to Full-Time Work

The intern will receive a job offer on the last day of the internship, based on his or her performance. There is an internal evaluation process for this.

You get the summer off to study for the CPA exam, so full-time work starts in the fall.

The intern experience is helpful, since you already have some expertise when starting full-time work, have used the firm’s audit tools, and may be assigned to the same clients.

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Accounting for Acquired Intangible Assets (#189)

In this podcast episode, we discuss the new accounting standard relating to the accounting for intangible assets in a business combination. Key points made are noted below.

The Amortization of Goodwill

If you elect to amortize goodwill, then there is an option to stop separately recognizing some kinds of intangible assets. The first kind is noncompetition agreements. The second kind is customer-related intangible assets, unless they can be sold or licensed – which is unlikely. It is difficult to place a value on these types of assets, which means that someone reading the balance sheet of a company that has recognized these assets tends to ignore them. In short, no one thinks they’re real assets.

Rules for the Treatment of Acquired Assets

Under the old rules, if your business acquires another entity, it’s usually necessary to bring in a valuation expert who figures out what these intangible assets are worth. Then you record these manufactured assets as separate assets, and amortize them over time. And the outcome is just a number that’s stuck on the balance sheet. No one really cares if you now have an asset called customer relationships that’s worth a million dollars. In short, the acquirer pays a lot of money to create an unusable asset.

With the new standard, these types of intangible assets are shifted back into goodwill, which is probably where they should have been all along. And once they’re in goodwill, they’re subject to the standard amortization period, which is ten years or less.

The new standard does not apply to existing intangible assets. So any of those intangibles that are already on the books have to stay there, and you should continue to amortize them.

There is not much of a downside to this new standard. A private company will now spend less money on valuation experts, the accounting staff will spend less time tracking intangible assets, and the balance sheet will look a bit cleaner.

However, if there’s any reason to believe that a privately held company is going to go public in the next few years, then avoid this option. Since it only applies to privately held companies, going public means that you’d have to recast prior financial statements to include those intangible assets that you’ve previously avoided.

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Advising Management (#188)

In this podcast episode, we discuss how the accountant should give advice to management. Key points made are noted below.

Focusing on Key Issues

Decide upon just a few key concepts that can really help the business, and focus on educating the management team about why these items are such a good idea. This means keeping the number of concepts low, such as just one or two.

How to Talk to Management

Next, spend a few weeks figuring out how to communicate the selected concepts. This could be a presentation, or might involve the use of a consultant. Continue to make your case over a prolonged period of time, using multiple methods, and talking to people throughout the company. Using continual repetition makes it easier to drive home the message, and they will really understand what you are talking about.

When taking this approach, be politically correct, rather than annoying because of all the repetition. When to push and when to back off is a judgment call.

Subsequent Activities

When management finally agrees with you, continue pushing to ensure that the concept is woven into the fabric of the company, such as through the use of reporting systems and bonus plans. Only after this is done can you move on to another project.

If management simply does not want to listen, then your choices are to stay or to leave. If the job is a good one, it could be acceptable to stay for a while, and just work on improving the accounting department. This bolsters your resume for a move somewhere else. However, the long-term prospect is to look elsewhere for a better job, where your efforts will be appreciated.

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Cash Forecasting Accuracy (#187)

In this podcast episode, we discuss how to improve the accuracy of the cash forecast. Key points made are noted below.

The Need for a Cash Forecast

The company controller or bookkeeper might think that the main work product of the accounting department is the monthly financial statements, and that’s generally true. However. In a smaller organization, the accountant is also asked to create a cash forecast, which probably comes out once a week.

The management team depends on that forecast to figure out how much they can spend, and invest, or need to fund raise. So, what’s their opinion of the accountant’s skill level if an inaccurate cash forecast comes out every single week?

Cash Forecast Accuracy Enhancements

And that’s why we need to focus on improving the accuracy of the cash forecast. There’re a couple of good techniques for gradually improving the forecast. The first one is to limit the time period over which there is a forecast. If you’re really shooting for a high level of prediction accuracy, only forecast for one month out. Within that time range, you can use the company’s existing aged accounts receivable report to estimate when cash is coming in. The same goes for the aged payables report for predicting when cash goes out. Beyond one month, you’re guessing at the amount of sales that will be generated and you’re guessing at the amount of payables. So basically, there’s an immediate accuracy drop off one month out.

If the management team really insists on a longer prediction period, then go ahead and give it to them. But do some re-education regarding what I just said, so that they understand the issue. And on top of that, put a thick vertical line down the cash forecast that separates the first four weeks of cash forecast from anything coming after it, so there’s a built-in reminder that everything to the right of that line is suspect.

Next up, improve your accuracy within that four-week forecasting period with the 80/20 rule, which is the Pareto Principle. This means individually including in the forecast the 20% of receivables and payables that make up 80% of the cash flows. These items are so big that you have to include your best estimate for each one, or else there’s a major risk that the forecast in total will be wrong. Obviously, that’s a lot of work, but there’s no way to arrive at a high-quality forecast unless you put this kind of effort into it.

As for the remaining 80% of receivables and payables, it’s usually OK to spread it evenly across the four weeks in the forecast.

The next thing to do is install a feedback loop. Keep a copy of each weekly cash forecast, and compare it to actual results as soon as each week is over. This means really digging into the individual cash receipts and cash disbursements, to see where the differences are. And start taking notes. This is where you can really boost the forecast accuracy over time. Chances are, a lot of issues are going to appear.

For example, certain customers have a pattern of paying a little later or earlier than what you expected, or maybe there’s a more general pattern, like all customers paying later when a national holiday interferes with their payment cycles.

Or, you find that certain types of payments were completely missed in the forecast. For example, there may be a property tax payment, which only happens once a year, or a quarterly dividend payment, or annual pay raises went through for an entire department. Or, certain payroll taxes are higher in the beginning of the calendar year, because they’re capped. A couple of actions need to come out of this. One is to start developing an annual calendar of payment events, and mark on it when you expect each event to take place. Review this calendar every time you update the cash forecast.

And another outcome is to start developing a network within the company that feeds you information for the forecast. For example, the corporate secretary knows when the board of directors has approved a dividend. Or, the human resources director knows when pay raises are scheduled to begin, and for how much.

Over time, you’ll gradually figure out the nuances of the cash flows. But even then, there’re always changes going on, so the investigation never stops. Customers change their payment patterns, the company switches to different suppliers who have different payment terms, maybe there’s an acquisition, or fixed assets are purchased. Who knows.

The main point is that you have to maintain an inquiring attitude about the cash forecast, because actual results are always going to differ in some respects from what you thought would happen.

Now, an additional issue is to put into the forecast management’s reaction to the forecast. For example, if there’s a clear cash shortfall projected, then there may be a requirement to hold off on paying certain supplier invoices for a week, or maybe there’ll be a commitment from an investor to give the company a short-term loan. These adjustments need to go into the forecast, which means that issuing the forecast is really a two-stage process. Version one goes out, and then adjustments to it become version two. You should retain version two for comparison purposes when you do the feedback loop.

And a final issue is that, if management issues a mandate to delay payments, that you follow through and make sure that this happens. Otherwise, your own inaction will cause a forecast variance.

So what we need for better cash forecasting is to expand the level of forecasting detail, but only for a four-week period, create a feedback loop, install a calendar of cash-related activities, and set up a network that feeds you information about cash-related events. And make sure that you follow through on any reactions to the forecast.

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Inventory Variances (#186)

In this podcast episode, we discuss the nature of inventory variances. Key points made are noted below.

It can be incredibly hard and very product-specific to figure out a way to count certain types of inventory, and the result may still only be a guesstimate. The cost-benefit of using perhaps dozens of measurement systems to measure different types of inventory may not be very high. You could spend a lot of money to obtain more accurate information about your inventory, but is it worth the cost?

Use Multiple Measurement Techniques

Divide the inventory into clusters and adopt a different measurement technique that is specific to each cluster. Each of these clusters has different unique characteristics. By using clustering, you can reduce the number of measurement systems.

For example, for fertilizer that is stored loose, transfer it into drums or some large bin that has a measurement marker on the side. Then count the inventory by adding up the number of drums or bins, and using the measurement markers to get a rough idea of partial container quantities.

As another example, shift liquids into standardized containers that have monitors on the dispenser valves.

Another option is to weigh smaller containers to judge the amount of their contents.

An option when dispensing alcoholic beverages is to create a preprinted measurement marker label that you can stick on the back of a bottle, showing the increments for each bottle size.

Expect Some Variances

These measurements are not precise, so the related inventory variance may move within a standard range for each of the inventory clusters. For example, fertilizer will compact over time, so the volume may decline by a certain amount per month. This natural amount of shrinkage will probably be quite obvious over time. So, monitor the shrinkage percentage on a trend line and then set a variance investigation threshold based on the historical percentage.

A problem with this approach is that you’re assuming the historical rate of inventory shrinkage is normal. But, if someone has been stealing inventory all along, then that rate of theft is now included within the threshold level, so it will never be spotted. To get around this problem, consult with someone who has a good knowledge of the standard shrinkage rates for these types of inventory.

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Going Concern Disclosures (#185)

In this podcast episode, we discuss having to disclose whether your business is a going concern. Key points made are noted below.

The Going Concern Requirement

The requirement to disclose whether a business is a going concern is a GAAP requirement. The disclosure is needed if there is a substantial doubt about the ability of the company to continue as a going concern within the next year. This is a major issue, since a going concern problem can result in loans being pulled, credit requests being declined, and investors selling off their shares. This is a common issue with startup companies in particular, given their initial financial situations.

Going Concern Evaluation Criteria

Management’s determination of this matter is based on its evaluation of relevant conditions and events that are known and reasonably knowable as of the date when the financial statements are issued. Those conditions and events would mean that the business could probably not meet its obligations during the next year.

Mitigating Events

The disclosure is reduced if management’s plans for the future will mitigate these conditions or events. Examples of these plans are selling off assets to raise cash, selling shares, borrowing money, reducing expenses, or restructuring debt. This option is only available if it is probable that the plans will actually be implemented, and it is probable that the plans will mitigate the issues that have been raised.

Information to Disclose

The disclosure includes the main issues that raised a concern, as well as management’s evaluation of those conditions. Also describe the nature of any plans to alleviate the going concern issue. If there is no way to improve the situation, then the disclosure also has to state that there is a substantial doubt about the entity’s ability to continue as a going concern. If this issue keeps coming up in later periods, then you have to keep on making the same disclosure.

This analysis needs to be done in every interim period, not just at the end of the year. From a practical perspective, it will probably only be addressed as part of the year-end audit for privately-held businesses. A publicly-held company will need to do a quarterly review, since the auditors are on-site to conduct a review every quarter.

Adverse Conditions and Events

Examples of adverse conditions and events are negative financial trends, ongoing losses, declines in working capital, and negative cash flows. Other indications of financial difficulties are loan defaults, being unable to pay declared dividends, having to restructure debt, and being denied trade credit by suppliers. Another area of concern is internal matters, which includes work stoppages, long-term commitments that are not profitable, and being substantially dependent on the success of a specific project. A final area of concern is external matters, which include lawsuits, legislation, loss of a patent, loss of a major customer, and an uninsured catastrophe.

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Internships (#184)

In this podcast episode, we discuss all aspects of being an intern in the accounting department. Key points made are noted below.

Intern Issues for the Employer

Audit firms pretty much always pay their interns, but I keep hearing about other types of businesses only having interns come in if they work for free. I think this is a really bad idea, for a couple of reasons. First, it doesn’t give interns much of an incentive to work hard, and it could put them in a financial bind. Someone still in college really doesn’t have the financial resources to put up with this kind of penny pinching.

Second, it gives interns a bad view of the business. Who wants to take a job offer from a business that’s already proven that it doesn’t want to pay a reasonable wage? And third, it’s probably illegal. The Department of Labor has issued six guidelines for when it’s acceptable to not pay an intern. I won’t get into all of them, but the key items are that someone is not paid if the internship experience is solely for the benefit of the intern, and the employer does not gain an advantage from the activities of the intern.

So unless the employer is really committing to just providing training for its interns, there’s no way that not paying them is legal. So don’t do it. And furthermore, what you really should be doing is the reverse. If you find someone who’s really good, and you want to offer them a full-time job, they’ll be more likely to take the job offer if you paid them a somewhat above-average wage to begin with. This means you value their services.

Intern Issues for the Employee

My first point is to join the accounting club at school, if you have one. When someone comes in from an audit firm or some other business to make a presentation, make sure you talk to them afterwards. My reason for pointing this out is that my wife did this. The speaker was a partner at Ernst & Young, and he called up later and asked if she’d like to interview for an internship. Which she got. So this does work. The point here is that you have an opportunity to make an impression outside of the interviewing process.

Another concern is your appearance. Buy a good suit.

This is not a waste, since you may need it for regular interviews once you graduate, and you’ll need it on the job. You need that suit to get through what I would call the first threshold. Which is, if you’re not dressed appropriately, the interviewer will immediately assume that you’re not serious.

And furthermore, wear the suit for a day or two beforehand, to get used to it. You’re going to be nervous enough in the interview, so don’t make it even worse by not being used to the clothes.

Of course, having just given that advice, I can’t help but point out that right now I’m wearing a polo shirt, Nike track pants, and moccasins.

Anyways, of more importance is to prepare for the interview, so you’re not nervous. My wife did this by joining toastmasters and doing speeches in front of the group. I did it by entering a speaking competition at college, where the prize was to escort a famous businessperson around campus for a day. I got to escort Steve Forbes, who ran for president a few years back.

You can also practice the interview in advance. This means getting someone from the placement office or one of the professors to come up with some boilerplate questions, such as why do you want to work in accounting, and why do you want to work for the company – whichever one it may be. Then get back in that suit, sit in an office chair, and have someone lob those questions at you. And if you don’t get an answer right, then do it again, and again, and again. The outcome you’re looking for is to reduce the number of things that can make you nervous.

Next up, think of a few questions you want to ask them, and memorize the questions.

You need to impress the interviewer with how interested you are in his or her company, even if this is the third interview of the day, and you’re incredibly tired.

Which brings up another point. Don’t schedule more than two interviews per day, and one per day is better. Interviews are exhausting, and you’re not going to make much of an impression if you keep yawning through the second interview. And three interviews in one day is crazy. Don’t go there.

How to Make a Good Impression

Now. You’ve been brought in as an intern. How do you make a good impression, so you can get a job offer in a few months? First of all, look around at the office dress code and do your best after the first day to fit in as closely as possible. This may mean a late night shopping trip after the first day of work, and spending money that you really don’t have. Spend the money anyways. You don’t want to look too casual or too overdressed. The goal is to make clothes a non-issue.

Next up. No matter what they ask you to do, do it. Some items may seem so beneath you that they’re absurd. Do them anyways. The goal here is to reduce the workload of your boss. If your boss’ life became easier because you were in the office, you score points.

So let’s say that a manager comes by and asked you to do some work. What that manager is not looking for is to have you blast out an incredibly fast piece of work and have it back on their desk in an hour. In the accounting profession, the emphasis is on accuracy, not speed. That means you finish the work, take a break, and look at it again. There can be no errors in what you hand back to that manager. If there is an error, what are the odds that the manager will ask you to do more work? Or that you’ll be hired? This is incredibly important. I keep handing out this advice to students, and they keep ignoring me.

In addition, if there’s any kind of social event at all, you must attend. If there’s a night out at the local bar and you have something scheduled already, cancel it. Most interns are only working at a business for a couple of months, so there’s a limited window of opportunity when you can make a good impression. That means being around people as much as possible. If you go home as soon as the work day is over, you’ve just lost an opportunity.

And finally. Ask for more work. There’s no point in sitting passively at a desk, waiting for someone to come to you with a work assignment. Instead, go out and ask for something. Anything. Passive interns are not offered jobs. This does not mean that overly aggressive interns are offered jobs, either. They’re just annoying. Instead, make the rounds and see if there’s anything at all you can do, and be appreciative when someone hands over some work.

And incidentally, most of this advice can also apply to your work anywhere in the accounting field; it’s not just for interns.

Materiality (#183)

In this podcast episode, we discuss whether to make adjustments to the financial statements based on materiality. Key points made are noted below.

How Materiality is Defined (Or Not)

Some potential adjustments to the financial statements are too small to bother with, because they are not material. A common view is that an error can be ignored if it represents less than 5% of net income, because such an error will not alter the investment decisions of someone relying on the financial statements.

However, materiality is not defined in the accounting standards, so that 5% threshold is just based on common usage.

The 5% threshold may not make sense in a number of cases. For example, a tiny upward adjustment in net income could trigger a major bonus payout. Or, a small increase in the reported earnings per share will satisfy analysts, and probably keep the stock price where it is, while a slight reduction could trigger a major sell-off of the stock. As a third example, a modest upward tweak to the numbers allows a company to remain compliant with its loan covenants, while no tweak will cause a loan to be called and the company to collapse. In short, even slight changes in the financial statements could have a major impact.

SEC Materiality Rules

The Securities and Exchange Commission (SEC) has created some rules in this area, which apply to publicly-held companies. The SEC states that you can begin with a percentage threshold, but you must also look at the impact of errors in aggregate. Also, if an error has been occurring for some time, aggregate it to see what the total impact is. A further examination is to see if an error has a significant impact on a subtotal in the financial statements. In all cases, the correction should be made to the financial statements.

According to the SEC, if an error has been going on for a long time, and the cumulative impact has only just become material, then do a prior year adjustment for the errors that occurred in prior years. This adjustment can be made in the next filing of financial statements made by the company, rather than replacing old filings.

It makes sense for a privately-held company to follow the SEC rules, both to create more accurate financial statements and to have the statements compliant if the decision is eventually made to take the company public.

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Accounting Updates (#182)

In this podcast episode, we discuss how to keep up with the latest accounting standards. Key points made are noted below.

Basic Sources of Accounting Information

It’s useful to know where you can get the basic set of source material each year. Generally Accepted Accounting Principles are put out by the Financial Accounting Standards Board in Norwalk, Connecticut, which we refer to as the FASB. And International Financial Reporting Standards are put out by the International Accounting Standards Board in London, which is called the IASB.

Each one of them sells the complete set of accounting standards that they produce; so, you can buy the four-volume set of accounting standards from the FASB from their website, which is fasb.org. You can also buy the two-volume IFRS set from the FASB, though you can also buy it from the IFRS website, which is located at ifrs.org.

Most people simply buy these editions, and that’s all they do. But it’s also useful to know about what’s changing in the accounting standards. If you look at the IFRS books, there’s a section at the beginning of each chapter that lists any changes to the topic. That’s an easy way to figure out if there’re any updates that might impact you. And this may be enough, since there’s usually a year or two delay before a new standard goes into effect. So even though the book may be a few months old, it may contain all of the information that you need.

And by the way, I find that the IFRS books are extremely easy to read, especially since they split off a lot of the supporting material and stick it in volume 2. That means everything you really need is in just one book.

GAAP Research Issues

The GAAP books are not so easy. There’s a status section at the front of each chapter that points out the general topic areas that have been changed, but then you have to dig around to find out what the changes really are.

So with GAAP, the better approach is to go to the FASB website and look up the accounting standards updates on their search bar. We call them ASUs. These updates are a really fine piece of work. You can easily skim down the list of updates and see which ones might apply to you, and then download the PDF file. Each of these documents lists the nature of the change at a summary level, and then it lists the detailed change. They also note how the changes vary from IFRS. I think these are the perfect way to keep up to date on GAAP. Strongly recommended.

This is definitely your best bet for information about GAAP updates.

IFRS Research Issues

Unfortunately, they don’t have the same thing on the IFRS website. If you do a search on the word updates on that site, they give you PDF summaries of their meeting minutes. And I don’t know about you, but I have a lot more important things to do than to skim through those.

You really have two choices for getting IFRS updates. One is to wait for the annual book to be delivered, and just scan through it for the updates. It’s not that hard.

The other choice is to sign up for their e-mail alerts, which is what I do. The trouble is, you may receive a lot of updates, and nearly all of them are just about meeting notifications. That means you’ll have to sort through all of the e-mails to spot anything that might relate to you. I just wish the IASB could adopt the format of the accounting standard updates. Oh well.

One more hint in regard to IFRS is to go to their website and do a search on “Latest File Uploads.” That takes you to a page that contains PDFs of all the most recent publications. The trouble is that most of them are translations, so you may see something that’s actually pretty old – it just happens to have recently been translated into Russian.

A variation on this is to get a free account for the site, login, and then do a search on publication director. This has a bunch of sort options, so you can dig around through a lot of material. But, it’s just not as simple to use as the ASUs.

So in short, bookmark the FASB accounting standards updates page in your web browser, and buy the annual editions from both organizations. That will certainly keep you up-to-date.

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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.

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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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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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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.

Related Courses

Accounting Controls Guidebook

Accounting Procedures Guidebook