The Consulting Division of an Audit Firm (#241)

In this podcast episode, we discuss what it is like to work for the consulting division of an audit firm. Key points made are noted below.

Selling Requirements

There are many differences between the management consulting group and everyone else in an audit firm. One of the key differences is the need for way more sales activity. In auditing and tax, you may pick up a new client and then stick with it for years, so it’s recurring business. On the consulting side, projects tend to be discrete – which means that they happen once and then they’re done.

So, consultants are expected to dig a lot harder to find new business. Otherwise, the department runs out of projects and people get laid off – so there’s quite an incentive. Where possible, the senior managers and partners will try to work their relationships to get a sole source deal for a consulting project. That way, they don’t have to bid against any competitors, so their prices are higher. But a lot of the time, the consulting staff has to respond to a request for proposals document that’s issued by a prospective client.

Which means that a large difference between working in consulting, versus or audit or tax, is that you’ll become very good at writing these RFP responses. You could be involved in several dozen of them each year. Some firms have a group of specialists who only respond to RFPs – they don’t do any other work.

Project Size

Another key difference is the size of the projects. On the consulting side, there’s a lot of overhead cost involved in responding to RFPs, and of course you may win only a fraction of these bidding contests – which means that the size of the projects being considered needs to be large. It’s just not cost-effective to even bid on a small project. Instead, you want to park a bunch of staff on a consulting project for a long time – preferably a year or more.

For example, when I used to work at Ernst & Young, the most famous consulting project was a massive redo of the computer systems for Farmers Insurance. The project ran for way over a decade – so long that at least one person spent his entire career on just that one project. Those projects make a lot of money.

Which brings up the issue of what kinds of projects can last a really long time. Historically, these have been related to information systems. A consulting group loves these projects, because it takes forever to define the project specifications, write the software, test it, and roll it out. Yes, this means that a lot of hard core IT types work in the consulting division. But not everyone. They hire lots of accountants, because they need people to work on system specifications relating to accounting, as well as people to help roll out the software, which means writing training materials and training people on how to use the software.

Special Projects

Accountants are also needed for any number of special projects. For example, I was involved in examining the cost accounting systems for a slaughterhouse – which also wiped out any interest in eating sausages for about ten years. I also worked on the accounting procedures for a national health club chain, any number of software selection projects, and even did a best practices review of the administration of a college. So the work is quite varied. But in general, the work tends to focus on large systems projects.

Types of Personnel Needed

What kinds of people are they looking for? If the consulting group has landed an IT project, then they’ll need to staff it up with a lot of software developers. To do that, they could possibly recruit from colleges. But most of the time, they want more experience, so they won’t appear on college campuses. Instead, they’d rather hire you maybe five years into your career.

This delay in hiring isn’t just about getting more seasoned recruits. There are two other factors. One is that clients will hire a consulting firm based on the quality of the resumes they include in their RFP responses. And someone fresh out of college doesn’t yet have much of a resume. Instead, they need someone who’s piled up some accomplishments that makes them look impressive on paper. This is not a small matter. In some of these bidding competitions, there isn’t really much of a difference between the competing consulting firms, other than the quality of their staffs.

This has an odd side effect, which is that some consulting departments are very heavy on managers and very light on junior staff. And that’s because clients are willing to pay for managers – they want their projects to succeed, so they hire the very best. Some clients don’t even want to see junior staff on their projects.

Promotion Track

As you might expect, this means the promotion track in consulting is quite different from auditing and tax, where you start at the bottom and work your way up. In consulting, you’re more likely to come in as senior staff or a manager, and then start working your way up.

Travel Requirements

I had mentioned that there were two factors involved in delaying the hiring of consulting staff. The first issue was waiting for people to gain experience. The second issue is to not wait too long, because then people start settling down, buying houses, and having kids. And that means they aren’t willing to travel. And consulting is all about travel. You go where the work is, and the work could be absolutely anywhere. For example, I was based out of Denver, but almost never worked there. Instead, I was in places like Seattle, Houston, Kansas City, and San Antonio. And some much smaller places, like Denison, Iowa.

And then there’s the weekend commute. You typically head for the airport mid-afternoon on Friday, so you’ll get home later in the evening on Friday. And in many cases, you’re expected to be back at work Monday morning, so you have to fly back on Sunday afternoon. Which means that you only get Saturday completely off. And in other cases, there’s not enough of a travel budget to go home every weekend, so you’re expected to stay on-site, sometimes for months.

Now the travel may sound hard, but it’s actually kind of fun – for a certain age group. I would say the prime age range for consulting is from 25 to 35. During that time, living in different parts of the country feels more like an adventure than a burden. After that age range, not so much. I did consulting for five years, and enjoyed it most of the time.

Partner Requirements

The criteria for partner are different from what it takes to be an audit or tax partner. In consulting, the ability to sell completely overwhelms every other skill. And in addition, partners never really stop working – they’re always on call. A friend of ours is a consulting partner, and almost every time we take her up into the mountains for a ski trip, she’s in the back seat checking e-mails and doing conference calls. Because of the heavy workload and travel, a lot of partners retire well before the mandatory retirement age.

Careers that Combine Accounting and IT (#240)

In this podcast episode, we discuss careers that combine accounting and information technology. Key points made are noted below.

Applicable Personnel

This is a good topic for two groups of people. One is for people still in college, who might be considering a double major in accounting and computer science. The other group is people who are already accountants, and who have gotten involved in IT work within their companies, probably doing system implementations.

Project Types

If you try to be an IT specialist within the accounting department, the controller is most likely to need you when a new system is being rolled out. This is especially the case in a smaller company where there’s not much of an IT department, if any. But once the system is rolled out, you’ll be expected to go back to being an accountant, which doesn’t leave much time to hone your IT skills.

In a larger organization, there may be an ongoing series of IT projects within the department, so you’ll never be short of work. But, in a larger company, there may be several department locations, so you’ll be expected to travel to each one to handle the implementation. So in this case, there’s certainly a job there for you, but also lots of travel, which can be burdensome. And because you’re traveling, it’s pretty difficult to stay focused on getting promoted within the accounting department – so the chances are good that you’ll be stuck in the same position.

The Best Jobs

The best place for someone with both accounting and IT expertise is in a consulting company, probably as an implementation specialist. The usual position for this type of person is as a specialist in one of the really large integrated software systems, like Oracle or SAP. As an implementation specialist, you’re expected to know exactly how the system works, which flags to set in the system, how to test it, how to trainer users, and so on.

These installations are enormous – figure on each one taking a minimum of a year to complete, and probably a lot more than that. During that time, expect to be working on-site with the client. And that can put you anywhere on the planet, and not necessarily in the nicest locations. Not all corporate headquarters are in Paris. Though, about 200 major companies are located in Paris – so you never know.

The Small Company Option

So, let’s pick apart the alternatives. If you’re working for a small company, any IT skills you have are more likely to be considered a nice side benefit for your employer, but not absolutely essential. There’s also a risk that your career will be sidetracked into the specialist who maintains the accounting system. On the other hand, your job might be somewhat more protected if there’s no one else to take care of the systems. In regard to pay, the compensation could be somewhat higher, but there’s less of a track to a senior position, so your pay would probably be capped at some point.

The Larger Company Option

Now let’s switch to a larger company. In this case, you’re more likely to be a representative of the accounting department who doesn’t really do much accounting. Instead, you’re working with the IT department all the time, installing systems all over the company. The job pays well. But the odd thing is that there’s no real track to the top in either the IT department or the accounting department. Instead, you’re most valuable to the company as a specialist, so they’ll keep you there as long as possible.

This does not necessarily mean it’s a dead end job, where the implication is that the pay level is low. It’s not. The pay level is high. But you might feel constrained after a while, because you may be circling around through the same company locations over and over again for years, making return visits to install different systems.

The Consulting Option

The other alternative, as I mentioned earlier, is working for a consulting company. Yes, you will travel as a consultant. And yes, the pay is good. But those two points are the same if you’re working for a large company. The main difference is that there’s actually a career track in a consulting firm. In this role, you can work through the staff consultant and manager positions, all the way up to partner. And there’s one big difference between a consulting firm and an audit firm. In consulting, the career track is not up or out, as it is in auditing. Instead, if you’re a valuable person, they will find a spot for you. You might be parked in a manager role, or maybe go all the way up to the principal position, which is a variation on being a partner. And that’s not so bad.

But there are other issues with consulting firms. You’ll be expected to maintain a high level of chargeability, and course there’s the travel.

The Independent Consultant Option

This leaves the accounting / IT person with one other option, which is being an independent consultant. If you have really great skills at installing a particular piece of software, you can work for yourself and accept the jobs you want, usually as a subcontractor of a consulting firm. That means avoiding some of the worst client locations if you don’t want to go there, or at least being able to work from home a bit more. And you can take time off without having to worry about your chargeable hours. On the other hand, you’re probably being paid by the hour, so if you aren’t working, you aren’t getting paid. And there aren’t any benefits, since you’re the employer.

Summary

So there’s the mix of opportunities available to someone with an IT and accounting background. I have several comments. First, if you have this skill set, it doesn’t make a lot of sense to work for a smaller firm. Either you won’t get to use your IT skills very much, or you won’t be fully compensated for them, or you’ll be stuck in a niche.

Second, if you gain the IT skills while working for a larger firm, and you’re young enough to tolerate a lot of travel, consider applying to a consulting firm for a job. By doing so, you can make use of both sides of your training, gain lots of experience, and be on a promotion track. Which, by the way, is what I did. I had installed several systems at a company while working as its cost accountant, and then applied to the consulting division of Ernst & Young – where I became a consulting manager.

Related Courses

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Fraud Schemes: Cash (#239)

In this podcast episode, we discuss fraud schemes related to the theft of cash. Key points made are noted below.

Cash fraud is popular, because cash is usually untraceable – so if you can stuff it into your pocket and get off the premises with it, you’ve probably gotten away with a minor crime. I say a minor crime, because most organizations don’t keep a whole lot of cash on the premises, just enough to meet their immediate needs - so the theft of cash is fairly small.

Skimming

Let’s go through a few fraud schemes. One of the most effective ways to steal cash is to remove a portion of any incoming cash before it gets recorded in the company’s records, which is called skimming. There’re some really obvious ways to do this, like pocketing the cash from the sales of a hot dog stand, where there isn’t any record keeping. And some techniques are way more sophisticated. I remember one time back in the 1980s, when Deloitte was hired to investigate the theft of cash from one of the bars on the Queen Elizabeth 2 cruise ship. The task was to have Deloitte people sit at the bar all day and watch the bartenders.  They couldn’t figure it out, until someone mentioned the number of cash registers at the bar – which was one register more than there were supposed to be. The scam was that the bartenders added their own cash register, rang up a portion of the sales on that register, and then took the cash from the register. That’s quite innovative.

It’s even possible for the owners of a business to engage in skimming. When they steal money from their own business, the company earns less money, so it pays a reduced amount of income taxes. And the owners don’t report the stolen amounts on their personal income tax forms. So, in a twisted sort of way, stealing from your own company makes sense. The problem for an owner is that the owner sets the tone for the business, so if other employees see the skimming going on, they’ll probably do it too.

So how can you cut back on skimming? One approach is to require credit card payments in order to keep cash off the premises, but that doesn’t work too well in some types of businesses where cash payments are the norm. Another possibility is to install security cameras. Even if no one is watching the cameras, just having them present makes employees wonder if someone is documenting what they’re doing.

A good way to detect skimming after the fact is to monitor the gross margin percentage over time. The margin should go down when there’s skimming, because sales drop while the cost of goods sold remains the same.

But no matter what you do, the main problem is that skimming usually involves fairly small amounts of cash, so you might spend more money monitoring employees than you save by having no skimming. This is a tough call. In some organizations, they realize there’s some skimming going on, but they choose not to waste time tracking it down.

Discounted Sales

So let’s move along to a different type of cash fraud, which is discounted sales. In this situation, a customer buys something, and the sales clerk records it normally, so the system records a sale and outgoing inventory. Up to this point, everything is normal. However, then the sales clerk records a promotional discount in the system, takes the amount of the discount out of the cash register, and pockets the cash. The customer never knows, because he’s probably already walked away. This approach is clever, and the sales clerk can get away with it if he only records a few of these discounts each week. Otherwise, the controller will notice a lot of discounts being charged through the system, and will investigate.

It’s possible to stop this type of fraud by requiring supervisory approval before a discount can be recorded in the cash register, though that means calling over the supervisor – which might not be efficient. And of course, you can also install security cameras over the sales clerks.

Fake Refunds

A variation on discounted sales fraud is the fake refund. In this case, the employee creates a credit memo for a refund back to a customer, and then intercepts the check payment before it goes out, signs it over to himself, and deposits the check in his own bank account. There are some variations on this. One approach is to record a product return in the accounting system from a customer, which triggers an automatic refund payment in the system. Or, the employee could authorize a volume discount for a customer.

Fake refunds are always triggered by someone in the accounting department who also has access to outgoing checks. Otherwise, some of the refund payments will get out to actual customers, and they might contact the company about why they’re receiving a payment that they weren’t expecting. Therefore, a good way to keep it from happening is to maintain tight control over outbound check payments.

A good way to detect fake refunds is to look for actual inventory counts that are lower than their book balances. The difference is caused by fake returned goods being logged into the system.

Altered Receipts

And finally, cash can be stolen by altering receipts. This is most common in small firms, where a bookkeeper has control over the entire accounting process. They can intercept cash payments and alter receipts to cover the theft. As long as the bookkeeper keeps the amount of theft fairly small, any minor discrepancies between the amount of cash on hand and the amount stated in the books will probably be written off to expense with no investigation.

To keep this from happening, different people have to be responsible for the receipt of cash, recording cash, and depositing it at the bank. When you can do this, the person recording receipts has no incentive to alter records, while the person handling cash has no control over the recordation process.

Parting Thoughts

I’ll finish with a few thoughts about cash fraud. First, it can be really difficult to spot, especially when the person stealing cash keeps it down to small amounts and doesn’t steal very frequently. In those cases, the grand total stolen over time will probably be pretty small, and the person engaged in the theft is both smart and careful. So, you may never figure out what’s going on. And, if you install some expensive systems to spot the fraud, this type of person is too smart to keep stealing, and will just stop. So the perpetrator is still there, but you can’t prove anything.

Which does not mean that your basic choice is to either let these people keep on stealing or spend a lot of money to catch them. Another possibility is to keep all avenues of communication open – with employees and customers, and anyone else who might have cash dealings with the firm. These people may notice that something isn’t quite right, and you want to be on good enough relations with them that they’ll come to you about it.

And also, vary your routine a bit. For example, occasionally reconcile an account that you usually ignore. Or come back to the office after you’ve left for the day. Or come in early. Or switch jobs with someone else for a few days. By being unpredictable, you might find evidence of cash fraud. It’s not easy, but you might get lucky.

Related Courses

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The Audit Partner (#238)

In this podcast episode, we discuss the skills and attributes needed to be a successful partner in public accounting. Key points made are noted below.

Skills Required for Auditors

The best way to cover the topic is to describe the skill set you need at each level of the promotion path in an audit firm. We start with the base-level, newly hired auditor. At this point, you’re expected to take what you learned in school and actually use it. That’s not as easy as it sounds, and this is why about 20% of the incoming class of new auditors will leave the firm within one year, and another 20% the next year.

The auditing tasks you’re assigned in your first year are not especially hard, and you’re supervised fairly closely, so you won’t screw up too much. The audit seniors and managers are watching to see if you understand what you’re doing, and if you’re smart enough to ask for help when you don’t understand something. However, asking for help too much indicates that your knowledge of accounting and auditing isn’t good enough. At the end of the year, the audit managers get together with the partners and decide who has flunked. If you’re not good enough, you’re counseled out.

Therefore, someone who wants to make it all the way to partner needs to have a solid understanding of the fundamentals of how to audit. The same goes for the second year.

Skills Required for Senior Auditors

In the third year, and this varies a bit based on the firm, you’re promoted to audit senior. This means you get to deal with more complex topics, like valuing inventory. For a stretch of two or three years, they’ll throw the more complicated topics at you, and you’d better show a solid understanding of the material – or, you’ll be counseled out of the firm.

As you can tell, as you go through this half a decade of being a non-management staff person, you’re being evaluated all the time. There are a couple of reasons for this. First, they need to make room for the next incoming class of new auditors, so they have to continually cut older people who just don’t have the skill level.

And the second reason is that the next promotion is to manager, where you’ll be running audits yourself. And they really can’t afford to have anyone in the manager position who might screw up an audit.

Skills Required for Managers

And then you’re promoted to manager. By now, you’ve survived a lot of job cuts, and maybe 10% of your original group is still working for the audit firm. At this point, it’s been established that you know the audit skills. And, getting back to the original question, this means that an audit partner has to have a seriously excellent knowledge of accounting and auditing.

But as a manager, the focus changes. Now, you need to live up to the title. Can you manage an audit? There are a lot of steps in an audit, and you have to keep track of everything. On top of that, you’re being asked to oversee the audit staffers who’re working on your audit. And by the way, this brings up a third reason why audit staff gets counseled out. The audit managers just don’t have time to hold the hand of anyone who isn’t getting it, because these audits have time budgets, and the managers are expected to meet those budgets.

And in addition, managers are faced with one audit after another, in succession, all year long. That means they also have to know how to wrap up the loose ends on the last audit while already working on the next audit. This brings up another issue, which is that managers start working some fairly serious overtime. You can get away with less overtime as a staff person, but that’s not possible as a manager.

So at this stage, managers start to take themselves out of the firm. They get burned out, and audit clients start to give them job offers. Between the punishment of the work and some pretty nice compensation deals, it should be no surprise that a lot of managers leave the firm.

Assuming they stick around, managers stay in that position for about three years. By the end of that time, you can expect that at least half of them are gone. Maybe more. So let’s get back to the question – an audit partner should have managed so many audits that he’s completely comfortable with how the work is done, and he’s willing to work the extra hours.

Skills Required for Senior Managers

And that brings us to the final group, which is senior managers. These people continue to manage audits, but now they’re also expected to bring in new business. That means spending time, both during the day and after hours, networking throughout the local business community. And this is where extroverts start to shine. Up to this point, someone who’s a terrific accounting technician can become quite a competent manager, and could be promoted to senior manager. But that’s where a lot of people run into a hefty barrier, because they’re so uncomfortable with trying to sell audit business. They just don’t get it.

Skills Required for Partners

So, let’s say that the typical interval for being a senior manager is three years. During that time, it’s going to be pretty obvious which ones are really partner material and which ones can only sell an audit if the prospective client comes into their office and begs them to take the work. Therefore, getting back to the question, audit partners can to pull in new business on a pretty regular basis. They’ve figured out which of their contacts generate the most business for them. They only sit on those nonprofit boards of directors that give them the best return on their time, in terms of sales leads. They can make sales calls and close business. And this skill is on top of having excellent knowledge of the fundamentals of accounting and auditing, and being great managers. As you might expect, audit partners work massive hours. There’s just no way to get the in-house work done, as well as all the networking, within a normal working day. Instead, figure on working somewhere close to a 60-hour week, and longer during busy season.

But, there’s one more step, which is going from junior partner to senior partner. As a new partner, you’re given some of the crappiest audits and administrative work, because the senior partners don’t want to do it. So, even though your compensation probably doubled with the promotion to partner, your stress level went up, too.

So those are the skills and attributes of a successful audit partner. The success rate for making it all the way to partner is around 2%. And even at that point, the stress forces some people to retire before the usual retirement age. So I suppose a final attribute of a successful partner is being able to deal with a never-ending pile of stress.

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Artificial Intelligence (#237)

The topic of this podcast episode is the impact of artificial intelligence on accounting. Key points made are noted below.

The Nature of Artificial Intelligence

Artificial intelligence is the simulation of human intelligence processes by machines, which includes learning, reasoning, and self-correction. AI is usually applied to expert systems, speech recognition, and machine vision.

Artificial Intelligence in Collections

So where can this fit into an accounting system? I’d be a bit concerned about having an AI actually keep the books, since you’d somehow have to monitor the journal entries it was making. It could come up with some pretty strange financial statements. However, it could work well in the collections area. First, consider the state of the technology in the collections function right now. At best, you have a database that tracks which receivables are overdue, who to call and when to call them, and which keeps track of the results of each collection call. In essence, it’s a database that supports the work of the collections staff. It also provides a certain amount of automation, like automatically dialing customers.

How could an AI improve on the situation? Consider what it would be like if an AI takes the place of the entire collections staff. You’d have to interface the AI with the collections database, and add a realistic voice synthesizer. Then have the AI call customers directly. Let’s go through how this would work.

The Mechanics of Customer Contacts

As an example, the AI automatically calls a customer. The customer claims not to have received whatever you shipped to him, so he’s not paying. The AI pulls up the delivery information from the third party shipping firm and sends the information to the customer instantly, while it’s still on the phone. This means the customer could be barraged with all possible forms of transmission. The information could be attached to an e-mail, or a text message, or even sent by an old-fashioned fax. Or all three at once.

Then the AI interprets whatever the person is saying, obtains some kind of a commitment from the customer, and transcribes the entire conversation into the collections database. And the AI could be having similar conversations with multiple customers at the same time.

This is the ideal situation. Now, what if the AI can’t understand the customer or the customer is being unusually stubborn. In this case, the call kicks out to a real collections person, who handles the call from there. But these instances should be relatively rare, especially as time goes on. The reason is that the AI is always learning, so it builds a bigger database of experiences over time. Eventually, it should have dealt with even very low-probability situations, and will know what to do.

Third Party Service Provider

Now, consider what it would be like if the AI was maintained directly by a third-party software provider, so the system is not maintained by the company. In this case, the supplier may be running the same AI for thousands of phone calls every day for all of its customers. This means the system keeps getting better, and at a fast pace. The AI could end up learning from millions of phone calls, so it recognizes all kinds of accents and knows how to deal with every possible situation.

So, why would it make sense for a software company to develop a collections AI? Consider the business case. The software company could make a sales pitch that it will take over the collections function from its customers. Entirely. In exchange for an annual contract, clients could eliminate their entire collection departments, which could be a huge savings.

Let’s say that the supplier sets its prices at half what the in-house collections function was costing its clients. Would it be profitable for the supplier? Well, what’s the supplier’s cost? It’s almost all fixed cost, with a variable cost component for a backup collections staff that takes over when the AI can’t handle a call.

Cost Structure for Artificial Intelligence

The fixed cost is a mainframe for the AI, a backup power system, and the costs for a few thousand phone lines, plus developers to monitor the whole thing.  This costing structure means that the breakeven sales level is fairly high, but it’s nearly all profit for the supplier after that breakeven point is reached. So not only would this business be profitable, but it could create a billion dollar business, because it would make sense for a lot of customers.

Advantages of Artificial Intelligence

The reason I’m focusing on collections as a target for AI is that it doesn’t directly impact the accounting system. Instead, it just mimics a person in dealing with customers. And using an AI for collections is appealing for companies, because they can not only save a lot of money, but also the AI may be better than humans at collecting on overdue invoices. That means an AI could potentially accelerate the cash flows of a business.

Artificial Intelligence in Credit Analysis

Could AI be used anywhere else? I think so. Assigning credit to customers would be a good place for an AI. The system could access online credit reports, review the information, and issue a credit limit within a few seconds. That has two benefits. First, an AI always follows the credit granting rules, so it always issues the same amount of credit under the same circumstances. Which is to say that it can’t be persuaded by the sales manager to grant a larger credit line. The system would also learn from the ongoing bad debt history of the company, so its credit granting capabilities should improve over time.

There’s a good market for someone to create a credit-granting AI, since it could potentially be sold into hundreds of thousands of medium to large-size companies.

Artificial Intelligence in Auditing

Credit and collections are the best two opportunities. In addition, there might be a use for it in auditing, but only if there’s a way to input a lot of client financial information into the system. For example, what if a really large audit firm, like Ernst & Young, fed the financials for all of its clients into a central AI, which could then churn through the data and flag possible fraud situations? The AI could learn over time from the masses of financial statements, and probably develop a terrific skill level in fraud detection.

In this case, I don’t see AI saving money for audit firms through cost reductions. It can’t really replace auditors, since a large part of the job is having face time with customers. Instead, by pushing the fraud analysis angle, an audit firm could reduce its risk of being hit with shareholder lawsuits if it misses a client fraud situation.

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Accounting Automation (#236)

The topic of this episode is accounting automation - what traditional accounting processes are currently being automated, what might be coming in the future, and how to prepare accountants for this future state. Key points made are noted below.

The Underlying Accounting Process

The underlying structure of how accounting is conducted hasn’t changed at all in a long time. There’s a basic process flow that’s followed every time, everywhere. So when we talk about automation, what we’re really doing is using a technology tool to accelerate a small piece of the entire process – but the process itself doesn’t change.

Payroll Automation

For example, let’s look at payroll. This is the area that’s been automated the most. The basic underlying process flow for timekeeping is that someone writes their hours worked on a time card, which is submitted to accounting, which converts the time card information into a total number of regular and overtime work hours, which are then multiplied by pay rates to arrive at a gross pay figure.

Now let’s look at the technology that’s been added to this one small area. We now have timesheet apps on smartphones, and on websites, that can route this information into the payroll database without any need for data entry. We also have computerized time clocks that do the same thing, as well as biometric time clocks. So, the underlying process is still there, but tools are now available that strip out the related work.

Inventory Automation

And there’re so many more tools that have been added over the years. We bar code inventory in order to scan it into the system. We have remote deposit capture to scan incoming checks into our bank accounts. The payroll and payables departments use electronic payments. Suppliers send electronic invoices. And the accounting system can automate the three-way matching process for us.

Now, speaking of three-way matching. That’s the bit where someone in the payables department compares a supplier invoice to the authorizing purchase order and receiving documentation to see if the supplier can be paid. It’s a control point. This is one of those rare cases where the underlying process can be altered to make the payables process more efficient.  One way is to have the receiving staff approve received goods for payment at the receiving dock by checking off the received items against a list of open purchase orders in the warehouse’s computer system. Better yet, suppliers can deliver goods straight to the production line, and they’re paid based on the number of finished goods that came out of the production line. But this is a rare exception. And in both cases, those ideas were formulated about a quarter of a century ago. Which is to say that accounting process improvements are very, very rare.

Highest Levels of Accounting Automation

Now, in regard to which accounting processes are being automated. The most obvious one is payroll. There have been some advances in billings, payables, and cash collections. It’s possible for the accounting system to compile less-complex invoices for customers without any manual intervention. The same goes for payables, where suppliers can enter their own invoices through a portal, and the accounting system schedules the payments from there. And in cash collections, there’re fairly accurate systems that can automatically apply cash to unpaid customer invoices.

Problems with Accounting Automation

But that still leaves a lot of areas that involve mostly manual labor, such as liabilities, fixed assets, equity, collections, taxes, and inventory – especially inventory. These are all areas of opportunity if someone can figure out some new automation. But I don’t think it’s coming any time soon. And I have two reasons for thinking that way.

One is that a jump in innovation tends to coincide with a major new technology platform. So, we had a slew of new innovations when smartphones appeared, like having phone-based timekeeping and credit card processing and billings. That platform appears to be pretty much maxed out, so I’d be surprised if we see any more innovations from that platform.

My other reason is that, looking back on when innovations were first introduced, the rate of advancement is actually pretty slow. The first bar code scanner was produced in 1974. The first computerized time clock? 1988. Remote deposit capture? 2003. So in short, even though it seems like there are lots of automation tools, they’ve crept up on us over a fairly long period of time. Which means that it may be a long time before anything else appears.

Prospects for Future Automation

As for the question of what is coming in the future – it’s really difficult to say. After all, who could have predicted bar codes? It’s an inherently odd concept that happens to work really well. So no, I cannot tell. I can say that the areas most in need of innovation are where there’s a high level of transaction volume and a lot of labor, which points toward collections and inventory. If someone comes up with a great innovation in one of these areas, the potential cost savings would be so large that the adoption rate should be fast. And given the potential for rapid adoption, this is where inventors are most likely to be concentrating their attention.

The really good question is how to prepare for the future. Clearly, we can’t tell which innovations will appear, or when. But we can assume that whatever appears will need to be properly inserted into the existing processes. So. What I suggest is to pay attention in your accounting information systems class. That means having a complete understanding of exactly how and why accounting systems work, and why we have controls at certain points. Then, get involved in all systems integration projects in the company, to gain experience in how the projects are set up and managed. For example, if the company wants to install bar coded tracking of inventory, learn about the types of bar codes, where the labels are placed on products for readability, where to position scanners, what to do when the systems fail, what kind of training to schedule for users, how controls are altered, how to write the procedures for the revised system. How to test the system. There’s a lot to understand. If you keep volunteering for these projects, you’ll not only be indispensable, but you’ll also be much more marketable than the average accountant. And if any nifty new technology comes along, you’ll be in a great position to install it.

One final thought. New technology might be rare, but there are all kinds of other events in the life of a business that will call for changes to the accounting system. For example, management might decide to add a warehouse, in which case you’ll need to add accounting systems over there. Or there may be an acquisition, in which the systems of the acquiree need to be integrated with those of your company. Or the company decides to outsource its manufacturing, in which case there’ll be systems changes to link up with the new supplier. These types of changes are vastly more likely than entirely new forms of technology, so this is the area for which you need to prepare yourself.

Related Courses

Accounting Information Systems

Lean Accounting Guidebook

Job Hopping (#235)

In this podcast episode, we discuss the pluses and minuses of job hopping. Key points made are noted below.

Definition of Job Hopping

Job hopping means switching employers of your own volition within one or two years of being hired. Which is to say, you weren’t forced to leave because of a layoff or something similar.

Benefits of Job Hopping

Let’s look at this from several perspectives. One view is that you go into a company already assuming that you’re going to vacuum up a specific type of experience, and then job hop into something else that offers a different type of experience. This could make sense, for example, if your ultimate target is to be a chief financial officer, and you want to do a stint in cash management, just to pick up the basics, and then spend some time in risk management, and maybe another job in currency trading. Theoretically, this approach could accelerate the time it takes to be hired into a targeted job.

Under this line of reasoning, it’s not about getting a pay raise just for the sake of the extra money. Instead, it’s about achieving a specific position, so you’re trying to advance your career as quickly as possible. I don’t really have a problem with this, since the focus is on career building. However, if you hop through all of those intervening jobs too fast, it would be reasonable to expect that no one is going to give you a favorable job recommendation, because you didn’t stick around long enough to make a favorable impression.

The Pay Raise Conundrum

Another perspective on job hopping is that you’re pursuing the same job at different organizations in search of progressively higher rates of pay. Employers really don’t like this, because it’s a mercenary approach to your career. Shifting jobs for a bit more money can alienate your employer. It can make more sense to stick around in one position for an extra year or two, just to build up some goodwill with whoever might be writing your next recommendation letter.

The decision to switch jobs can be more difficult when the amount of the pay being offered by the next employer is a lot more than what you’re making now. Depending on your financial circumstances, the offer may be too good to resist, even if you know you’re going to tick off your current boss.

When to Leave Right Away

Another situation involving job hopping is when you’re not enjoying yourself in the current job. The required skill level may be too high or too low, or perhaps you don’t get along with a co-worker, or the commute is too long, or the job environment isn’t healthy – from any number of perspectives. In this case, why prolong the agony? Being unhappy at work can trigger all kinds of health problems, so my advice here is to leave as soon as possible, as long as the replacement job is a clear improvement. Otherwise, you’ll end up hopping from one job to the next in quick succession, and being dissatisfied in each one.

There may be another reason for the job hopping, which is that accounting is not a good fit for you. Maybe you don’t like the attention to detail, or the need to minimize mistakes, or maybe you’re not good with numbers. That last one would be tough. Whatever the reasons may be, you’re not going to do well in any accounting position, so stop job hopping within the accounting field and try something different.

As an example, I once ran into someone who had been admitted into one of the best dentistry schools in the world. He spent part of his first day poking around inside someone’s mouth, decided that he did not want to do that anymore, quit school and joined an amusement park. And no, I’m not kidding. That does not mean you should join an amusement park.

Downsides of Job Hopping

Now let’s look at some downsides to job hopping. One I’ve already noted is that you’ll have a hard time getting any decent references from past employers. If anything, you may have pissed them off. Another problem is that prospective employers are really concerned when they see a series of short-term jobs on your resume. In fact, the first thing I did when reviewing resumes for a job opening was to look for job hoppers, and immediately ignore those resumes. It takes too long to train someone into a position, just to have them leave a few months later, so that was a huge black mark. That does not mean that you can’t have one or two short-term positions on your resume. As far as I’m concerned, everyone gets a free pass on a few jobs in a career, because shit happens - a job doesn’t work out, and you need to move on. Even so, think carefully before switching jobs, because you may find that the new job environment is not as good as what you just left, which could trigger yet another job hop, and so on.

Summary

I’m not entirely against an occasional job hop, as long as you have a good reason for doing so. However, I’m also not a fan of people who persistently do it. If you’re in a job that’s pretty good, with reasonable prospects for advancement, and decent co-workers, it might be worthwhile to stick around for a few years. Chances are, you won’t be able to match that experience somewhere else.

And a final thought is to be wary of that new job prospect that a recruiter is telling you about. If someone occupied that position before and it’s now vacant, I’d be concerned about why your predecessor left. It’s entirely possible that the job you’re heading for has some real problems with it, and you’ll be blindsided by those issues when you show up. Which will trigger further job hopping.

How to Find the Right Metrics (#234)

In this podcast episode, we discuss how to find the right metrics for your business. Key points made are noted below.

The Need to Change Your Metrics

Metrics tend to be quite stale. There’s usually a traditional list of items, such as the ending cash balance, the amount of available debt left on the line of credit, or maybe a trend line of sales or profits. And then there are usually a few measurements that crept in because there were problems in the past, so the president wanted to start keeping an eye on them. For example, there might be a measurement for the number of customer returns, or maybe a measurement for the number of customer orders that won’t be delivered on time.

This existing set of measurements is not all that useful, for a couple of reasons. First, they tend to be focused mostly on financial measurements, which are too highly aggregated to be of much use. Just because sales have dropped by 4% doesn’t mean that anyone is going to take action. It’s usually not an overly large change, so it’s ignored.

A second problem is that they focus on the problems that the company used to have. Getting back to my earlier example, the number of customer returns is being reported, because it used to be the problem. It may not be a problem anymore.

A third problem is that the existing measurements are old, steady, and reliable. When managers focus only on these measurements, there’s a built-in assumption that there aren’t any other problems that need to be measured, so they never go looking for them.

The Controller’s Responsibility

And that last point is the real issue. When adding measurements to the financial statements, the controller has two responsibilities – one is to report them properly, which is what 99% of all controllers focus on. The other responsibility – which nearly everyone ignores – is whether the right measurements are being reported. Usually, the controller keeps shoveling the same measurements into the financial reporting package, maybe for years, without considering even once whether there might be some other issues out there that are flying under the radar.

Why don’t more controllers make an effort to find the right measurements? Or, for that matter, how come nobody seems to do it? The problem is that just about everyone is in a nice comfort zone. For example, the controller has to deal with the month-end close, the sales manager has to prep for a meeting with her sales staff, and the production manager needs to monitor the release of new jobs to the production floor. These are all administrative issues, and managers are usually quite competent at dealing with these kinds of things. None of these items need to be measured, unless the objective is to show how successful you already are.

How to Identify the Right Metrics

The real issue lies elsewhere. It involves digging around the company, and maybe outside of it, to figure out where the next problems are coming from. The controller is not going to hear about these issues at the next executive committee meeting, since the other managers probably have no idea that there’s an issue. Instead, you usually have to dig around in the roots of the organization, way below the other managers, to learn about the real problems. For example, Steve Jobs at Apple used to handle customer service calls every now and then, just to see what actual customers were saying.

Or, if you don’t want to go quite that far, how about digging through the customer service database – if there is one – to get a more aggregated view of customer problems. Or, talk to the people in the returns department to figure out which products are being returned, and why. Or, if the company submits bids to customers and loses a bid, how about calling the customer to find out what the winner had that you didn’t have? Or, how about talking to the purchasing staff to see if there’re any issues with receiving raw materials on time from certain suppliers? Or, how about talking to the people at the receiving dock to see if any suppliers screw up their deliveries? Maybe deliveries show up late, or they send incomplete orders, or they send the wrong parts. And here’s another one. What about tagging along on a field service call to repair a product in a customer’s home?

You could find out about whether the customer has to wait a long time for the service tech to show up, and what it is about the product that keeps breaking. And you have a great opportunity to chat up the customer and see if there’re any other problems.

Now, it could seem like this is going way beyond the normal job description of a controller. You’re snooping around in the areas of responsibility of the other department managers, which can create conflict. But consider that the controller has sort of a free pass to talk to anyone in the company. This is because you’re seen as being responsible for the financial health of the entire business, so you have not only a right, but an obligation to talk to everyone.

Another concern is that you may not like what you hear. This can be a bit of a problem, because, as I said earlier, most managers are administrators who are good at dealing with the current situation. They don’t go looking for trouble. And controllers are just like other managers. They don’t like to do this. And they really don’t like being the person who brings up these uncomfortable issues with the rest of the management team. Nonetheless, this is part of the job.

And a good way of looking at the situation is that going out and actively looking for trouble is exactly what sets apart the great controller from the average controller. It shows that this is the one manager who’s taking an active role in improving the business.

The Need to Dump Old Metrics

And a final thought is that the controller is also responsible for getting rid of any metrics that are no longer needed. It can be fun to do this and see how long it takes before anyone notices. Which could be another metric.

Related Courses

Business Ratios Guidebook

Key Performance Indicators

The Casino and Gaming Industry (#233)

In this podcast episode, we discuss accounting issues in the casino and gaming industry. Key points made are noted below.

Casinos as Financial Institutions

Casinos are classified as financial institutions in the United States, because they accept cash, they exchange currency, they issue checks, they handle wire transfers, and a lot of similar activities. That means they have to fill out a currency transaction report whenever a cash transaction exceeds $10,000 in a single business day. That report is filed with the Financial Crimes Enforcement Network. These cash transactions can be for things like buying chips, making bets in cash, or depositing money.

Structuring

Customers with a lot of illicit cash don’t want to be reported, so they do things like structuring. Structuring occurs when a customer breaks up a large monetary transaction into a bunch of small ones, such as making 20 small deposits with a casino in one day, rather than one large deposit that could trigger a currency transaction report. Or, he could use gaming day overlap, where he splits his cash transactions over a couple of days, so that a total transaction of $10,000 is split up over different reporting periods, which doesn’t trigger a report. Another possibility is to hand out cash to your associates, so that the casino’s tracking system doesn’t figure out that a lot of money really came from a single source.

Suspicious Activity Reports

And on top of that, a casino has to file a Suspicious Activity Report whenever a customer seems to be avoiding the requirements of the Bank Secrecy Act, which usually means money laundering. For example, someone brings in stolen cash and swaps the cash for chips. He then plays very little, in order to avoid any gaming losses, and then cashes in the chips in exchange for different bills. In essence, he just laundered the money.

Casino Controls

Casino and gaming operations have an incredible number of controls, and that’s because each one was put in place because someone figured out a new way to steal from them. Let’s go through some of the better ones. We’ll start with controls for dealers.

Dealers have to wear aprons, or pants without pockets, so that they can’t put chips into their pockets. A lot of casinos don’t allow dealers to wear watches, especially large watches, because you can slide a chip behind the watch. Another control applies to when a dealer leaves a gaming table or moves chips to and from the storage area, which is called the chip rack. Whenever this happens, the dealer has to turn his hands upward with his fingers fully extended, which is called clearing hands. The intent is to keep a dealer from palming any chips and walking away with them.

How about controls over chips? First of all, casinos only buy chips from reputable suppliers that maintain tight control over their inventories. Otherwise, chips could be stolen at the supplier and presented at the casino for payment. Once chips arrive at the receiving dock, the security team takes over and matches them against the shipping documents to make sure than none have been stolen in transit. And then they’re stored in the vault. And finally, when chips are worn out, a specialist chip destruction firm is called in, which grinds up the chips while being watched by security. This might all seem like overkill, but keep in mind that chips are directly convertible into cash, so the controls over the chips need to be as comprehensive as the controls over cash.

What about the controls over the counting of cash and chips? This takes place in a count room, which is monitored by security guards and video cameras. The count table is made of clear Plexiglas, so that any currency falling under the table can still be seen. Anyone on a count team has his identification examined before he can enter the room. Everyone on the count team has to wear a jumpsuit without pockets, so they can’t slip any money into their pockets. The team divides up tasks, so that one person empties the incoming boxes of currency, while a second person sorts and counts the contents, and a third person recounts the currency and fills out a summary form. There’s also a man trap leading into the count room, which is a segregated room that requires key access to enter and exit. It’s used to lock someone in place as they try to pass into or out of the count room.

And then we have key controls. Currency and chips are stored in drop boxes. One key is used to release a drop box from it designated location, such as inside a slot machine, while a second key is needed to open the drop box. So you always need two keys. Keys are only issued to someone on the approved key access list, and you’re only approved for one key – not both. That means it always takes two people to remove money from a location and then open the box. There’re lots more variations on key control, but you get the general idea.

I’ve just described maybe one or two percent of the controls used in a casino. There’re also controls over specific games, such as Keno and bingo, and the race and sports book area. And so on, and so on. My point in mentioning controls is that this is the ultimate industry for cash controls. It can be really instructive to see just how detailed and multi-layered these controls can be.

Table Game Operations

I’m going to touch upon a few more aspects of the accounting for casinos and gaming. One issue is, how do you keep track of table game operations? A rack of chips is maintained at each table, so that players can be paid on winning wagers. This rack constitutes the table inventory. Over time, the dealer pays out winning bets from this rack and replenishes it with losing bets. Because the house has a small percentage advantage on the games played, the number of chips in the rack should increase over time.

If chips are bought with cash at the table, then the dealer issues chips from the rack and then drops the cash into the table’s drop box – which I already talked about, where a security team occasionally shows up and takes the drop box to the count room.

So, what about if the dealer has to make a large payout? Then the rack has to be replenished, which is called a fill. There’re a bunch of steps here, but basically a security officer shows up with the extra chips, which the dealer counts and signs for.

Whenever a table closes or there’s a shift change, the dealer reconciles the ending table inventory, just like a teller would do at a bank. When the beginning and ending chip inventories are taken into account, along with all of the transactions in between, the difference is the gross gaming revenue for the table.

Slot Machines

Let’s switch over to slot machines. A traditional slot machine accepts coins, which first fall into a hopper, which holds a certain amount of coins that are used to pay out jackpots. Once the hopper is filled by customers, the overflow goes into a storage box at the bottom of the machine, which is then emptied and sent to the count room.

When a customer wins a jackpot, the machine accesses the hopper to pay the required amount. If the hopper is emptied before the full amount of the jackpot has been paid, the machine sends an alert to the local change person, who handles the payment of the additional amount. This type of slot machine is starting to go away.

The replacement version is the ticket in, ticket out system. When a customer wants to cash out of this kind of slot machine, he presses the Cash Out button and the machine prints a ticket, which contains a bar coded dollar amount. This ticket can then be used to drop money into a different slot machine, or to cash out. This newer slot machine requires much less staff time for servicing.

Deferred Revenue

So far, I’ve been talking about reporting and operational issues. Are there any actual accounting issues related to casinos and gaming? Oh yes. First, we have deferred revenue. Bets may be placed in the race and sports book area on events that haven’t yet taken place. When this happens, the bets are recorded as a deferred revenue liability.

Discounts on Losses

Next, we have discounts on losses. A casino may offer discounts on losses incurred by their top-level players, so that the customer only has to pay a discounted amount of his losses. These discounts reduce the amount of revenue recognized. In case you’re wondering why a casino would do that, the point is to set the discount low enough so that the casino still earns a profit, while still attracting the business of high rollers.

Jackpot Insurance

And then we have jackpot insurance. A casino could buy insurance to protect it from really large payouts. When a casino has a claim under a jackpot insurance policy, the recovery is reported as net gaming revenue. The premiums paid are a reduction of net gaming revenue.

Unpaid Winners

There may also be unpaid winners, where someone wins a game, but they don’t come forward to collect their winnings. If so, the casino still has to record a liability.

Accounting for Chips

And you can even capitalize chips and treat them as fixed assets – though the usual chip acquisition cost isn’t really all that high, so the cost is usually just charged to expense.

Missing Chips

And finally, we have missing chips. These chips could be redeemed at any time by customers, so the casino has to maintain a liability on its books for unredeemed chips. Some of these chips will be lost, or maybe customers want to keep them as souvenirs. So, the accounting staff makes an estimate of how many chips may never be redeemed, and reduces the liability based on that estimate.

Related Courses

Accounting for Casinos and Gaming

Accounting Ethics (#232)

In this podcast episode, we discuss accounting ethics. Key points made are noted below.

The Ethical Quandary of the Controller

I’ve mentioned ethical issues off and on in the previous episodes, but let’s get into this in more detail. And let’s start with an example. Let’s say that you’re the company controller, and you’re fairly new to the job. It’s the last day of the year, and the entire management team is going to receive a hefty bonus if the company can ship out a lot of deliveries on the last day of the year. It’s now mid-afternoon of that last day, and the president calls a meeting of the management team – he says that the company will make its numbers, but only if the shipping department keeps shipping orders like crazy until 3 a.m. the next day.

At this point, the president looks at you and says, “That’s OK with you, right?” This puts you, as the controller, in a terrible position. Keeping the books open late is fraud, because you’re taking sales from the next year and stuffing them into the previous year. But on the other hand, let’s look at all of the pressure you’re under. The president has just asked for your opinion in front of the entire management team. The whole team will lose their bonus if you tell the president that sales will be cut off at midnight – which is what’s supposed to happen. And you’re new, so you don’t exactly have any power within the group to support your own position. Chances are, because of all that pressure, you’ll let the late deliveries be recorded in the wrong period, and you just committed fraud. What is everyone else’s reaction? The president personally thanks you, the rest of the management team invites you out for a beer, and you get a bonus. This is the problem with ethics when you’re an accountant, because there’s usually a choice between taking an unpopular position that opposes everyone else, or going along with the crowd. And that’s hard.

Before we get into what you should do about it, let’s keep going with that scenario. In the next month, sales are low again, because you incorrectly recorded some of its sales in the previous year. So the management team fully expects that you’ll leave the books open again, because that’s what you did the last time. And once your initial decision is made to commit fraud, you’ll always be tagged with having a reputation as an easy controller, someone who’s always willing to bend the rules, just to help out the rest of the company. If you extrapolate this scenario all the way out, it could easily lead to a controller - who came into the profession with good intentions – ending up committing a massive fraud and going to jail for it.

A key point to take away from that scenario is that it’s not just bad people who engage in fraud. It’s also people who are perfectly fine, but who get twisted by the circumstances they find themselves in. In fact, I’d say that only a tiny percentage of all people in the accounting profession have such a rigid sense of ethics that they always make the right ethical choice.

The Source of Ethical Problems

So, what can be done? Let’s go back to that example. Whose fault was it, really, that the controller made a bad ethical decision? It was clearly the president. The president imposed pressure on the controller to make a bad call. This situation is really common, because the people who run companies don’t necessarily have a strong moral compass. If anything, too many of them focus so much on performance that they completely ignore how to run the company in an ethical manner.

This is a real problem for new controllers in particular. Consider the situation. You’ve just landed your first job as a controller. Why? Why did the president hire you? Quite possibly because he knows you need the job, and you’re so junior that he’ll be able to force you into making all kinds of bad decisions. This is more common than you might think, because a bad boss runs through a lot of controllers. He’s constantly cycling through them, because they quit as soon as they can.

So the first thing to do when you get into a job at a new company is to take a really hard look at who you’re going to be working for. This means talking to fellow employees and maybe calling up the person who had your job before you. If you find out that your boss has caused problems in the past, then he’s going to do it to you, too. If so, start looking for a new job right away. Yes, I know – you may have been unemployed for months before getting hired, and it’s not economically possible to quit. I understand, but you need to start the next job search anyways, even if you haven’t quit yet. By doing so, you may be able to slide into a new job somewhere else before you’ve been damaged too much.

Boss Reformation

It might be tempting to think that you can reform your boss. By acting like a virtuous saint, your boss will see the light and start donating to orphanages. Right. Someone who is ethically challenged is probably going to stay that way for life. So I’d still say that the best solution is to go somewhere else.

The Accounting Code of Conduct

But if you really want to try to make other people behave better, I have some suggestions for changes that are within your control. One option is to create a code of conduct for the accounting department. And bring it up at regular intervals, so that the staff knows you’re serious. Also, make sure that every supervisor within the accounting department acts like a role model. That means you impose the highest possible standards on them, and reinforce your expectations with them all the time.

Scenario Discussions

Another possibility is to never put your staff in the position of having to make a sudden, knee jerk reaction to an ethically challenging situation. Getting back to my earlier example, what if there was a formal discussion within the accounting department at regular intervals about how to react when someone asks you to keep the books open into the next month? You can walk the staff through a bunch of these scenarios and talk about what the correct response should be. By doing that, no one is thrust into a bad position where they’re making an intuitive judgment call. Instead, they just know what to do.

That obviously helps a great deal with the accounting department, but what about with the rest of the company? The rest of the company is not under your control, so the best you can do is set an example. In this case, it means telling the other managers about what you’re doing. This sends a pretty clear signal that you take ethical positions seriously. And when they know that, they’re going to be much less likely to even present you with those ethically challenging situations. So, in effect, you set up the accounting department as the temple of right thinking. Within that department, everyone has discussed what might happen, and they know how to respond.

The Impact of Good Working Conditions

What else can you do within the accounting department to avoid ethical issues? One approach is to provide them with good working conditions, like flexible hours, not much overtime, and a fair wage. When this is the case, they’re less likely to get back at you by stealing assets or engaging in some other shenanigans that aren’t good for the company.

Set Reasonable Goals

Another possibility is to set reasonable goals for people. Don’t set goals so ridiculously hard that the only way to attain them is by committing fraud. Instead, set modest goals that they should be able to achieve.

Emphasize Communications

Another item is to work on the highest possible level of communication within the department. It could be a staff lunch every week, or cycling through lunches with the entire staff on a regular basis, or maybe just wandering around a lot, so that everyone has a chance to talk to you. That way, if there’s a problem, you’ll hear about it sooner, rather than later.

The Benefits of Fairness

And a final item is fairness. An employee is more likely to engage in unethical behavior if he feels that he’s being dealt with unfairly. For example, there’re two candidates for the assistant controller position, but only one position. So someone is going to lose out. And the loser may be more inclined to do something self-serving to get back at the company. When you have one of these situations, be very clear about the criteria you’re using to make a decision, and explain your reasoning. Someone is still going to lose out, but it’s possible that with the extra communication, they just might understand your position.

Parting Thoughts

All of this may sound quite grim, and you may think that I have a skeptical view of company presidents. Yes it is a grim discussion, because you’ll run across more ethical issues than you would think possible over the course of your career. And yes, I do have a somewhat skeptical view of company presidents, because quite a few of the ones I’ve worked with just don’t think about the ethical ramifications of what they’re doing to their employees.

Related Courses

Behavioral Ethics

Ethical Responsibilities

Unethical Behavior

Dealing with a Subpoena (#231)

In this podcast episode, we discuss how a CPA should respond to a subpoena. Key points made are noted below.

Definition of a Subpoena

A subpoena is a formal document that orders someone to give testimony, and it’s usually issued by a court. Though, to be accurate, it’s usually issued by an investigating attorney without the knowledge of the court.

There’re a few kinds of subpoenas. The first kind is a witness subpoena. As the name implies, the recipient has to appear in court on a certain date and testify as a witness, usually in a trial. A variation on this is a deposition subpoena, where the recipient has to provide copies of business records and possibly appear at a deposition to answer questions asked by one of the parties in a lawsuit. This variation is part of the discovery process before a trial.

And the one that’s most likely to matter to the CPA is a subpoena for the production of evidence. This version requires the recipient to produce any records under his control at a specific time and place. In this last case, the CPA may be able to just mail in the records, or perhaps even use e-mail for the delivery. Which is to say, there may be no need to appear in person at all.

If you don’t comply with the requirements of the subpoena, then you can be charged with contempt of court, which can lead to fines or jail time. So in short, there is a legal requirement to comply.

Why the CPA Receives a Subpoena

So why would a CPA receive a subpoena? Probably because you have control over some client records that an attorney wants to look at. For example, there may be an investigation of fraud at a client company. Whatever the reason for the subpoena, this presents a problem for the CPA, because the AICPA Code of Professional Conduct states that a CPA should obtain the consent of a client before disclosing any confidential client information. However, the code of conduct also provides for a few exceptions to the rule, one of which is that it’s acceptable to disclose confidential client information if there’s a validly issued subpoena enforceable by court order.

Steps to Take

So, you’ve received a subpoena. Now what? The first step is to contact your attorney. The attorney will want to review the subpoena to see what kind of legal proceeding is involved, such as whether it’s a civil case, a criminal case, a tax case, and so on. There’s a different set of rules governing each of these types of legal proceeding. The attorney will also want to review both the situation and the document, to see if the subpoena was served properly and that it’s valid. Depending on the rules, a subpoena might have to be served to the CPA in person, or it might be acceptable to mail it. As another example, a subpoena issued by a state court is only valid in the state where it was issued.

The attorney will then want to talk about exactly what’s supposed to be produced. The attorney can advise on which documents need to be produced and which to hold back for other reasons.

According to the AICPA’s interpretation of its code of professional conduct, you do not have to notify the client that its records have been subpoenaed. Though you still can contact the client, except in cases where the subpoena is supposed to be kept confidential – which can happen with a grand jury. It might be useful to contact the client, in case your agreement with the client allows you to bill it for the cost of preparing any documents for a subpoena request.

The AICPA’s interpretation also advises that you might want to consult with your state board of accountancy, perhaps so that they can provide some additional knowledge about how the state-specific ethics rules might relate to the subpoena.

Objecting to a Subpoena

The client or your attorney can request that you object to either the scope of the request or the nature of the documents to be provided. This can be a valid concern when the subpoena covers confidential information, such as trade secrets or market development plans.

But before making an objection, it can make sense to have your attorney contact the attorney that issued the subpoena, to get a better understanding of what’s going on. The person who issued the subpoena may not realize just how much effort is needed to comply with it, and so could allow you to respond with a reduced amount of paperwork. This means negotiating for a narrow scope on the subpoena.

If you do decide to object to a subpoena, document everything in a letter and send it to the issuing attorney by registered mail, so there’s a record that the attorney received it. Depending on the situation, making an objection can mean that you no longer have to comply with the subpoena, unless the issuing attorney obtains a court order that enforces it. Consult with your attorney about this, since the rules depend on the situation.

A variation on issuing an objection letter is to file a motion with the court, asking that those parts of the subpoena relating to your objections be cancelled. This approach might work better when the issuing attorney is being a pain.

The Issuance of Documents

When it comes time to send documents to the issuing attorney, be sure to only send copies of the documents, since the originals might otherwise get lost or damaged. Also, make a complete record of exactly what was sent, which can guard against complaints that you didn’t send everything that was requested.

Accountant-Client Privilege

That’s the essential process flow, but we’re not done yet. In addition, quite a few state governments recognize an accountant-client privilege. This privilege means that the information communicated to the CPA by a client in regard to an accounting engagement is confidential. This information belongs to the client, not the CPA, so consult with your attorney to see if any documents are protected by this privilege.

There’s something similar to the accountant-client privilege in the tax area, which is the federally authorized tax practitioner privilege. This one only applies to tax advice between a client and its federally authorized tax practitioner. It probably doesn’t apply to most of the work papers involved in preparing a tax return.

Related Courses

Professional Rules of Conduct

Sales and Use Tax Audits (#230)

In this podcast episode, we discuss sales and use tax audits. Key points made are noted below.

The state government may send a team of auditors to a business, to see if it’s been remitting the correct amount of sales and use taxes. If it hasn’t, the business not only has to pay the missing amount of taxes, but also interest on the unpaid amount and penalties.

Your Chances of Being Audited

Who is most likely to be audited? Look at it from the perspective of the government. Audit teams are expensive, so they need to be targeted at businesses that are most likely to end up paying more in fees and penalties than the cost of the teams. This means larger firms are more likely to be targeted. In addition, if an audit team finds a significant problem, the business will probably be put on a watch list, and so is more likely to be targeted again in the future. This does not mean that a small business will never be audited, but it is less likely.

Another possibility is that a company will be audited as the result of an audit of someone else. For example, a supplier is audited, and the auditors note that the company wasn’t charged sales tax on a large invoice. They then target the company to see if it paid use tax on that invoice. Use tax compliance tends to be much worse than sales tax compliance, so this kind of investigation can be easy money for an audit team.

How Auditors Find Errors

How does an audit team find sales and use tax errors? They send a notification to the targeted company, stating which time periods they want to look at. When they arrive, they select a sample of the customer billings and supplier invoices from these periods, and see if there were any cases on these invoices where sales or use tax was not paid. When no tax was paid, the auditors see if there was a valid sales tax exemption certificate that was the basis for the nonpayment. The auditors also check to see if all sales and use taxes were remitted to the government, both in full and by the required payment dates.

The auditors may go even further, and investigate whether any sales made to dispose of old assets had sales taxes charged on them. After this work, the auditors compile a list of all exceptions found, and forwards them to the company controller for review. At this point, keep in mind that the business is assumed to be guilty unless it can prove otherwise, so the controller has to make a valid case for why sales or use tax was not paid.

The Error Rate Extrapolation

If the controller cannot make a persuasive case to the auditors, then the exceptions are included in an error rate extrapolation. What this means is that the auditors extrapolate the error rate percentage they found in their sample to the full population of customer billings and supplier invoices.

For example, if the auditors find that $100 of sales tax was not collected in a sample that comprises ½% of a company’s total sales volume, it will extrapolate this finding to the rest of the company’s sales – which in this case results in a total charge for uncollected sales taxes of $20,000. And then, the auditors add a late payment interest charge onto the extrapolated amount, plus penalties. The result can be a startlingly large amount that has to be paid.

Pursuing Customers for Sales Taxes

It is technically possible that a business could go after its own customers for sales taxes that it never charged them, but this is not likely, either because it damages customer relations or because the sales occurred so far back in time that collecting the amounts due is impossible. So instead, the company has to pay the entire amount.

Damage Mitigation

How can we minimize the damage caused by one of these audits? First, conduct a periodic review of the Department of Revenue’s listing of what is and is not exempt from sales tax. This is most applicable when the company currently is able to not charge sales tax, since that exemption could go away. Second, if customers have submitted sales tax exemption certificates, make sure that they’re up-to-date and completely filled out. If not, the certificates are not valid and sales tax must be charged. Third, make sure that there’s a solid process in place for calculating and paying use tax. This is an area that’s usually quite weak. And finally, conduct your own internal audit to see if any exceptions crop up. If they do, figure out how the process broke down, and fix it.

How to Treat Auditors

An additional issue is how to treat auditors when they show up on the premises. As an overall guideline, these people are professionals, so treat them with respect and give them a decent amount of office space to work in. That being said, there are a few guidelines for minimizing the damage they can cause. First, have them work in an area away from the rest of the employees, so that they don’t overhear conversations that might cause them to expand their audit. Second, have just one point of contact between the auditors and the rest of the company, and have this person carefully review everything submitted to the auditors. Doing so keeps the auditors from ever receiving inaccurate or misleading documents. And third, minimize communications between the auditors and the rest of the company. It is not helpful for the auditors to walk around, quizzing everyone about what they do and trying to dig for more information. So, talk to the accounting staff before the auditors show up, and tell them to only respond to direct questions and to not volunteer information. And finally, don’t volunteer to give them a tour of the company. If they get a tour and then see some large and expensive equipment on the premises, they may want to investigate whether sales or use tax was paid on it.

Parting Thoughts

In general, the key to surviving a sales and use tax audit is to have solid systems in place already, so the auditors won’t find much of anything to include in their error rate extrapolation. This means that charging sales tax to customers should be your default method of operation. Any sales tax exemption certificates from customers should be well-organized and reviewed on a regular basis. There should be a solid use tax calculation system in place. And finally, make sure that sales and use taxes are paid on time, every time.

Related Courses

Sales and Use Tax Accounting

Sales and Use Taxes (#229)

In this podcast episode, we discuss sales and use taxes. Key points made are noted below.

Sales Tax Basics

Sales tax is charged when there’s a sale of tangible personal property, which is to say, most anything but real estate. And it can also be imposed on the sale of some services. The seller collects the tax and remits it to the government, which in the United States is usually the applicable state’s Department of Revenue. That much seems simple, but then things get more complicated.

The seller only has to collect sales tax if it has nexus, which means that it has regular and systematic contacts in an area, usually through its employees or property. That means the seller has to collect sales taxes if, for example, it maintains a warehouse in a state, or its salespeople travel to a state to solicit sales, or it uses its own vehicles to transport goods into the other state. If this is not the case, then the seller does not have to collect sales tax. Instead, the buyer has to pay the government the sales tax, except now it’s called use tax. Also, the use tax is paid to the government where the buyer is located, not to the government where the seller is located.

So in other words, some sort of a tax is always paid, except that the name of the tax may change, and the government to which the tax is being paid may also change.

Sales Tax Exemptions

But of course, the situation gets even more complicated. Then we have sales tax exemptions. Each state has its own list of exemptions where you don’t have to pay sales tax. And it’s a long list. I looked up the exemptions list for the State of Colorado, and it’s 20 pages long. For example, no sales tax is due when selling firewood or propane for residential use. Or, alteration services are not taxable, as long as they’re billed separately from the sale of clothing. Or – and I like this one, it nearly defines what a bureaucracy does for a living - water sold through a pipeline is not subject to sales tax, though bulk water sold in tanks is subject to sales tax. Go figure.

The point is, there’re many exemptions from sales tax, so you have to check the rules that apply to wherever you have nexus. And on top of that, some buyers have sales tax exemption certificates.

These certificates authorize a buyer to not pay sales tax, either because of the manner in which it’s using acquired goods, or because of the nature of the business. For example, the purchases made by a farmer are usually tax-exempt, because the purchased goods are then used to grow crops. Or, the raw materials bought by a manufacturer are tax exempt, because they’ll go into finished goods that will then be sold, and the buyer of those goods will pay sales tax. Or, the nature of the business may allow an organization to avoid paying sales tax. This usually means governments, religious institutions, and non-profits.

When the seller receives one of these sales tax exemption certificates from a buyer, the seller needs to keep a copy of the certificate, in case its books get audited by the government and it needs proof that it acted correctly. If the exemption is out of date or was only partially filled in, the auditors can declare the certificate invalid, in which case the seller is now liable for the full amount of the sales tax that it didn’t charge the buyer.

And it gets better. Even when the seller has received an exemption certificate, the seller is not necessarily off the hook for sales tax liability.  The seller has to use his best judgment to see if a sale falls within the restrictions imposed by the exemption certificate. If a buyer tries to buy something that’s outside of the exemption range, the seller is supposed to figure this out and charge sales tax. And that really means that the sales clerks who are taking care of these sales have to be trained in how to deal with exemption certificates – which they probably aren’t. Instead, it’s quite likely that they’re relying on what the customer tells them, which may not be accurate.

Layers of Sales Taxes

But of course, it gets even better. Sales taxes can come in multiple layers. There’s the state-level tax – except for states that don’t have any sales tax – and there’s the county-level tax and the city-level tax, and there’re probably one or two special tax districts inserted in there somewhere, too. An example of a special tax district is one that’s intended to pay for a new sports arena that the taxpayers voted for. Once the bonds are paid off, this type of special district goes away. Other districts, like transportation districts that pay for a subway or light rail line, are more likely to be permanent. In total, there’re about 10,000 government entities in the United that can charge sales tax. The clear champions for tax districts are Texas, with more than 1500 of them, and Missouri, with more than 1200.

Each of these tax districts gets to charge its own tax, which is piled on top of the sales taxes from the other tax districts to create the aggregated sales tax that a person or a company actually pays when making a purchase. If any one of these districts changes its tax rate, that changes the tax rate that the seller charges when it sells goods. As you might expect, tax rates usually go in only one direction, which is – up. Therefore, if the seller doesn’t keep up-to-date on the latest sales tax rates and keeps charging the old rate to its customers, it may find that it’s been under-collecting sales tax. And when this is the case, the seller has to come up with the shortfall.

Overcharged Sales Taxes

In those rare cases where the seller has been over-charging sales tax, it cannot keep the overage. Either it returns the excess to the customer or it forwards the excess to the state government.

Private Letter Rulings

What if an organization is in an unusual line of business that doesn’t seem to be covered by any of the sales tax regulations? In that case, you can request a private letter ruling from the state government. To do that, you send them a letter that describes your circumstances – along with a fairly hefty fee – and they send back a ruling. You can usually rely on this ruling in deciding whether to charge sales tax.

In addition, the state government then deletes all identifying information from the ruling and then posts the letter on-line for everyone else to see. The private letter ruling can only be relied on by the business that asked for it, but everyone else can use the ruling to make an estimate of how the letter pertains to them. I strongly suggest bookmarking the page on your state’s website where these rulings are listed, and checking it every now and then to see if any new rulings have been posted that might apply to you.

Use Taxes

Let’s switch topics, to the use tax. How do you calculate it? The most labor-intensive approach is to review every single supplier invoice to see which ones don’t contain a sales tax and aren’t covered by an exemption certificate, and then accrue an expense for the use tax on the remaining invoices.

To save time, create a report in the accounting system that aggregates all invoices coming from out-of-state suppliers. Then include a flag in the vendor master file for all of the out-of-state suppliers that still charge the company a sales tax, and use this flag to exclude those suppliers’ invoices from the report. Then use the same approach to flag suppliers that only ship goods that are exempt from sales tax.

After you’ve completed these refinement steps, the total use tax due on the final report should be fairly accurate.

Sales Tax Payments

And one final comment. Sales tax payments usually – but not always - go to the state government, which turns around and allocates a portion of each payment to the applicable county, city, and special tax districts. This makes the remittance of sales taxes fairly easy for the seller.

This is not always the case for the payment of use taxes. You may need to make separate use tax payments to each one of those entities. That means a separate use tax payment to the state, and the county, and the city, and each one of the special districts.

In short, I think you can consider the sales and use tax regulations to be a sort of full employment guarantee for accountants.

Related Courses

Sales and Use Tax Accounting

The Best Practices Trap (#228)

In this podcast episode, we discuss the best practices trap. Key points made are noted below.

Problems with Best Practice Installations

Installing every possible best practice is not always a good idea. In fact, it can be a trap if you go too far down the best practices road.

Installing best practices involves a mindset of wanting to reduce costs and be more efficient. And that mindset works great in accounting, because the accounting department is clearly a cost center. That is, the department consumes costs and it really doesn’t create any significant revenues. Therefore, any reasonable controller or CFO is going to want to reduce costs within the department as much as possible. And to do that, they employ best practices, like altering process flows to make them more efficient, or automating the payroll system.

There’s a positive feedback loop that occurs when you install best practices, because costs go down. This looks great to senior management, so there’s a natural tendency to keep looking for more best practices to install. That means controllers and CFOs get caught up in searching the literature and going to conferences to find more best practices. And they spend the rest of their free time supervising best practice implementations.

Cost Eliminations from Best Practices

So what kinds of costs get eliminated from the accounting department as a result of best practices? Look at the department expense report, and you’ll find that most of it is labor. Which is to say, wages, payroll taxes, and benefits. So as best practices are installed, it’s pretty likely that the department headcount goes down.

So let’s work through the scenario as far as it can go. If the department is focused on best practices, there’ll be fewer and fewer employees in the department. Ultimately, there may only be a small number of process experts who oversee a bunch of highly automated processes. What could be better, right? The problem is that the accounting managers are viewing the value added by the accounting department to the rest of the company only in terms of cost reduction within the department.

Headcount Reduction Problems

If this is your viewpoint, then costs can be reduced to a certain point and the department is staffed with process experts who have no expertise in anything else. In essence, the unending focus on cost reduction has narrowed the skill set of the department too much and has eliminated its ability to deal with additional projects. The accounting department no longer has the ability to assist the rest of the organization in any other ways.

For example, there’s no one to provide due diligence work on a prospective acquisition. Or, there’s no one to do a financial analysis of an asset purchase to see if it makes sense. Or, a process is changed somewhere else in the company, and there’s no one left in accounting to provide advice on the controls that should be used for the revised process. In other words, the advisory and analysis roles of the department have been purged.

This is not good, because the decisions made by the senior management team may be the wrong ones, due to the lack of in-house advice. The result is costs being incurred that are much higher than the cost savings that the controller or CFO created by eliminating staff positions. For example, there are too few accounting staff on hand to deal with the due diligence work on a possible acquiree, so the senior management team decides to go ahead with an acquisition without the due diligence – and then incurs massive losses when the acquiree’s sales turn out to have been faked. Which is something that the accounting staff would have spotted.

Problem Mitigation Actions

So what can you do? After all, there’s usually ongoing pressure to cut costs, so it’s not easy to advocate retaining extra staff.  There’re a couple of possibilities. One is to make a list of every best practice that you still want to install, and list next to each one the amount of expected cost savings. Then sort the list in declining order of cost savings. There’s a good chance that the projected savings will start being pretty slim once you get just a short ways down the list, so consider pausing the best practices effort after those first few big cost savings projects are completed. It’s a good bet at that point that ladling out advice elsewhere creates more value than continuing to push for more best practices implementations.

Another possibility is to build a case for retaining a core group of advisory staff. You can do this by creating a comparison of the cost of this group to the savings they’ve generated for the company over the past few years.

This analysis is not that easy, since it may involve situations where the accounting department kept the company from making a bad decision – which is difficult to quantify.

In short, best practices are a good idea, but keep in mind the bigger picture of helping out the entire organization before you gut the department to reduce expenditures.

Related Courses

Accounting Information Systems

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Cleaning up Messy Books (#227)

In this podcast episode, we discuss how to handle a situation where the books are a mess. Key point made are noted below.

This is a fairly common problem, especially if you’re in the bookkeeping business and a new client has basically been operating out of a shoe box. In short, there really aren’t any accounting records, there are just source documents. Or, someone might have tried to keep the books, but they had no idea what they were doing, so the accounting records are incredibly bad.

Stop Any Further Damage

So, the first step is to stop the damage from occurring from this point forward. That means routing all of the new, incoming source documents through a reliable bookkeeping system. This presents a bunch of problems. First, is the original bookkeeper still going to be involved? That might be bad, because the person clearly hasn’t demonstrated any ability to keep the books so far. This is going to be a judgment call. If the person is clearly incompetent, then remove him from the accounting operation immediately. If the person simply didn’t have any training, then it may be possible to correct his behavior.

Take Control of the Source Documents

The next issue is taking over control of the source documents. Make sure that all supplier invoices and employee expense reports are being routed straight to you. The same goes for payroll records and customer billings. It’s impossible to keep the books if the paperwork is scattered all over the company.

Enter Transactions Properly

Then set up a chart of accounts in a simple accounting software package and start entering the accounting transactions the way they’re supposed to be entered. The emphasis is on getting an operational system running as soon as possible. What this does is give you a functional general ledger from the current day forward. With just this information, you should be able to construct an income statement without too much trouble. The problem is that it’s impossible to create a balance sheet without the prior records – and that brings us to the second step, which is using the old source documents to construct general ledger transactions for prior periods. And this presents another bunch of problems.

The first problem with reconstructing the old records is that you may not be able to load them into the new accounting software that you’re now running the business on. Some of these packages don’t allow you to create accounting periods prior to the current period. If so, you’ll need to initially store these old transactions on an electronic spreadsheet. When you’re done researching the old records, you may need to start up a brand new accounting software package and load in both the old accounting records and the new records that you’ve been maintaining since you took over the books.

An alternative that’s less messy is to initially set up the earlier reporting periods in the accounting software and leave them empty, and then start recording entries in the current period. Then re-open the earlier periods when you have transactions to record in those periods.

Determine What to Record from Prior Periods

The next problem is figuring out what to record for the prior periods. There are two key principles to follow. One is that every transaction has to be verified, which means that there must be a source document. If you record an accounting transaction and it’s not based on a source document, then, if you’ll excuse the expression – you’re just making shit up. The other principle is to verify every transaction you’re recording through the company’s bank statements. There’re actually some situations when a source document doesn’t appear in the bank statements, which I’ll get to in a minute.

The bank statement is the best possible record of what the business has been doing, since it shows all cash inflows and outflows, and the bank should have an online image scan of every check and deposit that was processed through the account – which is valuable evidence.

So, based on these two principles, the reconstruction of prior period accounting records involves coming at the work from two directions. You can start with the source documents in that shoe box and verify that they happened by checking them off on the relevant bank statement. Once you’re sure it happened, create a double entry journal entry for it in the correct reporting period and then move on to the next source document.

Then turn the situation around and trace all items that have not yet been checked off on the bank statements back to the source documents. This might result in clear evidence of a cash payment or receipt, but no source document, in which case you may have to dig around for it, maybe by contacting a supplier or customer for the relevant document.

At this point, you’re probably going to have a set of supplier invoices that didn’t trace through to the bank statement, and that’s because they haven’t been paid yet. These are recorded as accounts payable. And, along the same lines, there’ll be customer invoices that don’t appear in the bank statements, and that’s because they haven’t been paid yet. Those are recorded as accounts receivable.

As you might expect, this is a slow and incredibly painful process. The longer the books have been a mess, the longer it will take to conduct a complete clean up. At some point, a reasonable question to ask is whether it’s really worthwhile to keep going further back in time.

Complete Financial Statements and Supporting Reports

After going back to the beginning of the current fiscal year, you’ll be able to put together some semblance of a balance sheet, and you’ll have sales and profit figures for the entire current year. And, if the rollback work was for at least three months, you’ll probably have reconstructed something pretty close to the actual aged accounts receivable and aged accounts payable reports.

With this information available, the business is operational. So, depending on the circumstances, you can then restart the general ledger as of the beginning of the year and load in all of the earlier transactions. Or, if you initially set up the general ledger with a bunch of empty earlier reporting periods, then you should have now populated those periods with transactions.

Switch to the Accrual Basis of Accounting

Here’re another consideration. When someone is operating out of a shoe box, they are probably operating on the cash basis of accounting, which means that they record revenues when cash is received and expenses when bills are paid in cash. This would be a good time to switch the company to the accrual basis of accounting, since you’re putting their books through a complete overhaul anyways. And THAT means going back into the accounting records to record accruals for the prior months that you’ve reconstructed, so that each month now has accrued expenses on the books. By doing that, the reported profit levels are likely to be more consistent in the earlier periods, rather than gyrating around, depending on the dates when cash came in or went out.

Related Courses

Bookkeeping Guidebook

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The Learning Process (#226)

In this podcast episode, we discuss the continuous learning in which an accountant can engage. Key points made are noted below.

Accounting Standards Updates

This is a large topic, because it’s so broad. Let’s start with just accounting learning. Most people are going to find that, for their chosen industry, the accounting doesn’t really change that much. To stay on top of anything that might impact you, go to the accounting standards updates that the Financial Accounting Standards Board posts on-line. If you check the updates maybe once a quarter, you should be fine.

A larger problem is how to advance your overall knowledge. As you become more senior, other people are going to start judging you based on your knowledge and also on your opinions. So if you stop trying to educate yourself, outside of the occasional accounting standards update, you may find that people stop considering you for higher-level positions – because you don’t behave like someone who deserves to be in that kind of position.

News Sources

There are a couple of ways to deal with this. At the most minimal level, it helps to be generally aware of what’s going on in the world. My main source of information for a quick scan of the headlines is Google News. I check it first thing in the morning when I get up, just to see if there’s anything that I should know about. I might click on one or maybe two of the articles and spend a few seconds to see what’s going on. The intent is to appear reasonably informed if the people I deal with bring up a news item. If I don’t spend five minutes on this scan each day, I’m going to appear ignorant.

Podcast Sources of Information

There’s lots more learning that I do, but a major consideration is how much time it takes. As you’re going to find out as you advance in your career, there’s nowhere near enough time in the day. So one thing I do is sign up for podcasts that I can listen to when I’m in the car. A good one is The Economist Radio podcast. They put out maybe a half-dozen episodes per week, mostly short ones, where they talk about business and politics. Another possibility is the HBR Ideacast. It’s put out by the Harvard Business Review magazine, which I’ll get back to in a minute. The Ideacast comes out once a week and each episode is about 15 minutes. I find that these can be a little too professorial and abstract, so maybe one episode in three is really informative.

Another podcast that’s quirky and really informative on odd topics is Planet Money, which is produced by National Public Radio. The general scope is absolutely anything involving business or money. For example, recent episodes were about the old monopoly on cheese in Switzerland and interviewing some of the staff at Wells Fargo about the issues that were going on over there during the recent scandal. Those episodes run about 20 minutes.

Another possibility is the Entrepreneurial Thought Leader series, which is produced by the Stanford Business School. They bring in business leaders, usually very senior-level managers or investors, to talk about business startups. Every episode is good, but they’re also long. These run for an hour.

And my last podcast recommendation is The World Next Week, which is produced by the Council on Foreign Relations, which is a Washington think tank. You get doctorate-level people talking about the most important foreign events – and it’s just great. Their perspective is not conservative or liberal. It’s more from a practical or maybe a pessimistic viewpoint about what’s going on in the world.

Travel as Education

I happen to like The World Next Week because I think the greatest education is traveling all over the world. Once I spend the time to really get to know a country, I remain interested in it for life. So far, that means I’m always digging through the news to learn more about the 36 countries that I’ve visited – so far. I try to add on a couple of countries every year.

I also find that experience is the best form of education, because those lessons really stick. The next best form of education after experience is a really deep dive on a specific topic – something that runs for several thousand words, and which comes from a reputable source.

Recommended Magazines

Which brings me to the next form of continuous learning, which is magazines. And when I say magazines, I also mean their on-line sites. First, business magazines. I’ve subscribed to Fortune, Forbes, and Business Week at various times, and eventually dropped Fortune and Forbes, and kept Business Week. The problem with all of these magazines is that some of the articles seem to have been written by the public relations departments of the companies that are being spotlighted. There’s some investigative journalism, but not a whole lot. So I keep Business Week around just to be informed at a modest level about the most current business topics.

I also subscribe to the Harvard Business Review. The articles are always well-written and they go pretty deep on business research topics. Each edition has a different theme, so one edition might have nothing but product development topics in it, while another one might have nothing but marketing articles. By and large, I really like what they do, but that’s partially because I write business books and they’re a good source of ideas. Some people may find that HBR is too much information. It may not be for everyone.

Another source of deep information is not a business magazine at all. It’s the New Yorker. A good thirty pages of each edition is about local New York activities, which may not be of much use. However, there are usually one or two amazingly detailed articles in the middle of the magazine that make the entire thing worthwhile. For example, they just ran a long article about the political situation in the Philippines, and the week before that they did the same thing for Venezuela. So if you have an interest in foreign affairs, the New Yorker is a good bet.

ProPublica

This may seem like a lot of good sources of information, but actually things have gotten a lot worse over the past few years. Newspapers are not profitable, so they’ve laid off many reporters, which means that the quality of reporting has gone down. And this is where I’m putting in a plug. There’s a nonprofit website called propublica.org. They’re based in New York, and at the moment they have 45 reporters who all do investigative reporting. They’ve already picked up three Pulitzer prizes, so they’re good. They’re also non-partisan, so they will investigate anything. You’ve probably already read their stories, since they have dozens of partner news organizations that distribute their articles. Take a look at propublica. If you like them, consider sending them a donation. I send them money every month.

General Impact of Learning

I’m going to finish up by describing how this lifelong learning has impacted me by talking about – Turkey. I traveled pretty extensively through Turkey years ago, met a lot of people, and have a very high opinion of the country. I’ve rarely seen that level of hospitality anywhere. Since that opinion was experience-based, I’m probably going to keep it for life. It also means that I’m quite interested in what goes on there.

A couple of years ago, Wikileaks posted a massive number of State Department reports on its website. Even though I’m not a great fan of WikiLeaks – separate story – I went to the site and looked up what they had on Turkey. There was an amazingly detailed analysis of Prime Minister Erdogan that spotlighted his personality and how he might react to opposition, and lots of other things. Since this was a deep analysis and it came from a reputable source, that affected my opinion – not of the country, but of its leadership.

And then there was the coup attempt a short time ago, where now-President Erdogan cracked down all over the country and also demanded that the United States extradite a cleric who was based in Pennsylvania, but who he claimed had initiated the coup. Having read the earlier State Department report, I was skeptical about the claim.

But then the New Yorker put out another one of its great articles about this Pennsylvania cleric, and it turns out that there might be some truth to Erdogan’s allegations. At a minimum, there are a couple of very large egos battling each other.

So what does that example have to do with the continuous learning experience for a CPA? On the face of it, nothing at all. But what you should be getting out of my story is the process I went through. I initially formed an opinion based on personal experience and then added to that opinion based on some very solid information sources. I did not rely on those one-paragraph news snippets that you see so much of these days.

Now this does not mean that I’m an expert in everything – I’m probably just an expert in accounting and nothing else. But what I do have is a fair amount of learning on topics that interest me. And if anyone wants to hear my opinions on those topics, then I can hold forth pretty well.

Now, remember what I said earlier about how people will judge you based on your knowledge and your opinions. If you follow the path I’ve described – going out and getting experience, as well as learning from the best news sources – you’re going to come across as a much more interesting person – and probably a more influential person – and that will most definitely help you in your career.

The Reserve for Obsolete Inventory (#225)

In this podcast episode, we discuss the reserve for obsolete inventory. Key points made are noted below.

The Need for the Reserve for Obsolete Inventory

This reserve means that you recognize an expense in advance for inventory that’s already on hand, and which is likely to be thrown out or disposed of in some other way. The presence or absence of a reserve can be a big deal when a company has a large amount of inventory on hand and it’s not doing a good job of managing it. In this case, who knows how much of the inventory is obsolete? A quarter? Maybe a third? No one knows. From my experience, the proportion is frighteningly high. But that doesn’t mean you need a reserve in all cases.

Where a reserve is needed is when the inventory turnover level is low, the investment in inventory is medium to high, and there’s not a good system for tracking it. When those conditions are present, there’s bound to be a lot of old inventory that should be eliminated.

Now, just turn around those conditions to figure out if you don’t need a reserve. The inventory turnover level is high, so the inventory is being flushed out rapidly, and doesn’t have time to become obsolete. The investment in inventory is low, so even if there is obsolete inventory, the write-off is minimal. And third, if there’s a good inventory monitoring system in place, then management already knows which items are getting stale and is taking steps to eliminate them.

So let’s assume you’re in the first group, so there’s likely to be obsolete inventory mixed in with the other inventory. In this case, there’s something else to think about before you go anywhere near creating a reserve for it – which is that the management team routinely denies the truth and claims that there’s no obsolete inventory. They do this because creating a reserve triggers a hit to profits. In essence, they can put off recognizing a loss until next year, so let’s just leave things the way they are.

How to Set up a Reserve

This is a real problem if you’re the accountant and you’re trying to do the right thing and set up a reserve. Your best bet is to get the auditors on your side and have them demand the reserve. Even then, management is going to press for a really small reserve, but at least it’s a start.

Now, how do you figure out the amount of the reserve? There’re a couple of ways to do it. One is to have an experienced group of users examine the entire inventory on an ongoing basis and figure out exactly which items are obsolete. Then estimate the amount that the company could earn by dispositioning the inventory in the most profitable way. The difference between the book value of this inventory and the proceeds from dispositioning it is the amount that the company is going to lose. That’s the amount of the reserve.

But there are a couple of problems with this approach. First of all, it assumes that there’s a well-organized system in place for figuring out which inventory is obsolete and how much it can be sold for; which may not be the case.

As another issue, consider that a reserve is really intended for losses that you don’t yet know about. Which is to say, once the obsolete inventory is identified, would it make more sense to write down its value to its disposition price right away, rather than messing around with a reserve?

To take that concept one step further, a precise identification of obsolete inventory is probably going to fall short of the actual total amount of obsolete inventory, since there’s always some amount that will be unknowable. So keep these shortcomings in mind.

An alternative approach is to just make an estimate. To do so, compile the cost of the obsolete inventory that you’ve disposed of in the past year, and divide it by the average cost of the total inventory for the same period. And that’s your obsolete inventory percentage, which is the basis for creating a reserve. This approach works pretty well, but only if you’re tracking charge-offs due to obsolete inventory.

If you’re not, and people are just throwing away old inventory, then there’s no way to make the estimate. Instead, the lost inventory just means that the ending inventory valuation is now lower, which means that the obsolescence losses are being dumped into the general cost of goods sold expense. To get around this problem, set up a system for charging off the cost of these throwaways to a special account for obsolete inventory losses. After a few months, you should have a reasonable idea of the cost of this inventory.

But – and it’s a large but – only if management is willing to part with the inventory. If the warehouse staff is under orders from management to never throw away anything without their express consent, then you may find that the cost charged to this account is really small – if not zero.

Accounting for a Reserve for Obsolete Inventory

Despite the issues I’ve just noted, using a general obsolete inventory percentage as the basis for setting up a reserve is usually the best way to go. So let’s assume that you want to set up the reserve. How do you do that? Create a contra account that’s paired with the inventory asset account. That means the contra account has a natural credit balance, so that its balance offsets the natural debit balance in the inventory account.

Then charge the initial reserve amount to the contra account – which is a credit. The offset is an expense, which can be to the general cost of goods sold account, or a special expense account that’s just for obsolete inventory. Then, when you actually have obsolete inventory, write its book value down to the value the company can earn from its disposition. That’s a credit to the inventory asset account. Meanwhile, the debit is to the reserve account, which reduces the amount of the reserve.

What all of this means is that recognition of the expense is accelerated, rather than delayed if you were to just charge it to expense when something is eventually identified as obsolete.

So, what about dealing with the reserve on a going forward basis? The reserve amount as a percentage of the total inventory valuation should be kept fairly consistent, unless there’s a significant change in the underlying obsolete inventory amount that needs to be reflected in the reserve. Otherwise, you just need to make minor adjustments to the reserve on an ongoing basis to keep it at the right size.

Dealing with Management Opposition

I’ve kept mentioning that management wants to oppose this process. Even if you manage to create a reserve and it’s initially of the right size, expect management to push for a smaller reserve over time, so that they can delay the recognition of an expense into a later period. There is a way to combat this. Prepare an annual schedule that compares the size of the reserve as a percentage of the total inventory valuation, and run it back for a bunch of years. Then give it to the auditors when they show up for the year-end audit. They can then use this information to make inquiries regarding why management wants to have a smaller reserve.

Related Courses

Accounting for Inventory

How to Audit Inventory

Inventory Management

Construction Industry Accounting (#224)

In this podcast industry, we discuss the accounting for the construction industry. Key points made are noted below.

Unique Construction Issues

The construction industry is unusual in several ways. Pretty much every project is unique, so it varies from the usual business, where there’s a standard product. Also, the level of demand can go from really high to really low within a few months, so a construction company tends not to keep too many people on staff – instead, it relies on subcontractors for a lot of the work. And it can be difficult to schedule the subcontractors. It’s also hard to track resources, because specialist workers and specialized construction equipment may be moving among several job sites. All of these factors make it easy for expenses to get out of control fast.

To make matters worse, contracts with clients may be on a fixed fee basis, so the contractor has to absorb any cost overruns – and that means it’s unusually easy to lose money on a construction project.

Change Orders

To deal with these conditions, the accounting staff tends to be unusually large. It has to closely track the work hours of the staff, and the hours being charged to jobs for equipment usage. And an item unique to this industry is change orders, which are adjustments to the baseline contract for alterations to a project. The accounting staff needs to compile the cost of each change, give input on what kind of price to charge for the change, and then negotiate with the customer to have the change accepted. And then bill the change. If change orders aren’t handled properly, the company will almost certainly lose money on a job. These activities take a lot of time, which is why construction requires so much accounting labor. It’s also difficult to streamline the process, because each job is unique. In fact, a larger job may require its own accounting staff.

Cost Tracking

And then we have the cost tracking. There needs to be a job cost ledger, which is a subsidiary ledger that feeds into the general ledger. The job cost ledger compiles all of the costs for each individual job. The accounting staff makes sure that each cost incurred is assigned to the correct job. In addition, each client may have different rules for what types of overhead costs are allowed to be charged to their job, in cases where they’re being billed for the costs incurred. So the accounting staff needs to maintain a separate cost allocation calculation for each job.

Equipment Ledger

There may also be an equipment ledger. Each piece of construction equipment has its own account in the equipment ledger, so that costs incurred can be charged to each piece of equipment. You need this information in order to figure out what hourly or daily equipment rate to charge to each job.

Revenue Recognition

And then there’s the revenue recognition. For the longer-duration projects, the percentage  of completion is calculated, which can be based the proportion of costs incurred to date, or the proportion of labor hours incurred, or some similar measure. Based on this percentage, the accounting staff determines what percentage of job revenues and costs it can recognize in the reporting period. If the amount actually billed is less than this amount, then the contractor recognizes an asset called costs and profits in excess of billings. If the reverse is the case, where the amount billed is more than is indicated by the percentage of completion calculation, then the contractor recognizes a liability, which is called billings in excess of costs and profits.

And in case the situation already sounded complex, let’s get back to those change orders. The contractor may also have a bunch of claims that it wants the client to pay, and which the client hasn’t agreed to yet. For example, maybe the client had agreed to have a portion of the job site cleaned up by the time the contractor sent in a work crew, and it wasn’t – so the work crew had to spend time unexpectedly doing cleanup work.  So the project manager files a claim with the client to have this cleanup cost reimbursed. There can be a mass of these claims percolating in the background throughout a job, and they may not be settled for a long time, as the parties bicker about who is responsible for payment. You can’t recognize the revenue associated with claims, because payment is too uncertain, so the accounting staff is always pushing for resolution. Which means documenting claims and attending meetings with the client to go over these items.

Estimated Project Profitability

The accounting staff also has to run an ongoing estimate of the project profitability, based on the percentage complete and the amount of costs incurred to date.

If this analysis results in a projected loss, then the loss has to be recognized right away. This can require some pretty detailed cost estimating work, especially early in a contract when most of the costs haven’t been incurred yet. This analysis also puts the controller under quite a bit of management pressure, since they don’t want to recognize any losses, and especially well before a job has even been completed.

Retention

And yet another item is the retention. This is a percentage of the contract price that the client will not pay until after the job is complete and it’s accepted the job. The amount of the retention is usually in the range of five to ten percent, which can be a lot of money that’s not coming in to pay bills. So, the accounting staff needs to track the amount of these retentions and factor them into the cash forecast. And then to complicate matters further, the contractor might do the same thing to its subcontractors and impose retentions on them – which calls for splitting out the retention amount in accounts payable and figuring out when these items are supposed to be paid – which is a manual tracking process.

Construction Controls

Construction also needs a bunch of controls that you just don’t find anywhere else. For example, fixed fee bids have to be accurate, or else you either lose a project because the bid was too high, or lose a lot of money because you incorrectly bid too low. To counteract this, contractors use a cost checklist to make sure they didn’t forget to include any costs, as well as multiple reviews of the initial bid.

As another control example, construction equipment is frequently rented, and the daily rental rates are high. This equipment may be used on multiple job sites, so it’s easy to lose track of where it is, which means that the contractor keeps piling up rental fees. So, there’s a control to monitor where equipment is located and whether it’s being used.

Yet another area for controls is the job cost ledger. A job needs to be shut down in the ledger as soon as the job is finished. Otherwise, costs for other projects might be coded into this old job, which incorrectly makes other jobs look more profitable than they really are. Some project managers look for these old, open jobs and stuff expenses into them in order to make their own projects look better.

Another good place for controls is the job site. It’s fairly easy to steal materials from a job site unless you fence it in and maybe use a security guard.

And finally, a great place for controls is change orders. There should be a change order log that’s used to track the approval status of every change order, as well as a change order committee that meets regularly to discuss and approve change orders. Otherwise, there’s a real risk for the contractor of losing money on unapproved change orders.

Related Courses

Auditing Construction Contractors

Construction Accounting

Real Estate Accounting

New Controller Stories (#223)

In this podcast episode, we discuss several stories relating to being a controller for the first time. Key points made are noted below.

Don’t Piss Off Anyone

When I first became a controller, the previous controller had been fired the preceding Friday and I started work the next Monday morning. The company president didn’t like the job she was doing, and also thought the accounting staff wasn’t very good. So, he wanted me to show up, call a meeting, and tell everyone they sucked. You can imagine how this would have gone if I’d actually said that. Luckily, the president wasn’t sitting in the meeting, so I managed to put a more positive spin on things and just pointed out that we were going to clean up the systems. That’s a lot less personal. So, lesson number one – don’t piss off anyone on your first day.

Clean Up

After that, I asked the president about exactly why he didn’t like my predecessor. Turns out, she kept a very messy office and took between three and four weeks to issue financial statements. I inherited her office, which had probably a thousand pounds of paperwork in it. So, from the first day through about two months later, I spent the end of each day rooting through the paperwork to see what could be thrown out or archived. Most of it I threw out. At the end of that time, I have a big office with next to nothing in it. I kept a stack of paper that weighed maybe five pounds. So, lesson number two – clean up the mess, so you can focus on what’s really important – which is usually only a few items.

Produce Financials Faster

The paperwork cleanup was an ongoing issue, so then I met with the staff one on one. The assistant controller was really good, and the rest of the staff was anywhere in the range of adequate to good. So despite what the president was saying, the staff was actually OK. What was bugging the president more than anything was late financials. Since we were coming up on the end of the month, I decided to get the financials out really fast. However, this was a manufacturing company, and they were bursting at the seams with too much inventory. And the inventory records were not very good. So I ended up spending a lot of time in the warehouse to figure out what was going on with their systems. At this point in my career, I was already something of an inventory specialist, so word got back to the president that the guy in the suit actually knew how to run a warehouse. So about a week after I started, the president gave me the warehouse to run.

The Problem is the Systems

I can’t really recommend being given an extra department this early in the game. There’s just too much work to do already. Nonetheless, I took over the warehouse. And found that the warehouse staff was unusually good. The problem was in the systems. Which brings us to lesson number three – the problem is usually not the people. It really is the systems. If you can get people to trust you, it’s possible to mutually figure out what’s wrong and keep it from happening again.

That first month, we closed the books in something like three or four days. Which was taking a risk, because the inventory record accuracy was really awful, so the cost of goods sold figure was shaky. But there were still a bunch of months to go before the year-end audit, so there was time to keep improving the accuracy, which meant we’d have time to perhaps write off more inventory losses later in the year. As it turns out, the numbers were actually pretty close in that first month. So, when we issued financials so fast, and they were accurate, the president stopped complaining. Unfortunately, he also gave me the purchasing department to run. That was at about the end of the first month.

Limit Your Areas of Responsibility

I did not have time to run purchasing, because it had problems too. That brings me to lesson number four. Do not go around trying to grab additional responsibility when you’re just starting out. If you’re good enough, it will come to you. If you’re not good enough, you’ll sink under the weight of all the responsibility. So don’t try to run everything.

Identify Ethical Problems

But there’s more. I needed to meet the rest of the management team. Which meant talking to everyone – the sales manager, production manager, engineering manager, human resources, and so forth. This was a good group. But I got the impression very quickly that the president had major ethical issues.

He pushed the staff to do all kinds of things, like shipping goods without customers having placed orders yet, shipping goods well past midnight on the last day of the month, fudging inventory records, and so on. The reason was that the company had been partially acquired by a major international company, and the new owner was offering big bonuses if profits could be increased by a lot.

So this became an ethical strain as we got closer to the end of the year. The profit goal was about double what the company had made the year before, so the pressure was intense to jack up profits, no matter what. This had an interesting effect on the management team, which was really a decent group of people. We worked together to push back as much as possible, but the president was on everyone, every day. And he worked that gray zone pretty hard – where the decision to record revenue could have gone in either direction. We had Big Four auditors, and I ended up being much more on their side than the company’s in order to keep things honest. And at the end of the year, the president got his bonus – just barely.

When to Bail Out

Which brings me to lesson number five. No matter how good the staff is and even if the bulk of the management team is OK, you need to get out if the senior management group wants to stretch the rules. And from what I’ve seen and heard, that’s a lot of senior managers. So take the time to get the measure of those people. If it’s clear that you can’t trust them to be honest, then start looking for a new job. Otherwise, that company will earn a bad reputation, and it’ll be on your resume for the rest of your life.

So, to summarize. As a new controller, you’re ignorant of the company and the people who work there. So, be quiet and get to know everyone. Then figure out a quick win to gain a positive reputation – in my case, issuing financial statements. Next, don’t assume that employees are incompetent; in most cases, you cannot fix a problem just by firing someone. And finally, step back from the day-to-day activities and try to see what’s going on at a higher level. If there’re ethical issues, start planning your exit. And yes, I left that company after being there a couple of years – the experience was great, but the main lesson I learned was not how to be a controller – it was how to tell right from wrong.

Related Courses

Behavioral Ethics

New Controller Guidebook

Unethical Behavior

Data Presentation (#222)

In this podcast episode, we discuss the best ways to report performance measurements. Key points made are noted below.

Identify Actionable Items

Always pinpoint the underlying goal for reporting the measurements. It should be to tell the recipient about actionable items. That means you give the person some information, and he acts on that information. So let’s play with this concept for a bit.

First, narrow down the presentation to a few actionable items. The trick is to set change thresholds for reporting the measurements. There’re usually two thresholds, one on a percentage basis and one on a currency basis. For example, you might have a trigger that reports on changes in the amount of office supplies expense if it exceeds a 25% unfavorable variance or a $1,000 unfavorable variance. If the change is less than that, don’t report the variance.

But that’s not enough. The trouble is that some changes, even if they’re quite small, could be key indicators of bigger problems. For example, what if a measurement is the percentage change in products being returned? I don’t want to wait to see this information if it has to increase by 25%. I may want to know if it increases by just 1 or 2%. So what this means is that the threshold may change, depending on the measurement. You may not want to see an unfavorable office supplies variance unless it’s a seriously large one, because – most of the time – who cares?

But a very small change in things like the cost of goods sold, the order backlog, or product returns could be a good reason for people to run around pulling their hair out.

Consider the Baseline

The next issue to consider is the baseline. We’re talking about only reporting something if it exceeds a threshold, which is calculated as the change over a prior period. But which prior period? What if the immediately preceding period was also an odd month? For example, a major supplier invoice is lost in the mail in April, and no one notices, so the expense appears in May. So the calculation of the variance is based on the percentage change of the number in May – which was high – over April – which was low. In reality, there is no variance, because there was a timing problem. A good way to get around this is to base a percentage change over the average for the past three months. That way, the monthly anomalies are reduced through averaging, so there should be fewer big variances to report.

Watch the Trend

But that’s not all. Sometimes measurements have a way of creeping up on you, maybe at the rate of a fraction of a percent per month. So if you’re only spotting items based on their changes within a short time frame, you might never report on it, even though it’s actually pretty important. For example, if the cost of goods sold percentage is going up by a half a percent a month, it might not appear significant. But over a full year, that’s six percent, and that might put you out of business. So the way to get around that problem is to also compare the measurement to what it was 12 months ago. If there’s a significant year-over-year difference, then report it.

After spotting an issue, write up a report, sit down with the recipient, and go over it in person. The report length should be one page. That is the best way to convey performance measurements.

Simplify the Report

If you want to just lay out the performance measurements, then at a minimum, only report quarterly results plus the most recent month. By doing that, you’re dropping down from 12 data items per year to four or five, depending on the situation. Once you’ve reduced the number of data items, round off the numbers. Showing something to the third digit really doesn’t help. Just round up the number to a reasonable level. For example, a performance measurement is the total monthly sales for a product line, and let’s say the actual number is $14,326,820, you can probably report it as $14.3 million. As long as the rounding is still within about 1% of the actual figure, no one is going to care. And it’s way easier to read when you use rounding.

Alternative Presentation Formats

What about using diagrams and charts? For me, the answer is no and no. I prefer the straight numbers, and so Excel is what I use. But that is also my preference. It works for me, because I deal with numbers all day. What you might want to do instead is ask the recipient what he wants. If he prefers to see horizontal bar charts or pie charts, than give him that. If I absolutely have to report information in a chart, I use vertical bar charts. Again, it’s a matter of preference. I find them to be less vague than other forms of presentation.

When done right, PowerPoint is a great presentation tool. Doing it right means keeping the number of slides down to a tiny amount – like ten. Or less. And having just a couple of points on each slide – which it seems that almost no one can do. Instead, there are way too many slides and vast amounts of information crammed onto each one.  If you really want to try PowerPoint, just keep in mind that a clean, simple presentation probably took hours and hours to put together. And it may have started with quadruple the number of slides and then took about 20 iterations to boil it down to the essentials. So my comment in regard to PowerPoint is to avoid it unless you absolutely, positively have to give a presentation, and then block out a whopping amount of time to prepare it.

Related Courses

Business Ratios Guidebook

Key Performance Indicators