The Role of a Bookkeeper in an Accounting Department (#338)

Where do the job duties of a bookkeeper end and the duties of a financial accountant begin? It’s unclear what duties would change if a bookkeeper becomes a staff accountant.

Position of the Bookkeeper in an Accounting Department

First, and just to be clear, a bookkeeper is not part of the normal hierarchy of an accounting department. Either you have a bookkeeper who mostly works alone or with the assistance of an outside CPA, or you have a controller running things, along with maybe an assistant controller and some accounting clerks. So, if you have a bookkeeper title being used within a larger accounting department, then you probably need to give a new title to the person being called the bookkeeper.

That being said, where does the person formerly known as the bookkeeper end up within a larger accounting department? Well, consider how an accounting department usually evolves. It begins with just the bookkeeper, who handles almost everything, and only handing off to an outside CPA for the more difficult activities. Once the company gets a bit larger, management brings in someone with more expertise to be the controller, which means that the bookkeeper is pushed down in the organizational structure. A good initial spot for the former bookkeeper is the assistant controller position, because at this point the bookkeeper has a broad knowledge of everything, and so can offer advice to the controller.

Whether the former bookkeeper can stay in that position as the company continues to expand depends entirely on whether he or she can adapt to the increasing complexity of the business. If not, it’s entirely possible that the former bookkeeper keeps getting pushed down within the structure of the department, and probably ends up specializing in one of the major sub-areas, like payroll, or customer billings, or accounts payable.

It's much less likely that this person ends up in one of the specialized positions, like general ledger clerk, or cost accountant, or public company reporting specialist. Those positions are more likely to have a bachelor’s degree in accounting and may also have a CPA certification, which is usually not the case for a bookkeeper.

Risk of Bookkeeper Departure

And unfortunately, there’s a pretty high risk that the former bookkeeper will leave the company, and possibly fairly soon after the controller is hired. The reason is obvious. Would you want to stick around if you’ve gone from running your own department to having reduced responsibilities?

Having the bookkeeper leave is usually not a good thing, at least for the next few years. The trouble is that the bookkeeper is the central repository of information about accounting transactions, and will remain that way for a while. So, it makes sense to coddle the former bookkeeper for multiple months and maybe a year, until it’s clear that enough knowledge has been transferred to other people within the department.

Summary

So, to go back to the original question, it’s hard to say exactly how the duties of a bookkeeper will change once the person becomes a staff accountant. A fairly weak bookkeeper will be pushed down within the department’s organizational structure pretty quickly, whereas someone with a significant amount of skill could very well become the assistant controller, and stay there. It all depends on the person’s experience, knowledge level, and willingness to adapt to the increasing complexity of the business.

Related Courses

Bookkeeper Education Bundle

Bookkeeping Guidebook

Form W-9 Best Practices (#337)

The Form W-9

The topic of this episode is best practices for the Form W-9. This is a form that the payer of funds is supposed to send to the receiver of funds, or the payee. The reason for the form is to collect the name and taxpayer identification number of the payee, as well as its form of organization, such as a C corporation or a partnership. After the end of the year, the payer then uses this information to compile a Form 1099, which goes to the IRS and the payee, and which states the total amount that the payer paid to the payee.

Another issue arising from the W-9 is that, in some cases, the payer has to withhold a percentage of the amount paid and send it to the IRS instead of the payee. Which is deeply annoying for all parties concerned. Except the IRS.

So, the W-9 can cause a lot of grief for the payer, because if the information on it is wrong, the IRS will eventually send it a notice, saying that the name and taxpayer identification number on its Form 1099 are incorrect. And this means that the payer needs to keep bugging the payee for more accurate information, in the form of what are called “B” notices. And if the payee doesn’t comply, then the payer needs to start withholding funds from any new payments to the payee. This is a lot of administrative grief that wastes the time of the accounting department. So, what are some best practices for keeping this data collection process as streamlined as possible?

Form W-9 Best Practices

The best option is to require a payee to hand over a completed W-9 up front, before the payer sends it any payment at all. This is the only point at which the payer has leverage over the payee, so it almost sounds like a hostage deal. You give me the completed form, and I give you the money. Lots of companies already do this.

But that is not good enough. The trouble is that the information on the form might be incorrect, in which case the payer is still going to be notified by the IRS of an incorrect 1099. The way to resolve this problem is to go to the IRS’ TIN matching program, which it offers free of charge on its website. Basically, you enter the name and taxpayer identification number into the IRS’s website, and it tells you if you’ve entered a valid match.

If it’s not a valid match, then go straight back to the payee and ask for another W-9 that contains the correct information.

These two steps need to be done up-front, before any payments are made. Otherwise, don’t expect a lot of cooperation from the payee.

A decent third option relates to how the information on the W-9 is laid out. Line 1 of the form contains the name shown on the payee’s income tax return. Line 2 contains a business name, or a doing-business-as name. You should always issue check payments to the name provided in Line 1, not the name in Line 2, since Line 1 is associated with the IRS TIN match, and Line 2 is not. So, if you never use the name in Line 2 in your accounting records, there won’t be a risk of issuing a Form 1099 to that name, and then having the IRS bounce it back at you.

Those are the three absolutely must-do best practices for the W-9. But there are other ones to consider. In particular, watch out for payees that are limited liability companies. If an LLC is a single-member LLC, then the IRS ignores it for federal tax purposes, and assumes that the owner is the actual entity being paid. So, when one of these W-9s comes in, be especially sure to do a TIN match.

And the next LLC problem is… LLCs that are treated as corporations. An LLC can indicate on the W-9 that it wants to be treated for tax purposes as a corporation. If so, that makes it exempt from backup withholding. The problem is, you can’t tell if the LLC has actually filed with the IRS for tax treatment as a corporation. And the only way to find out is to ask for a copy of their Form 8832, which is the Entity Classification Election. Only by getting a copy of that does the payer have proof that no backup withholding is actually required.

Next up is the individual taxpayer identification number, or ITIN. This number is issued to individuals who are required to have a U.S. taxpayer identification number but don’t have a social security number. Historically, there’s been a much higher probability that these numbers will not pass a TIN match, so always do the TIN match when you run across one. And in case you’re wondering how to spot one, an ITIN has nine numbers in the same format as a social security number, but it always begins with the number 9. Also, the fourth and fifth digits are always within the range of 70 through 88.

On top of that, issue a notice to all payees once a year, just to remind them to provide a replacement W-9 whenever their ownership or legal structure has changed. So for example, if a sole proprietorship has converted into a C corporation, this would be grounds for a new W-9.

There’s also a best practice that applies to the payee. If the information stated on a newly-revised W-9 differs from the one the payer already has on file, the payee should write the word NEW at the top of the replacement form. In caps, and maybe in red ink. Doing so increases the odds that the payer will review the form in detail for changes.

Related Courses

Form W-9 Compliance

Accounting for Truckers (#336)

Most of the accounting for a trucking operation is fairly standard, so I’ll skip that and just focus on the unusual parts. Of which the most unusual is the financing arrangements. It can take quite a while for a trucker to get paid – usually in the range of 30 to 90 days from the billing date. This is a big problem, because most trucking expenses, such as compensation and fuel, have to be paid within a week or two. This results in a massive working capital problem, for which the solution is freight factoring.

Freight Factoring

Factoring is the sale of your receivables in order to get immediate cash. There’s an entire industry of factoring companies that just service truckers, and what they offer is called freight factoring, and it allows truckers to get almost-immediate cash after they bill a client. In exchange for a factoring fee, of course. So, one accounting task is recording the sale of receivables.

Compensation

Another accounting issue is compensation. A trucking firm either pays contractors who use their own trucks, or it maintains its own staff of drivers, or it uses a mix of the two. This means the accountant has to record contractor billings and pay them through the accounts payable system, or track driver hours and pay them through the payroll system – depending on which type of driver arrangement they have. In the latter case, this also means that drivers may be on the road when you need to collect their hours worked information, so there needs to be a system for collecting the hours.

Fuel Cards

The next accounting issue is fuel cards. These cards are used to buy fuel at wholesale rates. They’re not really credit cards. Instead, fuel charges are compiled into an invoice, and payments are automatically deducted from the trucker’s bank account, usually once a week. So, the accountant needs to record the fuel invoice, and verify that the same amount is deducted from the company’s bank account.

Driving School Expenditures

Here's another issue, which is driving school expenditures. Some trucking firms offer to pay the fees for driving school for drivers who are just getting into the trucking business. So, do you charge these expenditures off to expense right away, or write them off over time? That depends on the arrangement with the drivers. If you can force a driver to pay back these fees if he leaves the company early, then you might have grounds for recording the fees as a prepaid expense, and then write off a portion of it each month.

Trucking Permits and Fees

And then we have permits and fees. Lots of permits and fees. The accountant needs to record the annual Department of Transportation fee, which is paid to the state government in which the trucker is located. And then there’s the international registration plan tag, which is a license plate that’s issued by the state’s Department of Transportation. This tag allows the firm’s trucks to operate across state lines. And on top of that, there’s the heavy highway vehicle use tax, which has to be paid to the federal government when you have a vehicle that weighs more than 55,000 pounds. That tax pays for highway infrastructure and road maintenance. But – not done yet – there are also oversize and overweight vehicle permits. All of these permits and fees can really add up, so you might consider recording them in separate accounts, to keep better track of where the money is going.

Driver Per Diem Payments

Another fairly common accounting issue is making per diem payments to drivers. This happens when drivers are expected to be on the road for an extended period of time, so the firm pays them a daily stipend that’s supposed to cover their meals and lodging. Of course, some of them sleep in the truck, if it has a sleeper compartment, in which case the per diem only covers meals.

Truck Depreciation

As you might expect, the trucking business involves very large investments in trucks, so the depreciation of fixed assets is a major issue. Depreciation calculations always include salvage value, since trucks are sold off after a certain amount of time. Depreciation expense is a large number on the income statement, so these calculations have to be right.

Insurance Expenses

And then there’s insurance. When your entire business involves driving large and heavy vehicles that can tip over and cause a lot of damage, of course there’s going to be insurance. There’s general liability insurance, and cargo insurance, and commercial property insurance. And other types of insurance riders, depending on just how hazardous the cargos are. For these reasons, the insurance expense in the trucking business tends to be a lot higher than in other industries.

Accounting Reports

Which brings me to the most important activity for the accountant, which is reporting. Trucking is a miserable business. Margins are low, and cash flows are worse. So, bankruptcy prevention is a pretty big deal. This means knowing the breakeven point of the business, so they can focus on keeping sales above that level. It also means tracking the cost of every job, to see if the business is generating a profit. This means tracking fuel, per diems, compensation, tolls, and parking charges for every single job. If you don’t do this, then management will not understand where profits and losses are coming from, and the business will probably fail.

This also means reporting on the cost of deadhead miles, which is the miles driven without a load. There’s no revenue associated with these miles, so it’s pure cost. The accountant is not responsible for reducing the number of these miles, but management needs to understand their cost, so routes can be restructured to reduce deadhead miles.

And there are lots of metrics to compile. The accountant can report on things like revenue per mile, cost per mile, and profit per mile. There’s also fuel cost per gallon, as well as days sales outstanding, which is driven by the quality of the company’s customers and how well the accountant is collecting overdue invoices.

In short, this is a tough industry, so the accountant has to focus on every possible reporting option that highlights where profits and losses are being generated. The general ledger has to be structured with the same goal in mind, so that information is summarized to support the reporting function. To be blunt, if the accountant does not provide good reporting, the company will not be around for long.

Related Courses

Accounting for Truckers

A Return to the Formula 1 Accounting World Championships (#335)

Accounting Penalties in Formula 1

The topic of this episode is a return to the Formula 1 accounting world championships, which I talked about in June, in Episode 326. To refresh your memory, I talked about the new cost cap rules in Formula 1 racing, where if your team spent too much money, you could be penalized for it. So, it’s worth returning to the topic, because what I talked about back then has happened. The violating party was Red Bull Racing, which inaccurately excluded some expenditures from its cost cap. The total amount by which they exceeded the cost cap was 1.6 percent, or two and a quarter million dollars.

Under the rules, this is considered a minor overspend breach, for which the penalty should be fairly minor. However, the Cost Cap Administration Committee tagged them with a seven million dollar fine, and – probably more importantly – a reduction in the amount of wind tunnel testing they can do for the next 12 months.

I’m looking at the full report on the cost cap breach right now, and I would guess that the reason for getting whacked so hard is that this wasn’t just one case of not following the rules. It was actually thirteen cases, including things like not properly accounting for social security contributions, the accounting for bonuses, travel expenditures, and even how fixed assets are disposed of. So, it sounds like Red Bull had some significant accounting control issues throughout the organization.

Though, to be fair, I’m going to include some testimony from Red Bull’s team principal, Christian Horner. He held a press conference about this, and noted that Red Bull took some aggressive stances on which expenses should be included in the cost cap, and which ones should be excluded. And he may have a point, because there are some gray areas in the rules, and those rules are extensive. So, maybe we have some control issues, and maybe we have some management decision issues.

Wind Tunnel Testing

So, getting back to the wind tunnel testing. This is really important, because, on a per-lap basis, there isn’t really that much of a speed difference between the cars. If your car has a one-second advantage per lap, that’s enormous. In the front of the pack, a reasonable difference in lap times is more like one or two tenths of a second. So, the teams have got to put their cars into wind tunnels for hours and hours to test various configurations.

Back before Formula 1 decided to make things more competitive, the top couple of teams would spend tens of millions of dollars each year on wind tunnel testing, pretty much doing it around the clock. So, as the season progressed and they gained more experience with the cars, the best teams would keep making adjustments and eventually pull away from everyone else.

But under the new rules, the team that did the worst in the preceding year – which was Williams Racing – is now allowed the most time in the wind tunnel, while the winner – which was Red Bull Racing – is now allowed the least time in the wind tunnel. It’s sort of like the draft order in American football, where the worst team gets the top draft pick for the next season.

So, now that Red Bull has won the 2022 championship, not only does it get the least wind tunnel time for its next car, but it’s now being fined ten percent of the reduced time that it was already allocated.

There’s a bit more to it than that. The total wind tunnel allowance covers a period of 12 months, so Red Bull could – and probably will – front-end load its testing, to verify that its initial design works well by the first race of next season, which is in Bahrain on March fifth. And I wouldn’t be surprised if Red Bull starts off at the front of the pack. But where you’re likely to see degradation in performance is over the rest of the season, where Red Bull won’t be able to do as much testing as everyone else, so their modifications to the car won’t keep up.

This doesn’t mean that Red Bull won’t win the entire season, but it’s likely to be a much closer contest than it was in 2022.

So, to summarize, it appears that a lack of accounting controls within the Formula 1 teams might actually have an impact on the race results. Who ever expected that?

Valuing Intangible Assets (#334)

What is an Intangible Asset?

Intangible assets have no physical substance, so their value is derived from any associated legal rights. For example, the value of a broadcasting license is the legal right to keep anyone else from using the associated radio frequency. It should generate some sort of value for you, such as when the owner of a taxi license rents it out in order to generate an inflow of rental payments.

There are lots of examples of intangible assets, such as Internet domain names, copyrights, royalty agreements, trademarks, and mining rights.

Why Value an Intangible Asset?

There are several good reasons why you might want to place a value on an intangible asset. For example, you might want to account for an asset acquired in an acquisition, or maybe you want to know how much to sell it for, or maybe to set a transfer price when you want to shift it between subsidiaries. From the perspective of an accountant, the most likely reason for valuing an intangible asset is because you acquired it as part of a business combination.

How to Value an Intangible Asset

The accounting standards say that the asset should be recorded at its fair value. Fair value is defined as the estimated price at which an asset can be sold in an orderly transaction to a third party under current market conditions. An orderly transaction means that there’s no pressure to sell.

Well, that’s a nice accounting definition, but when it comes to intangible assets, a valuation can be pretty hard to do. So, within that concept of fair value, what are your options? There are three, and they are the market approach, the income approach, and the cost approach.

Under the market approach, you use the prices associated with actual market transactions for similar assets. Under the income approach, you derive a value from estimated future cash flows. And under the cost approach, you derive an estimate of the cost to replace the asset.

So, when would you pick one method over another? The market approach might be the best choice when there’s an active market for the sale of similar assets, such as the sale of franchises or perhaps broadcast licenses. It’s an especially good idea when there have been similar sales or licensing transactions recently, and especially when there have been a lot of them. With lots of this type of information on hand, it’s easier to defend any valuation you might derive.

On the other hand, the market approach is probably a bad idea when the other transactions in the marketplace are for assets that are quite a bit different from your intangible asset. In this case, you’d have to make such a large adjustment to the market data that your conclusion could be questioned. Or, the market data involves the sale of a bundle of assets, which makes it too difficult to tease out the value of just the one asset that you’re interested in.

The income approach might be a better option when the asset produces either operating income or licensing income. This would be a good choice for valuing franchise agreements, where there’s a clearly discernible cash flow associated with each one.

And then we have the cost approach, which is basically for everything else. It’s especially useful when you intend to keep using the asset, because if you didn’t have the asset already, you’d have to create a substitute for it or obtain the use of such an asset from someone else, probably in exchange for a royalty payment. On the other hand, the cost approach should not be used to value older intangible assets, since they might not have much of a useful life left.

In short, the valuation method chosen will depend on a lot of factors. For an especially valuable asset, you might need to use several methods, and then derive a midpoint valuation based on the results.

Now, how do they work? For the market approach, you have three options. First, you could search for information about the sales of similar assets outside the company, or the rates at which comparable assets are being licensed to third parties. You might be able to find this information in online databases, though you may have to pay an access fee. Another option is to run a comparison of the profit margins being earned by similar businesses that do and do not own a similar asset, where the difference is assumed to be profit generated by the asset.

That’s a tough one to justify, since there are lots of reasons for that profit differential – including the competence of management and the experience level of the work force. And finally, you could use the relief from royalty method, which is based on the royalty rate that the organization would otherwise have to pay a third party to use a similar asset. That last one is a distinct possibility, if there are licensing deals available. In short, the method used depends on the circumstances.

Moving along, how would the income approach work? That has three components. First, you need to estimate the income directly associated with the asset. For example, a patent could be used to generate a flat fee from a licensee, or a percentage of revenue, or maybe a profit split. Or, when it’s not possible to directly measure the income generated by an asset, you could compare the owner’s actual income to a benchmark measure, such as the industry’s average profitability level. Any income generated above that benchmark amount is assumed to be due to the asset.

There’s also a more complicated variation on the income approach, where you first identify all assets that contribute to the generation of income, such as working capital, real estate, and fixed assets. Then you assign a reasonable rate of return to each one. All income still left after these returns are subtracted out is assumed to be income associated with the intangible asset. This is obviously complicated, so it’s only used when there is no simpler method available.

On top of all that, the income approach also requires you to estimate the period of time over which the asset will generate income, since it usually has a limited usable life. To be conservative, you’d normally assume that this period of time is the shortest one over which income can be reasonably expected.

And finally, you’ll need to discount this stream of cash flows to a present value, which is forward-looking, and incorporates your risk of being able to achieve the expected income level. So if your future income estimates for an asset are pretty rough, then it would make sense to use a higher discount rate.

Which leaves us with how to derive a valuation using the cost approach. The typical assumption is that you’re deriving the replacement cost new, which is the cost that would be incurred to create an asset of the same utility level of the current asset, but by using the most modern approach to the work. Taking this approach tends to result in a somewhat lower cost. At a minimum, the costs to include would be all direct and indirect replacement costs. On top of that, you’d add on the developer’s profit, which is the return that the developer expects on funds invested in the development process. This might be calculated as a percentage mark-up, or as a percentage return on the direct and indirect costs.

Once you’ve compiled the asset’s presumed replacement cost, you’ll also need to subtract out a deduction for obsolescence, on the grounds that the asset being valued is usually not new; instead, it may be approaching the end of its useful life, which might call for quite a large obsolescence deduction. Another type of obsolescence to consider is external obsolescence, which is a decline in the value of an asset that’s caused by external events, such as the passage of a law that eliminates the use of taxi licenses in two years. If so, any taxi licenses you own will be completely obsolete as soon as that law goes into effect.

So, that was a lot to stuff into a single episode. The main takeaway is that you’ll need to adjust the valuation method chosen, based on the type of asset and the availability of valuation information. In some cases, this is a major chore, which is best left to a professional appraiser who will charge you a pile of money to prepare a thick report. I suggest that you only use an appraiser when the asset is quite valuable, or when the range of possible values is really broad. In short, when there’s a risk of really screwing up a valuation, dump the work onto a licensed professional.

Related Courses

Intangible Asset Valuation

Accounting for Pass-Through Funds (#333)

The Nature of Pass-Through Funds

Pass-through funds occur when you’re expected to collect cash from a customer on behalf of a third party – usually a government – and pass along the cash to that third party. The usual example of this is sales taxes, where you’d collect the sales tax on behalf of the applicable government, and then remit the tax to them – usually once a month, but sometimes less frequently. In the listener’s case, the company collects vehicle licensing and registration fees from its customers and then passes them along to the Department of Motor Vehicles.

Accounting for Pass-Through Funds

It doesn’t really matter what the type of fee is, because the underlying accounting concepts don’t change. For example, if you’re collecting a vehicle licensing fee from a customer as part of a vehicle sale, then the sale is charged to a revenue account, while the licensing fee is charged to a liability account. We do this in order to keep the licensing fee from being recorded as revenue.

The listener goes on to ask if the licensing fee could be recorded within revenue and then subtracted out as a cost of goods sold. The answer is no, because you’d be artificially inflating the reported amount of revenue. Also, you’d be inflating the reported cost of goods sold. So, no – these pass-through funds should never appear on the income statement. Instead, they only appear in the liability section of the balance sheet as a short-term liability. When they’re remitted to the government – or some other entity – then the cash balance declines and the liability disappears from the balance sheet.

That’s the basic accounting. On top of that, consider setting up different liability accounts for these pass-throughs, one for each type of liability. For example, if you’re collecting vehicle licensing fees and registration fees on behalf of the Department of Motor Vehicles, you might have to report these amounts on different forms, and remit the funds to different government bank accounts.

Best Practices for Pass-Through Funds

That means using one account to store the licensing fees, and another account to store the registration fees. And on top of that, if your business remits these fees to the agencies of more than one state government, then you’ll need separate accounts for each one. For example, if you were remitting vehicle licensing fees and registration fees to the Department of Motor Vehicles for Washington, Oregon, and California, then you should have a total of six liability accounts in which to store these transactions.

Otherwise, you’ll have this hopelessly muddled single liability account that’s almost impossible to reconcile. And if that calls for a lot of pass-through liability accounts, then so be it.

Another issue is that, sometimes, the amount you collect from the customer will be different from the amount that the government is actually supposed to receive. If the amount collected is greater than the amount you have to remit to the government, then you do not – ever – recognize it as revenue. That money is not yours. Instead, the residual amount goes back to the customer.

What about the reverse case, where the amount you collect is too low? In that case, you’ll have to go back to the customer and try to collect the difference. If that’s too difficult, then your business will have to pay the difference. Governments will not accept a reduced amount, so you can’t just send them a reduced payment. If these shortfalls are minor, then it’s best to write them off as a cost of doing business, since it may be administratively more expensive to pursue the customer for payment. If these shortfalls are for large amounts, then you’d better look at your procedures and employee training, to see if there’re better ways to avoid incorrect customer billings.

Intercompany Eliminations (#332)

The Nature of Intercompany Eliminations

Intercompany eliminations occur when a business has subsidiaries that engage in activities with each other. For example, a manufacturing subsidiary sells some of its widgets to another subsidiary that specializes in selling them to outsiders. The manufacturing subsidiary records a sale and a profit on these transactions. If the buying subsidiary then sells the widgets to an outsider, then the consolidated financials for the combined business will record the sale twice – once for the internal sale and once for the external sale. Which is a great way to generate fake sales. Which is why we have intercompany eliminations. When producing consolidated financial statements for the entire business, including all subsidiaries, these intercompany transactions have to be backed out. In this example, you’d have to reverse the internal sale, including reversing the internal cost of goods sold, which in turn eliminates the internally-generated profit or loss.

When to Use Intercompany Eliminations

So, when do we have to do these intercompany eliminations? The basic rule is that you can only recognize sales or profits when the transaction is with a third party – so any transactions between subsidiaries that generate sales or profits have to be eliminated. Also, any intercompany transactions that move account balances around have to be eliminated. Which calls for an example. Let’s say that a corporate parent loans money to its subsidiaries, and charges them interest for the privilege. When the parent does this, it records interest income, while the subsidiaries record interest expense. This is a wash, since the recorded income and expense offset each other, resulting in no change in the overall profit or loss of the consolidated entity. However, it creates an interest income line item and an interest expense line where there weren’t any before – so these intercompany transactions also have to be eliminated. So those are the two rules of intercompany eliminations.

Examples of Intercompany Eliminations

So let’s apply some examples to these rules. First, what if the corporate parent employs most of the staff, and bills them out to the subsidiaries based on hours worked? This won’t impact reported profits, as long as no profit percentage is added to the intercompany billings, so rule one is not violated. Also, rule two is not violated, since the staffing expense is not being shifted among different financial statement line items – it’s still going to be reported as compensation expense on the consolidated financials. In short, no need for an intercompany elimination.

On the other hand, if the staff were billed out by the parent entity at a profit, then the profit would have to be backed out.

Here’s another example. What if the corporate parent’s overhead expenses are allocated to the subsidiaries? It doesn’t impact profits and it still appears in the same expense line item in the consolidated financials, so there’s no need to do any eliminations.

And one more example. A subsidiary sells some machinery to another subsidiary, and does so at a profit. This is not so good, because you can only recognize a profit if the equipment is sold to a third party. So, the gain on the sale will have to be eliminated. But we’re not done yet, because the purchasing subsidiary has acquired the machinery at a higher price, and so has to depreciate more expense per month than the selling entity was doing. This means that the incremental increase in recognized depreciation also has to be eliminated.

So as you can see, expense allocations across the various entities are generally going to be OK, while sale transactions or anything creating a gain or loss will require an elimination.

Intercompany Payables and Receivables

But no matter what type of transaction it might be, there’s another problem, which is the associated intercompany accounts receivable and accounts payable. For example, if an expense allocation is just handled as an intercompany journal entry, then there’s no receivable or payable on the books of anyone, and so there’s no need to deal with intercompany eliminations. However, if one entity bills another one for these charges and this billing is not paid at month-end, then this creates an account receivable on the books of the billing entity and an account payable on the books of the receiving entity – and those receivables and payables will appear on the consolidated balance sheet – which we don’t want.

What this means is that every unsettled intercompany receivable and payable on the books at the end of a reporting period has to be eliminated before you can create consolidated financial statements.

Now, all of this is quite annoying. It can be all too easy to miss some of these transactions on your books, which the auditors might find at year-end, and require an embarrassing adjusting entry to fix.

Intercompany Elimination Tracking

How can you make sure that all eliminating entries are made? The best approach is to operate the parent business and all of its subsidiaries on the same accounting database, so that every entity in the overall business is automatically flagged by the accounting software, which then takes care of the eliminations for you. If each business is instead operating its own accounting system, then you’re going to have to institute a manual month-end review of all transactions, to see if there are any intercompany transactions that need to be backed out. It’s an annoyance, but that’s what you get with a decentralized accounting system.

Technical Accounting (#331)

The Nature of Technical Accounting

What is technical accounting? A good way to look at this is to separate the general area of accounting expertise into two parts, where the base layer is basic bookkeeping, such as transactional activities like processing payables and payroll. Basically, the type of accounting knowledge that you can pick up from a principles of accounting textbook. Everything above that base layer is technical accounting, especially when you put in the effort to be a seriously high-end expert.

The concept usually applies to financial accounting, like knowing all the accounting standards – in detail – for things like derivatives, or leases, or pensions. But, it can also apply to a deep knowledge of the operational side of accounting, such as being an absolute expert in closing the books, or maintaining a really superlative inventory tracking system.

The concept of technical accounting is really important, even though you may never have heard the term before. It’s because this is where you add value to the organization – by being an expert. And by being an expert, you’ll be recognized for your work, and are more likely to be promoted, and just more visible than someone who doesn’t make the effort to elevate their skills.

You might think that being an expert in every possible area of technical accounting is the way to be recognized within the organization even more, but that’s not really the case. The trouble is that some of these areas can require enormous amounts of time to really learn in detail, so if you try to spread your time across multiple areas, you’ll never be an expert in any one of them.

How to Select a Technical Accounting Field

Which leads to the question of figuring out which technical accounting area you want to jump into. There are a couple of ways to look at it. One, and really the most important one, is simply whether you like the topic. If you really like accounting for derivatives, then great, go for it. If you’re like ninety-nine percent of all accountants and you’re repulsed by the idea of learning more about derivatives, then steer clear of it. Whatever you do is going to require a large time investment, so don’t spend a few thousand hours on a topic you don’t like.

This can be a problem for relatively junior-level auditors, because the audit managers and partners are always trying to force you into a certain audit area, like nonprofit auditing, so that you can be presented to clients as an expert in that area.

Well, that’s fine, but what if you don’t like the direction in which they’re pushing you? It’s best to figure that out early, and see if you can transfer to a different area.

Another view of the situation is looking at it strategically. Try to figure out what the organization really needs, and that will get you recognized, and pursue that area of expertise – as long as you like it.

For example, if your employer is an airline and it’s hedging its fuel costs, maybe you could consider learning all there is to know about the accounting for these types of hedging activities. Whereas learning about the accounting for payroll for that same airline might not get you as much recognition.

Technical Accounting Responsibilities

So if you’ve selected a technical accounting area, what does that mean? Well, if you’ve picked a financial accounting area, which is most common, then you’ll need to keep up-to-date on all new accounting standards pertaining to that topic, and know the existing standards in detail. Your knowledge should be at a level where everyone in the company comes to you for advice, and you might even be considered an expert within the industry. On top of that, you’ll be expected to represent the company’s position if the auditors bring up any issues related to your area of expertise.

On top of book learning, you’ll also be expected to prepare the policies and procedures for your area. And to train others in your area. And provide internal consulting advice. Furthermore, if the company is engaged in any accounting activities in your area that you think are a bit suspect, then you need to point out the problems and present solutions. And finally, if there’s any wiggle room in the accounting standards for how transactions should be treated, then you’re the one who’ll be expected to present the options and recommend which way to go. In short, you’re the expert.

System Conversions (#330)

How do you handle a complete system conversion? Switching to an entirely new accounting system is a massive undertaking, and people screw it up all the time. In fact, controllers lose their jobs over failed conversions.

Initial Considerations

So first, as a guiding principle, this is not an area where you want to be aggressive. You don’t just swap out the accounting software on short notice, because it seems like a good idea. Spend months thinking about, looking at the alternatives, and deciding whether you can keep going with the existing system instead of switching to a new one. Unless there’s a clear benefit to using a new system, you probably want to stick with the old one.

Clean Up Existing Processes

Next, clean up what you’ve already got. If you have complicated accounting processes, you’ll somehow have to switch them over to the new system, which could turn out to be a complete mess. This could be a major concern if you have to conduct custom programming while also installing new software. Instead, try to make your existing systems as simple as possible. That way, you can more easily adapt those systems to how a new accounting software package works. If you try to do the reverse and alter the new software to match your old systems, then the odds of failure just went up.

Select Software

Next up is deciding on which software package to buy. Entire books have been written about this topic, so I’ll focus on just a couple of items. First, never go with a new software provider. You do not want buggy software, because you could get fired if the system doesn’t work. Second, make a list of the functionality that you really, really need, and make your decision based on that. Most accounting software packages contain the same features as all the other ones, so the decision will be based on just a couple of factors.

This could make your decision a lot easier, especially if you’re in a specialized industry where there are only a couple of software packages designed for it. And finally, you’ve got to check references. Preferably, go and see an active software installation. Focus on how the system processes your most important transactions. Ask about the quality of support from the software company, and whether they have a process in place for requesting feature changes.

Convert to the New System

So now you’ve picked the software, you only have the minor task left of converting over to the new system. Chuckle. There are three ways to do it.

You could shut down the old system on one day and start up with the new one on the next day, also known as the cold turkey approach. Or, you could run the old system and the new system in parallel, until you’re sure that the new system works. Or – final choice – you could install one module at a time and construct a custom interface to make it work with the remaining modules in the old system. Then you gradually install new modules over an extended period of time, gradually shutting down the old system.

Remember what I said earlier, this is not an area where you want to be aggressive. So, just shutting down the old system and starting up the new one is generally not a good idea. The only case in which you could pull this off is when your accounting system is very, very simple, with a low volume of transactions, and you can afford to have systems nonoperational for a week or two while you figure out the problems with the new system.

But that’s not possible with a business of any size. In these cases, you really need to use some level of concurrent operations, where some aspects of the old system are still running while you’re getting the new system operating.

I think the best choice is to run the old system concurrently for a few months, while you install the new system. I know, it’s a lot of work – but by doing so, you have a great fallback in case the new system doesn’t work as you expect – and in some respects, it probably won’t. So assign some of your staff to just maintaining operations on the old system, while you run the same transactions through the new system, and test the output against the old system. Then shut down the old system when you’re good and ready.

Now, I also mentioned a third option, which was converting one accounting module at a time. This approach works best for really large companies that might have to switch over the software at multiple locations. In these cases, even a parallel operations approach isn’t really feasible, because it might take them two or three years to complete the conversion. For them, the only option is probably to conduct a very careful conversion, module by module. It’s slow, it's really expensive, and it’s safe. These organizations have to hire a large group of system conversion specialists that works separately from the in-house accounting staff.

When to Use Consultants

Now, a word on consultants. System conversions are all about reducing your risk, and consultants have a lot of knowledge about doing these conversions, so hiring them reduces your risk. They are also insanely expensive. Doesn’t matter. If you’re going to do a big system conversion, you will need consultants, so budget for it.

Also, consultants have their own methodologies for these conversions, which are incredibly detailed, and take a lot of time to complete – so whatever you budgeted for consulting, expect to add a zero to the price. I’m not kidding. This process is expensive.

Department Management

And a word on how to manage the department while a system conversion is going on. Shut down all other projects you might have until the conversion is complete. This is no time to get distracted by unrelated activities. Conversions are career threatening, so treat them like they are the only issue that matters. Because it’s true. You screw up a system conversion, and it’s quite possible that you’ll lose your job. So, focus the department’s attention 100% on converting to the new system. Nothing else matters.

Furthermore, tell the accounting staff in advance that overtime is a distinct possibility, and prohibit all vacations during the conversion period. You’re going to need maximum staff time to make the new system work.

And finally, block out lots of time in advance for the staff to be trained on the new system. This should be intensive, and done right before the conversion work starts. If you skimp on the training or schedule it too far in advance of the actual conversion, then no one’s going to have a clue what’s going on.

Buy a Big Upgrade

One more note on this topic. I’ve pointed out that system conversions are expensive, time consuming, and can get you fired if you screw up. Because of these issues, whenever you do a system conversion, buy into the biggest, most robust accounting system that you possibly can. That way, the company can grow for a long time without having to deal with another conversion. Ideally, acquire a system that can handle the company’s needs even if it’s a big publicly-held company. That way, you never have to worry about doing another conversion.

Related Courses

Accounting Information Systems

The Fixed Asset Policy (#329)

The Nature of a Fixed Asset Policy

This episode covers the main contents for a fixed asset policy. First, what is a fixed asset policy, and why do we need it? It describes how you’re supposed to account for fixed assets. This isn’t minor, because without it, there’s a good chance that you’ll set up a different useful life, depreciation type, and salvage value for every asset you acquire, which can be quite a mess.

Fixed Asset Classifications

The first step in setting up a fixed asset policy is deciding upon how many classifications of fixed assets you’re going to use. For example, you could set up classifications for buildings, furniture and fixtures, vehicles, computer hardware, and production equipment. It all depends on the nature of the business.

The reason for doing this is to assign a standard useful life and depreciation method to each classification, which is then applied to each fixed asset within that classification. So for example, you might assign a seven-year useful life to the furniture and fixtures category, with straight-line depreciation, and no salvage values allowed. That last part is useful for some categories, because there’s rarely any salvage value associated with furniture.

Now, don’t go too deep with the classifications concept. Unless your business has thousands of assets, it doesn’t make a lot of sense to have dozens of classifications. Keep it relatively simple. Ten classifications or less might be fine, and if you go past twenty classifications, you should start to question what the extra level of detail is really achieving.

Then assign useful lives and depreciation methods to each of the classifications. The useful life figure can be calculated from an average of the company’s experience with its own assets. Again, don’t be too anal about it. If your research indicates that the useful life of computer hardware is 3.8 years, then round it up to four years. That’s good enough.

Depreciation Methods

As for depreciation methods, I personally prefer the straight-line method in all cases, because accelerated depreciation tends to skew a bunch of performance ratios, like return on assets. But that’s your call. Whatever method you decide to use, try to apply it consistently across all of the fixed asset classifications. You don’t have to, but consistency of application will make life easier, and you’ll make fewer mistakes when calculating depreciation.

Fixed Asset Salvage Values

As for salvage values, that will vary by individual asset. But I would suggest that you apply a flag to each of the classifications that either allows the application of salvage values, or it does not. By doing so, you don’t have to mess with trying to derive what are probably minor salvage values for most fixed assets. For example, building assets and equipment assets probably have significant salvage values, while furniture, computer hardware, and computer software probably don’t.

The Capitalization Threshold

That covers asset classifications. Next up, include a capitalization threshold in the policy. This is the dollar value for an asset purchase that represents the dividing line between charging the purchase directly to expense, or recording it as a fixed asset. This threshold is used to keep from wasting time recording minor items as fixed assets. For example, a wireless mouse for your computer will be used over several years, and so it could be classified as a fixed asset – but why bother when it only costs a few dollars?

The usual approach is to make a common-sense judgment about what types of purchases you want to keep track of over the long term. Also, if you do an historical analysis of how much various purchases cost, there’s usually a natural dividing line for what appears to constitute a fixed asset. The exact amount will vary by company. A really small firm might set the capitalization level as low as $1,000, while others might use $2,500 or $5,000. A really large firm might decide that $10,000 works for them.

A key point here is that the accounting standards do not state that you can use a capitalization limit. It’s simply allowed through common usage. Auditors will allow it, because charging something off to expense in the current period is always more conservative than capitalizing it and then charging it off through depreciation over a number of years. And auditors like conservative accounting.

Multiple Fixed Asset Purchases

A final item is what to do with lots of assets purchased on a single invoice. For example, you could buy a bunch of chairs that individually fall below the capitalization limit, but which exceed the limit when charged to the company as a group, on a single invoice. My view is that these items can be capitalized – but you can go either way with it. Just include it in the policy, and apply your decision consistently.

Fraudulent Financial Reporting

That covers the basics. Another issue to be aware of is that the fixed asset policy is prime territory for fraudulent financial reporting. That’s because someone could lengthen the useful life for an asset classification in order to delay recognizing depreciation expense. Or, altering the depreciation method from an accelerated method to the straight-line method would do the same thing.

They can make these changes look like standard procedure by altering the fixed asset policy. To keep this from happening, institute a rule that the audit committee has to approve any changes to the fixed asset policy. This rule might not work, since the people making these changes are company managers, and they may just “forget” to inform the committee. Still, you can at least have the rule in place.

The Need for an Exhaustive Fixed Asset Policy

A final thought is in regard to the original listener question, which was about how to develop an “exhaustive” fixed asset policy. It’s that word “exhaustive.” Accountants have a reputation for being too bureaucratic, maybe because we want to have rules in place for everything. That’s not actually necessary. You should only create a rule if an issue keeps coming up. If it only happens once, then there’s no need for a rule. To apply this concept to the fixed asset policy, keep it relatively short and to the point. Only expand the policy if there’s an actual ongoing need for a rule.

Related Courses

Fixed Asset Accounting

Fixed Asset Controls

Long-Term Cash Flow Forecasts (#328)

Is it possible to construct a viable long-term cash forecast? Answering this requires some clarification of how a cash forecast should be constructed.

The Receipts and Disbursements Method

A cash forecast has three distinctly different formulations, depending on how far out you want to go into the future. The most predictable cash forecast only goes out about a month, and is based on a detailed accumulation of data from a couple of sources within the company. Most of it comes from the accounts receivable, accounts payable, and payroll records, though some other significant sources are the treasurer, for financing activities, and even the corporate secretary, for scheduled dividend payments. Since this part of the forecast is based on detailed itemizations of cash inflows and outflows, it’s sometimes called the receipts and disbursements method.

The short-term forecast is quite reliable, though even here there can be some uncertainty, since payments from customers don’t always arrive when you expect them. And if those cash inflows are not as predictable as you’d like, then outbound cash payments might be delayed to minimize the risk of running out of cash.

The Medium-Term Cash Forecast

Next, we have the medium-term cash forecast, which begins at the end of the short-term forecast. The components of the medium-term forecast mostly come from formulas, rather than the very specific data inputs used for a short-term forecast. For example, cash outflows related to the cost of goods sold might be based on an estimated percentage of sales, with a time lag based on the average supplier payment terms. Or, the sales forecast can be used to estimate changes in production headcount, which in turn can be used to derive payroll payments. Or, cash receipts from customers are based on a standard time lag between the billing date and the payment date.

The concept of a formula-filled cash forecast that automatically generates cash balance information breaks down in some parts of the forecast. For example, some expenses are based on contracts, such as rent payments, and so are set up with specific cash payouts on specific dates. Or, some expenses are only associated with specific events, like the company Christmas party, and so have to be manually added to the forecast.

And, one of the biggest manual additions is any type of step cost. A step cost is an expense that is constant for a given level of activity, but which takes a large step upward when an activity threshold is crossed. For example, if projected sales surpass a certain point, then the cash forecast has to include additional expenditures to staff up a new production line, or maybe to rent more facility space.

The methods used to construct a medium-term cash forecast are inherently less accurate than the more precise information used to derive a short-term forecast. The problem is that much of the information in the medium-term forecast is derived from the estimated revenue figure, which declines in accuracy just a few months into the future. For that reason, it’s dangerous to develop a cash forecast that extends very far out. And on top of that, there’s an immediate decline in forecasting accuracy as soon as you switch from the short-term forecast to the medium-term forecast.

The Long-Term Cash Forecast

Since I mentioned a medium-term forecast, of course there has to be a long-term forecast, too. This can be used to extend the forecast out for a year or two past the end of the medium-term forecast. The information for the long-term forecast comes from the corporate budget, so it’s only going to be as reliable as the budget – which might not be reliable at all. Long-term cash forecasts are only approximate representations of what will actually happen, so they shouldn’t be used as the basis for any specific management actions. That being said, a long-term forecast can give you a general idea of where your cash balance might be in the future, so it can be a guide for approximately when you might have a cash shortfall, which might require some financing activities.

Whether to Issue a Long-Term Cash Forecast

So, does it make sense to issue a long-term cash forecast? If you do, be sure to point out that the quality of the data declines at specific points – which are one month out, when you switch to the medium-term calculation method, and again further out, when you base the forecast entirely on the budget. If someone insists on a long-term cash forecast, then they have to understand the quality of the information they’re receiving.

Related Courses

Corporate Cash Management

Converting to the Accrual Basis (#327)

How do you convert from the cash basis of accounting to the accrual basis Under the cash basis, you recognize revenue when cash is received, and expenses when cash is paid. Under the accrual basis, you recognize revenue when it’s earned, and expenses when they’re incurred. So, the timing of revenue and expense recognition can be totally different.

Doing the conversion from the cash basis to the accrual basis is pretty common, since small businesses typically start with the cash basis, and then flip over to the accrual basis when they get larger. You might need the accrual basis in order to convince a lender to issue a loan, or maybe because an acquirer wants to see your financials prepared under the accrual basis.

Step 1. Add Accrued Expenses to the Financials

The conversion involves six steps. First, you have to add accrued expenses to the financials. This means adding back all expenses for which the business has received a benefit but hasn’t yet paid the other party. You should accrue for all types of expenses, such as wages earned but unpaid, direct materials received but unpaid, office supplies received but unpaid, and so on.

Step 2. Subtract Cash Payments

The second step is to subtract cash payments. This means subtracting out cash expenditures made for expenses that should have been recorded in the preceding accounting period. It also means reducing the beginning retained earnings balance, which thereby incorporates these expenses into the earlier period.

Step 3. Add Prepaid Expenses

The third step is to add prepaid expenses. Some cash payments might relate to assets that haven’t yet been consumed, such as rent deposits. You should review expenditures made during the accounting period to see if there are any prepaid expenses, and move the unused portion into an asset account. If you want to do the same for expenditures made in prior periods, then adjust the beginning retained earnings balance to remove the expenses that are now being shifted into a prepaid expenses asset account.

Step 4. Add Accounts Receivable

The fourth step is to add accounts receivable. This means recording accounts receivable and sales for all billings issued to customers and for which no cash has yet been received. This can be time-consuming, depending on sales volume.

Step 5. Subtract Cash Receipts

The fifth step is to subtract cash receipts. This is because some sales originating within a prior period might have been recorded in the current period, because the related cash was received in the current period. If so, reverse the sale transaction and record it instead as a sale and account receivable in the preceding period. To do this, you’ll need to adjust the beginning retained earnings balance.

Step 6. Subtract Customer Prepayments

And the last step is to subtract customer prepayments. You may not have to worry about this one at all, but customers might have paid in advance for their orders, which would have been recorded as sales under the cash basis of accounting. You should record them as a liability until the related goods have been shipped.

Additional Conversion Issues

So, that’s obviously a lot of work. And it’s worse than you think, because you might not catch everything that needs to be converted. The only way to be certain is to examine every single transaction during the year being converted, and in the final quarter of the preceding year. Which might be a huge amount of work.

To make things even more difficult, a small business tends to not have an overly well-run accounting department, which means that its accounting records aren’t exactly well documented. Which makes it more difficult to figure out if a transaction needs some kind of adjusting entry.

So, what is the strategy for this? How do you go about actually doing the conversion? There’s clearly a lot of work involved, and you might not have enough staff to do it. A couple of options are available.

One is to hire an accounting firm to go through your records and figure out the entries that need to be made, and then make a bunch of one-time entries to flip over to the accrual system. I recommend this approach, because you’re getting people to do it who have – hopefully – done it before, and so are less likely to make mistakes. It also means that you’ll be able to start with a fairly reliable set of accrual basis financials as of a designated date.

Another possibility is to work your way into it gradually. This could work if you want to do everything in-house, which might even be the only option if you can’t afford to have an accounting firm do it for you.

This might sound a bit unorthodox – and it is – but a possibility is to slowly go through each of those six steps that I outlined, and gradually convert over. What that means is that the final year under the cash basis of accounting would actually be done in accordance with a hybrid of the cash and accrual systems, which is not allowed by any accounting framework. But, if you just want to take your time and slowly roll out the conversion, and no one is especially concerned about the results you’re posting during that transition period, then you could try this option. The main advantage is that you can get by with the minimum amount of resources over a more extended period of time.

The final option is to keep the work in-house, do the research in advance of the conversion date, and run the same journal entries that an outside accounting firm would use if you had hired them instead. The benefit here is that you’re not paying the fees of the outside accountants. The downside is that – presumably – no one on staff has done this before, so the risk of making a mistake is higher.

To avoid the mistakes associated with any type of in-house conversion, you might consider hiring an accounting firm just to check your proposed entries, to see if anything is wrong or missing. There will be a fairly hefty billing for doing this, but it’ll be much smaller than if you hired the accounting firm to do the entire project.

Related Courses

Accountants’ Guidebook

Bookkeeping Guidebook

The Formula 1 Accounting World Championships (#326)

The topic of this episode comes from Christian Horner, who is not a listener, and it is the Formula 1 accounting world championships. He stated recently that the new budget caps that have been imposed on the Formula 1 teams are so complicated that they might actually decide who wins the championship. And in cases where the points total is close, he might have a point.

But first, for some background. Yes, I am a Formula 1 nutcase, and check on the latest Formula 1 news every single day. I also just got back from watching the Canadian Grand Prix, which is held every year at a race track outside of Montreal. Very cool. Also very, very expensive. And as a side benefit, I caught COVID while I was there. Already recovered, no worries.

So, who is Christian Horner? He runs Red Bull Racing, which is currently leading both the team championship and the individual championship. And they’ll probably win the whole thing this year.

The Formula 1 Cost Cap

And what is he so concerned about? How on earth does accounting enter into the Formula 1 championship? Well. The main problem with Formula 1 is that there are 10 teams, but only three of them usually have enough money build a car that’s good enough to actually win the championship. Those teams are Red Bull, Ferrari, and Mercedes. The other seven just don’t have the cash. So, to make things more competitive, Formula 1 imposed a cost cap on the teams that starts in 2022. Under the new rules, you can’t spend more than $140 million dollars for the entire season for 21 races. If an extra race is added, then the cost cap goes up by $1.2 million, which tells you how much money a team spends to move to a new venue and operate its cars there for four days.

Also, the cost cap goes down even more for the 2023 race season, with a cap of $135 million.

This creates some issues. One is that freight costs have gone up astronomically this year, so that transferring the cars and everything else from one race to the next costs three times more than they expected. And that’s a lot when you’re shipping by air freight. Horner guessed that costs have gone up so much this year that a majority of the teams might not even be able to compete by the end of the year, because they hit the cost cap.

So there’s one issue, which is a loss of competition due to the new cost cap rules – which is the exact opposite of what the cap was intended to do. But there’s more.

Cost Cap Rules

So. The $140 million cap does not include any financing or marketing or human resources costs, or the amounts paid to the drivers, or the travel costs of those drivers. And there are lots of other exclusions, like entertainment expenses and foreign exchange gain and losses. Which means that there’s lots of room for interpretation.

There are also pages and pages of rules about how to account for inter-team transactions. For example, Ferrari sells its engines to the Alfa Romeo and Haas teams, while Mercedes sells its engines to the McLaren, Aston Martin, and Williams teams. If you dig into Formula 1 at all, you’ll find that it’s quite incestuous. All of the seven other teams are interrelated with the Red Bull, Ferrari, or Mercedes teams in some way. Which also means that there’s room for some interpretation of where costs were charged.

There’s also an issue with redundant inventory, which most people would call obsolete inventory. The cost of redundant inventory goes against the current year cost cap, so of course there will be arguments about whether something is redundant.

And believe me, I’m only mentioning a sliver of the total costing rules.

Cost Cap Administration

There’s a group within Formula 1 called the Cost Cap Administration that issues guidance on how to interpret all of the cost cap rules. Sounds an awful lot like the Financial Accounting Standards Board, except that it only applies to Formula 1. The Cost Cap Administration reviews the reporting documentation that has to be submitted by each team, and can bring in an outside audit firm to conduct investigations.

And here’s a key item. The Cost Cap Administration can investigate a reporting year at any time within the following five years. So lets talk about some of the implications.

If the adjudication panel of the Cost Cap Administration finds that a team has made a procedural breach of the rules – like making a late report submission – then it can impose a financial penalty. Not a big deal.

Cost Cap Penalties

If a team goes over the cost cap by no more than five percent, that’s considered a minor breach. Which will result in a financial penalty and maybe also something called a minor sporting penalty. Despite the name, that minor sporting penalty can be a big deal, since it can include a deduction from the championship points total, and maybe exclusion from a race.

And if a team goes over the cost cap by more than five percent, then it’s committed a material overspend breach, in which case a championship points deduction is required – not optional – along with a financial penalty. And a team might even be kicked out of the championship entirely.

So let’s get back to that five year limitation on auditing the books. The Cost Cap Administration could hear from an insider that a reporting breach occurred a couple of years prior. Its investigation concludes that there was either a minor sporting penalty or a material overspend breach. If so, the resulting point deduction could strip a team of a championship that was awarded a couple of years ago.

If you’ve ever watched the Netflix series Drive to Survive, you’ll know that the top teams in particular are always filing complaints against each other for all sorts of perceived infractions. After all, these races can be decided by very small amounts, so anything that gives a team an advantage seems to be worth pursuing.

Will this now include arguments over the cost cap? Very likely. And it sounds like the squabbles could continue for years after a racing season has supposedly been decided. The only thing that’s certain is that Formula 1 teams will be hiring cost accountants.

Special Purpose Acquisition Companies (#325)

What is a SPAC?

A SPAC is a special purpose acquisition company. It’s a shell company, which means that it has no revenue or operating history at all. Instead, it’s designed to buy another business, using money that it raised through an initial public offering, or IPO, and which is initially stored in an escrow account. Depending on how a SPAC is designated when it’s formed, at least 80 percent of the money raised through an IPO usually has to be spent on an acquisition within two years. If not, then it has to dissolve and return the cash to investors.

If a SPAC is dissolved, the investors don’t get back any of the money earned while the cash was held in escrow, since those earnings are used to pay for operating expenses.

These arrangements certainly might not work out, since the operators of a SPAC might not even know which businesses they want to acquire when they take the business public. Instead, they’re just sitting on a pile of cash, and looking around for opportunities. And, even if they find a possible acquisition target, the purchase is put to a shareholder vote – which might turn down the proposal. Alternatively, the investors might approve of an acquisition, in which case the cash is released from escrow, and the target company is purchased.

If a shareholder votes against an acquisition, then that person can get his funds back that were held in escrow. On the other hand, if the share price of the SPAC has gone up since the date of the IPO, it can make more sense for a shareholder to vote in favor of the deal, and then sell his shares to someone else on a stock exchange at a higher price.

The Cost of a SPAC

What about the cost of a SPAC? This is its main advantage. It usually incurs a 2% underwriting fee at the time of the IPO, and then another 3.5% underwriting fee when an acquisition is completed. Compare that to the 7% fee usually charged on the funds raised through a traditional IPO. Of course, if an acquisition never occurs, then the 2% underwriting fee is essentially lost.

The SPAC Sponsor

So, who starts a SPAC? The party that starts one is a pre-IPO investor, and is called a sponsor. This might be an investment fund, which links up with someone with lots of experience in the industry where the SPAC is going to look for investments. Investment funds like to engage in SPACs, because they have an easy exit – they can just sell their shares on a stock exchange, which is a lot easier than trying to sell off the shares of a private company.

Sponsors have to provide a small amount of pre-IPO capital, usually a few million dollars. In exchange, they receive founder shares in the SPAC. On the day of the IPO, these founder shares are converted into somewhere in the range of 20% to 25% the common stock of the SPAC. Pretty sweet deal for the sponsors.

On top of that, the sponsors receive a warrant for each share of sponsor capital, which allows them to buy an additional share of the SPAC following a successful acquisition. The usual arrangement is that the share price of an IPO is $10 per share, and the warrants have an exercise price 15% higher than that, which is $11.50. It would only make sense to exercise a warrant if the market price of the stock exceeds the $11.50 exercise price. Or, a warrant holder could just sell the warrant to another investor.

Based on these compensation arrangements, it doesn’t make much sense to invest in the IPO of a SPAC – the sponsors are taking such a large ownership interest in the entity.

Accounting for a SPAC

So, what about the accounting for a SPAC? Initially, there’s not much to do. It reports some minor operating expenses, with most of it related to its required quarterly reports to the SEC. If an acquisition is completed, then the owners of the acquiree may be paid in cash, or in SPAC shares, or a combination of the two.

In an acquisition, the SPAC might be considered the acquiring entity, which means that it records the assets and liabilities of the acquired entity at their market values. If the total payout exceeds the net value of these assets, then the residual is recorded as a goodwill asset. When the SPAC is the acquirer, the financial results of the acquired business are recorded starting on the acquisition date.

Or, depending on the circumstances, the acquired entity might be classified as the acquiring entity. This happens when the shareholders of the acquired entity receive a majority of the voting shares of the SPAC, rather than being paid in cash. When this is the case, it’s called a reverse acquisition – where financial statements are issued under the name of the SPAC, but the financials are essentially a continuation of the financial statements of the acquiree.

Some lesser accounting issues are recording the value of the warrants issued to sponsors, and the cash flowing into and out of the escrow account.

Accounting for Buying Commissions (#324)

This episode covers the accounting treatment for buying commissions paid by an importer to an agent on goods imported. A buying commission is a fee paid by an importing buyer to its agent for the service of representing it abroad in the purchase of goods. Representation might involve searching the market for the best available prices, negotiating with suppliers, conducting quality inspections, and making payments on behalf of the buyer.

There is nothing in the accounting standards that specifically covers buying commissions. On the other hand, there’s a great deal about it in the rules and regulations for any country that charges a customs duty on the value of imported goods. The basic question from a customs duty standpoint is whether the value of the buying commission is part of the purchased goods, and so gets to be whacked with a customs duty. The importer obviously wants to avoid the duty, and so tries to keep the buying commission separate from the stated value of the goods.

From an accounting perspective, we don’t care about all the arguments pertaining to customs duties, since they all vary by country anyways. Instead, we can rely on the accounting rules pertaining to the cost of goods sold – which we just happen to have covered in the last episode. The main rule is that an expense is included in the cost of goods sold if it’s clearly a cost of the goods that are sold. Therefore, the key question is, could the importer obtain the imported goods without paying the buying commission? The answer is – no, it could not, because the agent will not represent the buyer if it is not paid this commission.

Also, the buying commission is usually a percentage of the goods being purchased, which closely ties the expense to the cost of goods sold. This also means that the commission can be considered a direct cost, because it’s only incurred if goods are purchased. Being a direct cost is a prime determinant of being classified within the cost of goods sold. So there you have it, cost of goods sold all the way.

What is the presentation of this expense in the income statement? The answer is, within the cost of goods sold section. Unless you’re breaking out lots of line items on the income statement, it’s probably going to be aggregated into the main cost of goods sold line item.

The Cost of Goods Sold (#323)

The topic of this episode is, what goes into the cost of goods sold. This might seem obvious, but that’s not always the case. The topic sort of came from a listener, who was wondering about what might go into the cost of goods sold for a software as a service company. That topic was too narrow for the podcast, but it seems worthwhile to back up for a minute and discuss the criteria for what should go into the cost of goods sold.

Accounting Rules of the Cost of Goods Sold

The accounting rules for the cost of sales and services is described in section 705 of the accounting standards codification, which covers generally accepted accounting principles. The funny thing is – there’s literally nothing in it. Section 705 just refers you out to specialized areas, like agriculture and federal government contractors, for more information.

So, what we have here is a presentation issue for which there really isn’t any guidance – what goes into the cost of goods sold, as stated on the income statement?

Criteria for the Cost of Goods Sold

One possible rule is to include in the cost of goods sold anything that’s a direct cost of sales. This means that a cost is only incurred if a sale occurs. The obvious items here are direct labor and direct materials, which everyone puts in the cost of goods sold. But what about credit card fees, and sales commissions? These expenses only happen if there’s a sale, so shouldn’t they also be presented within the cost of goods sold?

Both items might very well be listed lower down in the income statement, with credit card fees listed within the bank expenses line item for the accounting department. And you might find sales commissions within the sales department’s expenses, as part of compensation.

So, you could include these items in the cost of goods sold, though general practice places them lower down in the income statement. A possible reason for not including them in the cost of goods sold is that jamming them into the cost of goods sold lowers the reported gross margin. If you happen to be a public company, then this could be a problem, because your reported gross margin would then be lower than what everyone else in the industry is reporting.

To muddy the waters even further, consider this scenario. During the pandemic, a lot of tenants couldn’t pay their rent, so they struck deals with their landlords to pay them a portion of their revenues instead of the usual fixed rent payments. Should these payments be included in the cost of goods sold? Variable rent payments are a direct cost of sales – but they have nothing whatever to do with the cost of the goods that are being sold. So, no – variable lease payments are an administrative expense.

So, my possible first rule of what to include in the cost of goods sold doesn’t seem to work that well. Let’s try a second rule, which is to base the decision on the name of the line item in the income statement – the cost of the goods that are sold.

This sounds a bit more traditional. Under this logic, we can include the cost of direct labor, and direct materials, and factory overhead – pretty much what you’d normally see in any income statement. This sounds great – for a manufacturing company, where tangible goods are being sold. Lots of companies don’t do business that way, which makes the situation more difficult.

For example, let’s go back to the original question posed by a listener, which was – what goes into the cost of goods sold for a software as a service company? In this case, subscribers are accessing the provider’s software online in exchange for a monthly subscription fee. What is the cost of goods sold?

Well, the service being provided is the software and database combination that customers use. This certainly means that the computer system hosting cost falls within the cost of goods sold. On top of that, the cost of the people who keep the hosting environment running should be included. Also, if you’re paying royalties for the software being offered to customers, then that would be a cost of goods sold. And for that matter, if the company is helping its customers with implementation – to start using the service – then that could be considered a cost of goods sold.

So as you can see, the presentation decision varies enormously, depending on your industry.

At this point, I’ll offer a third rule for how to clarify the situation, which is rather than assuming that everything belongs within the cost of goods sold, do the reverse and assume that it belongs elsewhere else, and review the pros and cons. It might result in a change in classification.

Fourth rule. Look at accepted industry practice. You can hardly go wrong with the auditors if everyone else is already doing it. And, of course – fifth rule – just ask the auditors. They will probably be quite definitive about the key components of the cost of goods sold, but might leave some gray areas around the edges, where you can either include some expenses, or not.

A final thought is that, whatever you decide to do, stick with it for a long time. If you keep moving items in and out of the cost of goods sold, then it’s too difficult to figure out a trend line of the gross margin percentage. And management needs that number to run the business.

Related Courses

The Income Statement

The Interpretation of Financial Statements

Open Book Management (#322)

The topic of this episode is open book management. The general concept is to formally share your financial information with employees on a regular basis. Ideally, you’d provide training to employees about what all the numbers mean, and then do a presentation each month to talk about the company’s results, so they can ask questions.

Advantages of Open Book Management

The main reason for doing so is to get employees more directly involved in running the business. The thinking goes that if everyone understands the situation, they’ll be more likely to pitch in. This means contributing more ideas about how to improve operations.

 It might work especially well in start-up companies or in businesses that are in trouble, since everyone would know how dire the situation is, and be more likely to help. And it could be useful when employee pay is linked to the performance of the business, as would be the case with profit sharing.

Disadvantages of Open Book Management

 Based on that logic, you’d think everyone would use open book management. But it’s not used much at all. In fact, I’ve proposed it to every CEO I ever worked for, and got laughed out of the room every time. Their viewpoint is a bit different.

 There are a couple of arguments against it. First, if the company is losing money or its sales are going down and employees know this, then they might be more likely to leave. Whereas, if you didn’t tell them about the financial situation, they’d be more likely to stay.

 Another reason is that employees would be more likely to demand pay increases if the company was wildly profitable. I suppose there might be some validity to this, though I’ve run through the financials of hundreds of companies, and I can’t think of any that were doing that well. Most organizations are just scraping by or making modest profits.

 A continuation of that logic is that, if management doesn’t increase employee pay, then their reaction will be to work less, since they’ll feel they’re being undervalued by management.

 And another argument against open book management is that, once you start providing financial information to employees, it’s pretty hard to turn off the information flow. If you do, then employees will think that you’re hiding something.

 In essence, if you’re an optimist who believes in the better side of human nature, then you might be more inclined to try open book management. If you’re the reverse, then only threat of certain death will convince you to do this. In my experience, most senior managers are in the second camp. No amount of arguing will convince them that this is a good idea.

 And we’re not done yet, because you also need to consider the reaction of investors to this approach. Their main concern is how it will impact their return on investment. Again, it depends on their mindset about its impact. Having dealt with a lot of investors over the years, I think they’d only approve of the idea if you could prove a positive outcome in advance, which is pretty hard to do.

How to Implement Open Book Management

 So, a few suggestions. If you’re going to try open book management, start off at an extremely high level. That means just the sales numbers for the quarterly financial statements. You could get into all aspects of sales, so that employees understand things like the seasonality of the business, and which regions generate the most sales, and which products sell the best. At this level of information, employees are not being told about profits, so they can’t draw any conclusions about how their compensation fits into the financial situation of the company.

 Run the project at this level for quite a while – maybe a year – and see if it results in any additional employee engagement, such as more improvement ideas. If there’s a way to quantify it, then do so. If the results are good, then move down the income statement a little more, to include the cost of goods sold and the gross margin.

 At this level of information sharing, employees learn about what products cost and how much the company makes from each individual product sale. You could even get into details like the impact of volume purchasing discounts on raw material costs, and how much product returns cost the company.

 Again, if the results are positive, then consider moving down the income statement again, and talking about operating expenses and profits. This is a more incremental approach, which makes it easier to stop at any point.

 Also, by discussing information just once a quarter, you’re not getting employees overly accustomed to these discussions. That means you could pull out of the whole arrangement if there’s not enough support from senior management, and the employees may not notice.

Responsibility Accounting

 Another option is to use responsibility accounting instead. This involves only reporting financial information to employees for their areas of responsibility. For example, you’d send maintenance expense information to the maintenance manager, and sales data for the western sales region to the sales manager for that region. The presentation format is usually accompanied by their budget information, so they can see budget versus actual information.

 I’ve done this in every company I’ve worked for, and it always had total senior management support. The difference here is that information is specifically being provided so that you can hold people accountable for their areas of responsibility. People are expected to take action to fix whatever problems appear in those reports. Senior managers understand this.

 Compare it to the reasoning behind open book management, which is that employees might be more supportive if they know more about the company’s financial situation. The argument supporting it is inherently weaker. In short, I certainly recommend responsibility accounting, and suggest that you roll out open book management with just sales information to start with, to see how it goes. Then proceed based on what happens.

Accounts Receivable Financing (#321)

What is Accounts Receivable Financing?

The topic of this episode is to describe how accounts receivable financing works. Under receivables financing, a business uses its accounts receivable as collateral for a short-term loan. The loan has to be short-term, because the duration of the loan needs to match the underlying collateral, which is the accounts receivable. A business can essentially extend the term of the loan by constantly creating a new set of accounts receivable that then becomes the collateral on the loan as the earlier receivables are paid by customers. So, as long as the company can sustain the amount of receivables outstanding, it can keep borrowing about the same amount of money from the lender.

 A business uses accounts receivable financing when it needs cash sooner than the receivable payment terms. For example, if you need cash in five days, but the invoice payment terms are 30 days, then you have a problem. In this case, the loan from accounts receivable financing is intended to essentially accelerate the receipt of cash from the receivables.

Understanding Accounts Receivable Financing

 There are two ways in which accounts receivable financing can be set up. Under the first approach, the lender advances a percentage of the receivables balance to the borrower, and commits to collect the receivables. The lender monitors all receivables due from customers, and has payments sent to the lender’s designated location, which is usually a bank lock box.

 The amount loaned will be less than the amount of the receivables being used as collateral, possibly as much as 90% of their face value. When customers send their payments to the lender, it extracts the amount of its loan and any associated fees and interest charges, and then forwards the residual amount to the borrower.

 Since the lender is involved in collection activities, it may cherry pick which customer invoices it will include in the borrowing arrangement. That means it only takes invoices issued to the highest-quality customers, and probably only for larger amounts. This makes it more efficient for the lender to collect the invoices.

  Under this approach, it’s in the best interests of the lender to have customers send all accounts receivable payments directly to it, bypassing the borrower, so that it can be assured of being paid. This is not a small issue, since companies using receivables financing may be having financial problems, and could go under. If they do go bankrupt, the lender still has the accounts receivable as collateral, but it may take quite a while to extract its money from the bankrupt business.

 The problem for the borrower is that having customers send their payments to a new address gives customers the impression that the business is on a shaky financing footing – which might very well be the case – so they may be inclined to buy from someone else in the future. So in short, there’s an inherent tension between the lender and borrower about where the customer payments should go.

 The second approach to receivables financing is for the receivables to essentially be used as collateral on a cash advance from the lender, but where the borrower maintains control over the receivables and collects from customers. This approach is least visible to customers, so it favors the borrower.

The Cost of Accounts Receivable Financing

 There’s obviously a lot of paperwork associated with receivables financing, so lenders charge a pretty high interest rate. In addition, they charge an upfront fee to reimburse their underwriting and origination expenses. This fee can increase in size if the arrangement is a large or complex one. And on top of that, the borrower has to pay a processing fee every time a customer pays an invoice, which might be calculated as a percentage of the face amount of the invoice. Individual lenders have different rate structures, usually because they’re trying to attract different types of customers. So, it makes sense to shop around.

 All in all, this one of the more expensive financing options. Lenders claim that this is because the cost of administering these loans is unusually high, but I don’t buy it. If you check the cost per click for a Google ad for “accounts receivable financing,” it’s $70 – per click. The cost per click for “receivable financing” is $75. And the cost per click for “receivable factoring” is $80. When lenders are willing to pay that much for one lousy click on one of their ads, that tells me that plenty of profits are being made.

 So, why on earth would anyone pay these fees? Because they have nowhere else to go. Businesses that use receivable financing have been turned down by traditional lenders, probably because they’re not profitable or they don’t have any other collateral, or the founders don’t want to back up a loan with a personal guarantee.

 Because of the high fees, it makes no sense to use this type of financing if your margins are already low – the fees will just eat up your profits, and then you’ll go out of business.

When to Use Accounts Receivable Financing

That being said, there are a couple of situations in which it makes sense to use it. The first case is when a business has very little cash but is growing fast. It needs to finance an expanding amount of receivables, but doesn’t have the cash to pay for the underlying inventory. In this situation, use receivables financing as long as sales are going up fast, and stop using it as soon as sales level out.

 The other situation where it can make sense is when the company’s invoice terms are really long. This usually happens when a small company is forced by a large customer, such as a retail chain, to accept long payment terms, like 90 days. In this case, the business uses the receivables as collateral to get an immediate cash loan from the lender.

 There are a couple of lesser advantages to receivables financing. One is that you can qualify for financing a lot quicker than a typical bank loan, so if you need cash now, this is a good way to go. The other reason is that, if the lender is taking on the task of collecting receivables, the borrower can cut back on its own collection activities.

How to Apply for Accounts Receivable Financing

 So, let’s say you want to proceed with a receivables financing arrangement. The first step is to create a cash forecast for the next few months, to estimate the size of your shortfall. Next, review your list of outstanding invoices, and strip out any for which the probability of collection is low. The remaining invoices will be reviewed by the lenders. Then, assemble the company’s most recent bank statements and tax returns, as well as its business license, because the lenders will want to review this information as part of their credit analysis. After that, it will take a couple of weeks for them to review the information and decide whether to enter into a lending arrangement. Once approved, funding can be arranged within a few days.

Related Courses

Corporate Finance

Treasurer’s Guidebook

Consulting After the Pandemic (#320)

This episode discusses how consulting has changed after the pandemic. In other words, after the pandemic, do you really have to go back on the road to be a consultant? It depends on the situation. It will probably require somewhat less travel, but generally speaking, consultants need to be on the road. There are some good reasons for this.

Let’s start with consulting partners. They need to be on the road. Period. The number one responsibility of a consulting partner is to drum up more business, because – unlike auditing – consulting projects are not recurring. Once a project is completed, it’s not coming back. This means that partners have to be constantly networking, which means meeting with people. In person. And on top of that, someone who is about to spend millions on a consulting project is more likely to award the job to someone that he has a personal connection with, which – again – supports the need for partners to be on the road, meeting people. All the time.

The need to be on the road also depends on the type of project. For example, if you’re dealing with a technical issue, such as installing software for a client, that doesn’t necessarily require a lot of direct interaction with the client. It still requires some interaction, such as when you need to talk to them about how they want to configure the software. So in this case, you might be able to do the bulk of the work remotely, just using Zoom or Skype calls. Though, realistically, some time will still be needed on site.

And then we have change management projects. Consultants get called in a lot to work client employees through all sorts of transitions. For example, consultants might be brought in to overhaul a process, which means interviewing people to see how the current system works, and then going through brainstorming sessions to find a better way, and then implementing the new system. Or, a client might be conducting a large layoff, and needs consultants on-site to figure out how to reallocate the work among the people who are left.

In these cases, the work needs to be entirely in front of client employees, every day. I don’t really see how much of this work can be shifted off-site.

And then we have benchmarking and best practices consulting. These projects are focused on making client operations better. They involve going on site and measuring how well a targeted operation works, and then comparing it to performance benchmarks from some other best-in-class company. In this case, the work is intensively hands-on. Opportunities for off-site consulting would be few and far between.

There’s also controls consulting. This involves going through processes in detail, figuring out where controls are installed, how well those controls are working, and whether more controls should be added. This work can only be done on site. There’s just no way to see if a control is working properly when you’re parked on the other end of a Zoom call.

The impression I’m trying to convey here is that consulting is intended to be on-site. Yes, there are some limited technical situations where you might be able to do some work from home, but for most consultants, it means travelling to the client to help them at their location.

Realistically, the only consulting positions that will be able to mostly avoid travel will be low-level staff positions that are highly technical. This is really a support role, so if you want to advance into a managerial position, then expect to be sitting on airplanes and sleeping in hotel rooms – a lot. I really don’t see the pandemic changing the situation. This is just the nature of consulting.

Bank Feeds (#319)

Bank Feeds in Accounting Systems

Some accounting software packages allow you to download transactions from your bank directly into your accounting system, so you don’t have to record them manually. Or, if you’re using Paypal or Stripe to process payments, they can be accessed for a bank feed. For example, Quickbooks has a bank feeds feature that pulls in these types of transactions.

Advantages of Bank Feeds

There are some advantages to doing this. First, it’s really convenient. Once you’ve got it set up, it’s quite easy to import the transactions. Depending on the software, you may not have to manually log in to the bank’s system. Again, depending on the software, the bank transactions are imported into a holding account, where you can review them and decide whether to grant permission to import them. If you have a lot of bank transactions, then this can be a decent time saver. That’s the good news.

Disadvantages of Bank Feeds

There are also some downsides. The main issue relates to transactions for receivables and payables. In both cases, don’t accept whatever suggestion the software makes for how to apply it. Instead, manually apply incoming cash payments to specific open invoices, and manually apply outgoing cash payments to accounts payable. Otherwise, you can get some really screwy transactions in the system that you might have to track down and fix months later.

Also, in general, it’s too easy to skim through the suggested transactions recommended by the system, press the accept button, and then realize that some of the recommendations weren’t exactly what you wanted. And then you have to go into the system, find them, and fix them. Which takes way more time to fix than the time savings you generated from setting up the bank feed in the first place.

The real worst case occurs when you don’t spot an incorrectly recorded bank transaction, and the auditors find it at year-end instead. This can be quite a shock if you’ve created the year-end financial statements and think you have a good case for a certain profit number, and are then embarrassed when the auditors spot your mistake.

When to Use a Bank Feed

So, there are the pros and cons. My suggestion is, if you only have one bank account and not many transactions are running through it, then the efficiency gain from a bank feed is pretty minimal. In that case, just stick with manual entries. On the other hand, if you have to record a lot of bank transactions on a recurring basis, then it makes more sense to set up a bank feed. If you choose to do so, then conduct a 100%, very detailed review of all proposed transactions for the first few months, just to make sure that the system is working properly. Then switch over to a scheduled spot check every few months to see if the transactions are still being recorded correctly. If you spot anything wrong, then immediately schedule a detailed analysis to figure out what happened, and make corrections as needed.

And on top of those reviews, conduct a leisurely examination of all transactions proposed by the accounting system for bank feeds. And to keep people from reviewing them too fast and making mistakes, include bank feed accuracy in the performance criteria for whoever is put in charge of it. And one more thought is to put a senior accountant in charge of this who has a solid understanding of the transactions running through the bank feed.

Related Courses

Accounting Information Systems

Lean Accounting Guidebook