Shipment Cutoff Best Practices (#201)
/In this podcast episode, we discuss best practices for shipment cutoff, when the revenue associated with a shipment is to be recognized in one reporting period versus another period. Key points made are noted below.
Revenue Recognition Rules
Anything shipped by midnight on the last day of a reporting period is considered revenue for that reporting period. Anything shipped even a few seconds later becomes part of the revenue for the next reporting period. This is a major issue, if only because the auditors will check shipment cutoff at year-end as part of their year-end auditing procedures.
The real issue is that revenue could be recognized in the wrong period, which could trigger the reporting of profits that don’t actually exist in that period. Management might even encourage sloppy shipment cutoff practices, so that they can move revenue into different periods for their own purposes. For example, if management has promised investors or lenders that profits will be a certain amount, they can guarantee it just by keeping the books open, maybe for a couple of days after the actual end of the period. This is especially likely if the management team will earn a bonus if profits reach a certain number.
The Need to Systematize the Cutoff
A key best practice is to systematize the cutoff to the point where it’ll require some real effort for anyone to force a shipment into the wrong reporting period. For example, have the computer system print all shipping labels based on the system date. This means that someone would have to go into the computer system and manually alter the date in order to record a delivery in a different reporting period, which can be difficult. The shipments and their system assigned-dates then roll straight into the accounting system, where the software uses the assigned date to decide which period they fall into.
Prenumber Shipping Documents
Another possibility is to prenumber the shipping documents, so that any shipments made using a later document number are more likely to be associated with a later reporting period. This could involve running a report that notes the shipping document numbers for the last day of the reporting period. Any numbers that are too high are investigated.
Shipping Document Collection Procedure
Have a procedure where an accounting staff person is scheduled to pick up all shipping documents from the shipping department a few minutes after the end of shipment activities on the last day of the reporting period. Any shipping documents prepared after this pickup are assumed to be part of the following period’s shipments. This final batch of documents is then stored in a locked filing cabinet in the accounting offices until they can be processed the next business day.
Close the Books Quickly
Another approach is to close the books so fast that there’s almost no room for anyone to keep adding shipments to the preceding reporting period. For example, if it becomes standard practice to close the books and issue financial statements the next day, then there might only be a window of opportunity of a couple of hours for someone to keep recording shipments in the last reporting period.
Active Oversight of the Cutoff
A possibility that could create more conflict with management is active oversight of the cutoff. For example, have someone from the accounting department show up at the shipping dock and make note of the last shipment that went out the door as of the close of business on that day, and also make a copy of the shipping log. The actual revenues for the final day are then matched against the shipping log to see if any later deliveries were subsequently added to the period’s sales. A variation is to compare the pickup dates recorded by third-party shippers to the dates listed in the shipping log.
Active oversight is a solid internal auditing activity that should be used quite a bit. But, it can make sense to gain the support of the audit committee of the board of directors in advance. Otherwise, the examination might find an exception that was instigated by management to increase reported sales – and management will squash the findings. If the audit committee is already involved, it’s harder for management to interfere.
The Need for Backbone
The controller has to have a lot of backbone in enforcing a rigid cutoff. There can’t be any exceptions. If the controller ever allows employees to backdate deliveries, this opens the door for an ongoing stream of requests to keep doing it – and that weakens the ability of the controller to impose a strict cutoff.