The Trouble Blog

An Exercise in Negative Thinking

2011-08-19T06:23:00.000-07:00

The concept of conducting a "Financial Reporting Risk Assessment" can be a difficult one to grasp. That's because this is an exercise which requires the accounting personnel of an organization to put their heads together and think about what could go wrong with the numbers they are generating in their daily work.

Many of us know that focusing on bad things that could happen is a dangerous activity called negative thinking. It's not a good practice to regularly think negatively because our minds tend to find a way to bring into reality those things that we think about the most. This is why it is better to regularly visualize the positive results you desire in any situation rather than the alternative.

However, there is a benefit to occassional negative thinking. It does allow us to consider what can be done to defend us against what could go wrong. For example, it is commonly known that any time you get into a vehicle there is a chance you could be involved in an accident. Therefore as a precaution, hopefully you obey all traffic laws and put on your seat belt to protect yourself from the possibility of an undesirable outcome.

To determine what precautions are needed to protect your organization from accidents in financial reporting, you should annually be conducting a formalized "Financial Reporting Risk Assessment". This is simply a process of determining what numbers within the financial statements (or just the accounting system itself if you don't prepare your own financial statements) might not be correct when it is time for the open house of your books at year end.

Many organizations don't know where to start the Financial Reporting Risk Assessment discussion. It's really just a matter though of grabbing the most recent annual financial report and going down the Balance Sheet and Income Statement and brainstorming how errors or accidents might get into these numbers during the year and not get corrected by year end. Then you decide what precautions, or internal controls, you need to implement or already have in place to address the risk of these bad events occuring.

Here are some examples...

Cash & Investments

What could go wrong? Cash and investments could be unknowingly under or overstated on the books for various reasons such as unposted items, errors, or fraud occuring in the accounts.

How are we protecting against these risks? Staff accountant prepares reconciliations for each account within the first two weeks of the subsequent month to ensure all transactions are posted correctly and to identify any potential errors or fraud. The reconciliations are then reviewed and approved by the Director of Finance.

Due To / Due From Accounts

What could go wrong? Due to the heavy volume of activity flowing through these accounts for payroll processing and other transactions, there is a high risk of these accounts becoming out of balance and requiring a great deal of analysis time to correct.

How are we protecting against these risks? The Due To / Due From accounts are checked at the end of each month by the Staff Accountant to ensure that they are in balance. Variances are investigated and resolved so they do not accumulate and become a larger more complex problem.

Salaries and Wages

What could go wrong? The expense account codes used for state and federal grants could be inaccurate and not reflect the true time served by employees for these activities. Amounts regularly paid to employees could be inaccurate. There could be fictitious employees on the payroll.

How are we protecting against these risks? The Payroll Clerk reviews Payroll Distribution Reports by employee on a quarterly basis against the District's master schedule to ensure salaries coding still reflects actual efforts. At the beginning of each year when approved salary amounts are setup in the system by the Payroll Clerk, the Director of Finance reviews and approves a final salaries report from the system. After each pay run, the Payroll Clerk provides the Director of Finance with a Payroll Check Register to review for any unknown names or unusual pay amounts.

These are examples for only three of the financial statement categories, but I think you might get the picture now. If you would like a more extensive example to help get you started with your Financial Reporting Risk Assessment, send me an email and I'll be happy to provide you with an Excel template.

Has your organization thought negatively yet this year?

Accounts Payable. Why Must it be so Accrual?

2011-08-01T08:20:00.000-07:00

Operating on the cash basis of accounting would be so easy. Bills would count against the budget when the check is cut, and accounts payable would technically not exist.

Unfortunately, modified accrual accounting requires a bill to count against the budget when the related good or service is received, not when the bill is paid. Therefore, a little work is needed to figure out what accounts payable is as of a certain date and get that amount reported on the books.

Accounts Payable = All Unpaid Bills (Currently sitting on your desk or not)

The most important time to stress over getting the accounts payable balance right is at the fiscal year-end date. That's because both the external financial statements and the annual financial audit focus on this key date.

If your district has an 8/31 year-end, then start watching purchasing activity closely in July and August. Know what bills are still pending at year-end so you can set the accounts payable balance to the right amount as of that date.

Once you've identified what bills are still outstanding, put on your accountant's hat and post them to the books as follows as of 8/31 or earlier:

Debit Appropriate Expense Account XXX
Credit Accounts Payable XXX

If you can catch them all, even those yet to arrive in the mail, you can avoid audit adjustments in this area when the audit is conducted. Also, if you can post all accounts payable to your books before the last board meeting of the fiscal year, you will also have a more complete picture of the expenditures side of the budget for last minute budget amendment purposes.

The Auditor has a Crystal Ball

The annual financial audit is usually conducted at least a month after the fiscal year-end date. Therefore the auditor will be able to look into the future from the 8/31 date and see September and later bill payments.

Bills paid during this early time in the new fiscal year will be checked by the auditor to see if they were for goods or services purchased and received before the prior fiscal year-end. If this is the case, the next step will be to determine if these bills are included in accounts payable as of 8/31. If any are not and they are considered material, then an audit adjustment similar to the entry shown above will be proposed.

Yes, the cash basis of accounting would be nice. School districts must follow modified accrual accounting though which requires the reporting of accounts payable.

Will your auditor propose adjustments to your accounts payable balance this year?

Capital Assets 101

2011-07-24T11:17:00.000-07:00

Has Anyone Ever Sat You Down and Really Explained the Process of Accounting for Capital Assets?

I know, you're probably thinking "chained down" might be a better description of what it would take to get you through a lecture on capital assets accounting. However, if you would like to reduce, potentially to zero, the number of year-end audit adjustments that you are receiving in the area of capital assets, then follow me on this quick tour through Capital Assets 101.

Why Capital Assets Receive Special Treatment

Most Business Office personnel can automatically sense that really expensive items deserve some kind of special accounting treatment. And it’s true, high-dollar purchases of an organization do need to be set aside from the ranks of the ordinary expenditures and honored as capital assets. That’s because these items are expected to be used and have continued value well into future years. Through use of special account coding, these transactions find their way to the capital assets section of the Statement of Net Assets where this value can be shown.

The Capitalization Policy

It is not enough though to simply say that all expensive or high-dollar items will be given the crown of being a capital asset, or “capitalized” as this process is called. There must be a strict guideline that tells us at the time of purchase whether or not we will capitalize an item. A two question pass or fail test based on the adopted Capitalization Policy of your school district should be applied to each transaction flowing through the accounting system. If “pass” is indicated for both of the test questions, then the item should be capitalized.

You may already know that in order to keep school districts on the same page, the Texas Education Agency has required in the Financial Accountability System Resource Guide (“FASRG”) that all Texas school districts use $5,000 as the threshold for determining whether or not an item should be capitalized. Therefore, this is the criteria for test question number one: Is the item individually valued at $5,000 or more? And take special notice of the words individually valued in that question. Five computers purchased for $7,000 would not be individually valued at more than $5,000 each so this first test is failed already and you would know not to capitalize.

Test question number two: Is the purchased item expected to have a useful life of more than one year? This of course will be a given for land, buildings, and most building improvements. Also, heavy equipment should easily pass this test question as well. School buses, maintenance vehicles, and cafeteria ovens will last longer than one year, and most likely will have passed the $5,000 test, so these items would be capitalized.

It’s the smaller equipment items where you really have to carefully apply the two test questions. Often, things like computers or band instruments, which seem like logical capital assets, will be purchased in bulk and therefore have a large invoice arrive in the mail. However, each individual item will most likely not be valued at $5,000 or more and therefore should not be capitalized.

By the way, if you are building something, accumulate all costs of the project together, regardless of amount, and then apply the $5,000 per individual item criteria. The project itself is considered the individual item under this scenario. Capital projects funds are used for large construction projects such as for school buildings. All costs recorded within these funds are generally capitalized.

Get the Coding Right to Begin with and You’re Halfway There Already

Correct coding is crucial! And this can be said about all transactions flowing through an accounting system. With the daily bombardment of incoming invoices, each one must be funneled through an organized processing system, where the transaction is reviewed, assigned an account code, approved, keyed into the system, and filed away. If special care is taken at this point-of-entry for all transactions, the accounting system will be protected from potentially serious problems later on. Remember the classic saying “Garbage in, Garbage out”?

All personnel coding expenditures or approving the coding of expenditures in your organization must understand and apply the two pass/fail test questions for determining what should be coded as a capital asset. This is the only way to ensure that only items that should be capitalized gain access to those special codes of the accounting system.

The FASRG tells us that capital assets are to be recorded to the 66XX object codes. (Remember, the object code is the third category of the standard 20 digit Texas school district account code structure) Specifically, land purchases and improvements are to be recorded to the 661X object codes, building purchases and improvements are to be recorded to the 662X object codes, and furniture and equipment are to be recorded to the 663X object codes.

The Capital Assets Additions Schedule

If your organization is doing well with coding, then throughout the year the 66XX object codes will be getting filled with transactions. Depending on the size of the district and purchasing activities, these account codes could end up holding a large amount of capital assets by year end.

To properly close out the school district’s books at year end and prepare for the annual financial audit, every item recorded to the 66XX object codes should be specifically identified and listed on a Capital Assets Additions Schedule. The process of preparing the Capital Assets Additions Schedule is a great way to verify that each transaction recorded to the 66XX object codes has been given appropriate treatment as a capital asset. For larger districts or those with a lot of capital asset activity, the Capital Assets Additions Schedule should be updated monthly, not just at year end.

There could also be just as many items missing from the 66XX account codes that qualify as capital assets, and therefore could miss out on being capitalized. During the process of preparing the Capital Assets Additions Schedule, the overall general ledger of the school district should be reviewed to search for any miscoded capital asset transactions. The first place you should look for misplaced capital asset transactions is in the Repairs and Maintenance account codes. Making the distinction between whether a transaction is a repair or a capital asset is sometimes difficult, so definitely review the coding of the items in the Repairs and Maintenance accounts and make reclassifications if needed.

When you have completed the Capital Assets Additions Schedule, the total value shown for all assets on the schedule should agree to the total amount shown for the 66XX object codes. If you will go through this balancing process, and have correctly identified all capital asset transactions for the year, you will most likely have zero audit adjustments for the year arising from the area of capital assets.

The Capital Assets Deletions Schedule

Each year, capital assets that were added in prior years may become no longer useable, sold, or traded-in against the purchase of new capital assets. As these items are removed from service during the year, they should be tracked and their method of disposal documented. These items should be listed in detail on a Capital Assets Deletions Schedule which is made available to the auditor during the year-end audit.

The Depreciation Schedule

A depreciation schedule is what is used to track the original value, the estimated useful life, the current year depreciation expense, the accumulated depreciation balance, and the net book value for each individual capital asset purchased in a prior year and still being used by the school district. The values from the depreciation schedule are then reported on the district’s Statement of Net Assets and Notes to the Financial Statements in a summary format by major capital asset category.

Many small to mid-size school districts utilize their audit firm for assistance in updating the depreciation schedule each year based on current year activity on the school district’s books. However, the update process is simply a matter of adding the assets shown on the Capital Assets Additions Schedule and showing as deletions those assets on the Capital Assets Deletions Schedule. Once the new assets are added to the depreciation schedule, an estimated useful life is assigned, and annual depreciation expense on the asset begins.

The Annual Financial Audit

During the year-end audit, the auditor will be concerned with verifying that the capitalization policy of the organization has been appropriately applied. This process will involve the auditor reviewing the transactions coded to the 66XX account codes to check them for accuracy and completeness. To check for the accuracy of what is already coded to the 66XX account codes, the auditor will request to see some of the actual invoices supporting those transactions. To check for completeness of the transactions coded to the 66XX account codes, the auditor will a search the account codes of other areas looking for possible miscoded capital assets.

Auditors often find themselves in the position of having to create the Capital Assets Addition schedule during the audit based on transactions coded to the 66XX accounts. This can be much like putting together a puzzle and add a great deal of time to the Capital Assets area of the audit. You can make your auditor smile by providing him or her with a Capital Assets Additions Schedule that already reconciles to the total of the 66XX account codes on your books.

How well are you accounting for capital assets at your organization?

Credit Cards. To Be or Not to Be?

2011-07-09T10:23:00.000-07:00

Our clients often ask us our views about putting credit cards into the hands of employees.

We hear questions like...

"Is it okay to make credit cards available to employees for purchasing needs?"
"Can some employees carry credit cards all the time?"
"How would you recommend we monitor credit cards?"
"Do we have to use credit cards at all?"

I often respond by saying...

Handing over a credit card is like tossing your keys to a teenage driver. There's a lot of trust involved... and there can be that uneasy feeling deep down inside.

You are taking a leap of faith that the receiver of this vehicle of freedom is going to act responsibly. Everything does turn out fine most of the time, but occasionally there is that moving violation that could get everyone in trouble.

So what's the solution?

You may have heard the phrase, "Trust, but Verify".

Ronald Reagan made the phrase, "Trust, but Verify", famous when he was making deals with the Soviets. Much to the chagrin of Mikhail Gorbachev, our President used this phrase at more than one nuclear treaty meeting. That's because so much is said with these three words!

This describes the approach you must take with credit cards. You should trust that the user of the credit card will only make allowable and planned purchases on the card, but you must then verify that this is what has occurred.

Credit cards are naturally risky, and therefore they must be monitored closely.

Properly supervised, credit cards can add a great deal of convenience for certain types of purchases. But here is what we recommend you do to verify that they are being used appropriately:

Review all credit card statements monthly to check for the allowability of each charge.

Require that a receipt be turned in by the user for every charge made. These receipts should have brief notations as to the business purpose of the charge, especially for meals or general merchandise. The receipts should be attached to and filed with the statement each month.

Place low credit limits on the cards. The credit card limit only needs to be high enough to cover one month's estimated activity.

Keep most credit cards in the business office and require that they be checked out when needed. Probably only the top dog should be packing all the time.

Make purchasing on credit cards the exception rather than the rule. With proper planning, most expenditures can be paid through the regular bill paying process.

If your organization has a policy requiring purchase orders, ensure that this policy is still followed even when a credit card is used.

In God we trust, all others we audit.

Sometimes Finance Directors or Business Managers are shy about questioning the credit card charges or asking for receipts from the Superintendent or City Manager (aka "the Boss"). If you are in the position to have to do this, just break the ice by using another commonly known phrase, "In God we Trust, all Others we Audit". Although some bosses think they are God, most will understand you are just doing your job. And monitoring the boss is very important, because this is where many of the moving violations will occur, whether intentional or not.

Credit Cards. To Be or Not To Be? With proper monitoring we say go ahead and opt with To Be.

Of course, the highest internal control over credit cards is to not use them. This is one way to guarantee that you will never have to explain an inappropriate charge to an auditor. However, we believe credit cards are worth having as a purchasing option if the risks associated with them are appropriately managed. If you use credit cards in your organization, we recommend applying the monitoring discussed above. If you do so, the credit card users will observe the formality with which the cards are managed, and act with care. Without the proper monitoring though, things can quickly run amok, and get you in trouble.

How well are you monitoring your organization's credit cards?

Get Your Budget in Gear!

2011-06-29T11:25:00.000-07:00

Get your budget in gear at the end of the year
If you do this then you will have nothing to fear

When the auditors come they will look at this first
Checking for the approval of all funds disbursed

So you say that you know and you've heard this before
So why then each year are budget findings galore?

It's because your amendments, sometimes they fall short
For the lack of forethought of A/P of all sort

You have got to consider those bills yet exposed
For the goods that were purchased before the year closed

These will count as expenses no matter when paid
So amend for them now or you might be dismayed

For the auditors seek and they often will find
Those expenses that often are left far behind

Get your budget amended, make sure its in gear
If you do this you'll have a great audit this year!