The second most important external user of a company’s financial statements is a bank (or other debt or equity institution). The financial institution will dictate the report needed. Copies of tax returns and company-prepared financial statements may be all that is required. On the other hand, the financial institution may require a higher level of assurance by requesting that an independent accounting firm either compiles, reviews, or audits the company’s financial statements.

In this case, the company might want to know what is required and the difference between these types of reports. Accounting policies and procedures for financial reporting would help. First of all, only Certified Public Accountants¹ (CPAs) who meet a higher peer review level and other reporting standards can issue these statements. A public accountant (PA), tax practitioner, or an accountant who is not a licensed CPA cannot issue such statements. Fully-licensed CPAs must keep their licenses current, with continuing education and documented peer review, to be able to issue opinions on these reports.

Compilation

A business owner will need to find a CPA with the necessary credentials to request a compilation, review, or audit.  The least expensive report, and one that should satisfy most banks for small and mid-sized business, is a compilation.  Essentially, the CPA reviews the financial statements prepared by the company and attaches an accountant’s report to it.  No further investigation is performed.

Interestingly, the standard compilation report issued by a CPA is nothing more than a glorified disclaimer, stating that the CPA is providing no financial statement assurance.  The AICPA defines a compilation as “a service where the accountant presents, in the form of financial statements, information that is the representation of the company’s management and owners without undertaking to express assurance on the financial statements.”

Review

A review involves essentially the same process as a compilation, except that the auditor does perform certain analytical reviews — reviewing account balances for reasonableness and questioning management about material modifications that might be made in order for the statements to be in conformity with GAAP².  In a review report, the CPA expresses a “limited assurance” — not an opinion — of the reasonableness of the financial statements and their conformity to a comprehensive basis of accounting, like GAAP, cash basis, or income tax basis reporting.

Audit

A financial audit provides the highest level of financial statement assurance.  An audit normally takes considerably more time than either a compilation or a review.  The audit work, itself, can fill several large binders of documentation for a small-to-medium-size business.

Every balance sheet account is proven, within the limits of materiality³. Direct confirmations of account balances are mailed from the CPA to banks, customers, vendors, and other debt holders to validate the balances of cash, accounts receivable, accounts payable, and other assets and liabilities.  If inventory is material, the CPA must observe the inventory counting as of the report date.  The CPA also tests the accounting procedures and internal controls, including computer controls.  All transactions are subject to audit under a statistical sampling formula.

A surprisingly large amount of time is spent in non-financial areas to determine any claims, lawsuits, contingencies, or other events that could harm the company. Incorporation and other organizational papers are reviewed; all leases, loan documents and other contracts are reviewed; and all minutes and other relevant correspondence are read.  The CPA also sends letters to all attorneys asking for full disclosure on any relevant matter.

The AICPA defines an audit as an engagement where a CPA provides an opinion about the fairness of a financial statement presentation in accordance with a comprehensive basis of accounting, such as GAAP, cash basis, or income tax basis.  This is a fairly simple statement for what can easily involve weeks of work for even a relatively well-structured small business.

It’s important to recognize the relative costs of these three types of reports.  If the cost of an audit is $12,000, a review for the same business might average $4,000, and a compilation, $3,000.  Relative to an audit, a review and compilation are considerably less expensive.  However, the difference in cost between a review and compilation is not nearly as great.  This is important to remember if faced with a requirement from a lender or investor.  If they request an audit, you might try to convince them that a review is adequate and certainly provides more assurance than a compilation.  This could save you considerable expense.

SEC – Audit

For publicly-held companies, an audit is the minimum level of assurance required.  In addition to the audit, there are other SEC reporting requirements, depending on the size of the business.  A full explanation of these SEC reports is beyond the scope of this article.

Internal Reports

Much emphasis has been given to financial statement reports — the balance sheet, income statement, and the statement of cash flows.  These three are the most important reports on the overall financial condition of the company over a given period of time.  A primary objective in developing policies and procedures over the accounting function is to improve the timeliness, accuracy and completeness of these statements.

A company’s accounting or information system can provide much more than those three statements, however.  Management should be encouraged to use the data available in the accounting system for other uses.  Financial statements are extremely useful; however, they only provide current valuation, and transactional information from the past.

A statement of cash flow, reconciling the sources and uses of cash, can be a useful starting point for extrapolating data that projects the anticipated sources and uses of cash needed into the future.  By analyzing changes in aging of accounts receivable and accounts payable, you can develop more reliable estimates and better anticipate future cash receipts and future cash payments.

The relationship between sales, inventory levels, and related costs of sales can be used to determine the anticipated needs for additional inventory related to projected sales.  Using the data captured by the accounting system every day, a projected cash flow report, updated daily, can be a powerful tool to alert management in enough time to properly react to anticipated additional working capital requirements.

With a powerful forward-looking cash management tool, like the described projected cash flow report, the projected activity levels in future months can be used to create budgets in the current and succeeding months.

With income statement projections, projected cash flow reports, and budgets, we have a truly interactive management information system.  Data collected from the past is used to project the future, fed back into the budgets, which control the present and determine the future.  This creates a continually updated management information loop.  This provides a business with the tools to act, not just react.

SUMMARY

We hope this introduction to your Bizmanualz™ Accounting Policies and Procedures manual will increase your appreciation of the importance of establishing effective accounting procedures.  Your business is a continuously flowing stream of transactions.  Like a sturdy, well-maintained net cast across a stream, effective accounting policies and procedures help trap data completely and accurately. Once collected, the real benefit is utilizing the data to provide the information needed to review the past, position the present, and chart the future.

NOTES

¹The “chartered accountant” designation is more common outside the USA.
²A number of accounting authorities, like the AICPA and the IASB, are currently working on convergence of GAAP with IFRS (international financial reporting standards).
³Information is material if its omission or misstatement could influence economic decisions made on the basis of the financial statements. Materiality depends, in part, on the size of the item or error, evaluated in light of the circumstances of its omission or misstatement.

Four Main Accounting Cycles

Accounting transactions in the form of sales invoices, receipts, purchase invoices, checks, and payroll entries are posted to the appropriate journals. Simultaneously — as a form of internal control — these postings are recorded in the general ledger, or “GL”. The GL accumulates all transaction activity, where it is organized by account class.

Various reports, including financial statements, can be prepared from the data collected in the GL.  Corrections or necessary adjustments can be made to the general ledger by creating adjusting journal entries, posted to the general journal.

1. Revenue Cycle

Order Entry. Invoices entered through direct entry, sales orders, or a point-of-sale (POS) system, such as a cash register, are posted to the sales journal.  These entries also accumulate on the accounts receivable ledger, organized by customer.  If the business maintains an inventory, the posting of sales also affects the inventory ledger. Finally, all sales journal activity is also posted to the GL.  A discussion of your revenue cycle should be covered in your revenue procedures.

Cash Receipts / Deposits. Receipts on sales and other bank deposits are posted to the cash receipts journal.  Sales receipt information also accumulates on the accounts receivable ledger, organized by customer.  These postings are also entered on the bank account ledger.  Finally, all cash receipts journal activity is also posted to the GL.

Accounts Receivable. Accounts Receivable is a separate journal that records both sales and cash receipt data by customer.  The data comes from the postings to the cash receipts journal and the sales invoice journal.

2. Purchase Cycle

Purchase Orders / Purchasing. Invoices entered through direct entry, or through purchase orders, are posted to the purchase journal.  These entries also accumulate on the accounts payable ledger, organized by vendor.  If the business maintains an inventory, the posting of purchases also affects the inventory ledger.  Finally, all purchase journal activity is posted to the general ledger.

Cash Disbursements / Checks. Payments on account or for expenses are posted to the cash disbursement journal.  Payment on account information also accumulates on the accounts payable ledger, organized by vendor; these postings are also entered on the bank account ledger.   Finally, all cash disbursement journal activity is posted to the general ledger.

Accounts Payable. Accounts Payable is a separate journal that records both sales and cash receipt data by vendor.  The data comes from the postings to the cash disbursement journal and the purchase journal.

3. Payroll Cycle

Payroll data by employees are entered into the payroll journal.  These postings are also entered in the cash disbursements journal and the payroll ledger.  Finally, all payroll journal activity is also posted to the GL.

4. General Journal Cycle

Corrections or adjustments to the above major transaction cycles can be made through adjusting journal entries, posted directly to the general ledger. These are also compiled in a separate journal, known as the “general journal”.

How Does “Posting” Work?

The specific postings, as outlined in the cycles above, do not necessarily take place as separate steps, especially in computerized environments.  There are only two basic posting methods in computerized accounting systems: real-time and batch posting.

In real-time posting, the source transaction (check, bill, payment, receipt, etc.) is posted to the specific journal and any related subsidiary ledger (e.g., accounts receivable, accounts payable, inventory) and is simultaneously posted to the general ledger.

In batch posting, the journals and subsidiary ledgers are posted, but entries are not yet posted to the general ledger.  Posting these journals to the general ledger is done separately.  Typically, a group of transactions (often a full day’s worth) is entered.  Later, after the journals are reviewed for accuracy, this entire day’s group, or “batch”, is posted to the general ledger.

To understand this posting process better, it would be helpful to follow specific transactions through a sample company.  First, however, we need to define various accounting terms and concepts.

Accounting Terms and Concepts

Double-Entry Accounting

We can thank the 14^th and 15^th century Italian merchants for developing the double-entry system of accounting that we still use today.  It is widely believed that Benedetto Cotrugli (aka, Benedikt Kotruljevic) was the first to document this concept of double-entry accounting (in his accounting policies and procedures, perhaps?).  In 1458, he wrote Delia Mercatura et del Mercante Perfetto (Of Trading and the Perfect Trader), which included a brief chapter describing many of the features of double-entry accounting.

In 1494, Luca Pacioli, from San Sepulcro in medieval Tuscany, published the Summa de Arithmetica‘s 36 short chapters on bookkeeping (entitled De Computis et Scripturis, or “Of Reckonings and Writings”) so the subjects of the Duke of Urbino could learn how to conduct business and provide the trader with a fast, accurate method to determine his assets and liabilities.

For many centuries before this, commercial transactions had been recorded — journalized — on paper, papyrus, or clay tablets.  However, these journals provided only totals of transaction groupings. It was the Italians who first recognized that it is impossible for a business transaction to occur without affecting at least TWO accounts. There can never be only one effect from a transaction — there has to be balance.

An Italian farmer sells wood to a shipbuilder for 400 ducats. To account for this transaction, he would record, “wood sale – 400 ducats”. His “sales” account has increased by 400 ducats. But, what else has happened?  What other account was affected? His “cash” account also increased by 400 ducats.

What if he sells his wood to the shipbuilder on credit and receives no cash? In this case, it’s his “accounts receivable” account that increases by 400 ducats.

There Are Always Two Sides – at Least – to Every Transaction

Later, when the shipbuilder pays his debt to the farmer, the farmer records an increase in his cash account and a decrease in his accounts receivable by 400 ducats each.  You can see that an integral feature of the double-entry method is that transactions must equal. At the time, this new method was heralded as an astounding discovery and was described as “a magic mirror, in which the adept sees both himself and others.”

Today, double-entry bookkeeping is used for recording a transaction in two or more different places, or ledger accounts.  This practice simplifies finding errors since the totals of both ledger accounts should agree.

Debits = Credits

Bookkeeping entries are divided into debits and credits. The debit side is typically the left side of the ledger page and credits are on the right.  The origin of the words “debit” and “credit” come from the simple concept: “who owes you” and “to whom you owe”.

Debits are transactions relating to purchases, expenses, or increases in an organization’s assets. Credits are transactions related to revenues, or an increase in the firm’s equity and liabilities. Recording a transaction requires a debit and a credit entry.  If the entries are correctly recorded, the totals on both sides of the ledger agree.

The double-entry bookkeeping method — listing debits in one column and credits in the other — requires that the debit and credit columns add up to zero. The double-entry bookkeeping method is still the basis for tracking financial affairs, almost six centuries .   The following list illustrates the effect of posting a debit or credit entry on each major account type:

These account types are the general account classifications used in all accounting systems.  They are also used to organize the general ledger, from which financial statements are developed.  Your accounting policies and procedures should take into account the main accounting cycles, accounting methods, and accounting terms to guide the operation of your accounting system.

On one hand, popular accounting programs for small and mid-sized businesses have become more widely used than ever before.  On the other hand, industry consolidation has significantly reduced the accounting program choices to a handful.  These choices are typically inexpensive, easy to implement, and come with little support to develop appropriate accounting policies and procedures to ensure that the data generated by these programs is accurate and complete.  Entry-level software like Quickbooks® and mid-level software like MAS-90 or Great Plains share this common deficiency.  “Support” documentation is long on the explanation of user features and short on accounting policy and procedural advice.

Accounting Systems – The Recent Past

Only twenty years ago, small to medium sized businesses faced daunting choices for selecting an accounting system.  There were only three choices:  Continue to use a full manual system (a comprehensive pegboard “one-write” system, employing many journals anchored to an imposing cloth bound general ledger book that rivaled the size of the largest Webster’s Dictionary); purchase or lease a computerized accounting system; or build your own automated system.

The manual systems were not trivial.  They were produced by major firms, which provided on-site implementation and training.  These systems were well documented with many accounting policies and procedures built into the regimented use of the “one-write” journals and corresponding ledgers.   Internal controls were manual at best.

An alternative decision was to purchase or lease an automated accounting system.  But this required another decision of whether to buy a “ready made” product or build your own.  To make this decision, the company would typically hire a consultant or CPA firm to perform a comprehensive “needs” analysis.  The consultant would eventually select, either a commercially built multi-module accounting program (like Solomon, our Real World), or a programmer to develop the structure from custom code (RPG was a popular language used to create custom accounting programs).

Either one of these alternatives would have to run on a leased or purchased dedicated mini-computer system, (the IBM 36 was the popular mid-size business choice for many years).  Both solutions required tremendous resources in time and money.  Even the “ready made” solutions required plenty of additional programming to fit it into the specific company’s needs.  For a half a year or more, various consultants, programmers and specialists would write code, test and rewrite code.

In either case, documentation was paramount.  Hence Accounting Policies and Procedures, as they applied to the mechanics of the accounting system were well documented as a by-product of the installation and implementation process.  The total costs in the purchase or lease of the hardware and software (ready made or custom built), and in the company’s own human resources, was staggering.

Accounting Software – The Present

Imagine the months of decision making preparation, the months of development, the reams of Accounting Policies and Procedures documentation, and the total costs that easily went from tens of thousands to hundreds of thousands of dollars.  Compare this with current practice: The company owner (or the controller or other designee) walks into a local retailer, picks up a copy of the most successfully marketed accounting software package (i.e., the one occupying prime shelf space), drives back to the office, and loads the program on any available PC.  There you have it – the decision making process, needs analysis, implementation, and installation, all for one low price…or is it?

None of these accounting programs comes with supporting accounting policy and procedure documentations.  Internal controls do not exist and require manual processes and extra paperwork.  Your accounting software does not come with support  to help in your compliance with Sarbanes Oxley.  Of course you can develop your accounting policies and procedures yourself, from scratch.  But, this take a lot of time and expertise.

Accounting Practices – The future

The future begins today, with your purchase of this Bizmanualz™ Accounting Policies, Procedures and Forms.  This manual is needed more now than ever.  Accounting systems are more accessible than ever before.  Unfortunately, they come with no instructions.  The user guide that comes with the accounting software only explains what the menu options do, it doesn’t explain which options result in sound accounting practices.

Accounting software is looking more and more like your own internet browser home page, (no surprise since each manufacturer is competing to be your primary web portal).  New Accounting Software as a Service (SaaS) applications will make this a reality.  But, in the process, the actual functions of accounting are less obvious, and as a result, less understood.

This article series will take a look behind the scenes of the “splash screen”.  Hopefully, by understanding the concepts and consistent accounting rules utilized by all accounting software programs, you will develop more confidence to rely on the information generated by the program, you will have a deeper appreciation of the importance of accounting policies and procedures for internal control, and you will be able to use it more effectively to run your company.

That’s when your boss says, “Process? Did I say ‘process’? I meant processezzz! Plural!”  And before you can blurt out, “What do you mean?”, the boss says you need to develop procedures for all accounting processes, not just the one.  Oh, and he wants them by the end of the month!

A weak “Sure, boss…” escapes from your lips as “el jefe” turns and leaves, but an instant later, you’re thinking, “No way!”  You can’t possibly get all your accounting processes documented that quickly!  Or can you?

Break Down the Documentation Process into Its Component Parts

Start by mapping out the business process you need to document.  The process map acts as an outline for your procedure writing: you have to know the steps in the process that need documenting before you start writing.  With process maps in hand — one for each business process — you’re ready to start writing procedures.  Here’s where using pre-written procedures can save you time.

How You Can Use a Pre-Written Procedure to Save Time

If you’re looking for sample accounting procedures for your accounting processes, the Bizmanualz CFO Accounting Policies-Procedures Manuals set contains many sample accounting procedures you can use as starting points.  The CFO bundle contains 239 prewritten accounting procedure templates and 373 accounting forms, organized into five functional areas, or business manuals.  The CFO set covers the ten core accounting cycles.

Once the manuals arrive, the next step is “find an example procedure – a model for the one you need to write”.  All Bizmanualz procedures are in Microsoft Word format and can be easily tailored to fit your specific business process.  Let’s say you’re writing a procedure for vendor acquisition, or the “new vendor” process.  Where would you start?

The vendor process map you wrote shows eight steps:

1. Evaluate business requirements;
2. Identify qualified vendors;
3. Interview, Inspect and test vendor;
4. Review results and approve vendor;
5. Order from vendors;
6. Log orders and delivery performance;
7. Review performance against specifications; and
8. Vendor-related corrective and preventive actions.

Accounting Manual Index

The Accounting Policies, Procedures, and Forms manual contains a Vendor Selection procedure that you can customize.  How do you find it?  In the back of the manual, you’ll find the “Index”.  Search the index for your keyword, “vendor”.  (You could also look through the table of contents in the front of the manual.)  You find the Vendor Selection procedure, containing three steps, or activities (Vendor Selection, Vendor Inspection, and Vendor Files), in the “Purchasing” section.

Your process consists of eight activities, so you expand the prewritten procedure, adding the other five steps, or otherwise modify the Bizmanualz procedure to reflect your actual situation.  Add your process map (a handy visual aid) to the front of the procedure, and you’re done!

Writing a new procedure can take between 4 and 40 hours, depending on the complexity of the process you’re documenting and whether forms are required.  The complexity of a process, as well as your level of expertise in that subject, determines the amount of research — into standards, laws or regulations, references, and the like — you need to do.  Forms also require time and effort to research and produce, assuming you don’t already have them.  The Bizmanualz Vendor Selection procedure contains six pages of forms, including a detailed vendor inspection checklist.  Many Bizmanualz procedures also include a “References” section, which can help you as you research certain topics.

Let’s say this is a 40-hour procedure to create, with forms.  If you use the Bizmanualz procedure, with minor modifications you could have the same procedure ready in less than a day, saving yourself a great deal of time (and your eyes, a lot of wear).  Using a single procedure, saving 38 hours of time off the 40 you planned on, practically pays for the entire five-manual CFO series.

And you’re going to find more than one procedure you can adapt to your business requirements.  Most companies find dozens of useful procedures, which translates to hundreds of hours of time saved, before you factor in the opportunity cost of waiting for the procedures to be completed.

So, the next time you need to write procedures fast, take a look at the complete collection of Bizmanualz business policies and procedures.  Get your procedures project done now…before the end-of-month deadline your boss gave you.

If you qualify as a non-accelerated filer (i.e., your company’s public float is under $75 million), you’ll have to start complying with Section 404(b) of SOX, which requires company management and independent auditors to sign off on, or attest to, the effectiveness of your risk control framework or accounting policies and procedures for internal control.  Are your processes protecting you from the risk of material misstatements (RMM)?

Sarbanes Oxley Compliance Costs Too High?

When it was first enacted, the Sarbanes-Oxley Act (SOX) did not apply to non-accelerated filers because it was believed SOX compliance costs would be too high.  Several delays and extensions have been given to non-accelerated filers because the Office of Economic Analysis (OEA), which advises the SEC, needed to complete a study on SOX compliance costs. The study was completed in September, 2009, and was quickly followed by the announcement (on October 2) of the June 15th compliance deadline.

It didn’t surprise anyone when the OEA study showed that SOX compliance costs increase with company size; the study also confirmed that annual compliance costs decrease over time and that, overall, compliance costs have decreased since 2007.  In other words, while larger companies achieving SOX compliance had higher costs overall, there are fixed SOX compliance costs that impact all organizations, regardless of size, and companies have gotten smarter on how to implement Sarbanes-Oxley.

How Do You Control Sarbanes-Oxley Compliance Costs?

There are three major factors that drive up the cost of complying with SOX: cost of scale; cost of review; and cost of improvement.  The more control you have over all three of these, the lower your costs to implement Sarbanes-Oxley compliance will be.

Sarbanes-Oxley Cost of Scale

Why do larger companies incur higher overall compliance costs?  Because of the sheer size — scale – of their operations!  More operating locations, more employees, and more processes means more time and people needed to review accounting policies, procedures, and internal controls.  There is no easy answer to the question of scale: larger size translates into more risk management, internal controls, and accounting processes.

You can reduce the scope of SOX compliance by addressing the greatest risks first (note that PCAOB Auditing Standard #5 was developed for this purpose).  Don’t try to address all risks at once — this is what drives up compliance costs.  But, which risks do you address first?  Determine a threshold, or cutoff, for risk materiality, then decide which risks are most material to your company.

Remember — this is an ongoing process of improving your SOX compliance, not a one-time SOX compliance event.  Next year, you can (and probably should) lower the threshold and address your “second-tier” risks, and continue to annually adjust your threshold until you are comfortable.  Management decides on the internal controls needed to cover the identified risks.

Also, if you decide wrong and set your risk threshold too low or too high, you’ve identified a material weakness in your risk control framework.  You think you’ve exposed a flaw in your system, but consider that your system is also about continual improvement.  The only flaw is failing to improve: work on improving your internal controls – adjust your risk threshold – and you can demonstrate that you have a SOX-compliant system.

Sarbanes-Oxley Cost of Review

The cost of review represents the Check and Act phases of the Plan-Do-Check-Act (PDCA) process approach.  All companies needing to comply with SOX have to have some form of review process that tests accounting’s internal controls and gives management the confidence to attest to the validity of the company’s financial statements.

Internal audits, management reviews, management and auditor attestation, and board oversight are fixed costs of Sarbanes-Oxley compliance.  Every company has to operationally demonstrate to top management that internal controls are in place and are working.  Larger companies have to spend more, of course, but every company must spend a minimum amount for basic compliance.

As with the cost of scale, you can reduce the scope of SOX compliance by addressing the largest risks first in your audit plan.  You don’t have to audit every accounting process every year.  Start with the accounting processes that have the greatest impact — those that pose the greatest risk of material misstatement if they don’t work.  Review past audit opinions, your compliance plan, and your definition of materiality and adjust your audit plan to deal with the greatest risks.

Management decides on the internal controls and testing needed to ensure that the identified risks are controlled.  If you find that your audit plan hasn’t addressed the right risks, you adjust the plan.  Again, lessons learned — and implemented — show that your system is driving improvement and is, therefore, Sarbanes-Oxley-compliant.

Sarbanes-Oxley Cost of Improvement

The cost of improvement comes under the “Plan” and “Do” phases of the PDCA process.  Sarbanes-Oxley compliance starts with a compliance plan, one that identifies the risks you need to control.  Your compliance plan is the foundation of your risk control framework.  With a sound compliance plan in place, management can make better decisions regarding internal controls, such as implementing accounting policies and procedures that reduce or eliminate the risk of material financial misstatement.

Developing accounting policies and procedures is the “Do” in “Plan-Do-Check-Act”.  Your risk control framework identifies individual risks (e.g., the chance a receivable is not collected on time). Your accounting policies (e.g., collect accounts receivable within 30 days) and procedures (daily A/R aging reports, phone calls, collection letters, etc.) are forms of internal control that demonstrate your compliance with Section 404 of SOX.

Are your accounting policies and procedures for compliance, or control?  Well, control comes before compliance, but many companies have confused the two and wasted a lot of time and money.  You can reduce the scope of SOX compliance by controlling your greatest risks first with your accounting policies and procedures.

You don’t have to write a policy or procedure for every accounting process at once.  Once again, start with the accounting processes that, if they don’t work, pose the greatest risk of material financial misstatement.  Review audit opinions, your compliance plan, and your definition of materiality, then develop and implement the accounting policies and procedures that address your greatest risks first.

Management makes the final determination of which accounting policies and procedures are needed.  If you develop cash policies and procedures that do not (adequately) control the identified risks, you have a material weakness.  Improve your accounting procedures for internal control and you demonstrate Sarbanes-Oxley compliance.

Bizmanualz Accounting Policies and Procedures Reduce Sarbanes-Oxley Compliance Costs

Sample accounting policies and procedures serve as a model, or framework, for your own accounting policies and procedures.  The CFO Accounting Policies and Procedures Manuals set contains 239 procedures you can use to address the ten accounting cycles.

SEC Chief Mary Schapiro recently stated that “there will be no further Commission extensions.  It is important for all public companies – and their auditors – to act with deliberate speed to move toward full Section 404 compliance.”  Although legislation has recently been introduced to permanently exempt non-accelerated filers from Sarbanes-Oxley Section 404(b) compliance, there’s no guarantee that Congress will act or that the public won’t demand better information and you won’t need to comply with 404.  Besides, having an effective system of internal controls makes good business sense.

Using prewritten procedures will save you hundreds — possibly thousands — of hours in researching, writing, and implementing accounting policies, procedures, and internal control for Section 404 compliance.  Save even more time implementing additional internal controls for sales and marketing, security, disaster recovery, and ISO 9001 compliance using the CEO Company Policies and Procedures Manuals.  Download free samples of our procedures and judge for yourself.

When you deliver goods or services and you extend a business customer credit by accepting a promise to pay later through an invoice, then in a sense you are loaning your customers cash.  What steps can you take to make sure you get your cash back?  If you use good cash management practices to protect yourself from your employees and co-workers, then shouldn’t you be taking the same precautions with those outside your business?

Your Credit Policies Are a Part of Proper Cash Management

Of course, we are talking about a proper credit policy for clearly establishing the process of determining who can receive credit (can “promise” to pay later) and how much credit they are allowed.  Since determining credit may not always be a straightforward matter, a credit manual that includes credit policies and credit procedures, as well as clear explanations of the strategy or intent behind the policy, can be very useful.  Communicating the purpose behind credit policies can be a great help to those making the credit decisions.

Clearly communicating information about the how the company wants to extend credit is one important goal of your credit manual, credit policy and procedures.  Another important goal is to create consistency in how you handle and extend your business customer credit, both internally and externally.  But most importantly, your credit policy is about risk reduction.  It should be created in advance and take into account such things as its effect on sales, the impact on the company’s cash flow, and legal liability.

A Credit Manual Communicates Credit Policy and Intent

Internally, the credit manual can be an instrument to get various departments on the same page when it comes to customer credit.  For example, the accounts receivable department and the sales department are frequently at odds regarding what the credit policy should be.  Accounts receivable wants tight credit so they can collect within the proper period and not deal with delinquent accounts.  Sales, obviously, wants to book sales and they are not prone to turning away customers.  It is management’s job to establish clear credit policies and clear credit procedures, as well as explain the reasoning, in order to minimize the inherent conflict created by varied interests of these two departments.

Although it is frequently overlooked, part of the credit process should be regular communication between the various departments involved with using the credit policy manual.  Imagine the synergy created when accounts receivable, collections, sales and marketing, and even design and production all agree and cooperate in managing business customer credit.   The sales department knows and agrees not to waste its efforts on customers who don’t pay, and those making credit decisions know and agree when exceptions need to be made.

A Clear Credit Policy Helps Extend Credit Wisely

Besides establishing consistency internally, the credit manual can also ensure consistent and fair treatment for external customers.  The ability to extend short term credit is an important business tool, and if customers feel they are being treated unfairly or without a modicum of trust or respect – it can mean lost business.  When it comes to completing credit applications, references and credit checks, a certain level of consistency is expected, and this is especially true for making credit decisions.  The name or size of the company should not be a major factor in deciding who gets credit.

For example, I recently worked with training at a large construction company, and one of their regular customers was somewhat of a celebrity businessman.  Apparently, as a matter of practice, this well-known businessman delayed payment of owed invoices until they fell into collections, and then he would attempt to negotiate to a lesser settlement amount.  Eventually, however, the construction company had to tell their customer “you’re fired.”  By the time they considered the delay, the collection efforts, and the reduced payment, they were lucky to break even.

Apparently, this person relied on people wanting to do business with him because of his celebrity status.  You can’t, however, put a customer’s well-known name or brand in the bank to cover your payroll and your own accounts payable.  Your company is better off finding lesser known customers who pay their bills.  Consistent and fair company credit policies can help make sure that happens.

Cash Controls Include Company Credit Policy

Your credit manual and credit policies and procedures are directly related to protecting your cash, and you should understand that component as you develop and update them.  But just as critical as development of the credit manual is how clearly you communicate your policies and procedures clearly to all affected parties in your organization.  Poor credit practice is tantamount to leaving you cash drawer open… maybe no one will take advantage of your carelessness, but why take that chance?

Cash Security Is About Prevention

The same idea applies to your cash process; you want to use best cash practices and follow proper cash procedures.  In business you can reduce cash risk with good cash controls through removing opportunity and temptation.  While your employees may be honest, sloppy cash control is like leaving your car windows down at the mall… you are just begging for something bad to happen.

Proper cash security precautions in cash controls involve several basic tenets, but the most important is clear and accurate recording of all cash that is received and of all cash disbursements.  Make sure all cash transactions are documented and recorded immediately.  A delay in recording cash transactions not only introduces an opportunity for errors, but also creates the opportunity for temptation that could lead to cash fraud.  The recording element of the cash process doesn’t have to be difficult or complex.  In fact, simple basic cash records can improve the likelihood they will be done immediately and with less error, and thus reduce risks to cash.

Proper Cash Controls Need Proper Cash Records for Reconciliation

With the proper records created during all cash transactions, then regular reconciliation can take place.  Depending on your organization, there may be reconciliations that need to occur at several levels. These can include cash drawer reconciliations at the end of a shift or the business day, reconciliation prior to a bank deposit, and regular bank statement reconciliations.  As explained in the last week’s discussion on cash control procedures, management or owner involvement in reconciliation and regular internal audits sends a signal to all members of the organization who handle cash that internal cash control is a priority.

Separation of Duties Is a Key Facet of Internal Cash Control

Proper separation of duties is also an important tool that discourages unethical cash practices.  The idea behind separation of duties is that it is much less likely for two employees to collude to commit fraud than it is for one employee to act alone.  This obviously applies to the reconciliation duties discussed above.  The person who does the daily cash deposit reconciliation should not be the one conducting the monthly bank statement reconciliation.
Frequently, cash procedures call for two people being present any time a large amount of cash is being handled or transported.  This helps prevent internal fraud as well as discourages threats of external theft or robbery.  A restriction on the number of people who have access to cash is also an important method to prevent cash fraud and abuse.  It creates a high level of accountability, which in turn reduces temptation and your cash risks.  If 20 people work in a business, but only three have access to the cash drawer or petty cash, then theoretically you have reduced the risk of abuse by 85%.

Use Proper Physical Control for Cash Management

Physical control over cash means how the cash is literally stored and handled.  The obvious rule of thumb is that the less cash on the premises then the less chance for theft or embezzlement.   Make bank deposits as often as necessary and you can even engage an armored car service that will regularly transport your cash safely.  Keep the cash you have on hand in a safe if possible; or at least securely locked.  Without good physical control it is difficult to restrict access as mentioned above.

Along with good physical control of cash, it is a good cash practice to keep cash records in a separate location from the cash itself.  That way if fraud or theft does occur, they cannot easily take, destroy or modify the cash records.  Separation of cash records and cash can discourage theft, or at least allow the theft to be discovered and clearly documented.

Define Cash Processes and Keep Cash Procedures Current

Proper cash controls can be documented in cash procedures as part of your cash management process.  Be sure to understand the cash process and document it clearly in an accounting procedure.  Keeping your cash procedures correct and up to date also sends an important message to your staff about the due diligence of owners and managers.  If the cash process changes then changing the documented cash procedures should be a high priority.

Cash security practices are vital for internal cash controls, and the goal should be to prevent fraud and theft before it happens.  The proper control involves all the elements we have discussed; proper cash records, separating duties, regular oversight and audits, physical handling, and understanding the cash management process including correct cash procedures.  Proper control reduces temptation and opportunity – the keys to prevention.

Cash Management is Vital for Internal Control

Sloppy approaches to cash management can lead to temptation. Employees handling a significant amount of cash carry the greatest opportunity for fraud or abuse. Cash handling procedures are used to minimize cash handling risks. Multiple cash counts by different people make the basis of sound cash controls.

For example, the same person who handles the money should not be the one accounting for it. Cash funds should be counted often and by at least two people. Different people should handle cash, checks and deposits from those who record them in the books.

Cash handling procedures are one area auditors examine. Poor cash management policies and lack of control over cash handling will certainly make a poor impression, and possibly even impact an auditor’s perception of your accounting practices. Good controls using cash policies and procedures that are clearly communicated and regularly audited internally indicate to external auditors that cash controls are working.

Cash Policy and Cash Procedures Set Organizational Tone

Not only do proper cash policies and useful cash procedures send a clear signal to auditors, it also creates the required operating environment for employees. Due diligence and transparency involving regular management activity (including creating and updating cash policy and procedures) sets a tone that professionalism is the standard. Mistakes that are quickly caught and corrected convey a clear message about the importance of proper cash management.

Understanding key elements of your business, setting the proper environment for employees, creating a positive impression for auditors; these are just some examples of how proper cash policies and procedures can help your business. If you don’t feel you have the proper cash management controls in place, it is never too late to start. Begin by understanding your cash processes and identify what is important and what risks you face. Address them by creating cash procedures that incorporates data collection and review as well as the typical controls such as second person reconciliation.

If your business relies on cash flow, as most do, why would you leave cash management to chance?

The Accounting Department is an area where policies and procedures are usually a requirement, because they are considered part of the internal controls noted in Sarbanes-Oxley. The real question is: What approach are you taking to developing accounting policies and procedures? Are you just doing the minimum, or are you developing accounting policies and procedures in a way that will truly help your organization?

What Should be in Your Accounting Manual?

Most accounting manuals are just a set of procedures. But an accounting manual can play a bigger role in defining the operations of the accounting department. For example, the accounting manual should list responsibilities and describe accounting processes.

Read more about what your Accounting Manual should include…

Are Your Accounting Policies Providing Internal Control?

What is the difference between a well-conceived and well-written accounting policy and a poorly conceived and poorly written accounting policy? Of course, the needs of every organization are different, and the most important element of an accounting policy is that it helps the organization.

Read more about Accounting Policies and Internal Control…

Are Your Accounting Procedures Driving Improvement and Internal Control?

We know from COSO and Sarbanes Oxley compliance that accounting procedures are an important element of internal control. Organizations spend a lot of effort to produce an accounting manual containing accounting policies and procedures. So, if you are going to produce an accounting manual with accounting policies and accounting procedures, how can you make the most of the effort you put into them?

Read more about how Accounting Procedures drive improvement and Internal Control

On That Note:

Answer to this month’s question:

Rule-based “ballistic” procedures may meet the basic requirements for internal control. However, if you must take the time and effort to develop and maintain accounting policies and accounting procedures, why not make the small additional effort to build continual improvement into your accounting processes. Incorporate measurement and review into the accounting processes in order to see if important organization goals are being met. While some might see internal control as a set of rules, real control is awareness of how well accounting processes are operating and what improvements need to be made to meet goals and objectives.

Please feel free to contact us with any questions or comments. Also, please let us know if you’d like any specific topic addressed in our future articles.

Regards,

Chris

Bizmanualz

This obviously includes the accounting department. We know from COSO and Sarbanes Oxley compliance that accounting procedures are an important element of internal control. Organizations spend a lot of effort to produce an accounting manual containing accounting policies and procedures. So, if you are going to produce an accounting manual with accounting policies and accounting procedures, how can you make the most of the effort you put into them?

There are two important questions you should ask about your accounting procedures:

1) How well do your accounting procedures accurately capture your accounting cycles or processes?

2) How can your use your accounting procedures to benefit your organization?

A Positive Contribution from Accounting Procedures

Your accounting procedure probably describes an accounting process as a collection of process steps and associated rules. For example; a collection process might send out collection notices, make phone calls, collect money, deposit money; and then repeat.

Where in this accounting process, however, do you collect data that measures how effective the accounting process is? When are you comparing results to objectives? In a more broad view, control is more that just a set of steps and/or a list of rules. Control is awareness of how well your accounting processes are carrying out important functions. On this path the accounting processes your accounting procedures describe can really provide an important contribution to your business.

The legal, regulatory and ethical concerns surrounding accounting processes only emphasize the importance of having good accounting procedure documentation. But the difference between a controlled accounting process with measurement and review and an uncontrolled accounting collection process can be described with one word: success.

A Different Version of an Accounting Control Procedure

Controlled processes collect data as in integral part of the business process steps. Now, at regular intervals, the data can be reviewed and accounting process effectiveness evaluated. Are objectives being reached? If not, why? Are the objectives meaningful and reflect importance and risk? Now, the necessary corrections can be identified and implemented as a result of the review.

For example; a controlled accounting collection process might send out two different collection notices to test the response rate of different notices, you may also make phone calls at defined intervals to determine the response rate. Collecting data means making reflective and meaningful adjustments to the business process.

Typically, auditors accept accounting procedures that list steps and rules, with lots of inspection and verification steps, as an adequate internal control system. What value, however, does that internal control system provide for your organization? As a business owner, CFO, Controller, or accounting department manager, is an internal control system that does the bare minimum good enough?

Using Process Analysis to Develop Standard Accounting Procedures

Understanding the accounting processes is the first step in being able to document them with well-written accounting procedures. Besides noting the steps of the accounting process, consider the following:

• Who is the accounting process owner?
• How do accounting processes interact? What are the inputs, outputs, customers, suppliers?
• What are the most important facets for process and organizational success?
• What are the risks associated with the accounting process (what could go wrong and how material would it be?

You might find process maps, flowcharts, or similar tools useful during this phase. Be sure to identify accounting process objectives, key metrics and how they are recorded, as well as how frequently they should be reviewed.

Once you start reflectively analyzing your process, you may notice better approaches or waste that can be eliminated. You might, however, want to avoid introducing too much change too quickly. One strategy is to introduce the most important changes first (according to risk, return, etc…,) then introduce more process improvements over time through other improvement activities. Once you understand your process and incorporate process improvements, data collection, and review, you are ready to start writing your accounting procedures.

After planning and analyzing an accounting process, writing an accounting procedure to document it should seem easy. One tip is to focus on describing the accounting process and avoid too much mundane detail (i.e. computer instructions). Too much detail makes the accounting procedure unfriendly to users, and those details are only needed by beginners anyway. Keep that information in training materials or work instructions.

Remember, simplicity and consistency (even with other organizational procedures) is a positive attribute of an accounting procedure. It is easier to add necessary information later as needed than it is to identify and strip out useless information and needless detail.

Accounting Procedures to Benefit Your Organization

This approach to writing an accounting procedure that describes a well-defined, controlled accounting process aligns with the concept of accounting policies we presented last week. The accounting policy clearly communicates goals, and the accounting procedure communicates the accounting process in order to execute it and reach the goals. The periodic review of accounting process objectives provides feedback for the accounting policy ensuring it is still current in reflecting what is important to your organization.

To learn more about Bizmanualz Accounting Procedures go to http://www.bizmanualz.com/accounting/ and check out the Accounting Policies and Procedures Manual or sign up for the Bizmanualz Newsletter and download a free sample accounting procedure right now.