Establish Reporting Rules within the Finance Team

Members of the finance team have to realize that they are sculptors, not scientists. There needs to be recognition that the monthly accounts are not precise documents. Assessments need to be made, and the monthly accounts will never be right; they can only be a true and fair view. We could hold the accounts payable open for six months after month-end and still not have the plumber's invoice that arrives when the plumber's company is doing its year-end and realizes that it has forgotten to invoice for work done.

We therefore need some rules about the month-end reporting process which need to be signed off by all the accountants. The month-end financial report should:

• Not be delayed for detail.
• Be consistent—between months, judgment calls, and format.
• Be a true and fair view and error free.
• Be concise—less than 10 pages (include the major business units' one-page reports but exclude minor units reports. These are shown as a consolidated number in the consolidated P/L).
• Be a merging of numbers, graphs, and comments on one page.
• Not be changed for adjustments that are likely to be set off by others yet to be found—instead all adjustments are to be offset against each other on an “overs and unders” schedule.
• Be based on an agreed corporate view of materiality. Materiality will not be set at a different level for each budget holder. If materiality is set at $20,000 for a P/L item consolidated result, then this amount is set for adjustments, variance reporting, and accruals across all entities.

I have included a draft set of rules for the finance team in the reader download.

Catch All Adjustments in an “Overs and Unders” Schedule

Month-end reporting is not the time for spring cleaning, no matter how tempting it can be. This requires a re-education within the finance team and with budget holders.

All miscodings, unless resulting in a material misstatement of the P/L, are processed during the following month. Budget holders are educated to review their cost center numbers via online access to the G/L during the month and are requested to highlight any discrepancies immediately with the finance team.

We want to have a regime where we catch all material adjustments and see the net result of them before any decision is made to adjust (e.g., only a material month-end misstatement will result in processing an adjustment). The first time you do this, set up two overs and unders spreadsheets, see Exhibit 3.4, at the close of the last working day.

One spreadsheet is to trap major adjustments. If materiality is set at $40,000 for a P/L adjustment, I would recommend setting the threshold for the over and unders schedule at around 40–50%. In this case it would be between $16,000 and $20,000, so I would go for $20,000. The other overs and unders schedule is to trap minor adjustments between $5,000 and $19,000.

If they find adjustments, the accountants will enter them on the appropriate spreadsheets that reside on a shared drive on the local area network. More often than not, you will note that adjustments have a tendency to net each other off.

If there is a material misstatement of the net result, we will process one or two appropriate adjustments and then remove them from this schedule. This will bring the total of the overs and unders to an acceptable figure. We then process all the other adjustments during the quiet time in the following mid-month. In the quiet of mid-month, the minor adjustments are reviewed for their causes and work done to fix the problems. This minor schedule is now no longer continued.

Avoid a Huge Wave of Accounts Payable Invoices at Month-End

The last thing the accounts payable (AP) team needs is to receive a tsunami of invoices on the last day of cutoff, as shown in Exhibit 3.5. It is important to push processing back from month-end by avoiding a payment run at month-end. It is a better practice to have weekly or daily direct credit payment runs with none happening within the last and first two days of month-end.

Change invoicing cycles on all monthly accounts such as utilities, credit cards, stationery, and so on (e.g., invoice cycle including transactions from May 28 to June 27 and being received electronically by June 28). Since you are looking at one month's activity it is not worth preparing accruals for these suppliers as the previous month's reversing accrual will make any difference immaterial.

Early Closing of the Accounts Payable Ledger

I have not come across an organization that can justify closing off accounts payable after the last day of the month. Whatever date you pick to close AP, you will never trap all the invoices. Remember, we are after a true and fair view; we are sculptors rather than scientists.

If accounts payable is held open after month-end, you will find it difficult to complete prompt month-end reporting. What benefit does holding open the accounts payable for one or two days have? We could hold the accounts payable open for six months after month-end and still not get the plumber's invoice that arrives when they are doing their year-end and realize they have forgotten to invoice for work done on the refit.

Better practice is to cut off accounts payable at noon on the last working day. In my workshops, I have come across organizations that cut off accounts payable even earlier, on day 2 and day 3 (see Exhibit 3.6). They manage this by more reliance on recurring reversing accruals, supplemented by budget holders accruals for the larger one-off amounts. They place timeliness above preciseness. This requires good communication to budget holders and suppliers, with the latter sending their invoices earlier through changing the billing timings, as already mentioned.

In order to lock in this change you may need to run a workshop with the budget holders and follow up with one-to-one educational support, as required.

Close Accruals before the Accounts Payable Cutoff

The accruals cutoff does not need to be after the accounts payable (AP) cutoff; it can and should be before. Let me explain.

One smart accountant I have come across worked out that budget holders know little more about month-end purchase invoices at day+2 than at day 2. So, the accountant introduced accrual cutoff on day 2, the day before month-end. Budget holders were required to send their last invoices for processing to meet the month-end AP cutoff by noon day–2, which gave AP 24 hours to process them before the day 1 AP cutoff. He also told them to prepare their accruals in the afternoon of day–2, directly into the G/L.

All that is required is a guarantee that all invoices approved for payment by budget holders within the deadline will in fact be processed prior to the AP cutoff, or accrued directly by the AP team.

Cutting off accruals early recognizes that month-end invoices will not arrive miraculously by day+1 or day+2 so staff will need to phone some key suppliers to get accrual information regardless of when the cutoff is.

Set a Materiality Rule for Accruals

We need to set a materiality rule for accruals. If materiality is set at $40,000 for a P/L item, I would recommend setting the threshold for the minimum department accrual at around 40–50% of this number. In this case it would be between $16,000 and $20,000, so I would go for $20,000. If a department is too small to have $20,000 worth of accruals, then it does not need to do accruals.

If materiality is set at $20,000 for a P/L item, then we might set the minimum threshold for accrual total for each business unit between say $8,000–$10,000 (using the 40–50% rule). In this case I would set it at $10,000. If a department is too small to have $10,000 worth of accruals, then it does not need to do accruals. This should limit accruals to less than half the budget holders in the organization. If a manager of a small budget complains, point out that they will be able to accrue when they get promoted. We should set limits on the individual debit items in the accruals to somewhere around a quarter of the accrual threshold. If departmental accruals must be greater than $20,000, each debit must be greater than $5,000.

Avoid Inter company Adjustments

To stop the politics of intercompany disagreements at month-end instigate a simple rule that the accounts payable (AP) or accounts receivable (AR) ledger is always right, and the other party has to adjust accordingly. Leave the intercompany parties to sort the issues out in the following month. I have included a draft memo in Appendix A that the CEO would be advised to send out.

Resourceful organizations use intercompany software, where the transaction is entered by the selling party, and the software simultaneously posts the transactions in the buyer's and seller's general ledgers. They also only amend for major internal profit adjustments.

These tools are priced to be available for the SME market. To source this software, simply use one of these searches in your preferred search engine (“intercompany + software,” “intercompany accounting + software”).

Early Closing-Off of Accounts Receivable

Close off accounts receivable immediately on the last working day. If you have high last-day transaction volumes, it is better to go for a cutoff at noon on the last working day with transactions in the afternoon being carried forward to the first day of the new month. Closing off earlier is more important if you have an organization where the sales representatives make a lot of sales on the last working day of the month (e.g., car dealers). You simply say to them, “All sales made on the last day of the month will now be in the following month.” This will start their game a little earlier.

Remember that training will be required in dispatch and accounts receivable to ensure cutoff is clean each month-end.

Early Capital Expenditure Cutoff

Why are you performing depreciation calculations at month-end when inventive organizations have this already done much earlier? They close off capital projects at least one week before month-end. Any equipment arriving in the last week is therefore treated as if it arrived next month. It still can be unwrapped and plugged in or driven.

The depreciation is calculated and posted by day 3. In my workshops, I have found accountants, with organizations where depreciation is not significant, who use the depreciation calculations from the annual plan and correct to actual at month 12.

Early Inventory Cutoff

Sophisticated organizations can get their month-end inventory cutoff immediately at close of business on the last working day (day 1). However, some manufacturing organizations take a day or two into the next month to manage this process. This creates an unnecessary delay in month-end accounts.

If your systems are not state of the art, make the inventory cutoff at the close of business on day 2 with all production on the last day being carried forward to the next month. This gives one day to check the valuation and records. The close-off transfer of work in progress to finished goods also is done on day 2, with day 1 production treated as belonging to the next month.

These early cutoffs will require cooperation between accounts payable and inventory staff to ensure raw materials arriving on the last day and the matching liability are treated as the next month's transaction or accrued.

Always avoid a month-end stock count, as these should be done on a rolling basis and be held no nearer to month-end than the third week of the month (e.g., one jewelry chain I know counts watches one month, gold chains the next month at a quiet time during the month).

From 5 p.m. Last Day to 5 p.m. First Working Day

What happens in the next 24 hours is critical to the success of month-end reporting. At 5 p.m. on the last working day all the cutoffs should be done. We can print off the first cut of the numbers. This report would be designed for a detailed review and would contain the last three months' numbers and the months' numbers from last year in a series of columns. All the reporting and management accountants should take a copy home and look for areas where they think the numbers could be wrong.

Budget holders should be sent their accounts and they should be given until noon day+1 to complete their commentary on major variances. The variance must be over $___ (based on materiality level for whole organization) and >10 percent of budget before a comment is required.

At 9 a.m. the following day, all the accountants meet to discuss the areas where further work is needed to be sure that the numbers are “true and fair.” At the meeting, “Who is reviewing what?” is decided and a time is set to meet again before the flash report numbers are finalized that day.

Between 3 and 4 p.m. on the first day, you call all the accountants back and ask, “What did you find?” and then look at the net effect of all adjustments on the overs and unders schedule. More often than not, you will note that adjustments have a tendency to net each other off. Book only the adjustments required to restate the numbers as “true and fair.” You are now in a position to prepare the one-page flash report for the CEO.

Deliver a Flash Report at the End of Day 1

Issuing a flash report on the (P & L) bottom line to the CEO stating a level of accuracy of, say, + / – 5% or + / – 10 by the close of business on the first day is a very important practice. There is not a CEO on this planet who would not welcome a heads-up number on such a timely basis. See Exhibit 3.7 for an example of a flash report.

It is important not to provide too many lines because you may find yourself with another variance report on your hands if you have a CEO who fails to look at the big picture. Never attempt a flash report until the AP, AR, and accrual cutoffs have been successfully moved back to the last working day of the month. Otherwise, you will be using the accruals to change final numbers so they can closely match your flash numbers, a practice I would not recommend.

The flash result will act like a great appetizer, and the CEO's appetite for month-end information will be largely satisfied. This creates a great opportunity to reduce the CEO final report to an A3 page, as shown in Chapter 7.

Ban All Late Changes to the Month-End Report

Once the flash report has been issued, at the close of business on the first working day, teams should continue with recording any adjustment found in the relevant overs and unders spreadsheet.

No changes are permitted to the numbers reported in the flash report until the entire review has been completed. The accounting team can then assess which adjustments are worthy of processing. As many have no P & L impact, they would be held back for adjustment in the following month.

Once the reporting pack is prepared, no adjustments are allowed unless they are very material. There is nothing worse for the finance team than to submit a finance report to the CEO that is inconsistent. This is frequently caused by a late change not being processed properly through the report. As night follows day, the CEO will be sure to find it. I am sure many readers have been guilty of this one.

It is far better to hold back the adjustments. If the CEO says to you, “I thought the sales were higher,” you can say, “Pat, it is a pleasure working for such an astute CEO. You are right, the sales are understated by $30,000; however, there are adjustments adding up to $27,000 going the opposite way, so I have not booked the adjustments, as the net difference is immaterial. I am booking these through this month. However, if you like, I will adjust this month's report.” Most CEOs will feel pleased with themselves for spotting the shortfall and then move on to another issue.

Stop Variance Reporting at Account Code

This month-end we need to stop reporting variances at account code level. We should report at a higher level. I call this a category level, which is discussed in Chapters 9 and 16 on annual planning and rolling forecasting.

We also need to establish some rules for variance reporting. If materiality is set at $40,000 for a P/L item, then this amount should also be incorporated in the variance reporting rules: A variance has to be the greater of 10% of budget and over $__________ ($40,000 in the above example).

Stop Monthly Reforecasting of Year-End

One process that corporate accountants have done without really thinking about it has been the monthly reforecasting of the year-end position.

Reforecasting the year-end position monthly is wrong on many counts:

• The task is done after the month-end numbers are known, and it now delays the month-end results. It produces a number that, due to time constraints, has little input and no buy-in from the budget holders. I call these forecasts top–top forecasts, where the finance team members talk among themselves and with senior management.
• Why should one bad month or one good month translate into a change of the year-end position? We gain and lose major customers and key products rise and wane. This is the life cycle we have witnessed many times. Besides, if you change your forecast each month, management and the board know whatever number you have told them is wrong—you will change it next month, as shown in Exhibit 3.8.
• Reforecasting should occur only four times a year, using a bottom-up process and a proper planning tool, as explained in Chapter 16 on rolling forecasting. Only businesses that are in a volatile sector would need to forecast parts of their operations monthly (e.g., the airline industry would update exchange rates, passenger volume predictions, and aviation fuel costs).

Key Month-End Activities after Reengineering

The key activities in a day 3 month-end are set out in the Exhibit 3.9.