General Ledger Re-Classification Will Not Determine Your Cost
Jul 31, 2014
A few weeks ago I was talking to a CEO who was having difficulty with his costing system and he was looking to make improvements. He mostly wanted to be able to use the system to make management decisions about the profitability of his products. Unfortunately, the cost system was so problematic that for the last several years he was being questioned from his outside auditors on the value of the inventory. Specifically, the outside auditors wanted to see how the products were being costed, and they expected to be able to use the cost system for that purpose.
The outside accountant discovered that the cost system was so inadequate that they even further called into question the value of the inventory and the effects that it would have on profitability. Consequently, in the first year the auditors determined too little cost was being assigned to the inventory and as a result, a large inventory adjustment was required. The CFO at the time was quite concerned with the problem and took action to try to solve the dilemma. First, he took a number of general ledger accounts that would normally be assigned to general and administrative (G&A) and reclassified them into factory overhead. Second, he dramatically increased the overhead application rate that was based on labor hours.
The result of these two changes left the year-end inventory being overvalued which, of course, required yet another adjustment by the outside accounting firm. Typically, with these adjustments, the bank involved has many questions which calls into question the credibility of the statements.. This CFO was no exception as he had questions from not only the bank but the company’s ownership and the outside auditors.
As will likely come as no surprise, the CFO is no longer employed with the company and the CEO is currently worried about regaining credibility and producing accurate costing information.
I thought about that entire process and the specific problems related to the accuracy of the cost system. I mostly was surprised by the unique solution that the CFO had struck upon reclassifying certain sales and G&A accounts into factory overhead. His goal of course was to increase the overhead to be applied, which thereby assured that the inventory would have a higher value. I am just not sure why he thought this would pass an audit testing that most likely would be proving out the net realizable value (NRV). I have seen and heard a lot over the years, but this was the first time I had ever heard of this as a potential solution. I would think such re-classifications would be quite obvious to the outside accountants, particularly if the accounts themselves retained their original titles. Furthermore, those kinds of adjustments are relatively easy to find in the overall inventory testing if the outside accounting firm is doing normal year-end procedures related to NRV of the inventory and other cost assurance testing that would be part of most year-end audits.
In this case, the CFO was not interested in figuring out what was actually going on in product costs but rather offer a quick solution to value inventory and thereby pass the audit testing. Luckily for the owners of the company, the CEO had a far broader view of product costing and was looking to create valid management information from his cost system.
Categories: Cost Accounting
Financial Statement Relief is in Sight
Jul 29, 2014
It seems like each year, new accounting rules are issued that make financial statements more complicated and less relevant for privately-held companies, especially those that are small and medium-sized businesses. Most of the new accounting requirements have been intended more for larger publicly-traded companies. The good news is that there has been some recent relief for privately-held companies.
For those privately-held companies required to issue financial statements using generally accepted accounting principles (GAAP), the Financial Accounting Standards Board (FASB) issued in 2014 some amendments to accounting rules that should simplify the accounting requirements in regards to recording goodwill, interest rate swaps, and variable interest entities (such as leasing relationships that previously were required to be consolidated). These amendments become effective for annual periods beginning after December 15, 2014, with early application allowed.
For those privately-held companies whose financial statements users don’t require GAAP-based financial statements, the tax basis of accounting has always been a popular more simplified option. There is also a new non-GAAP basis of accounting available for small and medium-sized enterprises (SMEs) called the Financial Reporting Framework for SMEs. This basis of accounting is accrual-based and uses more simplified principles that don’t include deferred taxes, interest rate swaps, comprehensive income, variable interest entities, etc. that have complicated a lot of GAAP-based financial statements. This new framework basically is like an old version of GAAP before the more complicated rules came into being.
Let us know if you have any further questions. While the relief noted above doesn’t guarantee more simplified accounting for all privately-held companies, it’s definitely a step in the right direction.
By: Brent Ringenberg, CPA
Categories: Audit & Accounting
Inventory Valuation Made Simple
Jul 25, 2014
On July 15, the Financial Accounting Standards Board proposed an Accounting Standards Update inventory valuation methods. The purpose of the update is to cut back on both the cost and complexity of accounting for inventory. This simplification can be seen as gold among the dross, as the extreme complexity of accounting standards today can be overwhelming to business owners and accountants alike.
An advantage of this proposed accounting standard is an increased consistency of inventory valuation among different companies. Consistency an important aspect to accounting standards, as their underlying purpose it to provide useful information to readers of financial statements.
The current accounting standard for inventory measurement is by using the lower of cost or market method. As it may sound harmless enough, the complexity falls within the multiple definitions of what “market” cost can be. Market can be any one of the following three options:
• Replacement cost • Net Realizable Value or • Net realizable value less normal profit margin
The proposed update will change the inventory valuation method to “lower of cost or net realizable value.” This is not a complete change from the current method, but more of a simplification. Net realizable value is defined as “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.”
By eliminating the different options to “market” valuation, there will be a more consistent application of the measure of inventory. This will also prevent companies from having to make decisions on how they will choose their method for market cost.
Another additional benefit this Proposed Accounting Standards update provides is that it is very similar to the method used in International Financial Reporting Standards. With the merging of GAAP and IFRS on the horizon, any update that would help smooth out the transition will be a benefit when that time comes.
Reminder: Proposed Accounting Standards Updates are released for public comment. The entire exposure draft can be downloaded for viewing from the Financial Standards Oversight Board website at www.FASB.org. Electronic Feedback Forms are also available via the FASB website, or responses may be emailed to director@fasb.org or mailed to:
Technical Director File Reference No. 2014-210 FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116
By: Anthony Mifsud, Staff Accountant
Categories: Uncategorized
Foreign Bank Accounts and Other Foreign Financial Assets
Jul 23, 2014
You must report worldwide income on your US income tax return. If you have an “interest in” a foreign bank or financial account you must check “yes” on Schedule B of your tax return. You may also have to file Form 8938 with your return to report foreign accounts and assets. Additionally, you may have to file an FBAR (114) report separate from your income tax return each year.
Categories: Uncategorized
KPI Evaluation: 100 Widgets Produced = Sun Shining
Jul 23, 2014
First of all, someone hurry up and produce 100 widgets because the sun is not shining here in Northwest Ohio today. Typical Ohio weather! Yesterday it was over 90 degrees and sunny and today it’s cloudy, possible chance of rain and we will be lucky to hit 70! Some people like this weather and if it was fall I would too, but I do prefer the hot days of summer personally!
Typically comparing the sun shining to producing 100 widgets produced would be quite useless. I am sure there is some place where that comparison may make sense, but its clear these two things have nothing to do with each other. I would say they do not even fall in the apples to oranges category because at least those are both fruit!
When you are putting together and using Key Performance Indicators (KPIs) it is important that they are relevant and are giving you good, timely, information. Determining if you are meeting your production standards would make sense over a period of time, an hour, a shift, a day, etc. Looking at that by the minute or by the month most likely would not make sense.
Typically you want to make sure you have goals set for production, recovery, scrap, utilization, etc. Comparing those over relevant time periods and in a relevant bubble is crucial. If your time frame is too short you may be falsely lead to believe everything is accurate. If your time frame is too long you may have an ongoing issue that you could have interceded on before overspending.
It is also important to have financial metrics to make sure you are making goals for cash flow, profit, receivable cycles, etc. Again looking at these in a the correct time frame and comparing the correct things are vital. If you are looking at the receivable cycle you of course would not care about the payables you have. Of course if you do not collect on your receivables you may not be able to pay your payables, but the actual AR cycle does not have anything to do with payables.
Do not just compare things or look at metrics for the sake of looking at metrics, you are wasting your time if you are not comparing accurate and timely data. Determine what makes sense for you and your industry and step back and ask yourself do these things have anything to do with the other and what is it telling me and would a different comparison or different time frame give me better or worse information.
Categories: Cost Accounting