Accounting For Dummies. John A. Tracy

If the IRS comes in for a field audit of your income tax return, you’d better have good audit trails to substantiate all your expense deductions and sales revenue for the year. The IRS has rules about saving source documents for a reasonable period of time and having a well-defined process for making bookkeeping entries and keeping accounts. Think twice before throwing away or deleting source documents too soon. Also, ask your accountant to demonstrate and lay out for your inspection the audit trails for key transactions, such as cash collections, sales, cash disbursements, and inventory purchases. Even computer-based accounting systems recognize the importance of audit trails. Well-designed computer programs provide the ability to backtrack through the sequence of steps in the recording of specific transactions.

      Keep alert for unusual events and developments

Business managers should encourage their accountants to stay alert to anything out of the ordinary that may require attention. Suppose that the accounts receivable balance for a customer is rapidly increasing — that is, the customer is buying more and more from your company on credit but isn’t paying for these purchases quickly. Maybe the customer has switched more of his company’s purchases to your business and is buying more from you only because he’s buying less from other businesses. But maybe the customer is planning to stiff your business and take off without paying his debts. Or maybe the customer is planning to go into bankruptcy soon and is stockpiling products before the company’s credit rating heads south.

      Don’t forget internal time bombs: A bookkeeper’s reluctance to take a vacation could mean that they don’t want anyone else looking at the books.

      To some extent, accountants have to act as the eyes and ears of the business. Of course, that’s one of the main functions of a business manager as well, but the accounting staff can play an important role.

      Design truly useful reports for managers

      We’ve seen too many off-the-mark accounting reports to managers — reports that are difficult to decipher and not very useful or relevant to the manager’s decision-making needs and control functions. These bad reports waste the manager’s time, one of the most serious offenses in management accounting.

      Part of the problem lies with the managers themselves. As a business manager, have you told your accounting staff what you need to know, when you need it, and how to present it in the most efficient manner? When you stepped into your position, you probably didn’t hesitate to rearrange your office, and maybe you even insisted on hiring your own support staff. Yet you most likely lie down like a lapdog regarding your accounting reports. Maybe you assume that the reports have been done a certain way and that arguing for change is no use.

      

On the other hand, accountants bear a good share of the blame for poor management reports. Accountants should proactively study the manager’s decision-making responsibilities and provide the information that is most useful, presented in the most easily digestible manner. To a certain extent, this is what we mean when we say “reliable” (in the acronym CART). While financial information may be accurate, reliability speaks to the concept of producing and reporting financial information in a way that truly benefits a business manager and assists them in making informed business decisions. Don’t assume that accuracy automatically equates to reliability.

In designing the chart of accounts, the accountant should keep in mind the type of information needed for management reports. To exercise control, managers need much more detail than what’s reported on tax returns and external financial statements. And as we explain in Chapter 15, expenses should be regrouped into different categories for management decision-making analysis. A good chart of accounts looks to both the external and the internal (management) needs for information.

      

So what’s the answer for a manager who receives poorly formatted reports? Demand a report format that suits your needs! See Chapter 15 for a useful profit report model, and show it to your accountant as well.

Enforcing Strong Internal Controls

      

Any accounting system worth its salt should establish and vigorously enforce effective internal controls — basically, additional forms and procedures over and above what’s needed strictly to move operations along. These additional procedures serve to deter and detect errors (honest mistakes) and all forms of dishonesty by employees, customers, suppliers, and even managers themselves. Unfortunately, many businesses pay only lip service to internal controls; they don’t put into place good internal controls, or they don’t seriously enforce their internal controls (they just go through the motions).

      Internal controls are like highway truck weigh stations, which make sure that a truck’s load doesn’t exceed the limits and that the truck has a valid plate. You’re just checking that your staff is playing by the rules. For example, to prevent or minimize shoplifting, many retailers use video surveillance as well as tags that set off the alarms if the customer leaves the store with the tag still on the product. Likewise, a business should implement certain procedures and forms to prevent (as much as possible) theft, embezzlement, kickbacks, fraud, and simple mistakes by its own employees and managers.

      The Sarbanes-Oxley Act of 2002 (often referred to as SOX) applies to public companies that are subject to the federal Securities and Exchange Commission (SEC) jurisdiction. Congress passed this law mainly in response to Enron and other massive financial reporting fraud disasters. The act, which is implemented through the SEC and the Public Company Accounting Oversight Board (PCAOB), requires that public companies establish and enforce a special module of internal controls over external financial reporting.

Although Sarbanes-Oxley applies legally only to public companies, the accounting profession has taken the position that requirements of the law are relevant to all businesses. As a matter of fact, independent CPA auditors in their audit report state whether they think the internal controls over financial reporting are adequate for preventing misleading financial statements.

      INTERNAL CONTROLS AGAINST MISTAKES AND THEFT

      Accounting is characterized by lots of documentation — forms and procedures (digital or hard copy) are plentiful. Most business managers and employees have their enthusiasm under control when it comes to the documentation and procedures that the accounting department requires. One reason for this attitude, in our experience, is that nonaccountants fail to appreciate the need for accounting controls.

      These internal controls are designed to minimize errors in bookkeeping that processes a great deal of detailed information and data. Equally important, controls are necessary to deter employee fraud, embezzlement, and theft as well as fraud and dishonest behavior against the business from the outside. Every business is a target for fraud and theft, such as customers who shoplift; suppliers who deliberately ship less than the quantities invoiced to a business and hope that the business won’t notice the difference (called short-counts); and even dishonest managers themselves, who may pad expense accounts or take kickbacks from suppliers or customers.

      For these reasons, a business should take steps to avoid being an easy target for dishonest behavior by its employees, customers, and suppliers. Every business should institute and enforce certain control measures, many of which are integrated into the accounting process. Following are five common examples of internal control procedures:

       Requiring