The Final Score

The Super Bowl clock ticked down last Sunday with my home team, the New England Patriots, nursing a 17-15 lead over the New York Giants. Forced to punt with less than four minutes left in the game, the Patriots turned it over to their defense to pass their final and most important test of the year — to get the ball back to the offense without letting the Giants score.

Maligned all season long for their shortcomings, particularly in pass defense, the Patriots’ defensive players had a chance to redeem themselves, to prove to the world (after all, the whole world was watching, wasn’t it?) that the Patriots were more than the single dimension of Tom Brady. On the first play of the series, the defense failed the test. The fact that the Giants’ Eli Manning made a perfect pass and Mario Manningham a miraculous catch was less significant to this Pats’ fan than the defensive line’s inability to pressure Manning and the defensive backs’ failure to cover Manningham adequately.

After that, it was only a matter of time. It was clear that the Giants would take the lead. Patriots’ coach Bill Belichick hung the defense’s failing grade out for all to see by conceding the Giants’ go-ahead touchdown in favor of saving the clock. The final question was whether or not the Patriots’ offense could pass their test before the clock wound down to zero.

Brady passed on the first two plays from scrimmage — two catchable balls which fell incomplete — and absent the momentum that those plays might have provided, the rest was largely desperation. The offense, too, had failed.

So it is with your accounting team. During the regular season — the first eleven months of the fiscal year — your team keeps the score and reports it every month, your company’s wins and losses. If you, the owner or senior manager, have a sharp eye for numbers, you may spot some incompletions along the way. But the fumbles, those potential game-changers, often don’t show up until the CPA arrives to administer the ultimate test: the tax return, the review, or the audit. The result is frequently a year-end score that’s different from what your team has been reporting at each checkpoint. Like the referee who’s only going by the book, the auditor’s job is to throw a flag, which more often than not results in a penalty to your bottom line.

For your team to pass the test, it has to minimize the CPA’s dreaded “adjusting journal entries (AJEs),” which seemingly result from the application of accounting arcana to your day-to-day bookkeeping. Except that most of it is not really arcane. Most of it is just basic, straight-forward accounting that anyone with a degree in accounting or five years of progressive learning in the field of accounting should know.

If you, as the small business owner, are going to get off the sidelines and into the game to impact not only the final score, but the tally at each monthly milepost, here are nine accounting issues that should concern you before the CPA comes on the field of play:

  1. Revenue recognition: You can record it only as fast as you actually earn it. Avoid the temptation to book in Month One all of the income from a service that you’re providing over the full year. And definitely don’t book as revenue any of your favorite customer’s advance deposit until you have delivered, at least in part, against it.
  1. Inventory: Beyond accurately counting it in and counting it out, the trick is accounting for it while it’s still work-in-process (WIP). Whether it’s a product or a service, if you started working on it before the end of the accounting period, you’re creating additional value which should be capitalized on your balance sheet if it’s not out the door by month-end.
  1. Payroll: Accrual-basis accounting requires that you recognize your labor expense as it’s incurred. You may have issued payroll on January 6th for the week ending December 31st, but the expense relates to December, not January.
  1. Depreciation: There’s no need to wait for the outside accountant to determine this number. Your team can ask for the standard GAAP guidelines, calculate the monthly charge on new equipment, and add it to the rolling write-off on your asset-tracking spreadsheet.
  1. Receivables: In the absence of special factors (e.g. retainage or other unique terms), you should take an uncollectible reserve for any invoices more than 120 days old. Better to be realistic and do it as you go along than have to package it all in a year-end surprise.
  1. Payables: Get those invoices in! Outside contractors, in particular, are notorious for sloppy billing, as are some of your employees with their late expense reports. In the absence of a physical bill, book an accrual for the estimated expense to reduce the bad news that the accountant uncovers.
  1. Unapplied credits: Look for negative numbers on your accounts payable aging statement. They’re often an indication that your team made a duplicate payment on a vendor invoice.
  1. Misclassification: You and your CPA should agree from the start about the types of expenses that get charged to each account, and you should be rigorously consistent. An inordinate number of AJEs result from the simple reclassification of expenses.
  1. Reconciliations: Most of us learned how to do math proofs back in middle school (remember?). Reconciling your balance sheet is nothing more than that, yet a lot of valuable CPA time (and your money) is spent on tying out the general ledger balance sheet accounts to the appropriate back-up ledgers for bank and credit card balances, debt and equity, receivables and payables.

The Patriots had a terrific regular season, which had a lot of their True Believers (yours truly included) willing to overlook some fundamental flaws to a point at which they expected the best during the playoffs. So it is with your financial statements. Lack of rigor in closing the books during the first eleven months can lead to a better won-loss record on your bottom line than you have actually earned. When the truth comes out in the twelfth month, don’t blame the auditors. Like the Giants, they’re only exposing your weaknesses in their drive for the final score.