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Preparing for the Accounting Fiscal Year End By Eddie Peacock, Consultant, Edward B. Peacock, CPA Editorial Note: During our spring conference in Austin, we hosted a ‘write-on’ opportunity for pet peeves during year-end and audit. Unsurprisingly, we received comments from both sides of the process – the auditor and auditee. A popular perennial complaint from the auditors is that clients do not do their own work papers. From the client’s perspective we heard that they give auditors documents several times over and they do not understand why work is brought on at the very end by partner review that should have been identified up front. With these criticisms in mind, the newsletter committee solicited an article designed to be a year-end primer of sorts to help prepare for the audit process. We hope you find this educational and instructional. BLB Who’s in charge? We as directors and managers are primarily responsible for the successful completion of the accounting and financial reporting process. Generally this means that management assumes responsibility for issuing financial statements in conformance with Generally Accepted Accounting Principles (GAAP) and that there are no material misstatements whether caused by error or fraud. Whether we are doing the work or a portion of the work ourselves, to be effective leaders we must establish our commitment and our role as managers to understand, plan, organize, direct and monitor the accounting and financial reporting functions of the finance department. This article will focus on two major aspects of the accounting and financial reporting process: 1) defining a year end work plan for adequate general ledger maintenance and timely issuance of the city’s financial statements, and 2) understanding the internal control environment and the risk assessment process. Year End Work Plan A well defined and maintained work plan has many advantages. As a management tool it is a way to identify, plan and organize the tasks involved in reconciling and adjusting the trial balance. Once these are identified and organized, they are assigned to staff and monitored for progress and completion. Individual tasks can be linked to job descriptions. The work plan establishes consistency and continuity as it is refined and used from year to year. Attached is a sample work plan. Tips for some of the steps are listed below. In this example, we divide the work plan into two major steps: 1) fund level reconciliations and adjustments, and 2) government-wide adjustments. Generally step one is completed before step two. Fund level reconciliations and adjustments An important first query is to know if the prior year’s audit adjustments were posted. Validate this by running the prior year’s trial balance and reconciling it to the fund level presentations in the financial statements. This task also familiarizes us with how the funds and accounts summarize into the financial presentations. When working with the separate account reconciliations, a few tips are important to keep in mind. We present these ideas by account type. Cash and investments - Complete monthly bank and investment account reconciliations in good form by reconciling the month end general ledger cash account balance to the monthly statements. These should be completed by the end of the following month. Do not mess around or accept any substitutes or excuses for this one. Your audit process will not continue until these are complete. If you have found these are not completed properly or if you are several months behind, you will need to muster the resources to get current. At fiscal year end, the only outstanding reconciling items should be outstanding checks and deposits in transit. In addition, you should obtain monthly statements of pledged collateral from the bank on a regular basis. Have the collateralization agreement in place and a copy of the bank’s board minutes approving the agreement. Much more about collateral was covered in the September issue of Government Finance. Accounts receivable - Balances in the accounts receivable accounts should agree to the sub ledgers of customer accounts, i.e. agree utility accounts receivable to the utility accounts receivable aging report. The aging report is also useful in estimating and adjusting the balance in the contra allowance for uncollectible accounts. Taxes receivable should agree to the total of the property taxes due per the tax roll. The balance of net taxes receivable (less the 60 day accrual) should be in a deferred revenue account. Sales taxes and franchise fees receivable should agree to the amounts collected within 60 days after fiscal year end. NSF checks receivable should agree to a customer listing of NSF checks. Inventory - If you have a significant amount utility or fleet maintenance parts on hand, an inventory count should be documented as of the close of business on the last day of the fiscal year. The dollar value will need to be shown by extending the count times the unit price for each item. Accounts payable - Purchase orders: If you track purchase orders over a certain amount in the accounting system as encumbrances, then this list should be checked on a regular basis to remove open PO’s that should be closed, etc. Send out a memo in August reminding the departments to that PO’s issued after the end of the fiscal year will be applied to the next year’s budget. Also, ask for their cooperation by submitting the current year’s PO’s as early as possible before September 30 (you could even have a PO cut off date prior to September 30). Accounts payable accruals: For the first 6 weeks after the fiscal year end, separate invoices for accrual through the accounts payable process. Accrue invoices into the prior fiscal year for items delivered or services performed before September 30. Most accounting systems allow for this through accounts payable by allowing you to post an invoice into the prior fiscal year. These are then cleared through accounts payable in the current year’s check run. Payroll - Employment taxes payable should agree to any taxes withheld in the final payroll before fiscal year end that were actually remitted after September 30. The same is true for benefits payable. The employee deductions as well as the employer expensed portions should be agreed to the provider’s monthly invoices on a monthly basis. The 941’s should be completed within 30 days after the quarter end. Significant liabilities and/ or overpayments should be investigated and corrected. Fixed Assets and General Long-Term Debt - Prior to GASB 34 these were presented in the financials not as funds but as account groups. These can still be maintained in the general ledger as account groups and reconciled to the sub-ledger. These also require disclosure (tables) in the Notes and MD&A. Fixed Assets: The fixed asset sub-ledger should be set up so that summary reports can be run and summarized in the same disclosure formats required in the Notes and MD&A. Each asset record should specify an asset class (land, construction in progress, infrastructure, buildings, equipment, etc), depreciation expense account by department, and accumulated depreciation by asset class. To demonstrate correct identification of the current year’s fixed assets additions you can create a worksheet showing a reconciliation of the fixed assets additions to the expenditure ledger. Most accounting software allows import of general ledger data into a worksheet. You can import the expenditure ledger by fund and a list of expenditure accounts and year end balances. Then, if the expenditure accounts are coded by category, sort the accounts across all departments into groups such as personnel costs, supplies, contractual services, maintenance, and capital outlay. Accounts with potentially capital items can be sorted and then stratified by amount. Then you can focus on transaction details of accounts with balances large enough to potentially meet the capital asset recognition threshold (i.e. greater than $5,000). For example, you may have a balance in the supplies account of $23,000. Detail analysis shows this is a number of items less than $5,000 in unit cost except for one, a piece of equipment costing $7,500. You can then show in a separate column that of the $23,000, $7,500 is a fixed asset addition for equipment. The total at the bottom of the worksheet would show the total expenditures of the fund and in a separate column the total expenditures identified as capital or fixed assets. (Note: Some cities use the capital outlay accounts exclusively for fixed assets. Expenditures for items not meeting the fixed assets recognition criteria (i.e. not part of a capital project, unit cost greater than $5,000 and useful life more than one year) are budgeted to be paid from contractual services, small equipment or supplies, etc. This is a good idea, and works well in the budgeting process also.) Fixed asset disposals should be reported to accounting on an authorized form from the department having custody of the fixed assets. A worksheet should be prepared rolling forward the projects that were in construction in progress at the previous fiscal year’s end. Projects completed in the current fiscal year should be reclassed from work in progress to depreciable assets. Projects started during the fiscal year and not completed at fiscal year end are added to the work in progress account. Once the fixed asset sub-ledger is updated for the current year additions and disposals then it is ready to calculate current year’s depreciation. Each depreciable asset record should specify original cost and depreciable life. A depreciation expense and accumulated depreciation account should be assigned to each asset record. Depreciation expense can then be coded by department (so that depreciation expense can be summarized into a functional category for the government-wide statement of activities), and accumulated depreciation coded by asset class (so that accumulated depreciation can be summarized by asset class for the Note disclosure). General Long-term Debt: The principal amount of budgeted debt payments from the debt service fund should also be posted as a reduction of the liability accounts in this account group. In the proprietary funds the principal portion of the budgeted debt payments should be reclassed by journal entry at fiscal year end as reductions of the liability accounts. Separate the liability accounts into the current portion (principal amount due in the next fiscal year) and the non current portion (remaining amount of principal due through the life of the debt). Agree the total amount of outstanding debt to the debt service schedules. Calculate the liability for compensated absences and adjust the account balance by journal entry to agree to this calculation. This can be separated into a current and non current portion by calculating an average of the past three year’s terminations and using this as the current portion. Bear in mind that note disclosures require separate debt summary schedules for governmental and business-type activities. These summarize annual debt requirements for the next five years, then in five year increments through the life of the debt. The total outstanding debt should agree to the city’s debt service schedules and also to the total long term debt liabilities in the governmental activities and business activities columns of the statement of net assets. Fund balance roll forward - A fund balance roll forward schedule shows the beginning fund balance and its changes during the fiscal year. As we know, revenues and other financing sources increase fund balance and expenditures and other financing uses decrease fund balance. During the system close, mechanically the accounting system will zero out these accounts and the result is a net increase or decrease to fund balance. A roll forward schedule will also identify any manual adjustments to fund balance that could have resulted from an encoding error. Other manual adjustments to fund balance could be valid, such as a prior period adjustment or reclass from fund balance into a reserved fund balance account. Government-wide reconciliations and adjustments The government-wide adjustments are summarized on the face of the financials in two places. Permanent adjustments are summarized directly after the governmental funds balance sheet, and the current period adjustments are summarized after the governmental statement of revenues, expenditures and changes in fund balances. Additional details can be disclosed in the notes. These adjustments are illustrated in Appendix C of the GAAFR. In order to present governmental fund information in the aggregate as governmental activities, cities now have to track historic as well as current period adjustments to the governmental funds. How has your city tracked its government-wide adjustments? Some cities keep these adjustments in a separate worksheet that is updated at each fiscal year end. Some have actually created a separate fund in their accounting system to support the government wide presentations. Either way, the preservation of these historic adjustments from year to year is the responsibility of management. They should be prepared only on the basis of adequate supporting documentation and kept on file as journal entries of the city. If you have completed the fixed asset and long term debt roll forward schedules, then you will already have available the supporting information for some of the major adjustments including fixed asset and debt additions and retirements and depreciation expense. You also already have available the information for: 1) reclass of deferred revenue into program or general revenues, 2) reclass of lease or debt proceeds from an other financing source to a liability, 3) separation of compensated absences into current and non current portions. Other government-wide adjustments that you may have to do some additional work on are: 1) Calculation of accrued interest on governmental activities outstanding debt, 2) amortization of issue costs on governmental activities outstanding debt, 3) incorporation of assets and liabilities of internal service funds, 4) elimination of profit of internal service funds, 5) elimination of transfers within governmental activities, 5) consolidating net transfers between governmental and business-type activities, 6) elimination of interfund balances within governmental activities, and consolidating net internal balances between governmental and business-type activities. The government-wide statements also involve summarizing accounts that are maintained at the fund level (i.e. summarizing of departments into functional categories, or revenues into program and general revenues, etc). The city should establish a template for summarizing these accounts so that there is consistency from year to year in the presentations. There are some third party software products that may interface directly with your accounting software available to assist with this process. Internal Control Environment The municipal accounting and financial reporting environment has changed with the new auditing standards regarding risk assessment and independence of the auditor in audit engagements. In order to be independent, the auditor can no longer accept responsibility for the numerous accounting adjustments required at fiscal year end. Additionally, the auditor must now report their assessment regarding the level of internal control management has over its financial reporting processes, as well as whether or not management has the technical expertise to prepare and issue its financial statements. The following risk assessment points were presented to the Region 8/13 roundtable August 13, 2008 by Linda Low, CPA and Donna Mayes, CPA of the accounting firm of Rylander, Clay & Opitz, Certified Public Accountants: How to prepare for risk assessment We must show the external auditors that management is: 1. Concerned that all laws and regulations are being followed; 2. Leading by setting a good example; and 3. Sets adequate policies regarding the hiring of new personnel such as background and reference checks. Risk assessment We must establish that we follow a risk assessment process: 1. Establish a process to identify various risks (including fraud risk) faced by the city; 2. Identify steps to take before decisions are made to make significant changes to the internal control environment and evaluate how changes may impact financial reporting; and 3. Evaluate the risks that federal grants are being misspent Control activities We must demonstrate that adequate controls are in place. Some critical steps are to: 1. Structure job responsibilities between positions so that they are segregated by authorization, recording and custody functions; 2. Communicate job responsibilities in writing; 3. Conduct feedback on job performance; 4. Have an open door policy for staff to report fraud; and 5. Create or update accounting policies and procedures. Monitoring We must show that we follow our own policies, by the following steps: 1. Perform an internal audit function to ensure that staff are following internal controls as they are designed; 2. Ensure that management is sufficiently involved in daily operations to identify significant variations from the expectation; 3. Require that department heads review their own financial reports; and 4. Reconcile general ledger accounts on a timely basis. Conclusion Besides effectively managing our resources, our fiscal responsibilities also include executive communications with city managers and councils requiring a clear understanding of the budgetary and financial impact of major programs and transactions to the available financial resources of the city. An example of this is implementation of GASB 45, which requires recognition of a liability for OPEB benefits in the statement of net assets and has no impact on the fund level statements. Effective executive communication regarding this new government- wide liability involves presenting alternative steps to decrease this liability. Implementation of any of these alternative steps will have budgetary and fund level impact since they would require budgeted contributions from an operating fund to a trust/ agency fund specifically created for this purpose. This is a classic example of the importance for directors to “get in touch with their accounting side” and fulfill the executive expectations that we see things coming and help the city to plan for them. Information presented in the financials is an essential baseline for executive decision making and there are many executive implications contained therein that others without our financial expertise are not equipped to see. The role of the external auditor is only to express an opinion on the fairness of our presentations. The days are long gone that we can hand over a trial balance and expect a published financial report a few weeks later. This old process is detrimental to management. Too much valuable executive information gets lost when relying on the just the external auditor to complete and communicate the technical gaps in getting from the trial balance to the accounting reconciliations and adjustments, and the resulting financial statements. Upcoming training opportunities There are just some tips to help guide you through the year-end process. For more information, here are a few upcoming training opportunities: November 6, GFOA, Annual Governmental GAAP Update Satellite Teleconference November 18, Phoenix, AZ, GFOA, How to Prepare a CAFR December 16-18, San Antonio, GFOA, Advanced Financial Reporting for Governments
"Preparing for the Accounting Fiscal Year End"