Understanding the 3 accounting cycles is just as critical as its key control points to any accountants [particularly for controllers]. Reviewing the function of accounting among great structured corporation, it seems that accountants only concerned with the very end of each cycle processes, merely to get the number at the bottom line, load and stick them on the financial statement. On the contrary, nearly every transaction it processes should be of considerable concern to the accountant. Moreover, only by understanding the role of accounting within the greater structure of the modern corporation can the accountant see how changes in his or her department can cause issues elsewhere in the company, and vice versa. This post focuses to discusses the three accounting cycles that any accountant should understand. Enjoy!
Cash Disbursements Cycle
One of the primary functions in which the accounting department is involved is the cash disbursements cycle. This involves the entire process flow that begins with a request for materials, passes through the purchasing department, where an purchase order is placed, and eventually arrives at the accounting department, which is responsible for ensuring that all payments are authorized, and then pays suppliers. The general process flow is shown on below chart:
Initially, it appears that the accounting department is only concerned with the very end of the disbursements process. However, there are several key control points in the process that are of considerable concern to the accountant. For example, the match documents step in the exhibit refers to the comparison of purchasing, receiving, and supplier invoicing information to ensure that all payments are authorized and correct in amount. What happens to this step if the receiving department decides to allow the receipt of all incoming shipments, irrespective of the presence of an authorizing purchasing order? This will result in much more work by the accounting department, since it will have to send out supplier invoices for individual approvals by department managers.
Another area in the cash disbursements cycle that impacts the accounting department is the level of approval required for the issuance of purchase orders. If the purchasing department allows all requests for purchases, no matter who makes the request, then there is really no control over the purchasing process. This requires the accounting staff to gather additional approvals from managers prior to making payments to suppliers. Alternatively, if the approval process at the purchasing department were more rigid, the accounting staff could use a signature stamp to sign checks, since the additional control of having a check signer review the checks would then become superfluous.
Yet another impact on the accounting department is the ability of the purchasing software to verify available funding for purchase orders. If the computer system is capable of comparing purchase requests to the amount of budgeted funds available, and requires immediate department manager approval if budgets are exceeded, then the accounting department has no need to issue reports to managers after bills are paid, informing them that they have run over their allowable budgetary levels.
An area in which the accounting staff can impose extra work on “upstream” departments is through the use of an advanced accounts payable system. For example, if all purchase orders were to be made available on-line to the receiving staff, these personnel could check off items on purchase orders as soon as they were received, thereby allowing the computer system to automatically make electronic payments to suppliers with no further accounting participation in the process. Such a system would require considerable training of the receiving staff, as well as the design of extra controls.
It is apparent that the accounting department is impacted by many parts of the cash disbursements cycle, and so must coordinate its activities with those of other participants.
The sales cycle begins with the initiation of a customer order with the application for credit, proceeds to order placement, manufacturing and shipment of the order, and finally with the issuance of an invoice to the customer. The general process flow is illustrated on the next chart:
There are many variations on this process, such as the handling of credit by the accounting department instead of the finance department, shipment from stock instead of having to manufacture a specific product, providing a service instead of a tangible product, and payment by some other format than through an invoice. Nonetheless the process flow shown in the chart is indicative of the overall process.
The sales cycle can involve the accounting department only at its termination, when it receives shipping documentation from the warehouse staff, and uses this to create an invoice for the customer to whom a shipment has been made. However, the accountant needs to be concerned about several steps earlier in the process flow that are conducted by other departments. Of primary importance is the shipment itself—if the warehouse ships an order without first consulting a “stop order” report to see if there are any orders on hold, then the collections staff will have a much more difficult time collecting funds
from delinquent customers.
Another upstream problem in the sales cycle is the credit terms granted to customers. If the finance department grants inordinately large or lengthy terms to a customer, then the accounting staff may find itself without enough ready cash to pay for ongoing accounts payable—the company’s cash will have been used to fund the customer’s order.
Yet another concern is the payment of deposits by customers as part of the order taking process. If orders are being handled by sales personnel, who accept deposits as part of an order, it is entirely possible that they have control over large amounts of funds, which can present a serious control problem. Thus, it is evident that, as was the case for the cash disbursements cycle, the accounting department must be involved in far more than the last step of the process cycle.
Order Fulfillment Cycle
The order fulfillment cycle is a subset of the sales cycle, involving the scheduling of production for an order, quality reviews, and shipment of the product to the customer. At first glance, it appears to be entirely concerned with the materials management and production part of the business, which keeps it completely away from the concerns of the accounting department. However, it contains several control issues that impact the accounting department.
One control issue is the movement of materials through the facility. Since the accountant must report on work-in-process inventory levels, it is important that the record keeping system within the manufacturing facility be sufficiently detailed that materials are recorded as being in the production department when they are shifted out of the warehouse, so that they are no longer recorded in the financial statements as being part of raw materials.
Another control issue is that shipped products are removed from the finished goods warehouse records. Otherwise, the period-end inventory levels will be overstated, resulting in an artificially reduced cost of goods sold.
Yet another issue is the proper level of control over materials that are removed from the warehouse as part of the picking process that is used to bring raw materials to the production department. If pick lists are not used, or if unauthorized personnel are allowed into the warehouse to remove items for use by the production staff, then it is very likely that the accuracy of the raw material inventory records will decline in short order, making it necessary for the accounting staff to conduct physical inventory counts to verify the accuracy of the inventory records.
Thus, the order fulfillment cycle has far more impact on the accounting department than at first appears to be the case. The impact is not so much on the paperwork moving from the process to the accounting department, but rather on the accuracy of inventory records that are constantly updated as a result of the fulfillment of customer orders.
Other Important Control Areas
Thus far, we have focused on just three major cycle processes. Here are several other cases where the accounting department should concern:
Advertising Credits. The marketing staff may issue credits or splits to the distributors of company products if they advertise on behalf of the company. If so, the accounting staff can expect to receive requests for payment from distributors, which requires coordination with the marketing staff to verify.
Collections. One of the best ways to collect from customers is to involve the sales staff in the effort. This requires close coordination with individual sales staff, whose assistance is much more forthcoming if sales commissions are based on cash receipts from customers, rather than initial orders.
Commissions. The calculation of commissions can be extremely difficult if the sales manager continually alters the criteria for commissions, such as changing rates, adding commission splits, and changing override levels. Considerable coordination is required to ensure that the accounting staff does not become entangled in a web of continually changing commission calculations.
Credit Granting. The accounting department is usually responsible for the granting of credit to customers when there is no finance department to handle this task. If so, a significant potential impediment to its work is sales to new customers before any credit level has been granted. This frequently results in intense pressure by the sales staff (which has a commission riding on the outcome) on the accounting staff to grant the largest possible amount of credit.
Credits Issued by Customer Service. The customer service staff may be empowered to issue credits to customers to compensate them for faulty products or services provided by the company. If so, there must be a feedback loop to the accounting department, so that they can record the credits against customer accounts.
Payroll. If there is a company policy requiring manager approvals of pay rate changes, overtime payments, or shift differentials, then there must be a continual information flow between the accounting department’s payroll staff and all department managers.