Author Archives: Amber Hawkins

Avoiding Management Letter Comments – Inventory

what are we looking atCommon issues related to accounting for inventory include: incorrect valuation, too small or no allowances for slow moving inventory, not disposing of obsolete inventory and not having a regular count of inventory on hand.

Inventory should be valued at the lower of cost or market. The value of all items should be compared to market at least annually to ensure that market prices have not fallen below cost. If the market price has declined to less than the cost of the item in inventory an adjustment should be booked to reduce the recorded value. A key indicator would be if your organization has placed an item on sale for lower than the purchase price.

Determining original cost can be difficult if the items were produced in house and not purchased.  If the inventory is produced in house, the original costs is based on direct materials, direct labor, and a proportionate share of indirect costs. All costs used to determine the price of the inventory need to have supporting documentation.

The value recorded for inventory should also be adjusted depending on what method the organization is using to record sales; first in first out (FIFO), last in first out (LIFO), or weighted average.  LIFO and FIFO are the easiest to compute.  See below for how each method would affect the value of inventory and cost of goods sold (COGS).

FIFO is based on recording inventory so that the first widgets sold were the first ones purchased.  This would be used by grocery

stores or other businesses that have perishable goods. A schedule calculating inventory using the FIFO method is as follows:

Action Date Quantity Cost per unit Addition to inventory COGS Ending Value price per unit
Purchase 1/1/2001 100 1.00 100.00 0 100.00 1.00
Sale 4/1/2001 (60) 0 0 (60.00) 40.00 1.00
Purchase 7/1/2001 50 1.20 60.00 100.00 1.11
Sale 10/1/2001 (60) 0 0 (64.00) 36.00 1.20
Ending 12/31/2001 30 0 0 0 36.00 1.20
Purchase 2/1/2002 50 1.40 70.00 0 106.00 1.33
Sale 6/1/2002 (60) 0 0 (78.00) 28.00 1.40
Ending 6/30/2002 20 0 0 0 28.00 1.40

 

As you can see with FIFO the value at the end inventory is based on the most recent purchase as all older inventories has been sold. The COGS for the sale on 10/1/01 is based on 40 of the items purchased on 1/1/01 and 10 purchased on 7/1/01.  The COGS for the 6/1/02 sale is based on a similar calculation.
LIFO is based on the ending value of the inventory consisting of the oldest items in inventory.  This would be used in an industry where costs are rising and the business wants to match costs to rising revenues. A schedule calculating inventory using the LIFO method is as follows:

Action Date Quantity Cost per unit Addition to inventory COGS Ending Value price per unit
Purchase 1/1/2001 100 1.00 100.00 0 100.00 1.00
Sale 4/1/2001 (60) 0 0 (60.00) 40.00 1.00
Purchase 7/1/2001 50 1.20 60.00 0 100.00 1.11
Sale 10/1/2001 (60) 0 0 (70.00) 30.00 1.00
Ending 12/31/2001 30 0 0 0 30.00 1.00
Purchase 2/1/2002 50 1.40 70.00 0 100.00 1.25
Sale 6/1/2002 (60) 0 0 (80.00) 20.00 1.00
Ending 6/30/2002 20 0 0 0 20.00 1.00

 

LIFO looks remarkably similar to FIFO except the ending value is based on the oldest items. The COGS for the 10/1/01 sale is based on 50 from the 7/1/01 purchase and 10 from the 1/1 purchase.  The 6/1/02 sale is calculated similarly.

Weighted average is more complicated as it is based on the average price for the items remaining in inventory. This helps smooth the costs of rising prices over the period. Using the same data for purchases and sales as shown above in the FIFO and LIFO examples see how weighted average affects the ending balances. Weighted average is typically used by companies that produce mass amounts of the same item such as manufacturers, farmers, and fuel companies. A schedule using the weighted average method is as follows:

Action Date Quantity Cost per unit Addition to inventory COGS Ending Value price per unit
Purchase 1/1/2001 100 1.00 100.00 0 100.00 1.00
Sale 4/1/2001 (60) 0 0 (60.00) 40.00 1.00
Purchase 7/1/2001 50 1.20 60.00 0 100.00 1.11
Sale 10/1/2001 (60) 0 0 (66.67) 33.33 1.11
Ending 12/31/2001 30 0 0 0 33.33 1.11
Purchase 2/1/2002 50 1.40 70.00 0 103.33 1.29
Sale 6/1/2002 (60) 0 0 (77.50) 25.83 1.29
Ending 6/30/2002 20 0 0 0 25.83 1.29

 

In this example the COGS for the 10/1/01 sale is based on the average cost of the remaining 40 items at $1/unit and the additional 50 purchased at $1.20/unit for an average price per unit of $1.11. The 6/1/02 sale is similar, with it based on the average price of the remaining 30 units at end of the prior year plus the purchased items of 50 at $1.40/unit.

If the inventory become slow moving, selling only a few to none a year then an allowance should be booked for those items.  The allowance should be set up be debiting COGS and crediting an allowance account.  The longer the item is considered slow moving the larger the allowance should be until the item is considered obsolete.

When inventory is no longer selling due to it becoming obsolete (i.e. VHS, laser disc, etc) the items need to be written off.  To do this you would make an entry to inventory and COGS unless a previous allowance had been created then you would remove the allowance before writing off any additional remaining inventory to COGS. Carrying obsolete inventory on your books incorrectly overstates the value of the inventory.

Other inventory issues arise due to an organization not performing annual counts.  Inventory should be counted at least annually to insure that the quantity per the books agrees to the actual quantity on hand.  This discourages theft of items.  If they are never counted, items could slowly disappear from where they are kept. Annual counting also helps to spot items that maybe damaged or have become obsolete.

If you have any questions on how to value the inventory or how to determine an allowance feel free to contact us.

 

Avoiding Management Letter Comments – Bank Reconciliations

closeup of blank checkPerforming monthly bank reconciliations should be a standard practice for your organization. Occasionally, something goes wrong and a management letter comment is issued.  Some of the most common comments relate to stale checks, incomplete outstanding check lists, deposits in transit that don’t clear in a timely manner, and lack of approval of the reconciliation itself.

Stale checks – Stale checks are generally considered to be any checks still on your outstanding checklist that are over a year old. Organizations need to reach out to the payee of the checks to see why the check hasn’t been cashed. It maybe that they never received the check in which case you would need to void the original check and reissue a replacement check.  You can’t just void the check and go on your way, the money doesn’t belong to you. If you can’t get a hold of the payee to issue a replacement check or have them send you confirmation that you do not owe them that money any more, you will need to submit that money to the state government based on your states escheat laws.  To learn more about escheat laws see this article that was previously published in this blog.

Incomplete outstanding check lists – Having an incomplete outstanding check list causes issues with cutoff and could materially overstate your cash balance.  Things that could cause a check list to be incomplete are recording a check or wire in the wrong period or noting a check as cleared when it hasn’t.  An outstanding check list could also include too many items if a set of checks are cut at year end but are then held for a period of time before being mailed out.  Held checks should not be included on the outstanding check list but should be kept in your Accounts Payable balance.

Deposit in transit – Typically you would expect a deposit in transit to clear the bank within two to three days. It would be concerning to see a deposit in transit on the bank reconciliation that hasn’t cleared after more than a week.  This could be due to someone recording the deposit but then not actually taking the check to the bank.  Deposits should be taken to the bank the same day they are recorded.  Occasionally, there is a valid reason for a delay in the deposit clearing, such as if the bank places a hold on it for some reason, but this is not a typical occurrence for an organization.

Approval – Bank reconciliations should be reviewed and approved by someone other than the person preparing the reconciliation in order to ensure completeness and accuracy.  If someone is not reviewing the bank reconciliations, errors could occur and not be caught.

Avoiding Management Letter Comments – Net Asset Classification

rp_picking-a-benefit-plan-auditor.jpgA common management letter comment stems from the misclassification of net assets.  There are three main classifications of net assets: unrestricted, temporarily restricted, and permanently restricted.  Unrestricted net assets are not subject to donor restrictions.  Temporarily restricted net assets are subject to donor imposed restrictions that will either be met by actions of the organization and/or the passage of time (i.e. the donor wants their funds to go to a specific program or year).  Permanently restricted net assets (also referred to as endowments) are subject to donor imposed restrictions that neither expire by the passage of time nor can be met by actions of the organization. The issues occur when revenues are misclassified or releases from restrictions are not properly tracked.

Sometimes organizations receive contributions from organizations restricted for a purpose but the organization books the contribution as unrestricted revenue in error. This will make the temporarily restricted net asset balance incorrect.  All contributions should be reviewed for restrictions when received and booked as temporarily restricted revenue if a restriction exists. These funds should not be released from the temporarily restricted net asset account until the restriction has been met. If you are unsure about whether something is a restriction or not, contact your auditor.

For purpose restricted amounts, there needs to be a corresponding expense incurred for the project before the funds can be released.  Restrictions should not be released without supporting information.

Permanently restricted funds can only be released if the original donor removes the restriction, otherwise the funds are required to be held in perpetuity.

Another issue is caused when people make entries directly to net assets.  Nothing should ever be posted directly to net assets. Net assets should only be adjusted at year end when the expenses and revenues are closed out.

Cut-off issues and avoiding management letter comments

A common audit management letter comment given to organizations is due to cut-off issues.  There are two types of cut-off issues, accounts payable/expenses and checks.

Cut-off issues for accounts payable/expenses arise when an expense is booked in an incorrect period leaving the liability to be misstated. According to GAAP, expenses should be booked in the period the expense occurred.  Therefore if the work has been performed prior to year end, even if the invoice is received after year end, the expense and liability should be recorded in the previous year. For example, a lawyer gives you advice in December but you don’t receive the invoice until January. The expense and liability should be recorded in December.

Cut-off issues for checks occur when checks are back-dated or they are held after being cut.  Checks should never be back-dated.  They should always be dated on the day they are cut.  Back-dating causes issues when trying to determine what should be on the outstanding checklist at year end.  Back-dating a check is also not the proper way to get the expense in the correct period.  As shown above, if an invoice is received after year end then record an expense and liability at year end.  Another issue is checks that are cut at year end but are then held until after year end.  These checks incorrectly show up on the outstanding check list.  Another issue that affects cut-off is using check stock out of sequence.  This causes an issue when trying to assess if the list of outstanding checks and cut-off are appropriate and complete.

Cut-off issues are generally easy to fix. Just take your time and make sure you are recording items in the appropriate period.

Investments and avoiding management letter comments

A common audit comment given to organizations is in regards to recording investment activity.  An organization should track the changes in the investment accounts monthly by each individual investment that makes up each account.  After the changes are compiled in a spreadsheet the overall change should be recorded monthly in the accounting records.

Below are some common mistakes related to recording the investment activity and suggestions for how to fix them:

  • Realized gain is not computed correctly.  Just because a gain/loss number is provided by the Investment Broker does not mean it is the one you need to use.   Always recalculate!
  • Cash or money market activity.  This needs to be tracked as well.  It contributes to the overall activity in the account.
  • Reinvested dividends.  These increase the value of the stocks not the amount of cash in your account and should be recorded appropriately.

Below is a sample roll forward format that can be used to track your investments:

  Beg Bal Purchases Sales Realized Fees Reinvested Interest/ Dividends Unrealized Ending Balance Ending Balance per statement Check Figure
Cash 100 500 -50         550 550 0
Stock 1,500           20 1,520 1,520 0
Bond 2,000 50       10 10 2,070 2,070 0
Mutual Fund 3,000   -500 45 -5   -5 2,535 2,535 0
Total 6,600 550 -550 45 -5 10 25 6,675 6,675 0

 

You should complete the rollforward each month for each individual investment.  The check figure should always be zero so that the balance per your rollforward equals the balance per the statement.  The entry for the month of activity shown above would be:

  Debit Credit
Investments 75  
Realized Gain/Loss   45
Unrealized Gain/Loss   25
Interest/Dividends   10
Fees 5  

 

Below is an example of a table used to calculate realized gain:

 Sales  # of shares sold  Sales price per Share  Price per share in prior month  Realized
-500 10 50 45.50 45

 

  • To find the sales price per share you would divide the dollar value of the sales by the number of shares sold.
  • To find the price per share in the prior month take the ending value of the investment from the previous month divided by the number of shares held in the prior month. From the example above that would be a prior month ending balance of $4550 spread over 100 shares.
  • To calculate the realized gain/loss take the sales price per share and subtract the price per share in the prior month.  Multiply this difference by the number of shares sold.  You have a gain if the sales price is higher than the previous months price per share.

Unrealized gain is the change in value each month on an investment that hasn’t been sold.

Gain/loss on donated stocks should be recognized based on the value of the stock when you receive it not the original value of the stock when the donor purchased it.

Please don’t feel overwhelmed.  Once you get the hang of it, your monthly reconciliation will become a breeze.  If you feel you need help setting this up please feel free to contact us.  Part of our jobs is to help you help yourself.

View Archives

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Join 12 other subscribers

Latest Webinar Videos