Accrual reversal blues

“Get all those old purchase orders closed,” says the finance manager close to year-end in an email that is also circulated to the finance director. “All redundant POs must be closed by the departments responsible. No funny accruals for goods and services that won’t be received.”

The rest of us give a collective sigh of despondency. The same email goes out every year. You can set your time by it. Look carefully and you can even see where the dates in the email have been changed to bring it up to date from last year.

Those management accountants on the coal face know only too well that there is nothing more difficult than asking a cost-centre manger to show an under-spend on their budget. Okay, maybe making a spot-on sourdough is more testing, but it still comes close. Each cost-centre manager wants to hold on to every single penny on their budget. An underspend risks the budget being reduced.

Weary hearts

With a weary heart, we management accountants must go through the same script with our managers. Like programmed robots.

In my case usually there are Purchase Orders (POs) with sizeable underspends. Most of them created at the beginning of the year with high hopes of the goods or service delivery to be complete. Fast forward to March with only minutes to go for the year end cut off and the cost-centre manager is convinced the balancing invoice to fulfil the PO is imminent.

There is nothing more convincing than his trembling voice pleading with you to make the accrual. You as an accountant see the problem: the accruals are running in thousands of pounds. So, you do what all accountants around the world insist on – put it in an email and we’ll do whatever you want. As long as there is an audit trail we’ve covered all bases. And in a matter of minutes, the accruals have gone through. Cost centre variance turns out to be negligible on budget. Curtains drawn on another year end. Happy bunnies.

Accrual reversals

But (and there is always a “but”) that is not the end of it. In the dark corners of an IT room or some fluffy cloud that’s floating by holding all our financial records, a ticking clock summons in the new financial year. With it is unleashed the flood of accrual reversals. Many reversals are matched by actual invoices, and through the wonders of mathematics the value disappears from the new year accounts. 

There are those reversals however, and it’s the usual suspects, the hopeful accruals that are left lingering in the shallows of the new month without a match. These big credits are headaches for the management accountants. We accountants have to live in hope that eventually an invoice is received to negate the credit. Tick, tock, tick, tock. The months pass but nothing comes through.

The example below simply illustrates the issue for cost centre balances after processing estimated accruals. Year end accruals amount to £60k, In the following year £21k of actual invoices come through and the net effect is a credit of £39k.

After three months or so, if no invoice is received then you have to hold your hand up and admit that the accruals were maybe too optimistic.

One of my party tricks was to explain to non-accountants (and sometimes accountants) what accruals are and how they work. It is realising the transaction for the period it relates to rather than the period the transaction is materialised. This requires the accountant in this case to put a manual charge through the real cost period. The charge is then reversed in the following period as a credit which, in theory, is matched by the debit charge coming through.

Highway to hell

It’s at this point I look up and find everyone in the party has made new friends or have found therapy in counting ceiling tiles. In the main accounting for accruals serves a useful purpose. It does however open a highway to hell. A reckless company may bolster up their finances with alleged legitimate sales accruals, or in some cases omit expense accruals so the bottom line appears healthy, but therein comes the undoing.

Corporate history is littered with companies that have dubious accounting practices. The solution is quite tricky. Management accountants, and auditors to a large extent, must be motivated to challenge transactions. Accounting should be based on truth.