How to Prevent Over-Accruals (#197)
/In this podcast episode, we discuss how to close purchase orders that were not used or partially used in order to prevent over-accruals. Key points made are noted below.
Wait for Supplier Invoices to Arrive
As part of the month-end closing process, you can either wait several days for all supplier invoices to come in, or you can accrue for the expense if an invoice hasn’t arrived yet. Taking the accruals path works if you want to close the books fast, since some supplier invoices might not show up for a week.
Use Three-Way Matching
To figure out the amount of these accruals, have the purchasing department issue purchase orders for all of the expensive purchases. Then, when these orders are delivered, the payables staff matches the receiving documents against the supplier invoice and the purchase order, which is called three-way matching. At the end of the month, see if any received items don’t yet have any related supplier invoices. If they don’t, then accrue them based on the authorized price stated in the purchase order. In the better accounting systems, this is a standard report that the system generates. The report also gives good evidence of why the accrual was made, in case anyone wants to investigate an accrual.
The accrual should be based on receipts for which there is no supplier invoice. This means you need to be careful about the source document being used as the basis for the accrual.
Cancel Residual Purchase Orders
Some purchase orders stay open for months after they’re needed, or there’s a residual amount on them that a supplier can continue to ship against. It’s quite possible that a purchase order was issued because certain items were needed, but then the requirements changed, and no one ever bothered to close it. Or, most of the quantity ordered was received, and there’s still a residual amount that’s been authorized, and which the company no longer needs. A purchase order is a legal authorization to ship, so the company is obligated to pay if anyone ever takes advantage of an open purchase order and continues to ship goods to the company. This can cost some serious money.
The solution is in the purchasing department. Assuming that the purchasing systems are fairly well computerized, there should be a procedure for scanning through the list of open purchase orders in the system every day, to make sure that everything ordered is still needed. If there’re a lot of purchase orders outstanding, then each purchasing agent is responsible for reviewing his own outstanding purchase orders. And if the system is manual, then unfortunately, everyone has to scan through their open purchase order documents.
If a purchase order is closed that wasn’t completely fulfilled, then a closure document should be sent to the supplier, so there’s no longer an authorization to send more goods to the company. Also, keep a copy on file, in case a supplier still insists on sending more goods, and you want to prove your case.
In addition, consider including in the purchase order terms a statement that the purchase order is automatically voided once the designated delivery date has passed, unless specifically authorized by the company. That gives you a blanket termination with suppliers.
Review the Purchasing Manager
One additional item is to include these stray purchase orders in the annual performance review of the purchasing manager. It’s really obvious when there’s a bunch of unused or partially filled purchase orders that have been hanging around for months. At best, it’s bad recordkeeping, and at worst, it represents a liability for the company. And the purchasing manager is responsible for it.
Reporting of Residual Purchase Orders
From the perspective of the accounting department, all you have to do is include a summary of these unfilled or partially filled orders on management reports, so that everyone can see there’s a problem.