Steps management can take to safeguard its payroll include:
• Reconcile actual payroll against the payroll forecast every month and, if possible, as part of the monthly close process. Ensure all variances to plan, however small, are investigated fully and resolved to the satisfaction of at least one senior financial supervisor.
• Segregatee duties. Segregation of the payroll process itself from the person responsible for developing and reconciling the forecast can help to ensure that internal controls are properly balanced to safeguard the payroll account.
• Ensure that staff responsible for payroll-related issues take vacations.
No single employee should have control over the payroll process. When a backup person periodically takes charge of the payroll process,
anomalies are more likely to be uncovered than if the same person always takes responsibility for the process.
All Jobs Need Oversight
A large Midwestern professional services firm discovered that its
trusted payroll clerk had been diverting payroll funds to his own account while he took a vacation after more than five years without doing so.
During that five-plus-year span, the employee managed to divert over a
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quarter million dollars to his personal account. The employee was prosecuted and sentenced to jail for his actions.
Timesheets
The foundation for all cost accounting (and billing) in a professional services organization rests with the integrity of its time accounting system. Every employee in a professional services firm is responsible for completing his or her own timesheet, including the CEO and all other executives, even if their time is not charged directly to a client.
The actual amount of time worked on each client or project is recorded on some form of timesheet, whether it is a sheet of paper or direct input into an electronic system. General and administrative time is recorded in a separate account (or in detailed subaccounts) set up for that purpose, with all other client-related time charged to a specific client or project. For administrative personnel who otherwise would not need to complete a timesheet because their time is not charged directly to a client, use of the time accounting system to track vacation/paid time off (PTO) days used is generally the most efficient procedure because it avoids having to create a separate process/procedure to track such time.
Best practices call for all time reports to be reviewed and approved by the employee’s immediate supervisor. Any modification to the original time reported should be made only by the employee himself or herself, with a supervisor ’s written approval, and documenting the reason for the adjustment.
Time records may be used as evidence in legal proceedings, and the procedures surrounding their formation must be above reproach.
Vacation/Paid Time Off Tracking
Laws about PTO and vacation time vary from state to state, and local rules may supersede anything written here. However, as a general rule, employees earn vacation or PTO time ratably through the year and, in some cases, any unused time may be carried over into future years. To the extent that an employee leaves the firm with unused vacation/PTO time remaining, the firm is liable for payment of the value of that time based on a pro rata amount of the employee’s base salary. In states that mandate unused time be carried over or paid to employees (as opposed to other so-called “use it or lose it” arrangements), the collective value of that time is a liability to the firm and is recorded in its financial statements at its gross value. Some firms elect to pay out the value of unused vacation time in cash at the end of the year to minimize risks from these regulations and to reduce its balance sheet liabilities. If not managed properly, vacation or PTO time can become a significant liability to the firm.
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In general, a firm can best protect itself by having a written policy that clearly spells out the firm’s vacation/PTO program and maintaining the records to support the program in strict conformance with that written policy.
Importance of Records
In California, a professional services firm was sued by its former controller for unused vacation time not paid by the firm on his last day of employment. The firm maintained a written policy that stated clearly that nobody could accrue more than 25 days of vacation time. While finalizing his separation paperwork, the controller claimed that he was owed 35 days of vacation pay. Neither the HR department nor the finance department maintained a current record of each employee’s un-
used vacation time balance that should have been capped at the 25-day level in support of the policy.
Instead, when an employee left the firm, the HR department manu-
ally counted the number of vacation days the employee reported on a special vacation authorization form and subtracted that from the total number of days the person had earned during his or her employment period; if employees ended up being owed more than 25 days when they
left the firm, they were paid 25 days in conformance with the written policy. On the surface, management believed this policy and practice to be prudent. However, in this case, the former controller maintained his own records, which showed that he was owed 35 days.
The Labor Commission ruled against the firm and ordered it to pay
not only the additional 10 days of vacation but also an additional month’s salary plus interest because the full payment was not made on the employee’s last day of employment even though the ruling was issued a year after he left the firm. The Commission ruled against the firm primarily because the firm did not maintain a vacation tracking system that clearly computed the actual vacation balance at any point in time and mechanically capped that accrual amount once the limit was reached. In this case, the person who arguably should have been responsible for ensuring that proper records were kept by the firm was able to legally profit from his own mismanagement.
Accounting
Accounting in a professional services firm should be among the least complicated in our economy. The firm bills its clients for services rendered, the client pays the invoice, and the firm pays its employees, landlord, and other overhead suppliers. That’s about as simple as can be expected in a business.
However, once the firm begins to enter into complicated client compensation
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agreements, complex vendor contracts, and spend its client’s money with the understanding it will be reimbursed for its outlays, the accounting issues and risks to the firm’s financial statements begin to multiply.
Management of the financial records is the responsibility of not only the CFO but also the board, CEO, COO, department heads, managers, and supervisors. Each of those managers is responsible for ensuring the integrity of his or her respective area’s revenues, expenses, assets, and liabilities. This section reviews key accounting issues of which the senior executive should be aware.
Our discussion generally centers on corporate structures, but also are, for the most part, applicable to partnerships and Subchapter S corporations that may rely on the cash basis of accounting.
Fundamental Accounting Concepts
The most basic checkbook accounting system tracks total deposits and total withdrawals. If your deposits are greater than your withdrawals during a specific period of time, you made money, but were you profitable? Maybe yes and maybe no.
The answer to that question lies in the definition of the word profit. For hundreds of years, accountants have worked to develop a standard set of rules to follow to determine whether a firm was in fact profitable during a specific period of time. Those rules, which are continuously being refined over time, are referred to in the United States as generally accepted accounting principles (GAAP). These principles are a collection of theories, rules, pronouncements, and writings that have evolved over time to meet not only the general needs of investors and managers but also specific issues faced by each industry. Although most accounting principles have been published in any of a number of authoritative publications, no single list of all GAAP exists. Rather, they ref lect the cumulative consensus of industry conventions, current writings, and pronouncements on any particular accounting issue.
GAAP, in their simplest form, adhere to a set of about a dozen foundational principles that guide the formation of all other rules. Today these principles are even more rigorously applied in the audit process in response to Sarbanes-Oxley and other related legislative and regulatory actions. Key principles that professional services firm executives should understand include:
• Revenue realization: Revenue should be recognized when it is earned, not necessarily when an agreement is made or cash is received.
• Cost: Assets and liabilities generally should be recorded at their historical cost and expensed during the period to which they pertain.
• Matching: The matching principle guides timing of the recognition of revenues and expenses and seeks to ensure that revenues are recognized in the same time period costs related thereto are expensed. For example,