Financial statements must be balanced at the end of the month, every quarter, every six months, or every year. Balancing financial statements is much like balancing a checkbook. However, there are more variables. Instead of matching checks and deposits on the company side to cash additions and disbursements on the bank side, a controller balancing financial statements matches internal assets, liabilities, equities, revenues and expenses to each other so that the financial performance of the company is fairly and truly represented.
Sometimes, missing or forgotten transactions will come to light. Without them, the statements don’t tie together. Assets must equal the total of liabilities and equity. This sounds easy and it may be simple, but a good controller will pare through the transactions much like an auditor would, finding miscodings such as a new piece of equipment purchased and booked to an operating lease instead of an asset account.
This might seem easy to correct — just debit the asset and credit equipment rental expense. However, it may be simple but it’s never easy. With new equipment comes depreciation schedules. Depreciation expense then involves lowering the profit and period end retained earnings.
Other types of internal financial statement balancing exercises could be equally as treacherous. For example, prepaid insurances and accrued insurance expense, which are the asset and liability portions of current insurance premiums, are often confused by even talented bookkeepers. These accounts should hold the dollar value of the difference between the properly accrued annual insurance premiums and the amounts disbursed in cash on those premiums for the current policy period. If the amount accrued is more than the amount paid on a certain insurance line, then the accrued insurance liability would prevail — that’s where the difference will be booked.
If, on the other hand, the amount paid is more than the proper accrued amount for a certain insurance policy, the difference will be booked to the prepaid insurance asset account.
The prepaid insurance bookings are performed much like work in progress (WIP) bookings, which are made for the percentage of completion revenue accounting for work in progress. Similarly, either one asset or one liability is booked for each insurance line, but not both. The resultant prepaid insurance assets are all netted, and the accrued insurance liabilities are all netted so that there is one aggregate prepaid insurance account and one aggregate accrued insurance account on each side of the balance sheet.
The key figure to ensure first for accuracy is net income. This is done first by checking for proper year-to-date revenue by verifying the percentage of completion accruals against the WIP assets and liabilities, and verifying that the proper retainage is showing as held with accounts receivable at its proper amounts.
Once the proper revenue is confirmed, all the reductions to arrive at net income are verified for accuracy. This can be done more easily first by analyzing the costs booked in aggregate to all the jobs. Once all the job costs are accepted as accurate, which are the bulk of all costs (cost of sales), the operating expenses that are much smaller fall into line. This is especially true if the prepaid and accrued expenses are booked already, because those expense line items such as insurance expense will be at their proper levels already without any necessary verification.
After the net income is properly calculated and booked, the retained earnings will have the correct value on the balance sheet. Some balance sheet snafus, in addition to the prepaid assets, are loan accounts for vehicles (which may or may not have to be capitalized), accrued interest, and depreciation (which may or may not tie in to what is calculated and included on the tax return).
One of the biggest errors that controllers make is they try to match the books exactly to the corporate tax returns, which rarely is possible. Trying to book entries to mark balance sheet and income statement accounts to match exactly what was reported on the company’s tax return not only takes up extra time, but can also distort the financial statements.
For practical purposes, businesses should keep two sets of books — one to comply with Generally Accepted Accounting Principles (GAAP) and the other to comply with IRS rules. This is a legitimate business practice, which is not be confused with maintaining a hidden set of books to purposely defraud taxing authorities or investors.
Some business owners are skeptical because they always hear about companies being fined (or worse) because they have “two sets of books.” However, that is when owners intentionally create an extra set of books purposely to defraud, and then keep a secret set of “real” books for use by the owners. In contrast, having a separate set of books to run the company and one for the tax return is actually very helpful.
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