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Charts of Account and Performance Management

By Mohammed Herzallah posted 09-29-2018 07:54 AM

  

This is a small article I have published on Linkedin a year ago, and thought maybe I should put it here too. I have you have a nice read and feel free to comment.

Most companies have an accounting function in one way or another, its main duty being to record transactions whether it is a purchase, a sale, or a collection or payment of cash or cash equivalents in a manner that adheres to the International Financial Reporting Standards (IFRS). Because of the variety of the transactions a company gets involved in, a chart of accounts is created to record and categorize them in a way that their presentation to management can convey meaningful insights into the operations of the company, and one that would help them take proper decisions to advance their vision.

A chart of accounts can become and be a tool for performance management, one that highlights shortcomings in control, and highlights areas where improvements should be made.

Recently there has been movements that pushing for companies to acknowledge the value accountants can create as more than record keepers, or bean counters as some would say, and for accountants themselves to seize every opportunity to showcase their skills.

As an accountant, I am invested in such movements and in this article, I am showcasing how accountants can create value through the chart of accounts.

 

A chart of accounts is a set of codes through which data collected by accountants or a company's system is recorded and categorized, for it to be later represented to stakeholders so that they take the best course of action, of course stakeholders are not necessarily insiders they can be outsiders also.

Depending on the way a chart of accounts is structured, different information can be concluded from the accumulated data. It can be completely dedicated to make sure that records are complying to IFRS or it can have an extra dimension from which insights on the performance of the business, beyond revenue and cost, can be gained, the latter being my main concern here.

 

To demonstrate this, I will showcase multiple examples, with the two treatment options, the first option being the one not optimizing performance reporting:

  • Example 1: The scenario is that a company have incurred penalties because of multiple delays in completing their obligations with different customers, the penalties accumulated to an amount of AED 10,000.00.

The first option would be that the chart doesn't have a dedicated account to record penalties, instead the accounting team used a generic account, let's call it miscellaneous expense, and proceeded. Management saw the reports, noted that the account exceeded the budget, but didn't bother with inquiring about it any further, since they assumed it must be some various "miscellaneous" stuff, so no need to bother with it, and it is not really that high.

The second option would be that the chart does have a dedicated account to record such expenses. Management noted it, they don't budget penalties to emphasize that no complacency is allowed, it is not high yet, it is not acceptable. They inquire about it, instruct a review of processes to be conducted, to mitigate recurrence, and make sure this won't happen for bigger contracts, resulting in higher penalties, and reputational damage.

 

Note: neither treatment contradicts IFRS.

 

  • Example 2: A company that provides consultation services, may have its consultant setting idly, and others engaged with clients. The way in which their salaries is reported can differ.

The first option would be to simply record in salary expenses account, whatever that was paid, and case closed.

The second option would require each employee to fill time sheets, and the creation of several accounts; to elaborate on this, look at the below tables:



We can start off with noting that salaries paid and allocated to expenses do not match, the reason for this becomes clear in the next table that is allocating the expenses (which is based on submitted timesheets); one of the employees, Ali, didn't report all his hours, which is an indication of lack of discipline, and a risk that these may be engaged which entails that a customer may have been undercharged.

Regardless of Ali's negligence, structuring your chart in the above way, gives you a trove of information: it hints at the number of idle hours, how many hours lost because of national holidays, and how much of your salaries were converted to revenues (engaged hours), for the engaged hours you may categorize them as of costs of sale, and offset them against your revenue, allowing you to assess your gross profit percentage.

 

Note: none of what is stated above goes against IFRS.

 

  • Example 3: the previous example dealt with the hourly charges in terms of cost, in this example I will show how the chart of accounts structure helps in getting more info from the revenue recorded.

Company XYZ accepted an order to provide repair services of Air Conditioning Units, the company surmised that 15 labor hours are enough to finish the job, so they agreed with the customer on an amount of AED 2,250.00 (hourly rate of AED 150.00). After finishing the job, it was noted that the company ended up requiring 20 labor hours.

The first option would be to simply record revenues of AED 2,250. 00, since that is the agreed amount, hence collectable from the customer.

The second option would be to create two accounts, one would record revenue based on the actual hours used, and the other to adjust it back to the agreed amount, to elaborate consider the below:

By structuring the chart of accounts in this way, it becomes clear to management that a variation has occurred, and that an inquiry is needed to identify whether an error in the estimate has occurred, or that the variance is because of out of control occurrences, or that inefficiencies exist and should be addressed.

This method works in reverse too. Overcharging customers because of an over estimated number of hours, will build in time a reputation that the company is unjustifiably expensive, making the company less attractive to deal with.

 

Note: none of what is stated above goes against IFRS.

 

Some may already know what I stated above, for whom I hope it is a nice reminder, while others may be completely new to this and that this in return would give them an insight on the value accountants can create in an area which may be neglected by some.

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