The computer and software in general has really streamlined the business world.  Prior to the computer, a bookkeeper made all the accounting entries, posted to ledgers and created financial statements.  Accounting technology today often allows organizations to streamline their accounting entries through the creation of data in a few fields.  It is quick and may seem painless but if the wrong information is entered, the company may end up with results that create big problems.  Whoa!  I can hear you say, “What is he talking about?” 

So here goes…I’ve been in a couple of firms where creation of new parts becomes the responsibility of the engineering department.  The actual entry may be done by engineers, clerks or some other personnel but the process is similar.  These folks are rarely trained in accounting; they don’t understand accounting and may not really understand all the fields that they need to enter for accurate recognition of transactional activity. 

Think of it this way.  Accounting is designed to be a double entry system.  This means that for every single transaction two general ledger accounts should have entries.  Unfortunately, some folks don’t understand that process or have set up their files incorrectly and they end up using the same general ledger account for both the debit and credit entry.  Let’s look at that a little closer.

A manufacturing company has a part in stock that costs $100 and they sell the part for $150.  Their system handles the sale properly but is set up so that the following entry is made:

Cost of Goods Sold General Ledger Account     1200 (Inventory)                              $100

                Inventory Account                                        1200 (Inventory)                                              $100

In this case, the same account is used for both sides of the same activity.  There is no doubt that an item worth $100 is no longer in inventory, but when account 1200 is both the debit and credit the recorded value of inventory does not change.  If this happens frequently, the possibility for a major overstatement of inventory is very high.  In effect, no one can trust the integrity of the financial inventory records.

Another problem is using similar inventory accounts to record transactions.  Most manufacturing companies have general ledger accounts for raw inventory, work in process inventory (WIP) and finished goods inventory.  However, over time, inaccuracies begin to crop up, accounts start getting used for new purposes or any number of factors cause the basic information to be changed or altered.  When parts go from raw inventory to WIP the general ledger entries should be a debit to some WIP account and a credit to some raw inventory account or WIP goes up and Raw Inventory value goes down.  Using the same logic, when parts are finished, there should be a debit to a finished goods account and a credit to WIP account causing the value of finished goods to rise and WIP value drops. 

Unfortunately, it is not uncommon for companies to get this information wrong and debit or credit different accounts but the accounts may have the same general classification.  For example, it is common for all WIP accounts to start with the same account number like 1210 and then have an additional designation after the account to signify the department or division.  So account 1210-10 might mean WIP Metal Assembly and account 1210-20 could mean WIP electronic assembly.  In the situation above, if the part is being finished, it should never be debited to a WIP account.  (If you’re not sure about the difference between a debit and credit, I’ll be writing about that in an upcoming blog.)

A company can avoid this situation by generating exception reports that show items like, negative part balances, zero costs for parts, raw, WIP or finished inventory accounts that are not equal to the proper general ledger accounts.  If these reports are set up to run automatically on a daily basis, it becomes an easy process to look at the exceptions, correct them and move forward confident that the basic systems for the company are operating properly.

Another very helpful process is to create a series of templates for the various part item classes that a company creates.  Using this template, the engineering personnel can rely on the accounting department to create a form that allows the engineers to feel confident that the accounts that are specified in part master entry are correct.  Then, again using a series of internal reports, the company can easily master reports that look for parts that do not properly match the template for that particular part item class and generate daily reports to highlight errors and get them rapidly corrected.  I really like these reports reviewed daily so that the company can be assured that all transactions get properly recorded.  I don’t like the idea of transactions being recorded inaccurately…if the basics are correct the end result will be correct.