Bookkeeping – Policies and Procedures (Lesson 96)

This lesson is designed to help the bookkeeper understand the difference between policies and procedures and give some insight to the types of policies every company should have in place. There are multiple levels of control. The core level includes physical control, separation of duties, duplicity with accounting and actual monitoring. Above the core level are more administrative forms of control including documentation systems, verification, utilization of purchase orders, work orders, sales orders and governmental compliance. At the top of all controls sits the most important piece – policies. Right under policies are the procedures that carry out and enforce the policies.

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Policies

Policies are agreed upon rules that the company will follow to ensure success. They are created by the owners via the Board of Directors/Trustees. They are generally resolutions passed by the highest level of management oriented towards the end results the company desires. Think of this as something similar to a government’s guiding document, in most cases a constitution, that sets forth the rules the country will follow to enhance the lives of its citizens.

Policies cover multiple areas of the business operation including:

• Human Resources
• Operations
• Locations
• Products/Services Sold
• Management Style
• Marketing/Advertising
• Accounting

Within the accounting set of policies is a subset related to internal controls. Within this subset are rules the Board of Directors/Trustees agree to that assist the company in ensuring the information that is presented on financial reports is accurate and timely. Notice that controls are created to meet the two tenets of accounting: timeliness and accuracy.

For a company to successfully present good financial information, the policies cover everything from the generic to the esoteric related to accounting. Internal control policies include:

• Methods of Accounting, Basis of Accounting, Reporting Formats and Tax Methods
• Use of Accounting Systems:
  1. Payroll Systems
  2. Retail Systems
  3. Budgets/Estimates
  4. Cost Accounting
  5. Sales Orders
  6. Purchase Orders
• Balance Sheet Controls
  1. Cash Controls
  2. Accounts Receivable Management (including credit authorization)
  3. Inventory Controls
  4. Fixed Assets Management
  5. Accounts Payable Controls (Vendor Authorization Design, Approval Process, Acceptance Etc.)
  6. Credit Card Management
  7. Debt Management
  8. Equity Management
• Income Statement Controls
  1. Sales Systems
  2. Cost of Sales Systems (including definitions, matching to cost accounting, verification etc.)
  3. Expenses
     • Budgets
     • Leases/Legal Compliance
     • Tax Processes
     • Capital Accounting
• Sub-Systems
  1. Trial Balance Verification
  2. Accounting Cycle Closings
  3. Year End Closings
  4. Reconciliation Systems

Most of the policies covering each of the above have one or two paragraphs of wording to get the point across to a reader that the upper management is interested in implementing procedures to meet the intention of the policy. For example, the fixed assets policy may be stated as such:

Fixed Assets

The purpose of this policy is to insure items purchased with useful lives of more than one year are properly capitalized, recorded and depreciated in a consistent manner. In addition, the policy is designed to comply with the Internal Revenue Code and Generally Accepted Accounting Principles adjusted to comply with our economic sector and the respective ___________  industry.

All assets purchased with a useful life or more than one year and with a cost basis of more than $500 shall be recorded to the corporate books of record as a fixed asset within one the following groups:

• Furniture/Fixtures
• Technology – Computers/Software/Peripherals/Communication Systems or Devices
• Equipment – Non Transportation
• Equipment – Transportation
• Land
• Real Estate Improvements

All records of fixed assets shall be maintained in a separate fixed assets system with the summation value for the respective groups posted the ledger account in the accounting records. This fixed assets system shall incorporate controls to monitor physical control of the respective assets, location and life expectancy. In addition, this system will incorporate an asset maintenance schedule and compliance to that schedule.

Any disposition of property shall require approval of the Board of Directors.

Depreciation shall be strictly conducted in accordance with the Internal Revenue Tax Code and not under the Generally Accepted Accounting Principles with the exception of real estate improvements.

Since real estate is an instrumental function of fixed assets, any construction of real estate improvements shall be capitalized in accordance with Section 263(a) of the Internal Revenue Code.

Management is directed to create procedures to carry out the above policy.

More sophisticated organizations may expand this policy to create more descriptive guidance such as defining the respective groupings of assets, creating depreciation schedules, explaining how fixed assets are capitalized and so on. In general, every policy has a purpose, scope of authority and the actual policy within this statement.

To carry out the policy, procedures are created.

Procedures

Procedures are the tools to carry out the policies as set forth by the Board of Directors/Trustees. Most procedures are developed by the upper management team and often follow standard procedures accountants have created over many years. These procedures are designed to ensure that actual economic transactions are recorded to the books in a timely and accurate manner. If done properly, the financial reports will reflect the actual economic performance of the business.

Procedures are often much more complex and detailed and over time are developed to take into consideration many variances that may exist. As an example, customer returns of retail product have procedures such as:

1. One particular register in each store is used for returns;
2. Customer must provide original receipt of purchase;
3. Purchase return time period is limited to within 30 days of purchase;
4. Limits of return exist for particular products (such as no food products opened by the customer shall be returned);
5. Returns greater than $100 in value require approval by a sales floor manager;
6. Customer will receive in-store credit and not cash, if cash is demanded, the customer will receive a check from the company within 30 days.

Notice the extent of the procedures and the variances that often exist. The procedures can get more detailed depending on the nature of the particular product.   For example, a paint store will only offer credit on the customer’s account due to the frequency of getting color wrong with paints. Their procedure may require that the product return is moved to the discount section immediately or as a base for darker colors.

In general the procedures follow the physical process related to the policy and then a set is created for the accounting side of the equation. For example, the above may have the following accounting procedures:

1. Returns shall have a parent-child structure within the chart of accounts to account for the three major reasons for returns and include:
   • Wrong Product Purchased (Color, Size, Purpose)
   • Damaged Product
   • Volume (Customer Purchased Too Many)
2. Returns shall be an offset to sales within the chart of accounts.
3. The company will not create an estimated returns allowance.
4. Damaged product accounting will be posted to another receivable account from the respective vendor related to the actual cost of the product paid to the vendor.

In this case, wrong and volume based returns are simply returned to the physical inventory whereas damage goods are returned to the vendor for a refund.

As you can see, procedures can get quite detailed and they cover many areas of accounting and operations. Often companies seek guidance from their CPA to create and implement procedures.

Summary – Policies and Procedures

At the peak of the hierarchy of internal controls sits policies. Policies are written by the highest echelon of management for a company, its Board of Directors or Trustees. The upper tier and mid level management of a business develop procedures to carry out the policies of the company. Other forms of controls are used with procedures to ensure accurate and timely economic recording of transactions and the final results in the form of financial reports. With good policies and supporting procedures, a company has in place a system that can maximize financial success. ACT ON KNOWLEDGE.

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