Accrual Method

[Karin]

I work as the bookkeeper for a mail order company that just got acquired by a huge international company. We specialize in outdoor summer items, like lawn furniture, mosquito control devices, novelty pool items, grills, outdoor games, and so forth. The bulk of our orders come in during the months of May and June. We have a fiscal year end of June 30th, because once July hits, the orders drop off dramatically until next year. I’d say we do about 70% of our business in those two months.

My question has to do with the accrual method. I know that we do not include receipts in income until we ship the product. Prior to our acquisition, we were a small privately held company. We worked hard to get orders out as fast as they would come in. But now, the new managers just told us to slow down because we had already met our quota for the year. Apparently when they bought our company, they had certain revenue goals to meet. They want us to hold off shipping until July so that orders we have already received will count towards their quota for the next fiscal year.

Is that legal? Can they do that? And how does it affect the accrual method of accounting? Aren’t we supposed to recognize the income when we are ready to ship the product?

[Brad Imsdahl]

Delay in shipping

It may be immoral, but it is not illegal. Small businesses would never dream of doing something like that. Small businesses make money by working as hard as they can, selling and providing services as best they can and as fast as they can. Big corporations are run by managers who make money looking good on paper. Making sales quotas in the short term is all that is important. Never mind that the delay tactic will cost you business in the future. By the time the future gets here, it will be some other manager who looks bad for the juggling act because you already got promoted up the line.

As far as reporting the income, IRS Pub 538 says the following under the accrual method:

“You generally include an amount as gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Under this rule, you report an amount in your gross income on the earliest of the following dates.

* When you receive payment.

* When the income amount is due to you.

* When you earn the income.

EXAMPLE. You are a calendar year, accrual basis taxpayer. You sold a computer on December 28, 2002. You billed the customer in the first week of January 2003, but did not receive payment until February 2003. You include the amount received in February for the computer in your 2002 income, the year you earned the income.”


In your business, let’s say you receive an order over the phone for a piece of lawn furniture on June 15th. Management tells you to wait until July 5th to package and ship the order. You send them a bill on July 6th, and receive payment on July 20th.

When did you receive payment? July 20th.

When was the income amount due to you? July 6th when you sent them a bill.

When did you earn the income? July 5th, the date you packaged and shipped the product.

You do not earn the income until goods are shipped or services are performed. IRS market segment specialization papers tell auditors to match shipping records with accounts receivable. They want to see you book the income in the same period the product is shipped. They do not, nor can they claim you could have worked faster, earning the money sooner than you claimed. All they can go by is when it was actually shipped, regardless of how slow you were in shipping the product. Therefore, although it is immoral to hold off shipping an order received in June until July when it is the next fiscal year, it is not illegal. Nor does it break any accounting rules. Big companies do it all the time...It gives managers a justification for their jobs.

[Unregistered]

not all the time

I disagree with the notion it is done all the time. Maybe that is your experience, but I have known plenty of people in managment that would never do that. Many good people run big corporations. They do their job just like everyone else.

[Armando Beaujolais]

Legal?

I'm not so sure that it's legal to intentionally delay shipment of orders to make your incentive performance look better than it is. Is it a criminal act? Well, look at Enron. They cooked the books too.

I'm not saying it's illegal, but who knows. What about the fiduciary responsibility that a manager has for the well-being of shareholders? Delaying shipment to get a head start on the next period incentive program certainly would be a breach of fiduciary responsibility. It's determimental to the corporation's image (delaying orders, making customers mad), it's deterimental to the financial well-being of the corporation (money that should be in the bank account is not there yet), it's a clear case of serving ones own self to the detriment of fiduciary responsibility. We've seen with some of the big accounting firms sending managers to jail that breaching fiduciary responsibility can be "illegal."

I don't see such behavior as any different than kiting checks.

[Unregistered]

illegal?

What does cooking the books have to do with shipping delays? The accountants in Enron took historical facts and skewed the results to make it look like something it wasn't. Causing a delay in shipping does not change historical facts. No accounting fraud is committed.

What law says your employees have to work as hard as they do? Do you want the IRS to start taxing your potential, instead of what you actually did?

That's crazy.

[Bees Knees]

Fiduciary Responsibility

Armando didn’t say shipping delays are the same as cooking the books. He merely stated that a breach in fiduciary responsibility could be as guilty as cooking the books. Managers do have a fiduciary responsibility to their stockholders, just as CPAs have a fiduciary responsibility to the stockholders. Managers need to take care that the stockholder’s investment is not being abused for personal gain. CPAs need to take care that the financial statements presented to the stockholders by management clearly reflect the financial well being of a company. Both have a fiduciary responsibility to the stockholder, although their responsibilities are quite different in nature.

[Armando Beaujolais]

Sauteed Books

I believe that delaying shipments for the purpose of making yourself look better is the same as cooking books. Accounting by definition is telling a story with numbers. The numbers represent sales, revenue, expenses, and company behavior.

Revenue that should have been in the bank account on Date X was not in that bank account because it had been caused to be delayed. The reason was for personal benefit, not a legitimate business action. I see it as no different than a retail employee taking a bank deposit envelope and using the money for personal purposes, with the expectation of paying back the money in a few days, then making the deposit. Hey, as long as the deposit gets in before anybody notices anything, no harm done, right? Wrong.

[Unregistered]

I don't understand this topic. Why would managers delay shipping to make themselves look better? Wouldn't that make them look worse?

[JON]

Poor choice of year end!!!

The orginal choice of a year ending at your busiest time would be terrible. All the questions are conerning tax issues for a small company. Our choice is always to end at the slowest time after incurring the slowest revenue and income period. There is nothing unethical about that.

In both the original case and mine the biggest tax advantage comes in the intial year of the timing difference. After that it just by the net marginal increase. The bigger the company the materiality of the change in policy would be the question. If I was paying overtime to get things shipped quicker and loss of business was not in question I certainly would not care if shipping cycle was slowed. I am sure you can not slow it by a month, maybe a week maybe day(a).

[Brad Imsdahl]

If I was paying overtime to get things shipped quicker and loss of business was not in question I certainly would not care if shipping cycle was slowed. I am sure you can not slow it by a month, maybe a week maybe day(a).

Good profit reasons, but try telling your customer you decided to wait a week to ship because you didn't want your shipping department to incur overtime.

[Bees Knees]

I don't understand this topic. Why would managers delay shipping to make themselves look better? Wouldn't that make them look worse?

Interesting article on the subject at:

http://www.efmaefm.org/Bharat/Jensen_EFM2003.pdf#search=%22Shipping%20delay%20manager%20bonus%20quota%20inventory%22

From the article: “…the reality is that almost every company in the world uses a budget or target-setting system that rewards people for ignoring or destroying valuable information and punishes them for taking actions that benefit the company. These budget-based systems reward people for lying, and for lying about their lying, and punish them for telling the truth…”

“…manager’s who are within reach of the bonus cap have incentives to not exceed the maximum because they get no rewards beyond that point….In this situation managers have incentives to move expenses from the future to the present and revenues from the present to the future to increase bonuses in future years. And again, they have incentives to do this even if it imposes real losses on the company to do so…”