What is 'Work-In-Progress' ?

Commonly known as ‘WIP’, work-in-progress is the value of work that has been done that has either; not been invoiced to a customer, or within manufacturing, can reflect the value of a product in the ‘build’ stage that is not counted within ‘finish stock’.

How it is valued largely depends on the systems and procedures that a business has in place. First of all, let’s think about professional services like lawyers or architects. If time is being recorded, that time will have a value that can eventually be converted in to fees.

If we take a manufacturing company into consideration, calculating the value of work-in-progress can be a combination of raw materials (a ‘bill of materials required to build a product’), plus labour, and machinery costs incurred during the manufacturing process.

Accounting for Work-In-Progress

WIP is essentially another form of stock, whether this be physcial materials, or the value of time. A balance sheet account (like stock) is required for Work-In-Progress, and a profit and loss account (cost of sales/direct costs) will be needed for ‘Adjustments to work-in-progress’.

If the balance sheet currently reports a $0.00 value for WIP, but we have calculated there is a value of $10,000 at month-end, the accounting entries would be to Debit WIP on the balance sheet and Credit movements for WIP.

Depending on preference, the journal mentioned above will reverse in the next month to reset the WIP balance to $0.00, and the process will repeat at the end of the month. Alternatively, journals can be entered to approriately increase or decrease the current WIP balance as required.

The benefit of accounting for Work-In-Progress

Measuring WIP is important so that we can report an accurate and hopefully consistent gross margin in the profit and loss report. If a company incurs significant costs in one month to purchase materials and pay employees to build products that have a four-week ‘lead time’, it could be at least a month before stock is produced. It’s likely to be a further month before sales are made.

This is all part of the ‘matching concept’ discussed in a previous article. Accounting for WIP correctly removes the costs from the profit and loss and creates an asset in the balance sheet. It’s not until either goods are sold, or services invoiced, that the WIP cost incurred is then removed rom the balance sheet back to the profit and loss.

This ensures that the sales, and related costs are reflected in the same month, and an accruate gross profit margin is calculated as a result. Using nettTracker, a ‘Prepayment’ adjustment can be made to reflect the current WIP value.

Balance Sheet Reconciliations

What are balance sheet reconciliations? For anybody that works in an accounting or bookkeeping firm, ‘Balance Sheet Recs’, is a term that is in frequent use. In simple terms, it means having a full understanding of the value displayed against any category on the balance sheet.

How complicated are balance sheet reconciliations? Sometimes, they are relatively straight forward. One of the simplest balance sheet reconciliations can be the bank account of the business. If there are no ‘uncleared funds’ in transit, the balance shown on the bank statement will be the exact value displayed on the balance sheet. If there are uncleared transactions, the balance sheet value will be the difference between the bank statement and the uncleared entries.

With the use of accounting software, other simple balance sheet reconciliations are trade debtors and creditors (Accounts Receivable and Accounts Payable). The balance sheet will display a value of each type, but our reports will provide a summary breakdown that will display the unpaid values that agree to the balance sheet totals.

When do balance sheet reconciliations become a little more tricky? Whenever we start making ‘provisions’ in accounting, things can get complicated, and fully understanding what makes up a balance sheet total is not always easy. Fixed Assets is one example. Equipment is purchased, and depreciation is the provision that will write the value down over time.

It can be common for ‘general provisions’ to be made. These can be estimates of expected income or expenditure and when a mixture of these adjustments have been made they can be impossible to fully reconcile. There can be a value within ‘accrued expenses’ or ‘prepayments’ but nobody knows what the values relate to.

Why are balance sheet reconciliations important? Well generally if we have a value on the balance sheet, be it an asset or liability, the double-entry that will either increase or decrease that value will affect the reported profits. If we’ve not yet prepaid costs that relate to future periods, our costs will be too high. On the flip side, we may need to accrue expenditure if our suppliers have not yet billed us.

How frequently should the balance sheet be fully reconciled? This will often depend on the size of the business, and its reporting requirements. Very often the balance sheet is only fully reconciled on an annual basis by CPAs / Accountants. The downside of this is that adjustments are only made annually, so one month often contains distorted values. Whenever possible, it’s better to make adjustments, and fully reconcile the balance sheet every month. This helps to produce consistent monthly profit and loss reports, as well as always having a thorough understanding of the values held on the balance sheet.

The Matching Principle

The Matching Principle is part of the Generally Accepted Accounting Principles (GAAP). Income and expenditure are matched based on dates when events happen / the work is done.

When we are following true accrual accounting, it is important that any expenditure incurred to produce a sale, or deliver a service, is appropriately reflected in the same month as the income to which it relates. Any sales recorded should accurately reflect the period when the products or services are delivered.

Supplier invoices for general overheads, such as ‘marketing’, or ‘insurance’ could be dated January, but the total cost relates to a future period; February to January of the following year as an example. So again, the cost needs to be apportioned to each month.

In a previous blog post ‘Cash v Accrual’, some of the different accounting adjustments are explained (Prepaid Expenses, Deferred Revenue), and these adjustments are required to follow the ‘matching principle’.

Here is a simple example of the ‘matching principle’. A cleaning business sends an ‘annual’ invoice to a customer for services that relate to the next 12 months. The employees that do the work are paid monthly. The annual invoice needs to be ‘Deferred’ so that the income is reflected over the next 12 months, and appropriately ‘matches’ the employee costs incurred to carry out the services.

The same buiness could have purchased cleaning materials ‘stock’. This works like a prepayment. When stock is used in order to do the required work, accounting adjustments should be made to reduce the stock, and increase the costs associated with the service provided to the customer.

Quick summary of the ‘Matching’ principle:

Ensure that bills and invoices are reflected in the period to which they actually relate. For turnover and costs of sales especially, this will help to ensure that gross profit margins are reported accurately every month.

Depreciation - why bother?

Depreciation. It’s a topic that can easily baffle, or be dismissed as only relevant to businesses seven figure turnovers, owning thousands of assets. While there can be something to be said about the simplicity of ignoring depreciation in accounting, it can sometimes be a little short-sighted if we do.

What exactly is depreciation? It’s a method used to gradually write down the value of expensive items like plant and machinery or motor vehicles over their expected useful life. There are quite a few different methods of depreciation (the way the write down is calculated). The method used could be a company preference, or stipulated by the country/state the business operates in.

Financial Accounting v Tax Accounting: Depreciation in the context being discussed in this blog post is ‘Financial Depreciation’ - how the balance sheet is affected. ‘Tax Depreciation’ is another topic completely. When a tax return is prepared the entire cost of an asset could be offset against profits to reduce tax payable, even though the value of an asset has only reduced by 20% on the balance sheet.

So why do we depreciate an asset even if we can claim the full cost for tax purposes? Let’s say a company has purchased a van for $25,000. If this is treated as a cash cost our financial statements would not reflect the fact that we own a van with any value. Treating the van as a fixed asset will ensure the balance sheet reflects this investment. A year from now it’s likely that the van will be worth less than what we paid for it. So, using our chosen depreciation method, we gradually write down the value of an asset.

How frequently should adjustments for depreciation be made? Traditionally accountants/CPAs have created adjustments between the balance sheet and profit and loss annually when the books are being prepared. The downside is that very often ‘month twelve’ figures are distorted due to a single annual adjusting journal. For general reporting consistency it’s advisable that these kind of adjustments are made each month.

What are the benefits of maintaining an asset register and recording regular depreciation? Firstly, the balance sheet should reflect the true and fair value of assets owned by the company, and the profit and loss should report a consistent monthly charge against depreciation. If you need to report regularly to the bank, or if the business needs to apply for a loan or funding of any kind, accurate financial reporting becomes much more important.

Occasionally, self-employed business owners that are applying for mortgages will need to provide details of financial accounting statements, as well as general tax return information. If there have been significant asset purchases over the last couple of years that have been treated as ‘expenses’ instead of ‘fixed assets’, this could potentially create the difference between reporting a loss instead of a profit. Negative financial reporting could be detrimental to the success of a mortgage application.

Perhaps it’s time to sell an asset or maybe the entire business. Having a record of all assets purchased, and their current net book values held neatly in one place can make life easier when negotiating a sale. In the unfortunate event that a business has suffered from theft or vandalism, flooding or fire damage, the ability to provide an insurance company with a readily available fixed asset register will make life much easier when making a claim.

Fixed assets and Depreciation: Not just for the large corporations; all businesses, large and small.

Cash v Accrual

When recording bookkeeping entries, and then later preparing tax returns, there are really two main methods of approach. ‘Cash Basis’ or ‘Accrual Basis’. Without trying to over-complicate this, let’s compare the two.

Cash Basis: In very simple terms the ‘books’ or ‘accounts’ (depending on which side of the pond you live), could be compiled purely by recording all of the business related payments and receipts that had gone through the bank account, appeared on credit card statements, or possibly paid out in cash.

Accrual Basis: There will be some items accounted for in the same way as the cash method, but we are also accounting for income and costs regardless as to whether they have been paid or not. Customer invoices, suppliers bills could be dated prior to the year-end date date, but they may not get paid for a month or two. Nevertheless, we still need to account for them.

However, it’s not quite as simple as including amounts that have not been paid yet. Further adjustments are required to reflect the period to which the income/expenditure relates to.

Prepayments: For example, a bill for insurance may be received halfway through the year that covers the next twelve months. Six months for this financial year, and six for the following year. This is the kind of entry that needs to be ‘Prepaid’, and adjustments made each month so that the correct monthly charge is reflected within expenditure.

Deferred income: Some businesses invoice customers for subscriptions services that could possibly be for five years in advance. Receiving the paid invoice is great for cashflow, but again should actually be reflected in the profit and loss over the next 60 months so that it is in line with the costs associated to provide the service - paying employees as an example. So, the income is ‘Deferred’.

Accruals: If a supplier forgets to send a bill (or is sent late) but a business already recieved the goods or services, an ‘Accrual’ for those costs would be required. On the flip side, a business could have been working on project for some time and not yet invoiced the customer. Income should be accrued, or ‘work-in-progress’ (WIP), adjustments created.

Depreciation: If a vehicle is purchased for the business, or any other expensive items of equipment, they are treated as fixed assets and depreciated over a number of years in line with expected useful life. On a cash basis, the cost of the asset would be written off in the first year.

Which method should you use?

Your accountant or CPA should advise you which is necessary for your business type. Sometimes you will not have a choice. Depending on the country, region, size of business and turnover, it will be mandatory to have the books/accounts fully prepared on an accrual basis.

What are the benefits, pros and cons of each?

Well, let’s just start with ‘cash basis’ accounting. The obvious benefit here, is that it is simple. Money received, money paid, and voila, you’ve pretty much calculated your profit/loss for the year. However, it is unlikely the accounts will report the true profitability of the business. Some months could look drastically different from others. If five years worth of income was received in one year, and tax paid on that value, much more tax could have been paid than was necessary.

True accrual accounting helps to ensure there is much more ‘consistency’ in the values that are reported in the profit and loss on a monthly basis. If you need to prepare regular managment reports for board members, or the bank, they will be looking for consistency and trends in the financial reports. Too many peaks and troughs, and questions will be asked. ‘Why has income dropped?’, ‘why are the costs in this month so high?’. Using a series of adjustments to prepay costs, defer income and account for depreciation every month, the profit and loss should report figures that accruately reflect the way the business is operating.

The downside to true accrual accounting is that more work is involved. Calculating monthly adjustments, creating journal entries between the profit and loss and balance sheet every month, and monitoring and updating schedules so that we fully understand what our total prepaid expense and deferred revenue items are, and the breakdown of fixed assets.

True accrual accounting is made much easier with nettTracker. Taking care of all of the adjusting journal entries, and updating the statements you need to agree to the balance sheet. Month-end made easy.

Who doesn't love a good checklist?

Just like programmers love good logs, accountants really do like a checklist. Well, actually who doesn’t? My wife and I don’t go shopping without first writing out a list of what we actually need. Otherwise, it’s easy to get distracted buying things that aren’t required (‘Ooops, already had 3 tins of tomatoes!!!’), and then completely forgetting to purchase that all important box of tea bags. Resulting in one or two profanties when back home, and a return trip to the supermarket is required earlier than expected.

It’s no different when we are preparing a set of accounts at the end of each month, quarter, or year. We need a checklist. If not, something is easily forgotten, there is likely to be an outburst of profanities, and there will be more work to do. Sometimes more corrections to make than if we had our checklist in place first and followed it.

More accounting software programs are starting to add features that enable users to create checklists / tasks / workflows. However you wish to phrase them, they amount to the same thing. That is to follow a process, ensuring a job (producing a set of accounts / ‘get the books done’) is completed fully, and accurately.

Now if your current accounting software package doesn’t including a month-end check list, or perhaps you aren’t that keen on using the offering, there are lots of alternatives. Software applications like ToDoist, and Monday.com offer free versions that will be sufficient to help you get started with buidling regular tasks and checklists. If you are using Office 365 check out the apps store from within the Microsoft Teams menu. If you work in an accounting firm, there are an increasing number of practice managment apps available such as Liscio or Client Engager.

Now I wouldn’t advocate using Microsoft Excel in place of an app that has been designed to solve true task management, however, creating some form of template first could help give you ideas of what it is you need to do. Adding some conditional formatting against a field is easy to do with a simple Y or N typed to reflect if a task has been completed. With conditional formatting, cells can instantly change colour when adding relevant characters. Using office 365 or Google Docs, you can share easily with others if you are working in a team.

Just simply exporting your P&L or Balance Sheet into Excel could be the first step to help create your checklist as each account category should be reviewed or reconciled. Althought it’s a start, doing this alone though may not be enough as it doesn’t ask questions like ‘Are all the suppliers bills uploaded to Auto-Entry, now published into Sage?’

Check out this short 2-minute video on using conditional formatting in Excel. When you are using nettTracker to adjust your balance sheet accounts, you can enjoy entering the Y a lot quicker than if you are making adjustments manually.

As I previously mentioned, Excel is a good tool to help get you started, but software fully designed to meet the needs of task managment will provide much more than the ability to list tasks. Automated reminders, e-mail notifications when tasks are complete, and audit trails are just a few features that spring to mind that you won’t have using Excel alone. These extras become so much more important when working with your team and your clients.

A Free Tasks and Checklist Template can be downloaded using this link that may help give an idea on some of the monthly reviews required. Of course, the number of reviews undertaken, and frequency, will depend on the type and size of business, but the more accountants and business owners get into a habit of regularly reviewing financial statements, there tends to be fewer ‘surprises’ when accounts or books are finalised each financial year.

But how did it do that!!?

One of the beautiful features that nettTracker has is the ability perform automated tasks for our users. For example, all of the monthly balance sheet posting takes place automatically on the last day of the month. But it isn’t necessarily quite so beautiful if things go wrong. When systems perform tasks automatically, they unleash the nightmare that is diagnostic tracing.

It can be hard enough for a developer to work out why something went wrong when they can step through each line of code in a controlled environment and see what happened at each point, but when the code can be scheduled to run at specific times, usually overnight when processing loads & network traffic are at their lowest, tracing faults and being able to understand the causes is a critical challenge to the dev team.

We built two key architectural components when we started nettTracker. The first of these was a flexible task scheduling component that we could use to plug new automated tasks into the system as we created them. This is a really cool system and we can plug in new automated features without having to redeploy everything.

The second key component was our logging platform. And it saves our lives!!

This sophisticated tool allows each of the different sub-systems to put their logs and trace records in a single repository that can be analysed to give clear trends on how the system is being used, where we need to invest enhancement effort and, most importantly, what was happening before and after an error occurred.

We capture thousands of log entries each day that we can then analyse for errors & repeated faults. In many cases we actually identify problems before they even result in an error. We have have daily error reports distributed to the team so we can quickly pick up something that might have happened during the previous 24 hours. In fact, it is common for our support team to reach out to a customer to let them know they have a problem before they have even become aware of it themselves!

In most engineering environments, it is putting effort into the boring stuff that gives you reliability and stability, but for us programmers, nothing can beat a damn good log.

It's not always about being flash and exciting.....

Last year I moved house with my family. Our new home being a ‘new build’, you’d think it would have pretty much all the ‘mod-cons’ that you need. After all, it’s brand new, so it should be fully kitted out. Well, that’s not quite the case.

I live in what can only be described as a very ‘hard water’ area. After a week the kettle would need descaling, the shower head quickly covered in limescale, and all the taps around the house looking old before their time. So, we decided to invest in a water softener.

Now a water softener is not the cheapest appliance in the house, and to be honest, it’s not much to look at. In fact 99% of the time it is out of sight below the kitchen sink. It’s only really paid any attention every 6-8 weeks when the salt needs to be replaced. Other than that, it works away doing its thing.

Since the installation of the water softener 9 months ago, the kettle has not had to be de-scaled once, the shower head and taps look as good as new, and cleaning the shower and bathroom is less work. Not only that, it’s the limescale building up that you can’t see that can cause the most damage. In the pipework, the dishwaser, the washing machine. Often reducing the life of appliances by half.

Many accounting software programs have fantastic core functionality, but often lack the tools that are required to really comply with true ‘accrual’ accounting. This is when we get to the stuff that can sometimes feel a little ‘dull’ - but it’s important to get right.

We can be left with a lot of tasks that don’t fill us with excitement, yet still we plod on using methods that will generally take us longer than they should, because ‘that is what we’ve always done’. Not only do we stick with what we know, but quite often could be doing more harm than good. Using the same formulas in a spreadsheet that could have been incorrect for the last couple of years.

Investing in any type of software can sometimes incur a cost, and some time might be need to be spent to learn how everything works. Like a water softener, it might not always be for something that appears to be immediately essential, but gradually, these dull tasks can eat into much more time than we realise.

Understanding how technology can help your business, and identifying all tasks that can be automated will increase efficiencies and profitability. If there is anything that you do ‘manually’ on a regular basis, it is likely that there is a piece of software that can do the job more accurately in a fraction of the time.

Investing a little bit of time and money now on improving systems and processes, will pay you back dividends later.

It’s a date, just a simple date…or is it?

Who would be a programmer? Always under pressure to make features ‘just a little bit better’, all the while watching over our shoulders as ChatGPT and AI show why it is likely to replace us all over the next few years!! And then you get hassle because you can’t make a straightforward date field work - I mean, why are we getting paid at all!!!

In all fairness, life in a development team is not all bad, but it is surprising just how much trouble dates and times give developers, although perhaps it shouldn’t be when you look at one really simple problem: US-format vs UK-format. Here in Blighty (I can’t bring myself to call it Great Britain right now), we like to put the day number first, then the month and then the year, whereas our erstwhile friends across the Atlantic prefer to put the month before the day.

Does that really matter? Well, to a programmer this is a disaster, not least because for the first twelve days of every month there is absolutely no certain way to know what the date actually is - whether 5/4/2023 means 5th April or 4th May only a Jedi Master could tell you (too oblique?).

At nettTracker, this ambiguity is compounded because about half of our Company connections come from regions that use US date formats while our servers operate in European time zones. The way we deal with this is to inspect the region properties of the Company when it is first being connected to nettTracker and assign a date format accordingly. Our user interface (UI) then adjusts its date formatting according to the company and it all works very nicely. But with data input, things can get tricker.

Most UI systems utilise something called UTC or coordinated universal time, to encode a date and time value when sending it over the wire. This effectively resolves the problem of understanding whether a date is US, UK or any other format. UTC also includes a timezone component to assist the consumer know how the value compares to their current location, -8 indicating PST for example, showing it is 8 behind GMT. However, if the developer doesn’t pay really close attention, they may not realise that their code has translated the date and time value into their own timezone.

Why is this a problem?

When our servers receive a UTC date, it gets automatically shifted into GMT or BST. This means that any user in LA working after 4pm local time, will effectively be in the following day relative to the server. If a user was to submit a request that included a date, it is entirely possible that the servers would silently change this date to the next day and no one would notice.

Naturally, we have strategies to deal with these eventualities, but every now and then something slips through the net as we found last week. A new tool for changing the year-end date was not being correctly parsed and this resulted in a financial year with 13 months by mistake! A simple fix and a slapped wrist later, all is happy again, but it just goes to show how easy it is for something so simple to become such a problem.

Things like this are a great reminder why programmers are probably not going to be replaced by AI just yet…although, maybe they would not have missed the problem in the first place!!!

Reviewing working processes and implementing software

If you are looking at using any form of software, you’ve probably been thinking that some of your current processes could be improved.  In this digital era where new apps are emerging all of the time, it can be incredibly difficult to know what is going to be the best fit for the type of improvements you’re trying to make to any working practice. 

The apps ‘marketplaces’ for Intuit, Xero, and Sage combined, contain thousands of apps, and trying to find something that can really help can be like looking for needle in a haystack.  Sometimes, you think you’ve found what you need, only to discover several hours, days, maybe even weeks or months later, that it isn’t fit for purpose.  So off you go again, spending further time looking, further time testing, finding yourself going around in circles, no further forward, and probably confusing yourself over what it is you actually need.

All of that time looking for apps, and testing apps, can be saved if you reach out to the guys at Apps Advisory, and 4PointZero as they’ve done a lot of the legwork, and they are not biased towards any of the software solutions available.

If you are thinking about implementing any software, first of all consider if you really do need it.  What are the benefits.  Will it save time?  Will it increase productivity and profitability?  Sometimes, for sole practitioners, adapting to use new software can feel like an immediate additional cost when currently using Microsoft Excel or an Accounting Desktop Solution for 90% of all work being done.  After all, you are getting real value from that software, right?  Well, probably not as much as you think.

If you are the owner of an accounting firm, it can be little easier to put a price on employee time than if you are just working for yourself.  Either way, all time has a value whether it’s paying employees, having the ability to do more chargeable work in less time, or simply working less hours and spending more time with your family. 

It’s a good idea to work out exactly how long it takes to do certain tasks, the frequency required, and for accounting firms, are these tasks are being carried out for multiple clients?  You may surprise yourself as to how much time is actually being spent in certain areas.  Maybe even create a template in Excel and ask employees to contribute their thoughts so that you can calculate an average.  Everyone could have a slightly different perspective on the time taken to do different jobs. 

If we take an example of an accounting firm that has 50 clients requiring services that takes an employee 1 hour per month to complete, that’s 600 hours of work.  If we are being prudent and thinking we can cut time by 50% by using software to automate processes, 300 hours per year gives us back an extra day a week.

When was the last time you reviewed all of your current processes?  Whether it’s for general admin, task management, time recording, communications, bookkeeping, reporting, tax preparation and more, there is usually a piece of software that can free up time, making you much more efficient.

You might want to take on more work, or overall, just do less.  Sometimes the latter is actually better for us.