The Depths of Deferred Revenue
December 15, 2015 – Charlie Francis
Click here to see a list of all editions of the From the Desk of the Finance Director column.
From the Finance Director’s Desk …
The fiscal year was ending, and the auditors were on their way for interim testing. I rushed to prepare reconciliations for the various balance sheet accounts: cash, accounts receivable/payable, inter-fund receivables/payables, etc. As I reviewed the balance sheet, my attention was drawn to some accounts labeled deferred revenue.
Before desktop computers, these accounts would have been reconciled. I had a drawer of folders with ledger paper reconciliations for each balance sheet account in every fund. The amount of time invested each month in preparing these reconciliations more than compensated for the time it would have taken to do a full year’s reconciliation at the end of the year.
However, technology has improved substantially since then, removing the need to reconcile every account. Additionally, Enterprise Resource Planning (ERP) systems provide instant access to subsidiary journals that automatically substantiate the balance sheet amounts. Electronic spreadsheets like Excel have transformed sequential manual calculations into simultaneously created templates. And risk-based testing by auditors has limited the number of balance sheet accounts scrutinized annually to only those with material and substantial balances. In short, not every balance sheet account is reconciled!
And just as I was about to pass over reconciling these deferred revenues, it struck me that although individually the accounts were not material, when aggregated, they totaled an amount that would close the current year revenue versus expense deficit in the General Fund. “Hmm,” I thought, “perhaps I should dig deeper into these.”
The City pays its employees on a biweekly basis, so there are 26 pay periods each year. I found liabilities in accounts earmarked as deferred revenues that had been sitting untouched for some fiscal years. I researched each account’s history, and determined both the nature of the receipt and whether the revenue could be recognized. As appropriate, I prepared journal entries recognizing revenues that should have been recorded in previous years. The amounts were not material enough to require prior-period recognition (an entry that is anathema to auditors), but when aggregated, they started to close the $400,000 deficit we faced from an extra pay period.
The City pays its employees biweekly, or 26 times a year. Historically, the City had not accrued payroll expenses for the extra day each fiscal year that exceeded the 26 pay periods. Therefore, every fourteen years there are 27 pay periods. On one of these years, the City’s balanced budget didn’t include payroll for the 27th pay period, and this year’s final report would have reported a deficit of $400,000.
After the journal entries, I looked at deposits payable. I found deposits from which expenses were to be incurred (a legacy practice from former finance directors that encouraged off-book spending). In many cases, I determined the expenses were indeed incurred, but within departmental budgets. I liquidated these deposits into Miscellaneous Revenues. Of course, valid deposits that were due back to the original depositor were returned when identified as returnable. I also retained deposits required for valid purposes.
We also usually recorded a payable for an amount charged through the payroll process for State Unemployment Insurance (SUI). The amount was determined as a percentage of each paycheck. In this particular state, there is never a premium for SUI; the State sent the City an invoice reimbursing the State for any amounts paid to unemployment eligible recipients. The payable had grown quite large. I examined the historical payout amounts and determined that after planning for a reasonable reserve, the rest of the amount could be recognized as a Miscellaneous Revenue in the funds where the payroll expense was incurred.
We did close the fiscal year with a deficit, but it was a much smaller deficit than we would have without examining the deferred revenues. Ever since then, mining the balance sheet for hidden revenues has become standard operating procedure for me. However, the auditors and I agreed that we would continue not accruing the extra day each fiscal year. Kicking the can down the road, we figured that we both would be retired when the 14th year rolls around again. I hope my successor reads this blog and prepares to budget accordingly when that happens!
Charlie Francis is a municipal finance expert. He has more than forty years of local government financial management experience in both the public and private sector, including twenty years of experience as a Chief Financial Officer. Most recently, he served as the Director of Administrative Services and Treasurer for the City of Sausalito where he earned the unofficial title of “OpenGov super user”. He has also served as a finance manager for the Town of Colma, CA and as CFO and acting City Manager for the Cities of Indian Wells, CA and Tracy, CA.
Questions or comments? Email Charlie at firstname.lastname@example.org.
Category: Government Finance