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• Profit-related “executive” bonuses: Generally reserved for only the most
senior executives or partners of the firm, payment of profit-related
bonuses can either be discretionary or tied to a formula. In general, these
bonuses are tied to the firm™s overall financial success and are designed
to motivate the senior leadership team to make decisions that are best for
the growth and profitability of the firm. Long-term deferred bonus plans
are designed to reward performance over several years while incenting
the most senior executives to remain with and build the firm. The less
discretionary these programs are, the closer the link may be between de-
cision making and results.
• Management by objective (MBO)-related bonuses and deferred salaries:
Unlike profit-related bonuses, MBO-related bonuses may be considered
more like part of a salary that has been deferred for a period of time
(e.g., quarterly, semiannually, or annually) and are paid only after suc-
cessful performance of a set of predetermined tasks or responsibilities.
Effective MBO programs begin with a written statement of quantifi-
able objectives that the employee is to perform. In general, it is best to
focus the program on three or four of the employee™s most important re-
sponsibilities that can be quantified. Once those objectives are dis-
cussed and agreed to with the employee, they should be documented in
writing, with a copy given to the employee and another filed with his or
her personnel records. The advantage of this technique is that it mini-
mizes the amount of time required to perform the evaluation at the end
of the year and record new objectives for the following year. Finally, the
costs of such incentive programs, if properly established and managed,
may be accrued ratably as a salary expense each month instead of being
charged to bonus expense at the end of the year when paid. In some
client compensation agreements, this may properly increase the allow-
able amount of expense the firm may recover from its client, thus im-
proving the firm™s profitability.
• Spot bonuses: Spot bonuses are, as the name implies, paid on the spot
with short notice in recognition of a job well done, generally to lower
level staff. Imagine the euphoric feeling of having your supervisor walk
up to you, tell you that you did a fantastic job on a particular assign-
ment, and then hand you a check for $1,000. Although not a material
amount, the fact that the firm™s management recognized your perfor-
mance and rewarded it with something tangible can be a powerful tool
that builds loyalty and improves overall productivity.
Finance, Accounting, and Human Resources

MONTHLY SALARY FORECAST BY PERSON. To provide both a control
point over the payroll process and the foundation for what is normally the
largest cost element of the financial forecast, a detailed salary forecast should
be prepared /updated each month. A salary forecast is a detailed spreadsheet
(or database) that lists every employee, basic statistics about the person such
as hire date, annual salary rate, date and amount of the last few salary adjust-
ments, as well as a monthly spread of each individual™s compensation, includ-
ing all bonuses and other salary adjustments. Employees are listed within
their respective departments, with a copy of the worksheet given to the de-
partment head so that he or she can plan compensation adjustments for the
year and the resulting numbers can then be used to develop departmental
budgets to the extent used within the firm.
Each month, as new professional staff are hired, employees leave, salaries
are adjusted, bonus amounts are refined, and new positions are approved and
removed, the salary plan is updated to ref lect as many of these changes as
possible. Many of these updates are recorded in some form of personnel ac-
tion request form that the HR department uses to manage and control
changes to the employee population. The salary forecast is one of the profes-
sional services firm™s most important management tools and must always be
maintained in a current state and reconciled against actual payroll each
month by someone other than the one who administers payroll. This simple
control is vital in a well-managed firm.
Steps management can take to safeguard its payroll include:

• Reconcile actual payroll against the payroll forecast every month and,
if possible, as part of the monthly close process. Ensure all variances to
plan, however small, are investigated fully and resolved to the satisfac-
tion of at least one senior financial supervisor.
• Segregatee duties. Segregation of the payroll process itself from the
person responsible for developing and reconciling the forecast can help
to ensure that internal controls are properly balanced to safeguard the
payroll account.
• Ensure that staff responsible for payroll-related issues take vacations.
No single employee should have control over the payroll process. When
a backup person periodically takes charge of the payroll process,
anomalies are more likely to be uncovered than if the same person al-
ways takes responsibility for the process.

All Jobs Need Oversight
A large Midwestern professional services firm discovered that its
trusted payroll clerk had been diverting payroll funds to his own account
while he took a vacation after more than five years without doing so.
During that five-plus-year span, the employee managed to divert over a
350 The Back Office: Efficient Firm Operations

quarter million dollars to his personal account. The employee was prose-
cuted and sentenced to jail for his actions.

The foundation for all cost accounting (and billing) in a professional services
organization rests with the integrity of its time accounting system. Every
employee in a professional services firm is responsible for completing his or
her own timesheet, including the CEO and all other executives, even if their
time is not charged directly to a client.
The actual amount of time worked on each client or project is recorded
on some form of timesheet, whether it is a sheet of paper or direct input into
an electronic system. General and administrative time is recorded in a sep-
arate account (or in detailed subaccounts) set up for that purpose, with all
other client-related time charged to a specific client or project. For admin-
istrative personnel who otherwise would not need to complete a timesheet
because their time is not charged directly to a client, use of the time ac-
counting system to track vacation/paid time off (PTO) days used is generally
the most efficient procedure because it avoids having to create a separate
process/procedure to track such time.
Best practices call for all time reports to be reviewed and approved by the
employee™s immediate supervisor. Any modification to the original time re-
ported should be made only by the employee himself or herself, with a su-
pervisor ™s written approval, and documenting the reason for the adjustment.
Time records may be used as evidence in legal proceedings, and the proce-
dures surrounding their formation must be above reproach.

Vacation/Paid Time Off Tracking
Laws about PTO and vacation time vary from state to state, and local rules
may supersede anything written here. However, as a general rule, employees
earn vacation or PTO time ratably through the year and, in some cases, any
unused time may be carried over into future years. To the extent that an
employee leaves the firm with unused vacation/PTO time remaining, the
firm is liable for payment of the value of that time based on a pro rata
amount of the employee™s base salary. In states that mandate unused time
be carried over or paid to employees (as opposed to other so-called “use it or
lose it” arrangements), the collective value of that time is a liability to the
firm and is recorded in its financial statements at its gross value. Some firms
elect to pay out the value of unused vacation time in cash at the end of the
year to minimize risks from these regulations and to reduce its balance
sheet liabilities. If not managed properly, vacation or PTO time can become
a significant liability to the firm.
Finance, Accounting, and Human Resources

In general, a firm can best protect itself by having a written policy that
clearly spells out the firm™s vacation/PTO program and maintaining the
records to support the program in strict conformance with that written policy.

Importance of Records

In California, a professional services firm was sued by its former con-
troller for unused vacation time not paid by the firm on his last day of
employment. The firm maintained a written policy that stated clearly
that nobody could accrue more than 25 days of vacation time. While fi-
nalizing his separation paperwork, the controller claimed that he was
owed 35 days of vacation pay. Neither the HR department nor the fi-
nance department maintained a current record of each employee™s un-
used vacation time balance that should have been capped at the 25-day
level in support of the policy.
Instead, when an employee left the firm, the HR department manu-
ally counted the number of vacation days the employee reported on a
special vacation authorization form and subtracted that from the total
number of days the person had earned during his or her employment pe-
riod; if employees ended up being owed more than 25 days when they
left the firm, they were paid 25 days in conformance with the written
policy. On the surface, management believed this policy and practice to
be prudent. However, in this case, the former controller maintained his
own records, which showed that he was owed 35 days.
The Labor Commission ruled against the firm and ordered it to pay
not only the additional 10 days of vacation but also an additional month™s
salary plus interest because the full payment was not made on the em-
ployee™s last day of employment even though the ruling was issued a year
after he left the firm. The Commission ruled against the firm primarily
because the firm did not maintain a vacation tracking system that clearly
computed the actual vacation balance at any point in time and mechani-
cally capped that accrual amount once the limit was reached. In this
case, the person who arguably should have been responsible for ensuring
that proper records were kept by the firm was able to legally profit from
his own mismanagement.

Accounting in a professional services firm should be among the least compli-
cated in our economy. The firm bills its clients for services rendered, the
client pays the invoice, and the firm pays its employees, landlord, and other
overhead suppliers. That™s about as simple as can be expected in a business.
However, once the firm begins to enter into complicated client compensation
352 The Back Office: Efficient Firm Operations

agreements, complex vendor contracts, and spend its client™s money with the
understanding it will be reimbursed for its outlays, the accounting issues and
risks to the firm™s financial statements begin to multiply.
Management of the financial records is the responsibility of not only the
CFO but also the board, CEO, COO, department heads, managers, and super-
visors. Each of those managers is responsible for ensuring the integrity of his
or her respective area™s revenues, expenses, assets, and liabilities. This section
reviews key accounting issues of which the senior executive should be aware.
Our discussion generally centers on corporate structures, but also are, for the
most part, applicable to partnerships and Subchapter S corporations that may
rely on the cash basis of accounting.

Fundamental Accounting Concepts
The most basic checkbook accounting system tracks total deposits and total
withdrawals. If your deposits are greater than your withdrawals during a
specific period of time, you made money, but were you profitable? Maybe
yes and maybe no.
The answer to that question lies in the definition of the word profit. For
hundreds of years, accountants have worked to develop a standard set of
rules to follow to determine whether a firm was in fact profitable during a
specific period of time. Those rules, which are continuously being refined
over time, are referred to in the United States as generally accepted account-
ing principles (GAAP). These principles are a collection of theories, rules,
pronouncements, and writings that have evolved over time to meet not only
the general needs of investors and managers but also specific issues faced by
each industry. Although most accounting principles have been published in
any of a number of authoritative publications, no single list of all GAAP ex-
ists. Rather, they ref lect the cumulative consensus of industry conventions,
current writings, and pronouncements on any particular accounting issue.
GAAP, in their simplest form, adhere to a set of about a dozen foundational
principles that guide the formation of all other rules. Today these principles
are even more rigorously applied in the audit process in response to Sarbanes-
Oxley and other related legislative and regulatory actions. Key principles that
professional services firm executives should understand include:

• Revenue realization: Revenue should be recognized when it is earned,
not necessarily when an agreement is made or cash is received.
• Cost: Assets and liabilities generally should be recorded at their histor-
ical cost and expensed during the period to which they pertain.
• Matching: The matching principle guides timing of the recognition of
revenues and expenses and seeks to ensure that revenues are recognized
in the same time period costs related thereto are expensed. For example,
Finance, Accounting, and Human Resources

if salaries are paid to work on consulting projects during a year, the net
realizable value of those services should be, in general, recognized as
revenue during that same period even though cash for those services
may not be received until the subsequent year.
• Objectivity: Revenues, expenses, assets, and liabilities should be booked
at values that can be established through objective evidence. Documen-
tation supporting any value used in the accounting records should be
maintained and made available to authorized third parties to verify
(e.g., tax authorities, auditors, investors).
• Consistency: Financial statements should be prepared on a consistent
basis from period to period using similar methodologies in order to
yield meaningful comparisons among time periods.
• Disclosure: Financial statements should be complete in disclosing to in-
vestors and managers all pertinent information to ensure that the state-
ments by themselves are not misleading. Explanatory notes normally are
included with financial statements and are intended to supplement the
numbers presented to ensure that the complete package presents fairly
critical information to prevent the statements from being misleading.
Such disclosures include: changes of accounting methods, summary of
significant accounting policies, descriptions of lease and other long-term
debt obligations, stock option plans, and significant subsequent events.
• Materiality: Accounting principles recognize that it may be impractical
to account for all transactions in the same theoretically correct manner;
thus, immaterial transactions do not necessarily need to be accounted
for in a manner consistent with larger transactions. This is particularly
true if the cost of doing so exceeds the value of ref lecting the transac-
tion in the theoretically correct manner. For example, a $500 chair may
have a useful life of 10 years or more, but the cost of capitalizing that
asset and depreciating it over 10 years would far outweigh the cost of
expensing it in the period it was purchased.
• Conservatism: In preparing financial statements, many assumptions and
estimates are made in order to present fairly the full financial position of
the firm. When a reasonable basis exists for two or more different esti-
mates or values to be used for a particular item in the financials, the one
that shows the least favorable effect on the firm in the current period
should be selected. By selecting the least favorable method, management
enhances the quality of the earnings reported, which, over time, can
strengthen both the firm™s credibility and its relative financial position.

In summary, GAAP are the set of rules to be followed in the preparation
of all financial statements, and these general principles form the basis of all
other accounting concepts and practices. Other key concepts and issues of
which professional firm executives should be aware include:
354 The Back Office: Efficient Firm Operations

• Cash versus accrual basis of accounting: GAAP call for the financial
records of an organization to be maintained using the accrual basis of ac-


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