RT Tanner & Co Ltd
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Contents
Conclusions
Management
Operations
Trading Performance
Review of Balance Sheet
Future Prospects
Appendix
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Bank Report
5 Accounting Systems and Management Information
5.1 Introduction
In this section, we comment on the adequacy and reliability of the accounting systems and the management information produced by the Company.
5.2 Accounting Systems
All of the accounting functions are undertaken at Crayford under the direct control of M Jeffry (MJ), the accounts manager, with overall control
provided by PT. Due to capacity constraints on their previous computer system, a new one was installed at the start of 1991. This comprises a
minicomputer along with fourteen terminals in Crayford and modem links to terminals at Dartford and Leeds. The accounting software is an off
the shelf software package, Seachange, although various bespoke elements are to be added to meet the Company’s requirements. The software should,
when fully installed, provide and integrated nominal, sales and purchase ordering and invoicing, sales and purchase ledger, stock and payroll system.
The installation of this system, to date, has proved a disaster. The most critical problem is that the stock control system has not functioned properly
since the system was installed. As a result the Company has not had accurate records of its finished goods stock since 1 January 1991. Additionally,
much of the bespoke software has not yet been produced and many of the reports required by management are not yet being produced. This has left the
Company without much of the necessary information on which to base it’s manufacturing and sales decisions.
There appears to be many causes to the problem but all appear to stem from the original decision, largely based on cost, to award the contract to a
small software company, PSB Systems Limited (PSB). PSB is effectively a one man operation which sub contracts work as necessary. PSB had problems
with their original software subcontractor, the software not even being he current version. Inventive Computing Limited have now been appointed to
resolve the problems. All additional costs over and above the original contract price are, we understand, to be borne by PSB.
As yet, no timetable for resolving the problem and completing the installation to its original specifications has been prepared by the new software house.
The preparation of a timetable is, in our view, essential.
The new system appears to have lost all credibility amongst the staff and it may be difficult to recover this even when the system is operating correctly.
There is also a question mark over the adequacy of the support that PSB will be able to provide to the Company in the future.
We consider that the problems have had a very damaging effect on the Company, with much management time wasted and a lack of critical information being
available. In our opinion, it is imperative that the problems, particularly the stock records, are resolved as soon as possible. It is our view that if
the stock system is not going to be functioning properly within at least four to six weeks then, in the interim, a full stock count should be undertaken
and manual stock records maintained thereafter.
Two payrolls exist, a weekly payroll for the factory staff and a monthly payroll for non factory staff. Both of these are maintained internally under
the control of MJ. Clock cards are maintained for the factory staff and about twenty of these are still paid by the way of cash. The Board has to approve
all wage and salary increases which normally has to approve all wage and salary increases which normally are effective from 1 April each year.
Although a computerised cash book is maintained it only includes sales ledger receipts and purchase ledger payments. All other sundry receipts and manual
cheque payments are recorded in a manual cash book which is then entered on to the computer monthly by way of journal. The manual cash book is therefore
used as a source of the Company’s cash position. MJ admitted that the manual cash book is infrequently agreed/ reconciled to the computer cash book. In
our view, this should be performed monthly as part of the normal Bank reconciliation exercise.
All major items of capital expenditure are approved by the Board.
5.3 Management Information
a) Management Accounts
The monthly management accounts include a detailed profit and loss account, balance sheet and an updated monthly trading and cashflow budget. The profit
and loss account shows results for the year to date along with the budget and the previous years comparative. The revised monthly budgets are, in fact,
simply the original annual budget with actuals inserted for the completed months. No revision is made to the remaining months’ budgets even if it is
clear these are no longer achievable. Consequently , we believe these to be of limited use to management and suggest that the future months be reforecast,
where necessary, to give a more informative estimate of the year’s outturn. Furthermore, we suggest that the cashflow forecast should be prepared on a
rolling basis such that the following twelve months is always forecast. No written narrative or variance analysis accompanies the management accounts which
we believe would prove beneficial to the board in the effective running of the business.
The management accounts are prepared by MJ normally within three weeks of the month end. They are distributed to the directors and the Bank and are discussed
formally at Board Meetings as well as informally. In our view, the procedures adopted in the preparation of the management accounts are adequate with detailed
accrual, prepayment, depreciation and other such adjustments being made. The value of raw materials and chemicals stock is assumed constant throughout the
year and is only amended to actual at the year end. The value of this stock is believed to remain fairly constant throughout the year and management do not
believe that it is sufficiently material to impair the accuracy of the management accounts, a view with which we concur. Due to the problems with the new
computer system (para 5.2refers), there has not been an accurate finished goods valuation available. An estimate based on opening stock, purchases and sales
has therefore been used and consequently the cost of sales figure in the management accounts may be inaccurate. MJ believes that his estimate of cost of sales
is unlikely to be more than £30,000 different, either way, to the actual value.
b) Costing Procedures
Finished goods comprise stocks of bought in goods and internally manufactured standard and special products. Bought in goods are valued at their purchase
price excluding any discounts received and any carriage or stock holding costs. The production department is responsible for updating the standard cost
on a regular based on invoices received.
The standard cost of the Company’s standard products is calculated annually at the start of each financial year. Thereafter, it will only be updated if
the cost of materials alters significantly or experience indicates that the standard is inaccurate. This, we understand, is rare. Standard cost comprises
raw materials (paper, patches, gum and packaging), direct labour and production overheads. Direct labour is based on the time per machine (envelope making,
printing, cutting) at standard labour rates. The production overhead rates per machine are determined at the start of each year based on the annual budget.
Overheads are allocated between production, sales, warehouse and Leeds. Production department costs are then allocated to machines based on floor space and
an hourly rate calculated assuming a 70% utilisation. 10% is added to this to give the standard cost or factory selling price (FSP).
When an enquiry for a non standard product is received sales department will prepare a price quote. This comprises the production department’s estimate
of the FSP plus a further mark up which is at the sales department’s discretion (para 4.4 refers).
Although the method of determining the FSP appears broadly reasonable there are, in our view, a number of problems inherent in the costing procedures:
i) Labour time does not include an allowance for set up time. On long production runs the cost per envelope will be minimal. For shorter runs it
may be material eroding the small margins being made. This will be particularly the case for non standard orders.
ii) The assumption that machines are operating at 70% of full capacity is not appropriate for all machines. This may lead to an under recovery
of production overheads.
iii) Although FSP may, subject up to i) and ii) equate to the factory cost it is unlikely to represent the true cost since certain costs are
excluded, for example stock holding costs (warehousing and finance cost) and stock handling costs (movements to and from Dartford). The sales department
are responsible for obtaining a further mark up on the FSP which in practice varies from between 5% and 40%. This mark up is intended to cover selling
and distribution costs, fixed costs and to generate a profit. In our opinion, because of the above problems, the Company’s costing system may not be
reliable to give an accurate total cost of each product on which to base sales prices and sales decisions. We suggest that the costing system is thoroughly
reviewed with a view to incorporating the above weaknesses. Until this is done incorrect sales decisions may be made.
We note that standard costs are updated after the annual budgets are prepared in March/ April. This exercise takes place after the standard prices are
updated (para 4.4 refers). It would appear, therefore, that prices are set without costs having been determined. Although material and labour costs are
reasonably predictable this is not always the case for production overheads. Although we understand that pricing is going to be market led the process
adopted would appear potentially dangerous and we recommend that costing be budgeted prior to pricing.
c) Budgeting and Forecasts
A detailed monthly projected profit and loss account and cashflow are compiled by MJ in March/ April for the following twelve months. The sales and
production directors are responsible for setting the sales and cost of sales budgets respectively. Overheads are projected by MJ based on historical
levels and known changes. Once prepared the budget is formally approved by the Board. Cashflow forecasts are prepared by MJ based on the trading budgets
by applying historic debtor and creditor days and overhead payment terms.
The cashflow forecast assumptions appear reasonable and their accuracy is, therefore, dependent upon the accuracy of the trading forecasts. For the past
two years the trading forecasts have been optimistic in respect of the level of sales and margins but have been broadly accurate for overheads. The 1991/1992
trading and cashflow budgets have yet to be agreed. PT has prepared draft outline budgets assuming various future scenarios for illustrative purposes only.
Due to the problems faced by the Company and the need for certain strategic decisions to be made final budgets for the next twelve months have yet to be prepared.
As discussed at para 8.2, it is our view that management has now got to make a number of long term strategic decisions about its future. This should then be
incorporated into a five year plan. Once this has been done the detailed twelve month budgets can then be prepared.
5.4 Auditors
The auditor’s responsibility are limited to the annual audit, preparation of statutory accounts and the tax compliance work.
5.5 Accounting Policies
The stated accounting policies of the Company comply with standard accounting practice although the following points should be noted:
a) Stock is stated to be valued at the lower of cost and net realisable value but it does not appear that, historically, any
provision for slow moving or obsolete lines has ever been made (para 7.4 refers)
b) No depreciation is provided on land and buildings on the basis that their value is in excess of their book cost
c) There does not appear to be a deferred tax accounting policy (para 7.8 refers)
d) Pension costs are charged to the profit and loss account when paid which may not occur with the new accounting standard
on pension costs (para 7.7 (c) refers)
5.6 Conclusions
In summary, due to the problems associated with the installation of the new computer system the accounting system is currently inadequate for
the Company’s operations. It has not been possible to consider whether the current system, when fully operational, will be adequate or otherwise.
Internal control systems have been developed in most areas and are considered adequate for an operation of this size.
The principal concerns are the lack of stock records, and information on product profitability and sales analysis. We suggest that manual stock
records be maintained if the computerised stock are unlikely to be operational within, say, six weeks.
The costing system includes a number of weaknesses which, potentially, could lead to inaccurate costing information on which to make pricing/sales
decisions. We recommend that a full review of the costing system be undertaken immediately. Monthly management accounts are produced on a timely
basis and, excepting the current problems with stock figures, are reliable. A detailed commentary on the results should be prepared so as to
focus management’s attention on the key issues. This should be sent with the management accounts to the Bank.
No detailed forecasts for 1991/1992 have yet been prepared since management is aware that strategic decisions concerning Tanner’s future direction
are required. In our opinion, a thorough review of all areas of the Company’s activities is required, both strategic and short term operational.
This area is discussed at Para 8.2. Once completed the decisions taken should be incorporated into a five year plan and a detailed rolling annual
trading/ cashflow forecast.
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