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Advantages and Disadvantages for Outsourcing the Accounting Functions

Accounting Function OutsourcingIs it possible to outsource the accounting function? The answer is “YES”. The accounting function could be outsourced, though this is usually limited to only a few tasks within the function. A Financial executive would start thinking of outsourcing some of the accounting function when inhouse accounting staffs do not function in efficient manner. Fraudulences are usually the most reason. Lacking in technical skill, multi-national accounting standard compliance coverage are the next reason. If those are the case, YES, there are opportunities to outsource a wide array of services in this area, if a controller or CFO is willing to work with multiple suppliers to achieve this goal. Collection, Payroll and Internal Auditing functions are the most desirable. Cash management, transaction processing, taxation and even financial reporting are also possibly outsourced in some sub-functions.

Outsourcing The Cash Management Function

The cash management function can be outsourced. One reason is that a company manually moves funds between accounts and manually records this information, whereas a bank can automatically consolidate the cash in various accounts and sweep it all into an interest-bearing account without any manual interference at all. This allows one to reduce the fixed cost of the in-house staff it uses to track the flow of cash through its accounts in exchange for a per-transaction fee from the bank for performing the same service. Also, since the bank can fully automate this work, the company has a much lower risk of having any errors in moving funds between accounts.

The only disadvantage is that the company is forced to use the same bank for all of its accounts, which does not allow the company to use the services of multiple banks and have them compete against one another in offering the best prices to the company.

Transaction the Processing Function

Transaction processing can also be outsourced. One advantage is that the supplier may have a better knowledge of world-class processes that allows it to complete transactions faster than the company’s in-house staff. Also, if the company has a widely dispersed transaction-processing function, a supplier can consolidate these locations into a single, highly efficient location to reduce costs. In addition, a company may be able to replace poor in-house management with (presumably) top-notch supplier management.

The downside of outsourcing transaction processing includes the cost of doing so; unless they can use their greater knowledge of processes to cut costs, suppliers will be more expensive than the in-house function.

Outsouring the Financial Statement and Reporting Function

A company has a supplier create financial statements for it when its in-house accounting staff is not large or experienced enough to do so correctly in a timely manner. This can be a good idea if the accounting firm used is a large one, for its staff will have an excellent knowledge of all reporting requirements needed for financial statements, especially for all required footnotes.

A popular variation on this approach is to have an outside firm verify the accuracy of the financial statements that were produced by the in-house staff, especially if the company is a public one and its reports are going to the Securities and Exchange Commission (SEC), which requires a very detailed knowledge of the SEC’s reporting requirements. The downside of this approach is that accounting firms usually charge high rates for this service. Thus, one must decide if the improved level of reporting is worth the additional cost.

Outaourcing the Taxation Function

Taxation can be outsourced when a company is not big enough to support the fulltime services of a tax department of its own. This is frequently split into two pieces, with state and federal taxation reporting going to a supplier and local taxation being kept in house. The reason for this split is that many taxation firms are experts at state and federal issues because they have their own teams of experts who advise them on these issues; however, they have little incentive to develop an expertise in limited locals areas, such as enterprise development zones.

Outsourcing Collection Function

The best reason for outsourcing the collections function is that the supplier may pursue those customers who refuse to pay with greater energy than would the inhouse collections staff. Particular skill is required in persuading companies to pay for old invoices, and good collection companies employ people of this type.

The downside of using collection agencies is that they can be so aggressive with customers that they will refuse to ever do business with the company again; however, since the company had to refer the customer’s account to the supplier anyway, the company may not want to pursue further business relations. Also, a collections agency is typically paid a large percentage of each bill collected, normally about one-third of the total.

However, a company usually passes along a bill to the collection supplier only at the point when it does not believe it can collect the bill itself, so any collection, even if not for the full amount, is better than what the company had before. Furthermore, many companies write off accounts receivable that must be handed over to collection agencies, so there is no expectation of ever collecting the funds. Also, a company can sometimes work with collection agencies who are willing to be paid by the hour rather than on a percentage basis.

The alternative reduces the high cost of collection, but also converts the collection cost from a highly desirable variable cost to a fixed cost. In short, it is very useful to switch the most difficult accounts receivable collection items over to a collections supplier, since they are better at persuading customers to pay their bills.

Outsourcing the Payroll Function

The most commonly outsourced accounting function is payroll. Some of the advantages of outsourcing it are to:

  • Avoid filing tax payments – A company can shift the burden of making timely tax filings to the supplier. The government requires rapid tax filings, and has imposed stiff penalties if taxes are not filed on time. For those companies with a chronic tax-filing problem, handing over this task to a supplier may save the company more money in tax penalties avoided than the entire cost of outsourcing.
  • Avoid paying for software updates – Companies do not want to pay their software providers for new tax tables every year so they can correctly calculate payroll taxes through their in-house software packages. Since there are some incremental local tax rate changes somewhere every year, a company that runs its payroll on an in-house software package must incur this expense every year in order to stay current.
  • Avoid creating payroll tax withholding forms – A payroll supplier will accumulate all annual payroll information into withholding tax reports and even mail them to employees for the company. Otherwise, the in-house system would produce these documents and send them to employees.
  • Avoid printing paychecks – A payroll printing can tie up a printer for a long time if there are many employees, and it must be closely monitored in order to avoid jamming. By using outsourcing, neither the printer nor the employee are needed for this task.
  • Use direct deposit – Many in-house payroll systems do not allow direct deposit, whereas this service is offered by all major payroll suppliers. Direct deposit is most useful for companies whose employees are constantly traveling and who are therefore not on site to pick up and deposit their paychecks.
  • Use check stuffing – A supplier can automatically stuff paychecks into envelopes for delivery to employees, removing a clerical task from the accounting staff.
  • Use check delivery to multiple locations – Though most payroll services will not mail checks to individual employees, they will send batches of checks to multiple company locations for distribution to employees.
  • Stamp signatures on checks – The supplier stamps an imprint of an officer’s signature on all payroll checks, thereby keeping someone from having to perform this boring task.
  • Use custom and standard reports – Most payroll suppliers provide a plethora of reports that cover the needs of most companies. For special reporting needs, there is usually a custom report-writing tool available that allows the company to create any additional reports it needs.
  • Link to pension plan – A few payroll suppliers can make automatic deductions from paychecks and deposit this money directly into a pension plan on behalf of the company, thereby eliminating a great deal of paperwork associated with this function.

Despite the formidable array of advantages just noted, some companies do not outsource the payroll function, usually for one or more of the following reasons:

  • Cost – Payroll suppliers can be quite expensive if all possible payroll services are used. The most typical supplier ploy is to initially charge very low rates for the basic service of printing paychecks. However, once a company has signed up for this service, it will find that additional services may easily exceed the cost of the basic service. For example, additional fees will be charged for automatic signature stamping, check stuffing, delivery to multiple locations, access to custom reporting software, and direct deposits.
  • Conversion problems – There are a number of data items that must be properly converted over to the supplier’s database to ensure that employees will continue to receive paychecks in the correct amounts and with accurate deductions removed. If the conversion to the supplier’s database does not go well, the company may become so disenchanted with the supplier that it converts back to an in-house solution. Conversions can be a problem in part because so many companies want to switch to outsourcing at the beginning of the calendar year, which creates a major work overload for the system-conversion staff of the supplier.
  • Create manual paychecks – It can be difficult to determine the correct amount of tax deductions when cutting a manual check for an employee. However, many payroll suppliers now offer either automated call-in or Internet-based calculations that provide this information.
  • Must send in payroll information – The payroll supplier does not collect payroll information. The company must still do this, organize it, and submit it to the supplier for wage and tax calculations. As this may be the primary source of clerical time in computing payroll, one may not see how to save costs by shifting to a supplier. This is less of an issue if most company employees are salaried, since there is little timekeeping data to collect. Also, some payroll suppliers offer bar-coded time clocks that can be linked directly into their software, so there is little clerical effort required.

Outsourcing the Internal Auditing Function

Companies are now outsourcing their internal audit functions. The following set of reasons for taking this approach should be compared to the list of disadvantages that follow in order to fully understand the ramifications of using outsourcing in this area. Arguments in favor of outsourcing the internal audit function are:

  • Mix of skills – If the auditing firm doing the work is a large one, the auditors provided can be changed for each audit, only using those people who are most skilled in the requirements of each audit.
  • Management ability – The supplier can manage the audit for the company; since this is all the supplier does, it should be quite good at managing audits, and can probably do so better than an in-house staff.
  • Knowledge of best practices – An auditor who reviews the functions of many companies will build up a knowledge base of how processes can be performed most efficiently and effectively, or has access to that knowledge through other auditors at the firm, and can therefore recommend changes to the company. Many internal audit staffs have been with their companies for years and have not acquired this same range of process knowledge due to a lack of exposure to other businesses.
  • Variable cost – The company only pays for audits performed by the supplier, so the auditing cost can be switched from a fixed one for in-house staff to a variable one for outside staff.
  • Quick access – The company has the option to quickly bring in an experienced audit team if it acquires a new business in a foreign location that is inconvenient for its internal staff to reach.
  • Reduced travel costs – The company must fly its internal audit staff to any company location that needs an internal audit, whereas a large auditing firm can assign staff from its regional offices to go to those locations, thus avoiding the excessive travel costs incurred by the internal audit staff. This cost reduction only works if the auditing firm has regional offices near the company’s locations.
  • No downtime – Bringing in an audit team only for specific tasks allows the company to avoid the kind of nonproductive downtime that sometimes occurs with an in-house staff, such as the interval between the end of one audit and the beginning of the next.
  • No hiring and training costs – A company can avoid the substantial hiring and training costs needed to staff and retain a top-of-the-line in-house audit team.

There are several important reasons why the internal auditing function should not be outsourced in some circumstances. Management should be aware of these reasons before making the decision to outsource. Some of the concerns with outsourcing are:

  • Cost – A major downside of using an outside auditing firm for internal audits is their substantial cost, which includes overhead costs and a healthy profit margin. There may be an additional concern that fees will be low-balled until the company has disbanded its internal auditing staff and has become reliant on the supplier for this work, at which point the supplier will increase its fees.
  • Training – Some companies use the internal audit function to train their managers, since the job gives a good overview of many company functions. By taking away this job, a company loses its training ground for future managers. One solution is to team these personnel in training with the supplier’s audit teams in order to provide ongoing training.
  • Experience – The perceived quality of the auditors provided by the supplier may be lower than anticipated, since most auditing firms have very high turnover and also like to bring in junior employees in order to give them experience with different accounting systems. This problem can be avoided by previewing the qualifications of each person assigned to internal audits by the supplier.
  • Responsibility – Management must still realize that it is responsible for the establishment and maintenance of internal controls and the audit of those controls. If the company is sued over a lack of controls, it cannot point to the internal audit supplier as the culprit—management will still be held accountable.
  • Independence – An auditing firm is supposed to create “walls” within its own company that keep its internal audit work from interfering with the independence of its financial statement audit work. This is an especially difficult task for smaller firms, where there may not be enough people to separately assign to both the internal audit work and the periodic external audit.

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