Obviously, no one wants to go through this. It’s unacceptable for any organization. To help you understand the impact, here’s a small scenario showing the magnitude of the financial and tax implications. Please note that I’m not an accountant, so you may want to double-check my example to make sure it’s accurate.
FICTITIOUS SCENARIO
Let’s say you hire a lawn-mowing service for your business. In 2019, your lawn-mowing bill is exactly $20,000. So you make your 2020 budget with an expected expense of $20,000 based on the previous year with a reasonable annual increase of 5%.
Actual 2019: $20,000
Budget 2020: $20,000×1.05% = $21,000
In 2020, the company that mows your lawn is sold to new owners. At the end of your 2020 year, you still haven’t received your lawn-mowing bill. You call your supplier to get it. You’re told it will be sent shortly. This isn’t ideal, but it’s possible that new homeowners are having trouble with their billing.
You decide to record your lawn-mowing expense, close your 2020 fiscal year and file your taxes. You’ll have the invoice shortly to justify your expense.
Note that as a business or organization, lawn mowing is an expense that you can deduct from your income.
You make your 2021 budget. You budget for a 5% increase on the previous year’s price of mowing.
Actual 2020: $21,000 // remains uncertain!
Budget 2021: $21,000 X 1.05% = $22,050
In 2021, you don’t receive your 2020 bill or your 2021 bill. This becomes a problem because you don’t have a document to justify your lawn-mowing expenses. You call your supplier, who tells you he’ll send it to you shortly. He’s running out of time! Usually, this is when you terminate your relationship with the supplier. However, you give them another chance.
Again, you book the 2021 lawn-mowing expense, close your 2021 fiscal year and do your taxes. You hope to get the bill soon to justify your expense.
You continue to request your invoice from your lawn-mowing company for entry in your accounting records. It is necessary to have the supporting document to justify the expense in the event of a CRA or Quebec Revenue audit, otherwise the expense will be invalidated.
In 2022, you’re budgeting for a 5% increase.
Actual 2021: $22,050 // remains uncertain!
Budget 2022: $22,050 X 1.05% = $23,152.50
Once again, you finish your year and you still haven’t received your 2020, 2021 and now 2022 grass-cutting invoice. In spite of everything, you maintain the link with this supplier. You do your tax return and hope to have the invoice as proof of the expense shortly.
You draw up your 2023 budget, again forecasting a 5% increase in your lawn-mowing bill.
Actual: $23,152.50 // remains uncertain!
Budget 2023: $23,152.50 X 1.05% = $24,310.12
At the end of 2023, you finally receive your lawn-mowing invoices for the years 2020, 2021 and 2022 at the same time. To your great surprise, your 2020 bill comes to $42,000 instead of the $21,000 you’d expected. That’s double! This means that your budget explodes for all your previous years and especially for your current year, since this year you have to correct all the discrepancies from previous years.
Here’s the result of a supplier who sends his invoices three years later at twice the expected amount:
| Years | New costs | Anticipated costs | Differences |
| 2020 | 42 000$ | 21 000$ | -21 000$ |
| 2021 | 44 100$ | 22 050$ | -22 050$ |
| 2022 | 46 305$ | 23 152,50$ | -23152,50$ |
| 2023 | 48 620,25$ | 24 310,12$ | -24310,12$ |
| -90 512,62$ |
This represents a variance in the 2023 budget of $90,512.62 on an original amount of $21,000. A budget explosion of $69,512.62, or 331% over the period. As a company, how do you explain this to your business partners? Of course, you demand explanations from your supplier as quickly as possible!
Many companies refuse to pay the bill years later. Of course, most of them will terminate the agreement with the supplier long before that. This unhealthy financial management is damaging your organization.
In accounting, there’s a simple principle we all know, called “reconciling income and expenses”. Basically, revenues and expenses should be accounted for when they occur. Not two years later!
Accounting principle definition
Accounting principle whereby costs are expensed and netted against income, either directly or by systematic and logical allocation, in the period in which the income they helped generate is recognized. They are then taken into account in calculating results for the same period, contributing to a more appropriate measure of net income for the period.
Reference : https://vitrinelinguistique.oqlf.gouv.qc.ca/fiche-gdt/fiche/503517/rattachement-des-charges-aux-produits
Finally, if we were to compare the present scenario with a service agreement between two municipalities, it could cause headaches for the municipality that practices sound accounting according to recognized accounting principles. They don’t want to cause conflict, but they still need to be able to plan, monitor and respect their expenses, so as to justify them to their constituents.
Don’t hesitate to ask questions in the comments. I’ve tried to make this as easy to understand as possible.
