Introduction
As a business entity, does your regular daily financial transactions involve pennies to accommodate in accounting? One of the upscale enterprises did a 1 million dollar write-off as part of their annual financial reconciliation due to penny rounding errors. This write off is in addition to regular ones normally arising from account for fraud, pilferages, theft, inconsistent returns, damages or manual or system operational inaccuracies.
The objective of this blog post is to throw some light on challenges and best practices in a Payment Reconciliation System that emerge from rounding principles during an Order Management System (OMS) implementation.
Business Situation
During the implementation of an enterprise OMS solution, businesses often need to deal with attributes related to payment transactions like order totals, shipment totals, taxes and charges. Though businesses strive to optimize costs and manage the perfect order i.e. to fulfill all line items on the order in full quantity on promised dates from a single fulfillment location to reduce operational costs, dynamic constraints and unexpected impediments in supply chain do not allow the flow in the ideal way.
Examples:
- From single fulfillment location to single destination address
- On single delivery date
- With full quantity on all individual line items on the order
- With amendments requested from shoppers or even supply chain partners supporting fulfillment
- Without an opportunity to either completely return or partially return on the original purchase
Add to this complexity the highly probable love from mother Mathematics to induce recurring decimals and we all understand that any precision beyond 2 decimal digits in financial transaction doesn’t carry much business value and often tend be ignored. Potentially, there could be legal obligations driven by geo-specific federal or local government laws on local payment reconciliation systems to handle precision in accounting and, therefore, relevant rounding strategies must factor them in the solution.
Sample Scenarios
Scenario 1
An order basket costing $25.5 for 8 units of Item A attributing to a Unit Price = 3.1875. Only 3 units are shipped on day 1 due to available stock and the remaining units are back ordered for permanent cancellation in the payment reconciliation system. The payment settlement invoice transaction for accounting will have for 3/8* 25.5= $9.5625. Can settlement be rounded off to $9.56 or $9.57?
Scenario 2
In continuation from scenario 1, say 3 units are shipped on day 1 due to available stock and the remaining 5 units get fulfilled on day 4. The payment settlement invoice transaction to accounting will have as 3/8* 25.5= $9.5625 for Day 1 and 5/8*25.5 = 15.9375 on Day 2. If the rounding model is:
- Just 2 decimals or on the lower side, order total accounting will record as 25.49 causing a penny in suspense
Scenario 3
On another order, 3 units of Item B costing order total as $10. 1 unit on Day 1, 2 units as Day 3 gets fulfilled. The payment settlement invoice transaction to accounting will settle 1/2* 10.0 = $3.333333(recurring) for Day 1 and 2/3*10.0 = 15.9375 $6.666666(recurring) on respective dates. Regardless of any rounding precision model applied, the order total post complete settlement will be 9.999999( recurring).
From the above simple scenarios and challenges, in reality, using a payment reconciliation software involves more complex situations to handle business specified unit level charges such as shipping, gift-wrapping, value-added charges, etc. and related taxes to these charges. All of these components within a payment reconciliation system need accurate pro-rated accounting to handle above scenarios of partial fulfillment. Rounding strategy is something every business deals with in their own ways and in line with accounting principles where IT applications support them accordingly.
Our role as SMEs and implementation advisors would be to devise a wise approach to reduce the financial write-off. Few best practices are listed below though, nevertheless, there is a not a single canned solution to tame the rounding animal.
Charge Per Unit v/s Charge Per Line – Having charge per line model will invoice the entire charge during first invoice of line eliminating rounding errors. However, if remaining units of line don’t get fulfilled (need to refund the balance amount) or the fulfilled units are returned (triggering refund), then this brings back rounding calculation to determine accurate refund amount.
Charge per unit model can be used but management of decimal values during every invoice is a must. During the last invoice, blindly consume the entire remaining charge on line to settlement. Ex: 10/3 – $ 3.33 first settlement 1, $ 6.64 – final settlement use remaining charge as Total Charge on line – Total Invoiced Amount giving $3.34. This is typically deployed to manage recurring decimals.
First and Last Invoice – An order or each line on order can have potentially ‘n’ number of shipments and hence settling the remaining balance amount on last invoice of the order will eliminate the rounding off error to a large extent. This means a round off only during last invoice and not in all intermediate invoices because decimals will cascade at the final settlement and, again, demand a rounding iteration leading to supersession effect.
If there are valid fulfillments expected on the order in future dates, rounding can be done later to avoid rounding error in each invoice. Rather, do all the rounding in the last invoice to decrease error in decimal precision. But there is no guarantee that future planned fulfillments will not get cancelled and the already invoiced is the first and last one. Therefore, businesses must be careful to understand that there might not be an opportunity at all to correct the rounding which was not accounted at the time of first invoice.
Invoicing all the charges on first invoice of the line and taxes only on the last invoice of the line will cut down rounding errors to manage differences in tax amount during quote and actual settlement. The flip side of this approach would be to build intelligence into which charges are refundable, which are non-refundable, their respective tax components and conditional pro-rationing logic management which make accounting complex.
Multi Decimal Management – The accuracy of rounding is directly proportional to the number of decimals considered. This doesn’t imply to use big decimals to reduce rounding errors since currency beyond 2 decimals doesn’t carry much business value. However, the recommendation would be to choose at least 4-digit decimals to reduce the error scenarios. While rounding errors will reduce but it won’t be completely eliminated from the accounting books.
We Acuver Consulting are collaborating with our partners and customer stakeholders employing due diligence right during discovery workshop sessions on detailed aspects of a payment reconciliation system during OMS implementation solutions around the globe. Would be happy to share additional best practices and collaborate and create a mindshare with OMS practitioners. Happy rounding!!
Author: Jagadesh Hulugundi
