The Adjustments Only Secondary Ledger addresses a long-standing internal control concern that manual journal entries that have been made directly to the general ledger are commingled with the automated, routine journal entries flowing from subledgers or other automated sources. This causes problems such as poor transparency, reconciliation difficulties, and difficulty monitoring critical Sarbanes-Oxley (SOX) Section 404 controls.

Solving the Problems of Adjusting Journal Entries Using Adjustments Only Secondary Ledgers and Ledger Sets

As discussed at the beginning of the whitepaper, adjusting journal entries create several problems. So how does the use of adjustments only secondary ledgers address these problems

Ideally, your primary ledger should only contain data and balances that have assurance of correctness due to the underlying routine data processing controls, and only correcting entries that are made at the sub-ledger or detail level. As an example, accounts payable balances and related expense entries in the primary ledger should only contain entries that results from the normal day-to-day processing of bills which is assured with regard to correctness by controls such as the three-way match (i.e., a vendor invoice must be supported by a purchase order and a receiving confirmation). In this way, you do not circumvent the routine data processing controls. By avoiding making adjusting entries directly to your primary ledger, drill down from the primary ledger to the underlying transaction detail and roll up from the transaction detail to the primary ledger is always maintained – the definition of system transparency.

Distinct from correcting entries, which should be made directly to the primary ledger, adjusting journal entries should not be made directly to the primary ledger. To explain, adjusting journal entries are intended to ensure revenues and expenses match to the proper period. This action results in a correct net income because the revenues earned are matched with the expenses incurred within the period. This is the basis for accrual accounting under GAAP ‐‐Generally Accepted Accounting Principles. 

Adjusting journal entries are of two types: accruals and deferrals. Accruals are amounts for either expenses incurred for which the vendor has not invoiced or, in rare cases, revenue earned that has not been billed. Deferrals are entries made to ensure that revenue is not recognized before it is earned (i.e., a full annual membership payment received in January must be deferred and then recognized over the year.) or that expenditures are not recognized early (i.e., an annual insurance premium that is paid at the beginning of the year should be recognized evenly over the year).

In the past, deferred income was booked to the primary ledger at the end of each reporting period, and then reversing entries were made at the beginning of the next reporting period to make reconciliation of sales activity and AR subledger to revenue easier. Because the deferral entries were manual and supported externally, either through spreadsheets or another external tool, errors were more likely. The two most common errors that occur are spreadsheet formula errors, keying errors, and errors caused by getting out of synch with the primary ledger. To be sure, there are tools that help avoid spreadsheets errors, but it is important to recognize that by their nature, spreadsheets are subject to human error.

However, an adjustments only secondary ledger can eliminate the need to book and reverse those entries to the primary ledger. Instead, the adjustment is booked to the adjustment only secondary ledger. Then the adjustments are not reflected in the primary ledger and no reversing entries are required. For reporting, the adjustment ledger is combined with the primary ledger through consolidation (or in Oracle EBS – ledger sets), resulting in an adjusted trial balance without disruption to processing in the primary ledger.

Through the proper use of secondary ledgers, manual errors in the primary ledger are minimized or eliminated entirely. Then separate controls around the deferral adjusting entry process can be established to further eliminate the likeliness of errors. Some of these controls might be review and approval requirements or better yet, the automation of the deferral entries by linking the adjustments only ledger to the appropriate sub-ledger.

The adjustment only secondary ledger also gives one ledger for auditors to use and for supervisory approvers to review. This is ideal for enhancing transactional controls, but an even better benefit is that it can reduce audit time. Each year, external auditors do a general controls review around a company’s ERP system. Based upon that review, a decision is made regarding whether to try to rely on the routine data processing controls. If the auditor decides to try to rely, they will perform tests of system controls specifically as they related to routine processes such as order-to-cash and procure-to-pay. If the auditor can get to an assessment of effective-rely, then the amount of audit effort related to testing potentially hundreds of transactions and balance is significantly reduced. What this potentially could mean is that audit time spent in your primary ledger will be minimized. By segregating adjusting journal entries to an Adjustments Only Ledger, the auditors can focus on the adjusting journal process discretely with an emphasis on review and approval controls. In short, using a secondary ledger can avoid incurring additional audit effort.

Using Adjustments Only Secondary Ledger can help avoid circumventing the routine data processing controls, impeding system transparency, the likelihood of errors and incurring additional audit effort. However, the true power of Adjustments Only Secondary Ledgers is only realized when you begin using them in conjunction with a consolidation ledger or in Oracle EBS, a ledger set.

Solving the Problems of Adjusting Journal Entries Using Adjustments Only Secondary Ledgers and Ledger Sets – An Example

In general, most companies have good controls established around the routine data processing of transactions that flow up from the subledgers, such as accounts payable and accounts receivable transactions, but the same controls do not necessarily exist for manual journal entries. Instead, review and approval of journal entries is the most common control. But for any control to be effective, it is essential that the efficacy of that control is easily able to be monitored. When manual journal entries blend in with automated entries, such monitoring is impaired. Having a discrete, adjustments-only secondary ledger provides the ability to have only the routine, automated entries in the primary ledger with no manual journal entries allowed or needed. Then, any manual entries are booked to the Adjustments Only Secondary Ledger where they are easily monitored and have complete transparency.

Take, for example, the case of deferred revenue. A company books its sales as invoiced in the Accounts Receivable subledger. However, under GAAP rules, if the company had a service commitment for a period extending beyond the close of the reporting period, then an entry would have been made to defer part of the revenue or to reverse previously deferred revenue as income. This is a critical revenue recognition matter, and based on experience, one that your auditors will likely examine closely while testing revenue deferrals and also prior to making conclusions on the controls around revenue recognition. Prior to the Adjustments Only Secondary Ledger feature, analysis of the general ledger transactions had to be carried out to bifurcate the deferral entries from the automated subledger entries — a time-consuming process.

With the Adjustments Only Secondary Ledger, instead of booking the adjustments directly to the primary ledger, the adjustments are booked to the secondary ledger. For example, let’s say fictitious Company A determined that $120,000 in revenue needed to be deferred (revenue recognition deferral) because installation had not been completed (an open service ticket). With the adjustments only secondary ledger, if this was the only adjustment, the ledger would look like this: