What it means
Every business reports results for a period such as a month, quarter or year. Transactions do not neatly respect those boundaries, because goods are shipped on the last day of the month, invoices arrive late and services straddle two periods.
The cutoff point is the rule used to decide where each of those items is recorded. For sales, the cutoff usually turns on when control of the goods passes to the customer, which depends on the delivery terms rather than on when the invoice was raised.
For purchases, it turns on when the goods or services were received. A shipment that leaves the warehouse at 11pm on the last day with delivery terms that pass control only on arrival belongs in the next period.
Auditors test cutoff carefully because it is one of the easiest ways to move profit between periods, whether by mistake or on purpose. They look at the last few days before and the first few days after the period end, and trace sales, receipts and invoices back to the delivery documents.
Management teams that are chasing a target can be tempted to record next month's sales early. Outside accounting, the same phrase is used for any threshold that separates one group from another.
A lender may set a credit score cutoff below which applications are declined, and an investment committee may set a minimum return cutoff for projects. The idea is the same: a pre-agreed line that makes the decision consistent and defensible.
The nuance is that a good cutoff is both clear and applied consistently. A rule that changes from one period to the next makes results hard to compare, and a rule that no one documents invites disputes.
Written cutoff procedures and a close checklist solve most of the problem.
In practice
Real-world examples.
Example
A manufacturer ships a large order on 30 June under terms that transfer control on delivery, which happens on 3 July. The sale must be recorded in July, and the auditor finds it was booked in June. The correction lowers half-year revenue and the sales manager's bonus calculation.
Example
A marketing agency receives a supplier invoice for $14,000 of advertising that ran in December but arrives in January. The accountant accrues the cost in December so that the year-end expenses are complete. Without the accrual, December profit would have looked $14,000 better than reality.
Example
A bank sets a credit score cutoff of 650 for an unsecured personal loan product. Applicants at or above the cutoff go to automatic approval, and those below go to manual review. The risk team reviews the cutoff each quarter against actual default rates.
Formula
Calculation
Corrected revenue = reported revenue - revenue recorded early (goods delivered after the cutoff date)
Suppose a distributor reports revenue of $2,400,000 for the year ended 31 December. A review finds that goods invoiced at $180,000 were dispatched on 2 January, so they belong to the next year. Corrected revenue = 2,400,000 - 180,000 = $2,220,000. If those goods cost 60% of the sale price, cost of sales was also overstated by 180,000 x 0.60 = $108,000, so profit was overstated by 180,000 - 108,000 = $72,000.Case study
Seen in the real world.
Harbourline Foods is an illustrative, fictional wholesaler that was preparing for its annual audit. In the last week of the year the sales team pushed hard to hit a revenue target, and several orders were invoiced on the final day even though the trucks left in the first days of January.
The auditors tested the last ten days of sales against the dispatch records and found six invoices worth $310,000 that had been delivered after year end. The finance director agreed to reverse them, which pushed the company just below its revenue target and triggered a conversation with the bank about a covenant.
The illustrative outcome was a written cutoff procedure, a dispatch-date check in the month-end close and a rule that invoices are generated only when goods leave. The next audit passed without adjustment.
Watch out
Common mistakes.
- Recording a sale on the invoice date when the delivery terms say control passes to the customer later, which pulls revenue into the wrong period.
- Forgetting to accrue costs for services received before the period end but invoiced afterwards, which overstates profit.
- Changing the cutoff approach from one period to the next without disclosure, which makes results impossible to compare.
Questions
People also ask.
How many days around the period end should be tested?
There is no fixed number, but reviewers commonly look at several days either side of the period end and extend the window if they find errors.
Does cutoff matter for cash as well as profit?
Yes, because bank receipts and payments dated either side of the period end affect the cash balance and any bank reconciliation.
Is a cutoff point the same as a deadline?
Not quite, because a deadline is when something must be done, while a cutoff point is the line that decides how something is classified, although a close timetable often sets both.
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