REALLY,
REALLY SIMPLE ACCOUNTING
By J. M. Blazer
As a stable manager, you may be
asked to do the bookkeeping…the following is a simple bookkeeping system for
your use. There is no quiz with this
lesson…you will be tested often enough as you learn all the steps of bookkeeping.
More
than 18 million people are running their own businesses. Millions more are considering it. In 2005, these sole proprietorships accounted
for $969 billion in revenue. If you are
starting your own business, you are going to add to those numbers.
All
of these entrepreneurs need to keep records.
Why? Because
the Internal Revenue service says so.
“Your records must be permanent, accurate, complete, and must clearly
establish your income, deductions, credits, and employee information”.
The
law requires records, but the law doesn’t require you to keep your records in
any particular way. Nor does it tell you
how to run your business.
Of
course you want to know how your business is doing. So for your own enlightenment, you must have
some understanding of the bookkeeping.
This booklet will help you with that, but it is NOT going to even
attempt to make you a bookkeeper or accountant.
In
fact they would be very foolish if they did.
This booklet tells you what you need to know, and nothing more, so you
can spend your time growling and improving your business, not doing
bookkeeping.
You’ve
heard of debits, credits, left, right, increase, decrease. And you know of profit and loss statements,
balance sheets, income statements, and statement of condition.
Forget
about them. All you need to know is
whether you had a profit or loss. This
system will show you that, as often as you want.
BANKING
Bookkeeping
is only the recording phase of accounting.
It accumulates the data needed to prepare financial reports. Good records are needed for good
management. You will need to know what
your receipts and expenses actually are.
In some cases, it could be important to know the type, or source of
revenue. You must decide if it is
worthwhile to provide certain categories and classifications.
Accounting
is analyzing, interpreting, summarizing, and reporting the information that has
been gathered. This helps in planning
and making decisions.
First,
you should have a separate bank account for all your business transactions. It is not required, but it is sure
easier. It makes sense not to mix your
personal and business receipts and expenditures. If you make any money at all, you are going
to pay taxes on it. So don’t have a mess
at the end of the year trying to separate taxable income and deductible
expenses.
Don’t
pay by cash if it can be avoided, but if absolutely necessary,
be sure you get a paper receipt. Don’t
use a credit card, it fouls up your records because
the statement is always a month later than the transaction. But if you must, get a card for the business
only, and keep it that way---business purposes only!
Don’t
write checks to yourself or to “cash”.
Don’t write any checks until you have some type of bill, voucher, or
receipt to verify its business purposes.
If you don’t have one, and can’t get one, and still have to write the
check, then make your own voucher on a blank sheet of paper. Remember, to be deductible as a business
expense, an expenditure must be “ordinary and necessary, and directly connected
to your business”.
Copies
of invoices you send to customers and that have been paid by the customer, bank
deposit tickets showing the checks you have received, are all verification of
your receipts. The bills, invoices,
statements that you have paid, are verification of your expenses. These are called “documents of original
entry”, but you don’t have to remember that.
All
small businesses should be on a “cash basis”.
That means revenue is recorded when you actually receive the cash. So there is no need to “Accounts Receivable”
or “Bad Debts”. Charging off bad debts
is eliminated. You will have bad paying
customers, but they will never get into your books until they do pay.
ACCOUNTS
What
is an account? An account is a name we
give to a grouping of the same or similar transactions. For instance, payment of rent creates a “Rent
Account”. Your checkbook is your Cash
Account, and you should keep it up to date and balanced. But as we are only interested in revenue and
expense here, leading to the determination of profit or loss, we won’t be using
a cash account here.
By
naming the account, we know where to allocate, or assign, the similar items and
transactions. Besides depositing the
receipts, and paying the bills, you need to keep these documents some place in
an orderly fashion. Get file folders at
any stationery store and label them for the types of receipts and expenses that
you will have.
After
you have properly recorded the transaction, all the paperwork generated by that
transaction will go into the appropriate file folder. Thus your supporting
documents, or “backup” will be readily available when necessary.
You
may set up an account (that is, name it), then never use it. Obviously we don’t want that. Only when you think you are going to have a
lot of the same kind of transactions, start an account for them. But seldom occurring events can be combined
under one comprehensive title. For
receipts, “Sales” can cover everything.
Only if it is absolutely necessary to know, would you divide it into the
different type of sales.
For
expenses, the
If
you stick to the
RECORDING
Now
you need a place to list all the transactions affecting your newly named
accounts. You list them in chronological
order, total them at the end of your accounting period, and you will know
exactly how much you received and how much you spent. Your accounting period can be any length of
time you want---a day, a week, a month, a year. From now on, we’ll assume an accounting
period of a month, because that is the norm, and we’re keeping this
simple. At one page a month, twelve
pages equal the year. For the same
reason, avoid using a “fiscal year”; a calendar year is just fine, even if your
business is seasonal.
The
best thing for this listing is a columnar pad that you can obtain at any
stationery store. This is a pad
containing vertically and horizontally lined sheets. The horizontal lines are called rows, and the
vertical lines are called columns. Be
sure the pad you get has at the very least 32 rows, and at least
Put
a name or label at the top of each amount column, corresponding to the labeling
of your file folders. For instance,
column 12 could be “Sales”. If
absolutely necessary to separate categories of revenue, you could use two or
three columns. Draw a wide vertical line
between revenue and expense columns, to help avoid mixing them up. Now label as many expense columns as you need
for the different types of expense, according to your naming of accounts.
From
the bills, checks, and receipts you have obtained with each days transactions,
you enter the amounts in the proper column on that day’s row. According to the need and nature of your
business, you may need more than one row, but by combining the similar
transactions and entering totals, you can keep the use
of rows to a minimum. That’s why we want
more than 30 rows for 30 days. Each row
could contain a single transaction or many transactions. Explanation of entries can be used, but is
not really necessary. Remember, if you
have a question or need to verify an entry or amount, go to the file folder for
the original receipt or bill.
At
the end of the month, total all columns.
Combine the revenue column totals, if more than one,
and this is your total revenue. Combine
the totals of the expense columns. The
revenue total, minus the expense total, is your gain, or profit. Or loss, if the expenses
came to more than the revenue. By
adding each sheet’s (or month’s) totals you obtain the revenue and expense
totals for the year, and these totals transfer right to the same named lines of
the
In
addition, all totals can be carried forward to the next months
sheet, combined with that month’s business for an accumulated accounting of how
you’re doing.
If
your business requires that you keep inventories of products you sell, then you
will need to know what the products you sold cost. Mainly because the
It’s
not as complicated as you might think.
Make a count of all the product you have on
hand. Calculate the cost of the total
amount of product, that will be your “Beginning Inventory”.
On
your tabular sheets you will need to have separate columns for Purchases,
Labor, Materials and supplies. They will
be included along with all the other expense accounts in figuring your monthly
revenue, expense, and gain and loss.
But
at the end of the year, totals of these accounts will be separated for tax
purposes. On the back of Schedule C is
the format. On Line 35 is the beginning
inventory. Line 36 Purchases. Line 37, Labor, if you had any. Line 38, Materials. Line 39, we skip, because we don’t want to
explain what the “Other costs” were. If
you had any, they would fit in one of the other categories anyway. And these costs up on Line 40, calculate the
inventory at the end of the year, and subtract on Line 41, and you will have
your Cost of Goods Sold on Line 42.
Carry
that forward to the front of Schedule C, Part 1, Line
4. Subtracted from Gross Receipts, Line
1, gives you the Gross Profit on Line 5, and if nothing is on Line 6, the Gross
Income on Line 7. All your other expense
columns are deducted in Part II to arrive at your Net Profit or Loss.
The
key here is correctly figuring the values of inventory. Assuming the beginning inventory is correct, understatement
of the inventory at the end of year will increase the cost of goods sold, and
thus incorrectly reduce your gross profit.
Conversely, an overstatement of inventory will reduce the cost of goods
sold and thus falsely increase your gross profit. Any error will be compounded because the
ending inventory of one year is carried over to the next year as the beginning
inventory, thus the profit or loss will be misstated for two years.
Naturally,
the net profit will now be different from the profit or loss as figured on your
columnar pad, the difference being the result of any change in inventory
values, less the totals of the three columns that were used to calculate cost
of goods sold.
Click here for a link to
the IRS form: 2006 Profit or Loss from Business Schedule C (Form 1040)
Click here for the
instructions on how to fill it out.
DEPRECIATION
Depreciation
is an annual deduction allowed to recover the cost of business property having
a useful life of more than one year.
Depreciation starts when the property is first placed in service. Recognizing that recovering the cost of
property is an incentive to investment, thus stimulating the economy,
government has become more and more lenient with depreciation.
There
are several different methods you are allowed to use. You calculate it yourself, using one of the
methods according to your needs.
“Straight Line” is merely dividing the cost by the number of years of
useful life. “Double Declining Balance”
allows a much larger amount to be taken the first year, smaller amounts in the
later years. But you can’t deduct a full
year’s depreciation if the property was placed in service after March, because
of Mid-Quarter and Mid-month conventions.
Get the instructions from
Rules
are much different for “Listed Property”.
Listed property is simply property this is not used 100% for
business. For instance, if you have a
truck you use in your business, but also go to the grocery store in it, you
technically have listed property, and that requires a whole lot of
figuring---mileage records, dates, times, percentages, etc. We don’t want that. So get another car, use that for personal
trips, and then you have a legitimate claim that the truck use is 100%
business.
Fortunately,
There
is also an income limit which limits the deduction to the taxable income of the
business, or the taxable income from all businesses combined, if more than one.
Two other restrictions, the property must have been purchased, and the
deduction can only be taken in the year of purchase.
In
your favor, you don’t have to deduct the full cost of the property. You can claim a portion of the cost and
depreciate the rest. This gives you a
break if the income limit applies, or if you already
have enough expense for this year and want to save some deduction for next
year.
You
won’t need a column for depreciation on your sheets. You will figure it out at the end of the
year. Then subtract it from the gain as
calculated on your sheets for the year.
Or add it to a loss. Then your
column sheet gain or loss will be the same as on Schedule C.
DEPRECIATION
COMPUTATION
2001 Dodge Pickup
truck, Horse Trailer Hitch Installed
Placed in service,
Modified Accelerated Cost Recovery System
(MACRS) Straight Line
Business investment use, 100% GDS recovery period, five
years.
Mid Quarter Convention applied
Cash Price $18,477.22
Less:
Trade in old truck 2,200.00
Balance to be depreciated $16,277.22
2001 Depreciation, per Pub. 946
table 2.5% $
406.93
2002 Depreciation 20% 3,255.44
2003 Depreciation 20%
3,255.44
2004 Depreciation 20%
3,255.44
2005 Depreciation 20%
3,255.44
2006 Depreciation 17.5
2,848.51
Total
Depreciation Allowable $
16,277.20
Click here for a sample of
the 2006 IRS form 4562 Depreciation and Amortization.
Click here for instructions
on how to fill it out.
EMPLOYEES
To
be deductible, an employees’ pay must be an ordinary and necessary business
expense. In addition, it must be
reasonable, be for services actually performed, and incurred in the tax year.
You
cannot deduct your own salary or any personal withdrawals you make from the
business. You are NOT an employee of the
business.
If
you have employees you will have to report---and pay---employment taxes, which
include the following, Social Security, Medicare, Federal unemployment, and
State employment. Besides employer
taxes, you also have to obtain from each employee a W-4 form and withhold their
taxes from pay and, in turn, pay that to the Federal and State agencies. Reporting periods are monthly, quarterly, and
yearly.
To
do it properly, you should also have a third bank account just for payroll and
to accumulate payroll taxes. The amounts
you owe, and the amounts you withheld from the employees IS NOT YOUR
MONEY! More businesses have failed
and/or been charged with crimes over mixing and using this money for their
business needs. For this bank account,
get a special checkbook with payroll stubs for you and the employee. And you’ll have to have a special payroll
journal, with sheets divided quarterly for each employee, and a summary sheet,
to record each payday, total quarterly, and again yearly, to furnish the state,
the
Does
it sound complicated? Well, it is. And it has no place here, or in a small sole
proprietor business. So avoid employees
as long as possible. There are several
ways to do that.
Independent contractors.
Be sure you have justification when defining help as independent
contractors, not employees. There is not
problem if the help you get is from a professional
company. In some businesses, such as
agriculture, you can use transient and casual workers. If you can show that this practice is
prevalent in your industry, you can even use the same person practically and
exclusively and still be perfectly legal.
An example would be jockeys and grooms at a horse race track.
Temporary employee companies. They send the employee when you want him (or
her), for as long as you want. You pay
them, and they pay their employee.
Staffing companies. Similar to temporary help companies, but more of a permanent
assignment. Their company is the
employer, and takes care of the wages and taxes.
Any bookkeeping or accounting service. They take care of the payroll and taxes for
you. And any other service you want.
Your spouse. As part of the joint enterprise, not an employee.
In
any event, you should not be spending your time with such mundane, time
consuming work. You’re the boss, the
entrepreneur!
SELF
EMPLOYMENT TAX
Don’t’
think that because we’ve kept everything simple, and avoided tax complications
wherever possible, that you’re home free.
The
The
Form SE is what you use to figure that tax.
It has line by line instructions, so it is fairly easy to complete. When the final figure is reached---the tax,
on Line 5---it is carried over to the Form 1040, Line 56.
There
is another little gimmick that sounds good, like they
are giving you back one half of the tax.
Not so.
When
you have figured the tax and carried it forward to the Form 1040, there is one
more line, Line 6. This line has you
take one half of the tax and carry it forward to Line 29 on the Form 1040.
But
this line is not a reduction in tax. It
is merely a credit against gross income.
Thus, if the SE tax was $200, your income would be reduced $100. As the first $12,000 of income is taxed at
ten per cent, this results in a $10 reduction in tax, not $100.
Click here for a sample
of the 2006 IRS form 1040 Schedule SE Self-Employment Tax.
Click here for
instructions on how to fill it out.
Please
consult a certified public account for advice.