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 AND FILLING

 

          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 IRS has been gracious enough to name several accounts for us, and in alphabetical order.  Use them, but only the ones you really need.  “Advertising” is the first listed on Schedule C, but if you don’t do any advertising, don’t use it.  Try to keep your accounts to not more than five or six.  You can combine many expenses under one title, like “Advertising” if you don’t do much, “Bank and service charges” and “Dues and publications” can all go into the “Office expense” account.  “Legal and professional services” is another account that could cover a myriad of expenses.  After all, it doesn’t really mater what you call it, as long as it is a legitimate expense.  And “Supplies”, that covers everything.

 

          If you stick to the IRS titles, the Schedule C will be an absolute snap to complete.

 


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 12 amount columns, plus an explanation or description column.  (See sample sheet)

 

 

 

          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 IRS Schedule C., and that tax form is done.

 

          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.

 


COST OF GOODS SOLD

 

          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 IRS wants it that way.

 

          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 IRS Form 4562.  They are very helpful, providing tables for the proper deduction and useful life.  After you have figured it, the amount is entered on Form 4562, in the proper section, then transferred to Schedule C as an expense.

 

          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, IRS has provided a solution that makes it very simple.  It’s called “Section 179” property.  This allows you to deduct the entire cost---within limits, of course.  The dollar limit for an ordinary small business sis 2002 was $24,000.  For 2003, so far is $25,000 and is expected to increase to $27,000, and will probably continue increasing in subsequent years.

 

          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, October 6, 2001

 

 

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 IRS, and the employee with a W-2 form.

 

          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 IRS has another little trick you can’t avoid.  If you made $400 or more, they want their cut.

 

          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.

 

          Click Here to take the final quiz and assignment for this course.

http://www.equinestudiesinstitute.com/quiz/roleandresponse/final_quiz.html