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 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
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: 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, 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 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.
In the United States, if you have
employees you will have to report---and pay---employment taxes, which include
the following, Social Security, Medicare, Federal Income tax, and city or state
taxes (if applicable). 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 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.
Dear Student,
J.A. Blazer wrote this lesson for the
school in 2006. He has since passed away.
The basic bookkeeping format is still current, though the dates used in
the example are old.
My apologies to non-United States
students - some of the material in this lesson will not be pertinent. But the basic record keeping format may help.
There is no quiz or assignment for this
lesson. It is the last lesson of the course.
Best
wishes,
Eleanor
Blazer