really, really simple accounting

REALLY, REALLY SIMPLE ACCOUNTING

By J. M. Blazer

More than 18 million people are running their own businesses.

Millions more are considering it. In 2003, 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.

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




2006 Depreciation 17.5 2,848.51

Total Depreciation Allowable $ 16,277.20

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.

really, really simple accounting

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