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Chapter 3-Accounting & Bookkeeping

  Chapter Selections
Chart of Accounts
Cash or Accrual Accounting
Accounting Records & Recordkeeping
A Word about Computers
Internal Control
Illustrative Chart of Accounts

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Most operators of a new and growing business have a flair for the environment in which the business operates. They may be a great salesperson, an outstanding mechanic, carpenter, lawyer, or inventor. Unfortunately most people don't like to keep the books. As an owner of a business you must remember that your company's books and financial statements represent a score sheet which tells how you are progressing, as well as an early warning system which lets you know when and why the business may be going amiss. Financial statements and the underlying records will provide the basis for many management decisions and decisions made by outsiders such as banks, landlords, potential investors, and trade creditors as well as taxing authorities and other governing bodies. The necessity for good, well organized financial records cannot be over emphasized. One of the greatest mistakes made by owners of small businesses is not keeping good financial records and making improper or poor business decisions based on inadequate information.

Quality financial information does not necessarily translate into complicated bookkeeping or accounting systems. Far too often owners of businesses become overwhelmed by their accounting system to the point where it is of no use to them. An accounting or bookkeeping system is like any tool used in your business; it needs to be sophisticated enough to provide the information you need to run your business and simple enough for you to run it (or supervise the bookkeeper). Questions you should ask in developing an accounting and financial reporting system are:

  1. Who will be the users of the financial information?
  2. What questions do I need answered to manage the business?
  3. What questions should be answered for government or regulatory taxing authorities?

As your business grows, you should work closely with your accountant to ensure that your accounting system is providing you with appropriate information.

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Chart of Accounts

The basic road map into any accounting system is the chart of accounts. It is this chart which helps establish the information which will be captured by your accounting system, and what information will subsequently be readily retrievable by the system. This tool, like the rest of the accounting systems, needs to be dynamic and should grow as the size and needs of your business changes.

To help establish a good working chart of accounts you need to answer some questions, in conjunction with your accountant, as to how your business will operate and what is important to you. Some of these considerations might be:

  1. Will your business have inventory to account for? If so, will it be purchased in final form or will there be production costs?
  2. Are fixed assets a significant portion of your business?
  3. Will you sell only one product or service or will there be several types of business?
  4. Will you have accounts receivable from customers for which you will have to track?
  5. Are you going to sell in only one location or will you do business in several states?
  6. Are the products you sell subject to sales tax?
  7. Do you need to track costs by department?
  8. What type of government controls or regulatory reporting are you subject to?

Each one of these questions can have several answers and will probably generate more questions. Each answer will have an impact on how the chart of accounts is structured. It may seem that developing a chart of accounts is not particularly high on your list of things to do as you start a new business; the amount of time and money which a well organized accounting system may save you can be significant as the need to generate information for various purposes increases. An example of a basic chart of accounts follows this section.

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Cash or Accrual Accounting

One of the decisions to be made as you start a business is whether to keep your records on a cash or accrual basis of accounting. The cash basis of accounting has the advantage of simplicity and almost everyone understands it. Under the cash basis of accounting you record sales when you receive the money and account for expenses when you pay the bills. The increase in the money in "the cigar box" at the end of the month, is how much you made.

Unfortunately, as we all know, the business world is not always so easy. Sales are made to customers and you sometimes must extend credit. Your business will incur liabilities which are due even though you may not have received the invoice or have the cash available to pay them.

Most users of financial statements such as bankers and investors are used to accrual basis statements and expect to see them. Once you become familiar with them, they provide a much better measuring device for your business operations than cash basis statements.

Whether you use the cash or accrual basis, it is possible to keep books for income tax purposes on a different basis than for financial statements. It may be more advantageous (less tax) for you to do so. Your accountant can advise you on the advantages and feasibility of doing this in your particular circumstances.

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Accounting Records and Recordkeeping

Another question which the owner of a business must answer is "Who will keep the books of the business?" Will you do it yourself or out source it? Will the receptionist or a secretary double as a part-time bookkeeper, will you have a bookkeeper that comes in periodically, or will the volume of activity be such that a full-time bookkeeper will be required?

Very often the owners of a business decide to keep the books themselves and underestimate the commitment they have made to other phases of the operation and the time required to maintain a good set of financial records and books of account. As a consequence, the recordkeeping is often low priority and must be caught up later. This approach, though rarely planned, can require a substantial expenditure of time and money. While it is important for the owners of a business to maintain control and stay involved in the financial operations of the enterprise, this can be achieved by maintaining close control over the check signing function and scrutinizing certain records. Your company's accountant can help develop a good program of record keeping duties for you, your employees and any outside bookkeepers or accountants you may engage.

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A Word about Computers

The computer is probably the single most valuable invention for bookkeeping and accounting since the advent of double entry bookkeeping. If your business includes any of the following then a computer would be a useful tool in your business.

  1. Many repetitious or routine tasks
  2. Lots of paperwork; i.e., payroll checks, invoices, purchase orders, mailing labels.
  3. Lots of general correspondence
  4. Written reports, contracts, newsletters, catalogues or brochures.

The staff at Halcolm Bard CPA knows both your business and computers so they can take much of the confusion out of the selection process by assisting you in the purchase and installation of your computer.

There are a number of very good, easy to use accounting software systems which are commercially available, but none of them will solve the problems of inaccurate or poor quality financial records. All they will do is generate bad information faster. This is one of the reasons that the computer has also probably caused more headaches for the owners of modern businesses than any other single cause. If you want to use a computer based accounting package, either in your own business, with a service bureau or through your accountant, it is imperative that you generate accurate information to be entered into the system.

The real value of the computer becomes apparent once it is running smoothly in your business. Your accountant can then function in the capacity for which he was trained not as a "number cruncher", but as your business advisor, consultant, and strategist. Both of you can focus not on producing reports for various regulatory agencies but on analyzing your business to make it more profitable.

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Internal Control

What is internal control? It is the system of checks and balances within a business enterprise which helps to ensure that the company's assets are properly safeguarded and that the financial information produced by the company is accurate and reliable. When you're operating as a "one man shop" or at least handling all of the company's financial transactions, maintaining good internal accounting control is relatively straight forward.

However, when your company grows to the size where you must delegate some of the functions it becomes more difficult to ensure that all the transactions are being accounted for properly.

No matter the size of your business, you should always be able to answer "yes" to the following questions:

  1. When my company provides goods or services to our customers, am I sure that the sale is recorded and the revenue is recorded in accounts receivable or the cash is collected?
  2. When cash is expended by my company, am I sure we received goods or services?

The method used to ensure that these two questions can be answered affirmatively will be widely varied. They are essential stepping stones to maintaining good control in your business. The solution in your particular instance may be as simple as numbering the sales tickets and being sure all tickets are accounted for or reviewing all invoices and timecards before signing company checks. These are fundamentals in a well run business. As the company grows you will need to consider concepts such as segregation of authority as well as employee fidelity bonds or controlled access storerooms.

No matter what the size of your enterprise, you should consider controlling your business and safeguarding hard earned assets as a priority from the outset.

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Illustrative Chart of Accounts

Current Assets:

1110 Cash
1120 Temporary Investments
1130 Accounts Receivable
1139 Allowance for Uncollectibles
1140 Notes Receivable
1154 Interest Receivable
1170 Inventory
1190 Prepaid Rent
1191 Prepaid Insurance

Long-Term Investments:

1210 Land
1220 Investments in Bonds

Property, Plant and Equipment:

1310 Land
1320 Store Equipment
1329 Accum Depre-Store Equip
1350 Delivery Equipment
1359 Accum Depr-Delivery Equip
1360 Buildings and Impr
1369 Accum Depr-Bldgs and Impr

Intangible Assets:

1410 Patents
1420 Goodwill
1430 Organization Costs

Current Liabilities:

2140 Notes Payable
2130 Accounts Payable
2154 Interest Payable
2155 Salaries Payable
2160 Income Tax Payable
2170 Sales Tax Payable
2180 Withholding and FICA Tax Payable
2181 Federal Unemployment Tax Payable
2182 Pennsylvania Unemployment Tax Payable
2196 Deferred Income
2196 Deferred Income

Long-Term Liabilities:

2410 Mortgage Payable

Stockholder's Equity:

3510 Capital Stock
3511 Capital in Excess of Par Value
3610 Dividends
3650 Retained Earnings

Sales and Related Accounts:

4000 Sales 5170 Purchases
5178 Purchases Returns and Allowances
5179 Purchase Discounts
5200 Transportation In
5500 Cost of Goods Sold

Operating Expenses:

6001 Store Rent
6002 Advertising
6029 Depreciation Expense - Store Fixtures
6059 Depreciation Expense - Equipment
6070 Other Delivery Expenses
6080 Salesperson's Commissions
6090 Miscellaneous Selling Expenses
6501 Office Expenses
6511 Taxes, Other
6549 Bad Debts Expense
6555 Office Salaries
6585 Payroll Tax Expenses
6591 Insurance Expense

Other Revenue:

7010 Miscellaneous Revenue
7020 Interest Income

Other Expenses:

8010 Interest Expense

Income Tax:

8150 Corporate Income Taxes Federal
8160 Pennsylvania Income Taxes
8170 Pennsylvania Capital Stock/Franchise Tax

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  Links to other Chapters  

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2 - 
3 - 
4 - 
5 - 
6 - 
7 - 
8 - 
9 - 
10 - 

Chapter One - Selecting a Legal Entity
Chapter Two -Registering with Tax Authorities
Chapter Three - Accounting & Bookkeeping
Chapter Four - Payroll Taxes
Chapter Five - Selecting a Year - End
Chapter Six - Income Taxes
Chapter Seven - Cash Planning & Forecasting
Chapter Eight - Obtaining Credit And Financing
Chapter Nine - Insurance
Chapter Ten - Selecting Professional Advisors