Basics of Accounting
Many people want to do their own accounting and we could not be happier. Doing it right will be the difference between costly year-end accounting fees (for cleaning it up) or hefty fines (by the CRA for not being compliant of the rules). Doing right will give you the insights to your business and open lots of opportunity like strong financial reports when seeking financing, for instance.
WHO IS THIS FOR?
This is intended for the everyday user. The following is intended for educational purposes only as it is very general in natural. Consult a Chartered Professional Accountant.
KNOWLEDGE
Double-entry bookkeeping. This is the debits and credits. All transactions have two sides to an entry. Where the money comes from and where it goes.
Cash versus Accrual method. If you receive money right away and spend it right away, like a coffee shop. You are likely cash-based method. If you pay for something later, like a construction company. You are likely accrual-based method. Advantages and disadvantages.
Balance Sheet. A snapshot of your company’s assets, liabilities and equities.
ASSETS = LIABILITIES + EQUITY
Income Statement. Measures your net income over a period of time (usually a month or a year).
Income less Cost of Goods Sold equals Gross Income. Gross income less General and Administrative Expenses equals Net Income.
Fiscal year/period: Many businesses prepare their accounting records on a calendar year basis, with December 31 as their year-end date. Their fiscal year is the same as the calendar year. Some businesses prefer to have their year-end date coincide with a slow period in their business, so they may choose another date as their year-end. If they choose March 31, then their fiscal year, or accounting year, is April 1 to March 31. A fiscal period is normally 12 months, but may be less than 12 months when a business starts up.
WHY DO WE DO ACCOUNTING?
Our current favorite cloud accounting system, Quickbooks Online, asked the same question in their online website presentation.
See quick pointers about the Balance Sheet and Income Statements. This is a good piece for beginners to accounting.
MAJOR ACCOUNTING PRINCIPLES AND CONCEPTS
There are 10 fundamental accounting principles, we’ll start with three in this basic series.
Monetary unit assumption: All financial transactions should be recorded in the same currency.
Matching principle: Expenses incurred during a period be recorded in the same period in which the related revenues are earned. Businesses that use the accrual basis of accounting will report all financial information using this method.
Specific time period assumption: Financial reports should show results over a distinct period of time.
ASSETS
Generally the things you own and show up as a debit entry on the Balance Sheet.
Accounts Receivables are amounts owed by customers and found when you are using the accrual method of accounting.
Capital Assets are generally things you intend to use over a year or more and cost several hundred dollars and more. The big question is when you purchase something do you capitalize it or expense it?
And when you have capital assets, you will have contra accounts called accumulated amortization. Usually a good idea to look at Canada Revenue Agency’s Capital Cost Allowance (CCA) classes when setting up these contra accounts.
LIABILITIES
Generally, amounts you owe another party and will show up as a credit entry on the Balance Sheet.
Accounts Payable are amounts that you owe your vendor for instance, usually paid within a year, and are used under the accrual method of accounting.
Payroll liabilities hold source deductions for payment later, to Canada Revenue Agency.
Sales taxes payable hold federal and provincial sales (value add) taxes for payment later.
EQUITY
This part of the financial statement is the invested and residual money representing the company. It is generally in a credit balance on the Balance Sheet.
Owner’s equity usually represents money contributed by the owner for sole proprietor companies. Or common shares for incorporated companies.
Similarly, owner’s draw represent money taken out for sole proprietor companies. For incorporated companies, this is usually dividends paid out.
Retained earnings represents net profit (loss) less applicable federal taxes. in effect, the money left over from doing business.
REVENUE
Income you generate from your business will show as a credit entry on the Income Statement.
COST OF SALES
Also known as Cost of Goods Sold (COGS) for businesses that purchase and resale materials/supplies. When you sell an inventory item, the entry takes from the inventory account and debits the Cost of Sales (or COGS) account. These are just one type of “direct costs” and will have a debit entry on the Income Statement. Generally anything that is used directly to generate that amount of income is a direct cost. For instance, the paper cup and the beans, for the sale of coffee. And you will find that you can include the labour cost of the employee creating that cup of coffee.
OPERATING EXPENSES
Want to know what you can expense and reduce your business tax? In general, anything that you purchased to generate that business income. Really, it is that simple. Albeit there are special rules but there is far too many for the scope of this blog.
There are many operating expenses or “indirect costs” for us to get into here. Canada Revenue Agency has created a general list. Contact a Chartered Professional Accountant to help determine if it’s an expense you can “write off”.
COMPLIANCE
As a business you have the responsibility of keeping certain accounting records and for a minimum amount of time. Thankfully, electronic records are acceptable and the preferred method of retention!
