Advanced Accounting

In the last of our foundational series business owner we build on the previous two pieces. It should be a quick read, intended more to highlight a few areas that we think needs your attention.

There is certainly more to accounting. Look to future pieces as we delve into several areas we’ve covered in this series and more!

WHO IS THIS FOR?

This is intended for a Controller role or higher. Or an owner or manager with previous accounting training. As a pre-requisite try this series’ 1 and 2 – of 3, both the basics and intermediate of accounting. The following is intended for educational purposes only. Consult a Chartered Professional Accountant.

KNOWLEDGE

Specific Chart of Accounts (COA). Standard Chart of Accounts may not fit for every business. Outside of common GL accounts like AR, AP, GST/HST Payable, and Sales, there are many more accounts specific to certain industries. Not only will these accounts be used differently they also inform how specific transactions are taxed (or not) at year-end. Some examples:

  • Holdback payable – for construction businesses

  • Customer deposits (or deferred revenue) – for manufacturing or design/engineering firms

  • Employee tips payable – for restaurant businesses

Designing and using the right GL accounts is importantly on an operational and taxation level.

Accruals. The online magazine, Entrepreneur, provides a good definition: “Accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged. The term “accrual” refers to any individual entry recording revenue or expense in the absence of a cash transaction.”

Adjusting and closing entries. With the use accrual accounting and the principles such as “matching” there comes the need to make adjusting and closing entries.

Wikipedia provides a good definition, as “adjusting entries are journal entries usually made at the end of an accounting period to allocate income and expenditure to the period in which they actually occurred.”

You may not need adjusting entries if the work of doing it outweighs the benefit you derive from monthly reporting. Adjusting entries are almost always necessary at year-end, though.

Similarly, Investopedia notes, “A closing entry is a journal entry made at the end of accounting periods that involves shifting data from temporary accounts on the income statement to permanent accounts on the balance sheet. Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year.”

Closing entries are necessary at year-end. Look for your external accountant (ie. Purpose CPA) to provide year-end adjusting and closing entries so that you start off the new year with correct account balances!

Trial Balance. One for the first reports to produce at period end (which is an unadjusted trial balance) as a way to preview all the transactions. This reports shows all transactions to all accounts, meaning you see both the Income Statement and Balance Sheet on this one report. A balanced trial balance report doesn’t always mean it’s correct! It’s the start of examining your accounts.

External accountants, including Purpose CPA, usually ask for this report at period end for multiple reasons including your year-end tax filing and for audits. Most times there are adjustments and accruals at period-end and preparing an Adjusted Trial Balance after is one step after an unadjusted trial balance.

MAJOR ACCOUNTING PRINCIPLES AND CONCEPTS

We’ve covered seven so far. Three more here for the last of this series.

Cost-benefit principle: An accounting principle that states that the cost of generating the financial data, system, report, or virtually anything about the accounting, usually should not outweigh the benefit of the action. We say usually because you should weigh the pros and cons of action.

For instance, if a customer short pays an invoice by a few dollars, say $2.00. The cost of trying to get the customer to that amount, in the form of multiple staff members taking several minute to make a phone call and if they are lucky, to then process the payment. In this case, it is usually better to forgo the $2.00 and credit the accounts receivable.

Full disclosure principle: As the name implies, it’s the responsibility of owners and managers to disclose all the information that relates to the function of the business in the notes accompanying the financial statements.

There may be legal ramifications for incomplete information and certainly for not disclosing everything.

Objectivity principle: the concept that the financial information and statements of an organization be based on solid evidence. The idea here is that the financial information is not biased by management or the producers of the data, and that the information has been assessed objectively.

ASSETS

In part two, we covered some of the common assets. Here, in part three, we will look at a few more common assets that are susceptible to errors.

Inventory. It’s the goods businesses require to sell and make a profit. But of practice of managing inventory and accounting for it can be a tremendous task.

The big question: Do you track and record inventory?

Balance the need for tracking it against the cost of doing so (Cost-benefit principle). And consider other factors, such as, some lenders may want to know how much inventory is on hand because it is part of a loan’s terms. Or management wants a system to control theft and shrinkage, as well as an ability to report and review it periodically.

When tracking inventory, consider two methods:

  • Periodic inventory: use LIFO, FIFO, or weighted average value at the end of every period. May be easier to value if you have large and lower quantity of inventory to track. a bar code type system could help but not necessary.

  • Perpetual inventory: determines the value after every transaction. Requires a robust inventory management system using things like bar codes or RFID and trained staff to account for all inventory coming and inventory going out.

When tracking inventory is a high priority, such as in the case for e-commerce, a perpetual inventory system may prove to be best.

Work-in-Progress (WIP). Partially finished goods in production. It can be the raw materials, labour, and overhead costs for products that are in various stages of the production process. WIP is different than a finished good – the latter referring to a product that is ready to be sold to customers.

The same question applies: Do you track and record this category of asset?

The same to inventory applies. You must consider many factors to determine whether the benefit of tracking and reporting WIP outweighs the cost. Most mid to larger manufacturing companies will track WIP.

Minimizing WIP inventory before reporting is both standard and necessary since it is difficult to estimate the percentage of completion for an inventory asset.

Investments. Excess cash is best saved for raining day. Plus, you want to put it to work if you do not have other value generating options in the company.

A company can put into passive investments such as GICs, or index funds, or other vehicles. This is where it can get complicated. Accounting for investments is like accounting for your chequing and credit card accounts. You want to reflect what is happening with the investment accounts on your books.

Plus, new 2018 Budget rules surrounding passive income, add to the consideration of holdings investments in a business that is ordinarily in a different (not primarily trading in investments, etc.). Consult your Chartered Professional Accountant.

REVENUE

Work-in-Progress (WIP). We talked about work-in-progress above (assets) mostly for manufacturing type businesses. WIP is also an issue for the revenue category of transactions too. Designated professionals (defined as accountants, lawyers, dentists, doctors, veterinarians and chiropractors) should be aware of rules around WIP income.

OPERATING EXPENSES

Cash over/short. Or reconciliation discrepancy account. Especially useful when balancing out a transaction that is short or overpaid by a few cents or dollars! Meets the cost-benefit principle mentioned earlier because sometimes it may not be worth calling the customer for underpaying $1.00 on their invoice.

Company functions. Large company functions such as a Christmas dinner or a company-wide general meeting can incur large expenses. Unlike general meals & entertainment (where only 50% is tax deductible), there is a limit of six such events per year.

If you have this sort of function planned for your company, use a separate GL account and remember to retain all the records including invitation slips as there is a requirement for all employees to attend.

Rent or lease. Writing this article during the COVID-19 pandemic has forced many people to work from home. Employees may deduct eligible portion of a home office expense, if it is “required by the contract of employment”, if its not reimbursed by an employer, and if the employer can sign off a CRA Form T2200. There are more conditions to consider so please contact your Chartered Professional Accountant.

Another rent or lease situation is when a main operating company sells a real estate property it owns to a holding company and then leases the same property (from the holding company). There are many considerations such as the sale of the property (with any resulting capital gains or losses), the adjusted cost base (of the acquired property in the new holding company), and all the sales taxes. This is a brief preview of such a transaction and not meant complete in any means. Please consult your Chartered Professional Accountant.

OTHER INCOME AND EXPENSES

Ask your accountant. This is a common GL account to book any transactions with uncertain tax treatment or how to appropriately book complex transactions (ie. sale of portion of a capital asset with a portion as sales credit). For those uncertain about their accounting we suggest using this account. It can be a way to review a transaction and a learning opportunity.

COMPLIANCE

DO NOT DELETE TRANSACTIONS. We see a lot of reconciliation troubles simply because there are no policies or controls to prevent the deletion of transactions. Several considerations to avoid deleting transactions:

  1. Set an alert in your accounting system when users try to delete transactions.

  2. Close your books with an administrative password to prevent deletion of records in past periods.

  3. Set an administrator lock on transactions deletions, meaning a manager will need to provide a password before deleting.

  4. Have a written and enforceable policy when accounting users wish to modify a past transaction that has a hierarchy of thresholds. Such as any transaction less than $20.00 that is verifiably incorrect, for instance, can delete with a manager sign off and a printout of the questionable transaction as record.

  5. Instead of deleting transactions, most of the time can use a series of counter transactions to reverse the questionable transaction. The key is to retain a trace history of the transaction all the way back to the transaction that is in question.

  6. Instead of deleting a transaction, use void where possible.

SUMMARY

Our accounting series 1 to 3 is a general overview of most of the accounting that goes into any business. Most of it is applicable whether you are a sole proprietor or an incorporated entity. Some of it is only applicable for incorporated businesses (ie. shareholder loans GL account).

There is a lot to cover in the short span of a blog and so this may not be entirely appropriate for your organization type (for instance, if you’re a non-profit that uses fund accounting).

There will be more blog posts about accounting. As we dive into many of the areas we presented here as well as new ones.

We wanted to highlight some common areas of trouble and how to go about it the right way. Accounting principles and concepts may allow for one business to account differently than another business. A strong and complete understanding, coupled with years of experience, will help you achieve compliance for your business so please contact a Chartered Professional Accountant.