Bookkeeping Basics
Bookkeeping
Why Learn Bookkeeping ?
Why would you want to learn bookkeeping and keep up to date financial records anyway ? Can't you hire an accountant to come after the end of the year and get your check book and shoe box and do your taxes ? Sure you can ! And yes you will have adequately fulfilled your taxpayer obligations.
But in order to run a business and know what, where, and when to take corrective actions requires business information. How do you get and where do you find this information ? You don't if you don't keep accurate and current records about your business financial activities (bookkeeping).
What is Bookkeeping & Accounting ?
Accounting is the art of analyzing, recording, summarizing, reporting, reviewing, and interpreting financial information.
Let’s also define what bookkeeping is and is not. I hate to admit this but I’m going to tell a true story about myself in high school. I thought I was fairly smart back in my high school days and took all the college prep classes. My high school offered bookkeeping classes but I had no clue as to what that course was about.
I thought bookkeeping was a course on how to properly organize and stack the reading books in the proper place and shelves in the library using that Dewey decimal code. That is keeping the books isn’t it ? Well kinda, but that’s not the bookkeeping you’re going to learn here. Bookkeeping is one of the components of accounting. Think of accounting as the mom and bookkeeping as one of her children.
Bookkeeping is the process of recording and classifying business financial transactions (activities). In simple language-maintaining the records of the financial activities of a business or an individual. Bookkeeping’s objective is simply to record and summarize financial transactions into a usable form that provides financial information about a business or an individual.
Accountants normally plan and set up the accounting and bookkeeping system for a business
and turn over the day to day record keeping to the owner or one of his/her employees. In this age of computers, more and more of the daily bookkeeping is being done using bookkeeping software and computers although some businesses still maintain manual records. Due to the reasonable cost of computers and software, I recommend an automated (computer) bookkeeping system. In order to illustrate and understand what is actually being recorded and summarized by a computer bookkeeping system (behind the scenes) my lessons will illustrate the manual method of recording a company’s financial information.
Users Of Financial Information
Who needs financial information about a business besides the owner(s) ? Users can be grouped into two broad categories namely internal users and external users. Internal users are the managers and the owners and employees who actually work for the business. External users include lenders and other creditors (suppliers), investors, customers, and governmental regulatory and taxing agencies.
Why do they need financial information ?
All users need this information to make knowledgeable decisions.
Owner(s) and managers need information in order to properly manage and run a profitable business.
Lenders and other creditors want to make sure that they will be paid back for the credit that they have extended to a business. By analyzing financial information, they at least have something to base their lending or credit decision on.
The days of the “friendly” banker are gone. You need to provide them with financial information as a basis for their loan decisions. A “good ole boy” handshake won’t cut it now.
Similarly, customers want to make sure that the business they’re buying products or services from is going to be around and not be in such a poor financial position as to have to close its doors.
Government and taxing agencies need information to monitor compliance with laws and regulations.
Other users have their own reasons for using this financial information.
Do you actually need to know how to do the bookkeeping ? No, unless of course you’re currently a bookkeeper or wanting to be one. Anyone in business; however, does at least need a basic knowledge !
Before we start our formal training, I need to present some preliminary information that you should be familiar with. The objective is to give you a little business background information before we dive right in to the lessons.
Types Of Business Organization
One of the first decisions that a person(s) needs to make is how the company should be structured. The four basic legal forms of ownership for small businesses are a Sole Proprietorship, Partnership, Corporation, and Limited Liability Company. There are advantages and disadvantages as well as income tax ramifications associated with each type of organization. We aren’t going to delve in to this area but a brief description of the different types of organization and what they are is needed.
Sole Proprietorship
Most small business start out as sole proprietorships. These firms are owned by one person who is normally active in running and managing the business.
Partnership
A partnership is two or more people who share the ownership of a single business. In order to avoid misunderstandings about how profits/losses are shared , who’s responsible for what, and other management, ownership, and operating decisions the partners normally have a formal legal partnership agreement.
Corporation
A corporation is an organization that is made up of many owners who normally are not active in the decision making and operations of the business. These owners are called shareholders or stockholders. Their ownership interest is represented by certificates of ownership (stock) issued by the corporation.
Two types of corporations:
Regular or “C” Corporation
Earnings are taxed to the corporation. Shareholders are not personally liable for income taxes unless dividends are paid.
Subchapter-S
A special type of corporation allowed by the Internal Revenue Service (IRS) that passes or transfers its earnings to the individual shareholders who personally pay the income taxes.
Limited Liability Company (LLC)
The LLC is a relatively new type of business structure that combines the benefits of a partnership and corporation.
Factors To Consider
Some Factors and a brief description of what to consider when choosing a type of organization:
Tax Consequences – Federal and State
What taxes do you have to pay to the federal and state taxing authorities ?
Is the business organization a pass-through (income only taxed once) or is the income taxed twice ?
Ease and cost of formation and recurring registration fees
What documents do you need to file and what are the initial and recurring costs for the
type of organization ?
Degree of control
Do you want to call all the “shots” ? As a sole owner you get to.
Liability (personal)
Do your personal assets need protection from legal liability ?
Are you willing to be liable for others (partners) ?
Ability to get money (capital)
Do you need other investors to get your business “off the ground” ?
Financial Statements
Do all the types of business organizations use the same rules and financial statements ?
Yes, they all use the same rules and the same financial statement formats with one exception. The Equity Section of the balance sheet for corporations. This is discussed in a later lesson.
Type of Business
If your type of profession requires a special license, is it limited to what type of organization that can be selected ?
All the different types of organizations listed above have some unique methods and rules for accounting for their transactions associated with their equity (ownership) accounts. This tutorial in order to keep it simple and since many small businesses start out organized as sole proprietorships will focus on bookkeeping for a sole proprietorship.
Types of Business Activity
Our society is made up of all kinds of different types of businesses.
Some sell products directly to the consumer and are known as retailers.
Other businesses called wholesalers warehouse and sell large quantities of products to the retailers who in turn sell it to us (consumer).
Businesses like myself provide and sell services to other businesses and individuals.
Some businesses even tackle the task of actually producing (make) the products and are called manufacturers.
Many of these businesses are required to maintain and account for inventories of the products that they stock or have on hand. Again this being an introductory tutorial we are not going to cover the practices and procedures used in accounting for inventories. That being the case, the examples in this tutorial will deal with a service type of business.
Accounting Period
Believe it or not, a business needs to select an annual tax year. Your two main choices are a calendar or fiscal tax year. A Calendar Tax Year is 12 consecutive months beginning January 1 and ending December 31. A Fiscal Tax Year is 12 consecutive months ending on the last day of any month except December 31. The calendar tax year is used by most businesses.
A reason a business might choose a fiscal tax year is that they could select an ending month for their fiscal year when business activity is low. This makes the process of what is called closing the books a little easier. Also if a business has inventories, there would be less they would have to count.
For us yanks, our Internal Revenue Service (IRS) has guidelines for what accounting periods can be used based on the types of business organizations such as a corporation, sole proprietorship, partnership, etc. Normally, choosing a calendar year is a safe choice.
In our next Section, we'll discuss the Types Of Bookkeeping Systems.
