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The Most Wonderful Time of the Year – Accounting Clean-up Time!

Posted on November 28th, 2016

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

It’s that time again!  The taxes are coming due, and your books may have gone all year without being looked at by an accountant. If so, what many business owners don’t realize is that when your CPA or tax preparer takes your books to prepare your tax return, they are not performing an “audit,” so they are not providing any assurances to the IRS as to the underlying validity of the income and deductions you show on your books. They may make some obvious adjustments for tax purposes in their own tax software, but may or may not provide those changes to you to enter in your books.

Thus, whenever we review a client’s QuickBooks file, we look at it first from the viewpoint of a CFO / Controller to make sure the financials make sense (and for “book” purposes, not tax). Here are the types of things we look at before I send the financials to an outside CPA firm or tax preparer:

Balance Sheet – Pull it up as of December 31st, and create a comparison to the previous year, and check the following:

  • Bank Reconciliations – This is the starting point.  Make sure your bank accounts are reconciled to the bank statements. This tells you that you at least have accounted for all of your cash. Even if it’s not categorized properly, you can always correct the account classifications later.  Make sure that the “cleared” balance agrees with the ending balance on your bank statement.
  • Credit Card Reconciliations – If you track credit cards in QuickBooks, reconcile those the same way you would reconcile your bank account. Make sure all charges are entered and categorized, all payments are recorded, and that the “cleared” balance in QuickBooks agrees with the year-end credit card statement balance.
  • Negative Account Balances: (other than “Accumulated Depreciation,” “Retained Earnings,” and “Net Income”). Negative balances in any accounts other than these three indicate major accounting or set-up errors and need to be investigated and corrected. For example, common mistakes I’ve seen are setting up credit card or loans accounts as a “Bank” type account, or posting payments to accounts payable without first entering the bills.
  • Due To (liability) / From (asset) Stockholder Accounts:  Throughout the year, funds may be lent to the business by the owner (“Due To” account), or taken out of the business in the form of cash transfers or personal expenses (“Due From” account).  Care should be taken to make sure this information is accurate as these accounts affect your “basis” in the company.  For example, if you take money out of the business that exceeds your “basis,” it can cause you to pay more taxes even if your business had no income.
  • Inter-Company Loans: Multiple “company files” with extensive inter-company transactions, with no effort to reconcile and consolidate the financial statements.  The amount owed to Company A, “Due From Affiliate”(asset side), should logically equal the amount owed by Company B, “Due To Affiliate” (liability side).  If not, investigate and correct.
  • All other balance sheet accounts should be “tied out” to external documentation such as year-end statement balances, loan amortization schedules, etc. A common mistake we see is entire loan payments being posted against the loan balance or the Profit & Loss statement, rather than separating the principal and interest portion.

Profit and Loss – Account Classifications – After your bank accounts have been reconciled, the next step is to create a “detailed” Profit & Loss Statement report (or other accounting report) and do the following:

  • Salaries & Wages – Verify that they agree with your W-3 and W-2s.  If you do your own payroll, make sure it was done correctly and that “gross” salaries are just that, NOT your net paychecks.
  • Officer Salaries – If you are an S-Corporation, ensure that Officer Salaries are “reasonable” in relation to the business’ profit.  And note, what is “reasonable” is very subjective and something you should have discussed with your tax preparer before year-end, as this is closely monitored by the IRS and can trigger an audit.  Read More.
  • Meals & Entertainment are clearly identified.
  • Fixed Asset Purchases – Larger amounts, say over $1,000.00 (your tax preparer may use a larger threshold for tax purposes), should be posted to Fixed Assets on the Balance sheet, not the P&L, and clearly described in the memo field.
  • All other expenses are categorized where they belong and consistent with the prior year, which by now, should also have been adjusted to agree with the prior year tax return (except for book and tax differences).
  • Net Income – Ultimately, your prior year net income should agree with the “Net Income (Loss) Per Books” shown on your prior year tax return (Schedule M-1, line 1), as this is where your tax preparer will begin when preparing your current year taxes.

The above are just a few of the major items that need to be looked at, but these will go a long way toward achieving accounting accuracy.  Again, keep in mind that in the end, the burden of accurate reporting of income and deductions still rests with you – the business owner.


How You Use QuickBooks Can Distort Your Company’s Profitability

Posted on November 21st, 2016

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

As I’ve stated in several previous articles, business owners need to set up their internal accounting properly so that they know whether or not their company is profitable. Today, a large number of small businesses use QuickBooks, as it is heavily promoted as being a “user-friendly” accounting software, and you don’t have to be an “accountant” to use it. And both claims are true.  But as I always tell my clients, these “benefits” are also what make QuickBooks easy to abuse.

In QuickBooks, the key to accounting accuracy lies in the proper set-up of your Items List, Chart of Accounts, and Preferences.  How these are set up and managed in turn control how transactions affect not only what your “forms” look like, but also, the behind-the scenes accounting, and therefore, your profit or loss, the taxes you owe, and when.

Here are just a few examples I’ve seen of how companies can grossly distort their profitability:

  • Maintaining their books on a “cash basis” of accounting. In QuickBooks you can switch back and forth between accrual and cash-basis financial statements. Depending on your type of business, cash basis statements can grossly distort your profit margins, as you are analyzing your collections and disbursements which is a timing issue, NOT your profit or loss – apples and oranges.  Set your Preferences to Accrual.  If your tax return is prepared on a cash basis, most CPA firms have tools that can convert your accrual financial statements back to cash for tax purposes, and in their own tax software, NOT yours. (For more details on this subject, see my previous article, “Profit vs. Taxable Income”.)
  • Using “Non-Inventory Parts” to track inventory purchases.  As Non-Inventory Parts are usually pointed at a cost-of-goods-sold account, your costs may be posted in one month and your revenues in another.  This then causes your profit margins to be wrong in both accounting periods so that you can’t tell how you did in either one.  (Note: At times, for various reasons it may be preferable to use Non-Inventory Parts rather than Inventory Parts, but additional accounting adjustments are then required to get the revenues and costs into the same accounting period.)
  • Using “check” or “bill’ transactions to record inventory purchases in cost-of-good-sold, rather than tracking inventory using Inventory Parts.  Has the same effect as described above.
  • Entering a “Bill” to record a supplier invoice, and then paying it with a “check” transaction rather than the “Pay Bills” feature.  The expense has now been recorded twice.  This is a clear indication that the user does not understand how to use QuickBooks properly.
  • Entering a “Bill Payment” without first having entered a Bill – As Bill Payments affect the balance sheet account Accounts Payable, not the Profit & Loss Statement, the expense has not been recorded at all, and the account payable is now negative (which should never be unless your supplier has issued you a credit). This is another clear indication that the user does not understand how to use QuickBooks properly.

So it’s best to manage your books properly right from the start.  With my clients who do their own data entry, I try to make things as easy as possible by setting up “memorized transactions” for them to use on a day-to-day basis.  This helps keeps the accounting accurate and consistent, and removes all of the guesswork – as opposed to my client essentially having to learn “accounting” and QuickBooks’ unique method of accomplishing it (which some people find extremely frustrating and a non-productive use of their time).

There are numerous other examples I could mention, but the point is, many small businesses use their accounting software as a “checkbook,” thinking their QuickBooks accounting software is “miraculously” putting everything where it belongs behind the scenes – NOT TRUE!  As the old saying goes, “garbage in, garbage out.”  Sooner or later, someone has to clean-up the mess, and hopefully before tax time, or worse, the company is out of business.

In my next article, I will talk about various other indicators that your books are in desperate need of a clean-up.