Grasping the basics of keeping the books
By Cora M. Barnhart • Bankrate.com

Aug. 12, 1999 -- It is tough to think of anything less appealing about being your own boss than setting up the bookkeeping system for a business. Using a computer system and hiring a full-time bookkeeper seem like obvious ways to avoid this headache.

However, in the eyes of the IRS, business owners are ultimately responsible for any taxes owed by their businesses, regardless of what a trusted tax professional or computer program has done. This tax tip explains some of the basics that business owners need to understand when it comes to keeping the books.

Joys of Accounting 101
It's hard to tackle the topic of bookkeeping without reliving the horrors of a college accounting class. However, as the self-help center at nolo.com emphasizes, remembering the two basic goals of accounting serves as a great incentive for tackling this job correctly. First, accounting tracks the income and expenses of a business, enhancing its potential for generating a profit. Second, a business owner who carefully collects this information will already have what he needs when it is time to file tax returns.

Single- or double-entry
As the tip concerning record keeping explains, a business owner must decide whether to use a single- or double-entry bookkeeping system. Single-entry systems are the easiest to maintain. The first step involves composing an income statement. This financial statement totals income and expense sources over a given period of time. The statement must clearly spell out whether the company is making a profit or loss. A business owner using this system records income and expense flows. He also summarizes cash receipts daily and cash receipts and disbursements monthly.

The prospect of a double-entry system can be intimidating -- especially to new business owners who still have nightmares about that accounting class they took in college. Double-entry systems are more complicated to setup and maintain for two reasons.

First, a business owner has to initially record a transaction in a journal and then post it to a ledger account. Journals are a record of each business transaction in the business' supporting records. Ledgers contain totals from all of the journals and are organized into different accounts. Owners usually set up accounts for:

• Income
• Expenses
• Assets, which are resources owned by the firm.
• Liabilities, which are claims to resources owned by the firm.
• Net Worth, which is the difference between assets and liabilities.

Income and expense accounts are closed at the end of the tax year. The other accounts remain open permanently.

The second reason double-entry systems seem more complicated is that they require the business owner to record every transaction in an account as a debit on the left side of the account and as a credit entry on the right side of the account. The extra hassle does provide an advantage, though. Records with this system are more likely to be accurate because they are self-balancing. Once journal entries are posted to ledger accounts, total credits should equal total debits. These totals won't balance when there is a mistake. Books that won't balance should tip off the business owner to a blunder that needs to be corrected.

Doing it by computer
These days, more and more business owners are deciding to use computer software programs designed for keeping business records. It is easy to understand the appeal. They are easy to use, requiring very little experience in accounting or bookkeeping. They can also be practical -- finding old business records can be easier on a computer than it would be in an attic or a garage.

Regardless of the computer package selected, it should produce a paper trail of clear financial records, similar to the trail that would be produced if keeping the books by hand. Make sure the program will produce records used by the IRS to determine tax liability.

If a business owner decides to go the computer route, he still needs to maintain a paper record. It should describe the chores performed by the computer program and the program's procedures. The document should spell out any special procedures the business owner has put in place to ensure accurate processing. It is also a good idea to list any steps that have been taken to prevent unauthorized people from altering the computer records.

PC business programs deductible
Still on the fence about keeping business records with a computer program? It might help to know that the expense is probably going to be deductible. According to the self-help center at nolo.com, business owners generally must depreciate any software they purchase for their business over a 3-year period.

There are three exceptions to this, though.

First, does the software have a useful life of less than a year? Deduct it as a business expense in the year it is purchased.

Also, if the software comes with a computer and the invoice doesn't separate this cost, the IRS will consider it part of the computer's hardware. This means it should be depreciated over five years.

Finally, if the entire computer system, including bundled software, has a total cost of less than $19,000, it can be written off under Internal Revenue Code Section 179. This is a special provision that allows business owners to fully expense tangible property in the year it is purchased.

-- Posted Aug. 12, 1999