When starting up a new business many business owners are unclear on the different bookkeeping systems and methods available to them. It is important to determine which system and method will work best for your organization. This will ensure you are properly accounting for the organization’s income and expenses.
When referring to a bookkeeping system I am referring to how you will track your income and expenses. There are two methods available to use: Single entry and Double Entry. The single entry method is the simplest method and is what most individuals are used to using in their personal checkbooks. This method allows for only a single line to be entered for each transaction which means that while you are tracking income and expenses you cannot track the values of each. Using the single entry method is sufficient for income and expense detail for tax purposes but lacks enough detail for other areas. Generally this system is not sufficient for businesses. The single entry system of bookkeeping does not allow for:
- Tracking of accounts payable (liabilities) and accounts receivables (assets)
- Showing an accurate picture of the organization’s financial position (balance sheet)
- Errors may only be discovered through the bank statement or undetected altogether
The preferred system for bookkeeping is the double entry system. The double entry system provides built in checks and balances, more accurate record-keeping, and is self-balancing. This system also for: an accurate calculation of profit and loss, the inclusion of assets and liabilities to the books, and preparation of financial statements directly from the accounts. Each time an entry is made using the double entry system two accounts are affected. One entry is a debit to an account and the other entry is a credit to a separate account. For example is you received funds for your services the transaction would look like this:
The other key decision for your businesses bookkeeping and accounting is if you want to record your transactions on a cash basis or use the accrual method. The cash method is often used by start-up businesses. In this method income is reported in the year it is received not the year in which it is earned. For example, if you receive income in January for services performed in December this income is recorded in January not the previous year. This is also the same with expenses the organization incurs. If you pay in January for services performed in December this expense is recorded in January not the previous year.
Under the accrual method the income and expenses are recorded when they are incurred rather than when they are paid. So taking the examples above the income received in January would have been recorded in December as an accounts receivable and the expense incurred in December but paid in January recorded in December as an accounts payable. This method allows a business to have an accurate picture of what income is or will be coming in and what expenses are or will be coming out. A company must choose the accrual method when:
- It has sales of more than $5 million per year, or
- The business stocks inventory of items that will be sold to the public and gross receipts exceed $1 million per year. Inventory includes any merchandise you sell, as well as supplies that will become part of the item(s) to be sold
Starting up a business is fraught with various decisions that must be made that will impact the organization’s future activities. Two such sets of decisions are what bookkeeping system and what accounting system to use. Businesses are able to choose the single entry or double entry systems for bookkeeping. The simplest method is the single entry but the double entry provides more accurate record-keeping and a greater ability to detect errors. When choosing an accounting method the organization may choose either the cash or accrual methods. The cash method is more commonly used by small organizations and records income and expenses when received/paid not when incurred. The accrual method is used by large organizations or organizations with inventory and records income and expenses when incurred instead of when received/paid. Each system and method has its own advantages and disadvantages for a business. Choosing the one that works best for your organization is the key.