Many small business owners and start up entrepreneurs refuse professional bookkeeping services because they want to do it themselves and/or save money. This is certainly admirable and understandable.
However, there are bookkeeping, accounting and tax concepts that are incorporated as part of a company’s bookkeeping system that most business owners do not understand. These individuals would have worked as a Bookkeeper, an Accountant and/or a tax professional, if they were deeply educated in these concepts, instead of being business owners.
There are three options pertaining to bookkeeping services for a new or small business.
The first option is to have NO bookkeeping system.
This is a dangerous option because the business owner will have no idea how his or her business is doing. Please keep in mind that schedules created on MS Excel is NOT a bookkeeping system. There is a lot of back and forth between the tax return professional and the business owner regarding requests for documentation and/or additional inquiries when there is no bookkeeping system. Also, there is a huge risk that the entire profile of the business for a particular year is NOT represented within these MS Excel Schedules. The Internal Revenue Service expects that all financial statements and business income tax returns be supported by a bookkeeping system that clearly accounts for income and expenses during a particular year. The lack of a bookkeeping system will eliminate all deductions and credits on a business income tax return if the Internal Revenue Service conducts an audit on such return.
The second option out of three for bookkeeping services is to hire an external bookkeeping
Hire a bookkeeping, accounting and/or tax professional to perform these services on a weekly, monthly, quarterly, every six months and/or annually, depending on the nature and the number of transactions of the business. Bookkeeping services provide the right information, as backed up by supporting documentation, to report and summarize how a business is doing. This summary is referred to as financial statements which consist, primarily, of a Balance Sheet and a Profit or Loss Statement. A Balance Sheet shows the assets, liabilities, and equity of the business as of the end of a period such as a calendar year, or as of December 31. A Profit or Loss Statement summarizes all income earned, and all expenses incurred, within a particular period, such as January 01 – December 31, 2020, or for the calendar year of 2020. These two statements together are usually about two pages, which is all the information that is needed to process and prepare business income tax returns. Both statements are necessary to prepare a business income tax return. The tax return preparation process is much quicker with an external bookkeeping service and the corresponding financial statements.
The third and final option regarding bookkeeping is for the business owner or owners to do it themselves.
This is more dangerous than not having a bookkeeping system at all. And it could be more costly than HAVING external bookkeeping services. Bookkeeping is more than just recording income when a customer sends the business a check; or recording the bill that the business paid for business internet service. Bookkeeping involves much more, such as: the determination of whether a salary can be paid from the business to the business owner depending on what tax entity the business is. It is determining whether a particular expenditure should be classified as an asset or an expense. It means clearly distinguishing between what is salary paid to the business owner, and what is a distribution from the business to the business owner. It is making sure that personal expenses are not paid by the business, and, if so, it should not be a business expense for the business, but rather a distribution or a dividend. Bookkeeping is siphoning a tremendous amount of information from personal bank and personal credit card accounts to determine whether these expenses were business related; and whether these expenses should be recorded on the books of the business along with the corresponding capital contributions to the business. It also means examining the charges on business credit cards to make sure that any personal transactions on a business credit card are not recorded as expenses for the business. This is what bookkeeping is.
Also, it is clear and understandable that business owners do not consistently record all transactions of the business on a timely basis because the business owner or owners are busy with their business.
These two paragraphs result in an incomplete and inaccurate bookkeeping system, which results in incomplete and inaccurate financial statements and then, consequently, results in incomplete and inaccurate business income tax returns.
Therefore, because of this incomplete and inaccurate bookkeeping system, an EXTRA step must be performed to serve as a bridge between the do it yourself bookkeeping and the business income tax returns.
That extra step is called a compilation, and it is a separate billable service. This compilation can be done on a weekly, monthly, quarterly, every six months and/or on an annual basis, depending on the nature and volume of the transactions of the business.
A compilation is a deep dive into the activity within most general ledger accounts, within the do it yourself bookkeeping system, to make sure that everything is reported properly as per the above; and whether some income or expense items were not incorporated into the bookkeeping system because of inconsistent, intermittent and/or untimely bookkeeping entries. This can be a process of about 2 -4 additional days depending on the nature and number of transactions, and the response from clients as to documentation requests and/or other inquiries for information. Adjustments are then made to the bookkeeping system based upon a compilation engagement. It is this adjusted bookkeeping system that will be utilized in the preparation of the business income tax returns. This may cost more for the business than having professional external bookkeeping services.
Prepared By: Angelo Liberati, BBA, CPA, MST
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