| |Resources for Serious Bookkeepers| |
| | About | News | Resources | Order | Contact | Home | |
|
» The Truth and Nothing But the Truth
NEW!  Bookkeeping with QuickBooks ® The Canadian Guide 2nd Edition by Arlene Nora Arlow
Order Your Copy Now!
Paperback Edition
|  |
INTRODUCTION TO BOOKKEEPING EXCERPT FROM: Bookkeeping with QuickBooks ® The Canadian Guide 2nd Edition Chapter Objective: » Understand debits and credits » Name the five different account types » Know which account "types" make up the Balance Sheet » Know the basic Accounting Equation » Be able to discuss the three most common types of business entities » Know the difference between "Income Tax" and "Sales Tax" » Explain what a "Fiscal Period" is » Explain what a "Chart Of Accounts" is used for » Explain what a "General Ledger" is The Language of Accounting The language of numbers is older than the Roman Alphabet. Ancient civilizations that had oral communication but not written communication still counted things as part of survival. Today, accounting language is the same in many nations, but not always applied in exactly the same way. Accounting procedures are consistent throughout Canada, the United States, New Zealand, Australia, and most of Europe. Some countries have different ways of applying accounting, although the need for accounting is the same worldwide. Accounting is essential for governments that want to tax the earnings of its citizens. Accounting is a language of its own. That is why many people try but fail in understanding basic accounting. It is similar to an English-speaking person learning French. The need to communicate exists in both languages, but the sounds and syntaxes are different. And sometimes the rules of speech that we learn in English have to be thrown away when we are learning French. Both English and French are based on verbs, nouns, adverbs, adjectives and the like. French also has two important types of words: masculine and feminine. In English, that designation is completely unheard of and unnecessary. If a sentence in either French or English didn't have the required verb, nouns, subject etcetera, it would be completely meaningless. We expect gibberish from small children, but we expect them to sharpen and expand their speech and writing skills as they mature. The language of accounting is based on DEBITS and CREDITS. Seems relatively simple: "Debits" and "Credits". A "Debit" is the opposite of a "Credit". And obviously, a "Credit" is the opposite of a "Debit". And without BOTH a "Debit" and a "Credit", a transaction cannot happen. A "Credit" in accounting is not the same as "Credit my bank account". Just as one has to throw away the rules of English sentence structure when one learns French, one also has to throw away the lingo of banking when one is doing accounting. Hence, a "CREDIT" entry to a bank account in accounting actually means take money OUT of your bank account. In banking lingo, to "CREDIT" a bank account means to put money in. Two different languages, two opposite meanings. Like electricity, an accounting transaction must have opposites in order to happen. Electricity cannot happen without "Positive" and "Negative". If you have forgotten the basics of electricity, look at a standard double-A battery. One end is "PLUS" (positive), one end is "MINUS" (negative). And they are both packed into the same battery! And so, what happens when you put the double-A batteries in backwards in your TV remote? Well, you could end up damaging your remote and having to get a new one. Same with accounting. If you post a transaction with the "PLUSES" and the "MINUSES" backwards, you might have to discard that transaction entirely and enter a new one. With accounting, errors can be reversed. But unlike the TV remote that either works or not, an accounting transaction can be backwards or be posted twice and you may not realize it. Your TV remote either works or it doesn't. Accounting requires more careful attention. Basic Bookkeeping Principles: Assets, Liabilities, Equity, Income and Expenses Accounting requires "Accounts". There are five standard "types" of accounts. There are numerous accounts within each "type" and this manual will go into more detail later. Most businesses have more "Expense" accounts than they do "Income" accounts. This is merely the result of how we report our business transactions on a tax return. There are more categories of expenses on a business tax return than categories of income. The standard "types" of accounts are: 1. Assets (cash, bank accounts, petty cash, customer receivables, fixed assets) 2. Liabilities (credit cards, lines of credit, bills from suppliers, payroll outstanding) 3. Equity (the difference between your "Assets" and "Liabilities"). Equity is also called "Net Worth" The first three account types mentioned - Assets, Liabilities and Equity - make up what is called the "Balance Sheet". It is the most important report that a bank uses when deciding whether or not to give your business a loan. The Balance Sheet tells the bank whether the business has averaged a net profit (including prior years) and tells the bank if your business has any worth (if there is hope of you repaying the loan). Another way of remembering what the Balance Sheet is for is to think of the classic Western movie called "The Good, The Bad, and The Ugly": Assets (The Good) Liabilities (The Bad) Equity (The Ugly) Of the five standard "types" of accounts, most people are familiar with the last two of the five: 4. Income Accounts (the money earned) 5. Expense Accounts (the money spent) Similar to you trying to juggle your own personal bank book every month, a business can only survive if its income is greater than its expenses. The money "in" has to exceed the money "out". Income and expense accounts are not part of the Balance Sheet. Their job is to track where the money is coming from and where it is going to. The NET difference between income and expenses, however, does become part of the Balance Sheet. The report is called a "Balance Sheet" because the sum of the DEBITS must equal - or balance to - the sum of the CREDITS. The Balance Sheet and other reports will be covered in this manual. An important principle of accounting is the "Accounting Equation". It is intrinsic to the first three accounts (the Balance Sheet accounts), and is actually a mathematical equation that is used to "prove" the Balance Sheet. It "proves" that the "Debits" are equal to the "Credits" (debits and credits are the language of accounting): Assets = Liabilities + Equity Just as 1 + 1 = 2, the accounting equation can be reworked to the following: Liabilities + Equity = Assets The normal way of displaying the Accounting Equation remains: Assets = Liabilities + Equity. The Accounting Equation does not imply that Liabilities and Equity accounts are intrinsically similar. The "Accounting Equation" is not intended for anything other than to "prove" that the Balance Sheet actually balances. "Debits" and "Credits" are only possible in accounting by assigning each account a normal "balance", whether it be a normal "Debit" balance or a normal "Credit" balance: Asset Accounts have a "normal" debit balance (to increase an asset account, you use a "debit" entry) Liability Accounts have a "normal" credit balance (to increase a liability account, you use a "credit" entry) Equity Accounts have a "normal" credit balance (if you want to increase an equity account, you use a "credit" entry) Income Accounts have a "normal" credit balance (if you want to increase income, use a "credit" entry) Expense Accounts have a "normal" debit balance (if you want to increase expenses, use a "debit" entry) In this manner, "Debits" and "Credits" in a transaction balance each other because there are always two sides to every transaction (remember that accounting is a language of its own). To take the Accounting Equation one step further, Debits and Credits are applied to Balance Sheet in the following manner: Assets = Liabilities + Equity OR Debits = Credits + Credits Types Of Business Entities: Proprietorship, Partnership, Limited Company Business entities in Canada are categorized by the type of people (or entities) who own them. In the case of limited partnerships and limited companies, a separate tax return must be completed. » Proprietorship: One person owns and operates the business with the intention of profit. For legal and tax purposes, the person and the business cannot be separated. The fiscal year end is December 31st. » Partnership: Two or more persons own and operate the business with the intention of profit. Note that there are "Partnerships" and there are "Limited Partnerships". For tax purposes, each partner must report a consistent share of the income and expenses, depending on their percentage of ownership. For partnerships where the ownership consists of five or fewer persons, they can simply report their share of the income and expenses on the "Statement Of Business Activities" on their own personal tax return. A partnership of six or more persons OR a partnership where an owner is another partnership must file a Partnership Information Return. With few exceptions, the fiscal year end for partnerships is December 31st. » Limited Company: An incorporated entity owned by one or more persons or one or more corporate entities with the intention of profit. For legal and tax purposes, the owner or owners are separate from the business entity. The business must file its own tax return. The business name must end in "Ltd." or "Limited". The fiscal year end is as decided by the owner(s). For the record, Not-For-Profit Corporations, Non-Profit Organizations and Charities are some of the other types of entities permitted within Canada. This instructional book covers computerized bookkeeping procedures for businesses only. What Kind of Taxes Are There in Canada? Taxes in Canada come by many names. Alberta, Yukon, Nunavut and the Northwest Territories have no provincial sales tax, although Alberta does charge a Hotel Room Tax on short-term accommodations. Residents of all provinces and territories must pay income tax on taxable income. Canadian taxes include: » Income Tax: business owners, employees and limited companies pay provincial income tax and federal income tax on taxable income. » Canada Pension Plan (CPP): employees and their employers contribute for employees aged 18 through 69. » Employment Insurance (EI): employees and their employers contribute for all employees. » Goods And Services Tax (GST): a 6% federal sales tax on specific goods and services. » Harmonized Sales Tax (HST): a 14% "combined" sales tax which includes both provincial sales tax (8%) and GST (6%) in Nova Scotia, New Brunswick, Newfoundland and Labrador. » Provincial Sales Tax (PST): a provincial sales tax on specific goods and services in British Columbia (7.0%), Saskatchewan (7%) and Prince Edward Island (10%). In British Columbia and Saskatchewan the PST is calculated before GST is added onto the purchase price. In Prince Edward Island, the PST is calculated after the GST has been added onto the purchase price. » Retail Sales Tax (RST): a provincial sales tax on specific goods and services in Manitoba (7%) and Ontario (8%). In Ontario, it is also known as the OST or ORST. » Quebec Sales Tax (QST): a provincial sales tax on specific goods and services in Quebec (7.5%). In Quebec, the QST is calculated after the GST has been added onto the purchase price. » Hotel Room Tax (HRT): a provincial hotel tax on short-term accommodations in British Columbia (8%) and Alberta (4%). » Other accommodations taxes: provincial taxes on short-term accommodations are collected in Saskatchewan (6%), Manitoba (7%), Ontario (5%), Prince Edward Island (10%) and Quebec (a $2.00 per night flat charge). Except in Prince Edward Island and Quebec, the tax on accommodations is calculated before GST is added onto the purchase price. Some provinces have selected regions where the provincial sales tax or accommodations tax is "topped up" with a 1% or 2% regional/municipal tax. In Canada, there are also alcohol taxes, tobacco taxes, fuel taxes, admission to amusement event taxes and airport taxes to mention a few. This manual will not cover the application of those taxes. It is important to contact the appropriate provincial and federal agencies when starting a business to ensure you fulfill your obligations for collecting applicable sales taxes. Each province has different guidelines and rates. For example, accounting and insurance services are not subject to provincial sales taxes in all provinces. What Is A Fiscal Period? Century 21 Accounting Third Canadian Edition explains a "Fiscal Period" as follows: "The length of time for which a business analyzes financial information is called a fiscal period." It is simply a period of time that one selects for financial reports. A fiscal period can be a month, a quarter (a three-month period), a six-month period, or a whole year. A fiscal period does not ever exceed one year (see end of this section). A fiscal quarter is understood to coincide with the four quarters that make up the fiscal year of the business (see "Types Of Business Entities: Proprietorship, Partnership, Limited Company" for an explanation of the fiscal year end dates that a business can use). In other words, if the fiscal year of the business for tax purposes ends on December 31st (proprietorships), the first fiscal quarter automatically ends on March 31st, with the second fiscal quarter automatically ending June 30th. If the business has a fiscal year end of October 31st (limited companies), the first fiscal quarter automatically ends on January 31st. Fiscal periods must be carefully and consistently selected when reporting financial information for federal GST (Goods And Services Tax), federal HST (Harmonized Sales Tax), federal payroll deductions (CPP, EI and Income Tax) and provincial sales taxes. The reporting period for any one of these taxes may not be the same as other taxes. It is most common for GST and HST to be reported quarterly (for a full fiscal quarter). The next most common reporting period for GST/HST is annually (for a full fiscal year). In order to have an annual reporting period for GST/HST, the Canada Revenue Agency (CRA) must first authorize it. It is most common for payroll to be reported monthly (for a full calendar month). Large companies with dozens or hundreds of employees are required to submit their payroll to CRA twice a month. PST is most often reported monthly. Some jurisdictions such as BC's Consumer Taxation Branch - may authorize your reporting period to be quarterly, every six months, annually, or a combination thereof. Reporting periods for taxation are always a full fiscal year unless the business is brand new or has ceased to operate. In other words, the first fiscal period and the last fiscal period of a business are usually less than one year. Only a limited company is permitted to have a "first" fiscal period that exceeds one year (cannot exceed 53 weeks). What Is A Chart Of Accounts? The Chart Of Accounts (COA) is a list of the accounts used in the day-to-day transacting of the business's accounting. It is akin to the directory of tenants located by the main lobby elevators in a large office building. It tells you who or what is supposed to be there. If a tenant moves, someone is supposed to make the change in the directory of tenants. The COA is a guide to what the books are supposed to have in each specific area (each account). In other words, the name of the account should denote what the account is used for.The COA aids the user in deciding how to categorize all monies flowing through the company's books. In QuickBooks there are "Parent Accounts" and "Sub-Accounts". The difference between a "parent account" and a "sub-account" will become clearer later in this manual. An example of a QuickBooks COA is shown below for New Beginnings Lawnscapes. Note that the name of the company is displayed at the top of the computer screen along with the version of QuickBooks that is installed on the computer. In the example below, "Computers Asset" is a parent account. "1Computers Cost" and "Acc Dep Computers" are both sub-accounts. Editing and adding accounts to the COA will be covered in this manual: What is the General Ledger? Century 21 Accounting Third Canadian Edition2 denotes a "General Ledger" thus: "A ledger that contains all accounts needed to prepare financial statements is called a general ledger." The Chart Of Accounts is used to categorize financial transactions posted to the general ledger. All financial transactions of a business are recorded in the general ledger. QuickBooks has not forgotten this important ledger. QuickBooks has a "General Ledger Report" that can be created whenever you want, for any period of time. Every transaction posted in QuickBooks is recorded in the general ledger. As a QuickBooks user, you don't decide to record something in the general ledger because QuickBooks does it for you. The general ledger records every transaction IN EVERY ACCOUNT, and so the General Ledger Report can be very long and take up many pages. Thankfully, there are similar and less-complex reports in Quickbooks you can generate on an as-needed basis. The general ledger is used by accountants and management and for the most part, one only needs to know where to find it and understand that it includes transactions for ALL ACCOUNTS. GAAP, Accrual Accounting And Other Official Stuff GAAP is an acronym. It stands for: G enerally A ccepted A ccounting P rinciples GAAP is not an absolute, but it does have strict guidelines on to how financial information is recorded in the books of a business. GAAP has strict guidelines that dictate what kind of financial paperwork you need to keep, how to process that paperwork, how to be consistent in the way you record the financial paperwork, and what kinds of things need to show on the invoices that YOU give to your customers. GAAP is common sense. GAAP is the way that authorities (accountants, government and banks) know that your financial "language" is the same as theirs. Accrual Accounting is the manner in which income and expenses are recorded for most businesses in Canada and many other countries. It requires expenses of one period to be matched by income for that same period. Sounds relatively simple, but the fine details of Accrual Accounting come into play at the end of each fiscal year. Accrual Accounting requires one to declare income of services or goods sold even if you haven't been paid yet. Accrual Accounting also requires the expenses directly related to pursuing that income to be recorded in that income period even if you haven't paid for those expenses. One can't decide to expense a big-ticket purchase in a period that provides the best tax write-off. Instead, one must declare expenses in the period when the income relative to that expense was declared. If a big-ticket purchase can be linked to income from two fiscal periods, it must be split between those two periods. An example of businesses that use Accrual Accounting are the big department stores. Say you buy an item but you put it on your store credit card. The store hasn't got the money from you yet, but they must declare the income the same day it is rung into the cash register. Cash Accounting is the manner in which income and expenses are recorded for Farmers and Fishermen in Canada. There are tax benefits to this system, but only Farmers and Fishermen can use this method of recording income and expenses. The Cash Accounting method allows one to declare income when one gets the money instead of declaring it when the service or goods are sold. It also allows one to record an expense when one pays out money whether or not that expense directly relates to income in that same period. In other words, Farmers and Fishermen get to expense things sooner, and defer their income later. Do I Need To Understand Bookkeeping To Use QuickBooks? The answer is "yes". You needn't be a whiz at bookkeeping, but you do need to understand how bookkeeping works. If you don't know the difference between "bookkeeping" and "accounting", don't worry. Bookkeeping is simply accounting at its most basic level. Chapter Review: 1. What two elements are basic to the language of accounting? 2. What is the difference between an "Asset" account and a "Liability" account? 3. What three account types are included in the "Balance Sheet"? 4. What two account types are used for tracking where money is coming from and where it is going to? 5. What is the standard way of displaying the "Accounting Equation"? 6. What is the required fiscal year end date for a business that is a Proprietorship? 7. What is a Chart Of Accounts useful for? 8. What ledger includes all accounts and all financial transactions for a business? 9. What is the accounting method that most Canadian businesses are required to use? |
| |Resources for Serious Bookkeepers| |
| | About | News | Resources | Order | Contact | Home | |