BOOKKEEPERS’ BOOT CAMP:Get a Grip on Accounting Basics

numbers101SMALL BUSINESS

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Angie Mohr, CA, CMA

Self-Counsel Press(a division of)International Self-Counsel Press Ltd.USA Canada

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Copyright © 2003 by International Self-Counsel Press Ltd.

All rights reserved.

No part of this book may be reproduced or transmitted in any form by anymeans — graphic, electronic, or mechanical — without permission in writingfrom the publisher, except by a reviewer who may quote brief passages in a review.

Self-Counsel Press acknowledges the financial support of the Governmentof Canada through the Book Publishing Industry Development Program(BPIDP) for our publishing activities.

Printed in Canada.

First edition: 2003; 2004 (2); 2006

Library and Archives Canada Cataloguing in Publication

Mohr, AngieBookkeepers’ boot camp / Angie Mohr.

(Self-counsel business series)1-55180-449-2

1. Bookkeeping. 2. Small business — Accounting. I. Title. II. Series.HF5635.M63 2003 657'.9042 C2003-911150-4

Self-Counsel Press(a division of)

International Self-Counsel Press Ltd.

1704 North State Street 1481 Charlotte RoadBellingham, WA 98225 North Vancouver, BC V7J 1H1

USA Canada

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PART I: THE BASICS 11 Getting Started 3

The Numbers 101 for Small Business Series 4Bookkeepers’ Boot Camp 5How to Use This Book 5

2 A Brief Look at the Origins of Bookkeeping 7Double-Entry Bookkeeping 8

3 Important Concepts 10Generally Accepted Accounting Principles (GAAP) 10Stewardship 11Accrual Accounting 12Debits and Credits 12Accountants versus Bookkeepers 13

Bookkeeper 13Accountant 13

Accounting Jargon 14The Use of Estimates 14The Importance of Bookkeeping 14

4 Setting Up the Record Keeping System 16What Kinds of Paper Do I Need to Keep? 17

Invoices 17Statements of account 17Deposit slips 17Supplier invoices 17Check stubs or copies 18Purchase orders 18Bank statements 18Canceled checks 18

How Do I Account for My Source Documents? 19Where Do I Record This Information? 20

Journals and ledgers 20

Contents

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What Kind of Bookkeeping System Should I Get? 21Manual journal and ledger 22Computerized bookkeeping systems 23

5 The Balance Sheet 26The Purpose of the Balance Sheet 26The Components of the Balance Sheet 27

Assets 27Capital assets 30Other assets 31

Liabilities 32Current liabilities 32Long-term liabilities 34

Equity 35Capital stock 35Capital contributions 36Retained earnings 36Dividends 37

6 The Income Statement 39The Purpose of the Income Statement 40What’s on My Income Statement? 42Interpreting the Income Statement 44The Statement of Retained Earnings: A Tag-Along 45

7 The Cash Flow Statement 47Categorizing Cash Flows 47Back to the Balance Sheet: The Basis of theCash Flow Statement 48Putting It All Together 52What Is the Cash Flow Statement Telling Me? 52

PART 2: INTERMEDIATE TOPICS 558 Recording the Sales Cycle 57

What Makes Up the Sales Cycle? 57Recording Cash Sales 59Recording Credit Sales 60Sales Discounts 61Recording Cash Receipts 62

Partial payments 63Preparing Invoices 63Preparing Statements of Account 63Bad Debts: Analyzing Them and Writing Them Off 64

Screen your customers 65Set credit limits 65Make your credit terms clear 66Follow up with monthly statements 66Call your customers when they are overdue 66

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Contents v

Get professional help 66Pursue the debt in small claims court 66Writing off the debt 67

9 Recording the Purchases Cycle 68Purchasing Inventory 69Purchasing Supplies 70Common Cost of Goods Sold Categories 70Common Expense Categories 71Setting Up the Accounts Payable Sub-ledger 73Cash Payments 74

10 Inventory 76Inventory Tracking Systems 76Types of Inventory 77Inventory in a Manufacturing Environment 77Inventory Costing Methods 78

Specific identification method 79First-in, first-out (FIFO) 79Last-in, first-out (LIFO) 80Weighted average cost 80

Year End Valuation 81Setting Up the Inventory Count 81

11 Capital Assets 85What’s in the Cost of My Capital Assets? 86

Satellite costs 86Trade-ins 86

Depreciation: An Overview 87Land 87Buildings 87Equipment 88Tools 88Office equipment 88Signage 88Computer hardware 88Computer software 88Vehicles 88

Concepts Involved in Depreciation 89Useful life 89Salvage value 89

Methods of Depreciation 89Straight-line 89Declining balance 90Sum-of-the-years-digits (SYD) 90

Accounting for Depreciation 91Accounting for Sales of Capital Assets 92

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12 Leases and Loans 94Lease Transactions: An Overview 95Accounting for Operating Leases 96Accounting for Capital Leases 96Accounting for Loans 97Reconciling the Loan Balance 99

13 Transactions between the Company and Its Owners 100Shareholder Loans 101You Pay for a Business Expense out of Your Own Pocket 102The Company Pays for a Personal Expense 102What Happens If I Run My Business out of My House? 103

Step 1: How much space? 103Step 2: Calculating the expenses 104Capital improvements 105Repairs that affect the whole house 105Repairs that affect only the personal square footage 105Repairs that affect only the business square footage 105

Hey, the Business Uses My Car Too! 106Business mileage 106

What about Other Personal Assets Used for Business? 108Caveat 109

Setting Up the Management Bonus 109Dividends 110

14 Remittances to the Government 111What Are Government Remittances? 112US Remittances to the Government 112

Employment taxes 112State sales tax 113Other remittances to the government 113

Canadian Remittances to the Government 113Payroll taxes 113Goods and services tax (GST) 114Other remittances to the government 116

Reconciling the Remittance Accounts 116

15 Maintaining a Petty Cash System 118Setting Up the Petty Cash Fund 119Using Your Petty Cash 119Reconciling the Petty Cash Fund 121Replenishing the Petty Cash Fund 121

16 Reconciling the Bank 123The Bank Statement Arrives 123

Outstanding checks 124Outstanding deposits 124Bank charges 124

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Contents vii

Automatic monthly payments 124Bank errors 124

The Reconciliation Process 125Items on the bank statement that are not in the ledger 126Items in your ledger that are not on your bank statement 127

What Happens If I Still Can’t Reconcile? 127Example of the Bank Reconciliation Process 127

17 When the Damn Thing Just Won’t Balance 129The Process of Reconciliation 129Backwards Posting 131Transposition Error 131Addition Error 132

PART 3: ADVANCED ISSUES 13318 The Role of the External Accountant 135

Choosing an Accountant 135The Role of the Accountant 137

Starting your business 137Year end 138Employee evaluation and compensation 138Internal controls 138Management operating plan 138

What the Accountant Needs from You at Year End 139The Process of Creating Financial Statements 140Corporate Income Tax Returns 141Posting the Adjusting Journal Entries 141Rolling Forward the Year 142How Do You Know When You’re Outgrowing Your Accountant? 143

19 Budgeting: Planning for the Future 144But How Do I Know What’s Going to Happen in the Future? 144Setting Up the 12-Month Budget 145Aren’t I Just Making Up Fake Numbers? 146Changes to the Company’s Operations 148Rolling, Rolling, Rolling, Keep that Budget Rolling 148

20 Monitoring Cash Flow: How Not to Run Out of Money 150What Is Cash Flow? 150What’s the Difference between Cash Flow and Net Income? 150How Do I Know When My Business Is Going to Run Out of Money? 151Building Your Company’s War Chest 151How Can I Stretch My Company’s Cash Further? 152Barter: A Small Business Owner’s Secret Weapon 154

Accounting for barter transactions 155The Future: How to Avoid the Cash Crunch before It Hits 155

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21 A Brief Look at Foreign Currency 157Occasional Foreign Currency Transactions 157The Foreign Currency Bank Account 159Revaluation at Year End 159Reconciling the Foreign Currency Bank Account 160Foreign Currency Risk 160

22 Tax Planning 162Minimizing Tax versus Avoiding Tax 162What Is Tax Integration? 163Why You Need to Understand Tax Brackets 164Deferring Tax Owing versus Getting Rid of It Altogether 164Owner/Manager Remuneration: Getting Money out of Your Business 165

23 Graduation 167Boot Camp Test 168Boot Camp Test Answers 180

Appendix A — Glossary 189

Appendix B — Resources for the Growing Business 196

Figure1 The Operating Cycle 58

Samples1 General Journal 212 General Ledger 223 Balance Sheet 284 Partnership Equity Statement 385 Statement of Income 416 Statement of Retained Earnings 467 Comparative Balance Sheet 498 Balance Sheet with Difference 519 Cash Flow Statement 53

10 Statement of Account 6511 Accounts Payable Report 7412 Inventory Count Sheet 8213 Bank Reconciliation 126

Worksheets1 Inventory Count Sheet 842 Petty Cash Control Sheet 1203 Budget Template 147

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The statistics are mind numbing. In North America, 80 percent ofall small businesses started this year will be gone in five years. Ofthe lucky 20 percent to have survived, another 80 percent will begone in ten years. That’s a whopping 96 percent failure rate overten years.

Would you start a small business if you were told that youhave a 96 percent chance of failure? Not many people would. Butevery day, hundreds of people think they will beat the odds. Theymay be former employees, students, housewives, or others whohave never had any business training but are sure that their prod-uct or service is so fantastic, so completely unique, that they aredestined to succeed.

These are the people who walk through the doors of my ac-counting and consulting practice every day. They want to knowhow to make a lot of money, how to leverage their businesses, howto go public. I begin to talk to them about their plans for book-keeping for the business (“Oh, my wife will sort all that out”),what is in their business plan (“Oh, I’ll pull one of those togetherif the bank is looking for one”), and what their break-even point is(“We don’t have to worry about any of that; this product is goingto sell millions!”). They want to fly before they’ve learned to crawl.They do not understand that business management is a separateskill from doing whatever it is that their business does. For example,

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hairdressers think that because they are good at cutting hair, theycan own and manage a salon. Lawyers think that because they aregood at putting together a brief, they can run a ten-lawyer lawpractice.

Does it sound like I’m being hard on small business? Not at all.Small business is the engine of the world economy. Even Microsoftand Ford started in someone’s basement or garage. However, peo-ple all over the world have an idealized and unrealistic view of howto operate a business, and most discount the importance of the ba-sics. With the advent of bookkeeping software such as Simply Ac-counting and QuickBooks, many entrepreneurs have come to believethat these programs will magically do their bookkeeping for them.Because these people lack basic accounting skills, they are unableto analyze their business results and have no idea what’s workingand what’s not. It’s like driving a car in a foreign country wherethey can’t understand what the road signs are telling them.

The Numbers 101 for Small Business SeriesOver the years, my clients have asked me to recommend goodbooks on small-business management and accounting. I have al-ways found it difficult to do so, as most books on the subject are ei-ther dry textbooks or too general to be of any use.

This problem was the genesis of the Numbers 101 for Small Business series of books. The series functions as an easy-to-understand reference for small-business owners, and covers suchtopics as bookkeeping, analyzing and tracking financial informa-tion, as well as the complexities of starting, growing, and exiting abusiness. The series is distilled from the workshops, radio broad-casts, and one-to-one training sessions I have conducted in my ac-counting firm over the years. You, the small-business owner, willfind within this series everything you need to base your businesson sound financial and management principles. Throughout theseries, you will meet Joe and his wife, Becky. Joe owns a small busi-ness called (appropriately) Joe’s Plumbing. Becky does the back-office work for the business: answering phones, invoicing,bookkeeping, and banking. You will learn how Joe worked withhis accountant to strengthen his business and make it more prof-itable and risk proof. You will find samples of financial documentsand other useful tools that you can customize to your businessneeds. You will find more information and tools on our Web site:<www.numbers101.com>.

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Joe gets up when the alarm goes off at5:45 a.m. His once-tiny plumbing busi-ness has grown substantially over thelast year, and Joe always feels as if he’sin catch-up mode. He knows he has alot of work to do today. A presentationwill be made to a potential customer at9:30 a.m., a meeting with his bankerhas been set up for 11:00 a.m., hemust personally pick up a product from a supplier at 2:00 p.m., and at3:30 p.m., he must deal with a crankycustomer who is not happy with thequality of Joe’s work.

Joe makes his daily rounds after stopping at Starbucks for a double hitof espresso. He telephones his wife,Becky, from his cell phone to remindher to pull the invoices to discuss withthe customer that afternoon. Beckystays home and helps Joe run the busi-ness. She answers the phone, does thefiling, and deals with the mountains ofpaperwork that the business generates.

At 6:00 p.m., when Joe has finished his rounds for the day, he pullsthe truck into his driveway, slings hisjacket over his shoulder, and checks inwith Becky. He tells his wife that thebanker wants to see financial state-ments for the business to see if they aremaking money. Neither Joe nor Beckyreally knows if they are winning or los-ing. Becky adds up all the receipts atthe end of the year for the income taxreturns. As she tells him about thephone calls she received during the dayand the bank statement that appearsto be wrong, Joe digs through hispants pockets and pulls out piles ofcrumpled receipts: the day’s recordkeeping. Becky tries to put them insome semblance of order, wondering ifthere’s a better way to track the busi-ness results.

C A S E S T U D Y

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Getting started 5

Bookkeepers’ Boot CampBookkeepers’ Boot Camp, the book you are reading now, is the firstbook in the Numbers 101 for Small Business series. It deals with theessentials of record keeping for a small business and will show youwhy it’s necessary for you to track financial information. By theend of this book, you will have a greater understanding of the pur-pose and process of record keeping and a deeper understanding ofyour business and how it works.

I wish you the best in your business. You have taken a signifi-cant first step in understanding your business better. Drop me aline at <angie@numbers101.com> and let me know how your busi-ness is doing. I’d love to hear from you!

How to Use This BookBookkeepers’ Boot Camp is broken into three sections:

1. The BasicsChapters 2 through 7 start with the fundamentals of record keep-ing. This section is a great place to start for those who are just be-ginning to learn bookkeeping. It’s also a great refresher for thosewho have been doing it for a while. You will learn the basic meth-ods of record keeping for a growing business and the statementsthat make up the financials.

2. Intermediate TopicsChapters 8 through 17 show you the “meat and potatoes” of book-keeping. You will learn how to record the sales and purchases cycles, account for the everyday transactions that a business un-dertakes, as well as learn how to balance the bank account andwhat to do if you can’t reconcile it.

3. Advanced IssuesNow that you are all warmed up and have a good handle on theregular financial workings of your business, it’s time to sink yourteeth into more advanced topics. In chapters 18 through 22, youwill learn how to deal with foreign currency, tax planning, budg-eting, and the role of the external accountant. Following thesechapters comes Chapter 23: Graduation, an integrated self-test youcan take to see if you really know your stuff!

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Throughout the book, you will find some useful samples of fi-nancial documents, as well as a listing of terminology and defini-tions in Appendix A. Appendix B lists some useful Web sites,publications, and other tools for small businesses.

Do you have to read everything in the order in which it ap-pears? Of course not (unless you are fanatical like me and have adeep-rooted need to follow things in the order intended). You canreview the Table of Contents and just jump right in wherever youfeel that you will get the most benefit. I do recommend, however,that you eventually read the entire book, even if you already havesome bookkeeping experience. You may find that you gain somenew philosophical or mechanical perspectives on your business.

Once you are finished Bookkeepers’ Boot Camp, you are ready forthe next challenge: Financial Management 101: Get a Grip on YourBusiness Numbers. This book is the second in the Numbers 101 forSmall Business series. Financial Management 101 builds on yourbasic bookkeeping knowledge so that you can track and interpretyour financial statements and manage your business more effectively.

I hope you enjoy Bookkeepers’ Boot Camp. Please also visit ourWeb site at <www.numbers101.com> for more resource links andother cool tools for businesses. There is a place to sign up for ourfree e-newsletter, chock full of useful information for businessowners. There is also a link to my e-mail. Please feel free to dropme a line and let me know what you liked and didn’t like aboutthis book. It will help us develop future editions so that we canmeet the needs of entrepreneurs better.

Now, if you’re ready, grab a fresh cup of coffee, and let’s begin!

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