You have a choice when you set up your bookkeeping. Well, you actually have a lot of choices, but this is one you might not think much about and yet it could cost you a lot of money down the road to change.
The choice is how you will keep your books. You also have to make a choice with how you’re going to report your income on your tax return. There are three different ways you can keep your books:
Cash-basis means that you report your income when you receive it. You report your expenses when you pay them. But even with the cash-basis accounting method, there may still be times when you report on a quasi cash-basis. For example, with the cash-basis accounting you will show notes payable, notes receivable and accrued sales and payroll taxes. You won’t pay or receive that money right away, but it is still customary to report it under the cash-basis.
Accrual-basis means that you report your income when you earn it. So if you generally bill your customers/clients/patients and wait to get paid, then you will record accounts receivable on your balance sheet and income will get reported on your Income Statement. If you’re cash-basis you won’t report this until you get paid. Under accrual-basis, you’ll record your expenses as soon as you have incurred the expenses, even if you haven’t paid it yet.
Let’s stop here for a second. What we’ve talked about are two types of basis that can be applied to either the way you keep your books or the way you report your income. You can use one method for both your books and your tax return or you could use one method for your books and a different method for your tax return.
Generally speaking, you will want to keep your books on the accrual-basis method. Your CPA will help make the decision on how to keep your books for your tax return, but usually that is done using the cash-basis.
If you have a retail business and you want to report on your tax return using the cash-basis, there is one problem – inventory. You cannot take the deduction for inventory on your tax return even though you paid cash for it. Inventory is considered an asset, not a cash-basis expense.
There could be one more challenge, depending on if and how your bookkeeper has been working with QuickBooks. QuickBooks has a choice on how you want to print out your financial statements – cash basis or accrual basis. But if your bookkeeper hasn’t properly entered credits and payments through accounts receivable and accounts payable, you can end up with very strange balances in these accounts when you attempt to run the cash-basis financial statement. The numbers will be wrong.
It’s important to understand the type of accounting you’re using, but even more important to make sure you and your bookkeeper are on the same page when it comes to reporting items on both sets of books.