Accounting 101: Setting Up Your Books

January 22, 2018 | Article

Accounting, it’s all about the numbers. That’s what most think, but accounting is really a story. Your financial data (even though it is expressed in numbers rather than words) tells a story of where your business has been, where your business is currently, and where you can go in the future. Accounting is one of the functional pillars of your business; it’s important to get it right – the first time.

Understanding Your Business and Industry
It all starts with an understanding of your business and industry. Only then can you begin to ask questions about your accounting system. These questions include: 

  • What basis of accounting should I use?
  • What information do I need to track to make informed business decisions?
  • How should I track the information?

Selecting Your Basis of Accounting
The basis of accounting is the framework used to record your business transactions. There are several different frameworks however they most commonly include:

  • U.S. GAAP (United States Generally Accepted Accounting Principles) – an accrual based accounting framework in which revenues and expenses are recorded when earned and incurred, respectively. (Recommended)
  • Income Tax Basis – a framework in which recording of revenue and expenses depends on the tax regulations; eliminates the need for converting from one basis of accounting for recordkeeping to another for tax return purposes.
  • Cash Basis – a framework in which revenues and expenses are recorded when cash is received or paid, respectively. There are two different methods of cash basis accounting: pure and modified. The main difference is under the modified cash basis some transactions follow U.S. GAAP (ex. fixed assets are capitalized and depreciation is recognized).
  • Regulatory – a framework in which a regulatory agency prescribes the method.

Determining What Information to Track
The key is to capture all of the transactions that occur in your business (cash and noncash) in the simplest and most efficient manner. Based on your business or industry, you may need to consider tracking your business transactions in more depth. Below are several considerations (not all inclusive but should give you an idea):

  • Should I be tracking direct and indirect costs related to manufacturing or construction contracts so I am able to view the profitability?
  • Do I have different departments, product lines, divisions, programs, etc. that I should be tracking so I am able to view the profitability?
  • Do I pay commissions and should be tracking transactions, such as revenues, by each sales representative to determine the proper calculation for those commissions?
  • Do I work in several states and should be tracking transactions, such as revenue and payroll, by state for tax return preparation?
  • What sales tax jurisdiction do I need to track for sales tax reporting?
  • Do I need to track certain items such as meals, donations, etc. for tax return preparation?

Now that you have an understanding of the information you need to track. How do you track it?  

Developing Your Chart of Account
Your chart of accounts is a listing of accounts that are used to prepare financial reports.  It is typically structured as follows:

1000-1999 Assets

2000-2999 Liabilities

3000-3999 Equity

4000-4999 Sales

5000-5999 Costs of Goods Sold

6000-6999 Operating Expenses (General and Administrative)

7000-7999 Other Income and Expense

8000-8999 Income Tax Expense

The accounts 1000-3999 are used to prepare the balance sheet and 4000-8999 are used to prepare the income statement (profit and loss). The number of individual accounts within each category will depend on the needs of your business. Rule of thumb: use the least number of accounts to achieve the financial information you need and structure it for growth. What do I mean by growth? Let’s look a little closer at a condensed assets section:

1000 Petty Cash

1005 Checking

1010 Savings

1100 Accounts Receivable

1200 Inventory

1300 Prepaid Expenses

1400 Fixed Assets

1450 Accumulated Depreciation

Note: the account numbers are not in sequential order. This will allow room for growth in the business.

The chart of accounts can also be used to track jobs, departments, divisions etc. Let’s say you have a location in Fargo, Bismarck and Minot and you want to be able to view the profitability for each location.  You are able to track by each location by assigning a division number, 01-Fargo, 02-Bismarck, 03-Minot, and attaching it to each of the accounts as such:

4000-01 Sales

4000-02 Sales

4000-03 Sales

5000-01 Costs of Goods Sold

5000-02 Costs of Goods Sold

5000-03 Costs of Goods Sold

Certain software will allow you to track these profit centers outside of the chart of accounts. For example in QuickBooks, you are able to have just one sales and one costs of sales account by using classes and subclasses.

Selecting an Accounting System
Tracking your information can be accomplished in two ways: manually or computerized (desktop or cloud-based). There is no right or wrong way, however computerized accounting software is more efficient which is why manual accounting is almost non-existent  in today’s accounting. Cloud-based also give you the freedom to access your financial data from just about anywhere, on any device.

There are several effective accounting software solutions out there. Again, it is important to understand your needs prior to purchasing to make sure you get a solution that fits your needs.

Overwhelmed? Need more direction? Eide Bailly has the resources to help you design your accounting system or help you selected a solution that best fits your needs.

Check out our Business Outsourcing & Strategy Services to learn more. 

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