Monthly Bookkeeping
Let's assume that you are sitting down to do your monthly bookkeeping. It is a day slightly past the end of the month you are doing the books for - say, the tenth. The sun is shining, a bird is chirping outside your window... oops, sorry I got a little carried away there. Anyway, you paid as many bills as you could before the end of last month, you've received most bills you're going to get and - you're ready to do the monthly accounting.
Expenses paid by check
Go through and enter all the other checks you have written by check number and to whom they were written. In general, all those entries will be credit cash; debit expense (decrease cash, increase expense). Make sure you put everything in the correct expense account. (And, since you have followed your "rule" about writing down the expense category right when you made the purchase you don't have any trouble remembering what this purchase was for, right?) The exceptions to this have been noted above: payments on loans, payments made on large equipment or fixtures, or additions to inventory.
Expenses paid by cash
You may have paid for some things with cash. The entry here is exactly the same as if you paid with a check - it's just keeping track of these things that's different. You should have a file of receipts, and most of them will match a check (it will be easier to confirm if you've written the check number on the receipt). Any that were paid with cash should have that noted on them, along with what the item or account number was. Same entry - debit, expense, credit, and cash.
If you have more than one cash account, have a separate account number for each bank account, and credit the account from which you are actually taking the money out of. If you move money from a savings to a checking account, the entry will be: credit (reduce) savings; and debit (increase) checking.
Accounts Payable
At the end of any given month, you have things you have used or purchased, but have not paid for. These are listed as accounts payable. When you enter these bills, your entry is debit expense, credit accounts payable. Each month, you need to make and keep a list of items that were in accounts payable at the end of the month. When you are closing out our sample month, you will have paid these bills, which were in AP the previous month, reducing your cash. Using your list, identify the checks written for items that were listed in accounts payable the month before. You already listed the expenses the prior month - so you don't list them again. The entry to show on your books that you have paid your accounts payable is: debit accounts payable, credit cash. Reduce your cash; reduce your accounts payable. Assuming you pay all your bills each month, this step will bring your accounts payable to zero (and if not, the accounts payable balance per your books should equal all the outstanding bills). Later, you will rebuild a new AP list for the current month.
Cash Discounts - purchases
In our sample chart of accounts we have set up account number 7100 for cash discounts on purchases. If you are paying a material order and get to deduct 2% for paying early, by all means, try to do so. This is where that amount goes: you debit the entire expense to the materials account as if you didn't take the discount, but credit the actual amount of your check to cash, and credit the remainder to the cash discounts account. This helps you see the value of paying early, and if you're in a position to do this fairly regularly, it looks great to your banker - so take the time to book it correctly.
Petty Cash
Petty cash is a handy item to have for small purchases, but it needs to be accounted for correctly. Do a one-time entry in your books to set up the petty cash account. If you want $300 in the account, credit the bank account you are taking the cash from, and debit your petty cash account.
Then put that petty cash in a box. Every time you take some out to spend, keep track of what you've taken out, with a receipt.
Write a check to petty cash, which will be for the total of what you spent over the month, or $60.82. When you enter that check, credit cash and debit the three appropriate expense account numbers - supplies, small tools and postage. Cash the check, put the cash into the box, and start all over again. You can do this as many times over the month as you need to - every time you need to replenish the petty cash box, just write a check and make the balancing entries the same way. You never make the entries to Petty Cash itself after you initially set up the account, unless you want to make it larger or smaller at some point.
Payroll
This one's a bit trickier...you've actually done a lot of things when you write that paycheck. If you have an accounting system and are using payroll, you should be in good shape - but even then, you may need some understanding of exactly what that system is doing for you. If you're doing payroll by hand, you will calculate and record the components described below.
In Payroll you have:
- the wages themselves,
- the taxes the government makes you withhold,
- and taxes that you have to pay that you don't withhold.
Gross wages get debited to the wages expense account - divided properly between direct and indirect labor. (Recall that gross wages for people actually producing your goods or providing your services are direct expenses; gross wages for the office help and sales are indirect expenses.)
Payroll taxes
Some of these come out of the employee's check - the federal withholding and the employee's share of FICA. Others come out of your pocket, like the employer portion of FICA, state and federal unemployment taxes. The ones that come out of your pocket require two entries: they get debited to payroll tax expense (either direct or indirect, depending on where the employee's wages go), and credited to the proper liability account - either FICA payable, Fed payable, UI payable, FUTA payable or Workers Compensation payable.
Determining tax liabilities
For each of these you have to figure the total due based on the gross wages for that period - these taxes are figured as a percent of gross. For example, when the FICA and Medicare tax is 7.65% of gross wages, you take the gross wage, multiply it by .0765, and that is what you owe for the employer portion of FICA. You can get a chart which shows the Federal and state taxes due for each employee, based on their W-4 status and earnings. Unemployment will be based partly on a state multiplier and partly on your company's unemployment history. Workers compensation will depend on the industry code your employees work under, as well as your company's performance.
All the taxes that are withheld from the employee's check as well as those which come out of your pocket - are listed as liabilities, and are easier to deal with if you sort them out by what kind of tax they are. In the liability accounts, there is no need to separate direct from indirect numbers - it's just plain money you owe, and it doesn't matter whether it comes out of the employees check or out of you pocket. The FICA payable, for example, will contain all the FICA that was withheld from everyone's check, in addition to the amount that you are matching as the employer.
As a side note, here's a point you need to keep in mind: that person, who you thought was costing you $585.45, because that's what her paycheck says, or is costing you his gross wage of $700.00, is actually costing you $871.15 ($700 wages plus the payroll tax costs to you, which in this case total $171.15). If you're adding any benefits like insurance or retirement, put those on top. This is a prime example of the kind of overhead you need to make sure gets added into your pricing structure.
Sales & Customer Deposits
OK, now you've entered your accounts payable, your expenses, your payroll. Now for the good stuff - let's enter your sales. Remember: sales accounts are credit accounts. So when you want to increase the amount of sales. You have made, you make the entry as a credit entry. These entries are pretty easy, on the surface: you receive a check and put it in your account: debit cash. The sale, if it is an item you have on hand and give to the buyer, you enter as an immediate sale. Credit sales, the equal amount that you debited cash.
HOWEVER, if you have just signed a contract, and have not actually done any work on that project this month, you have not yet earned that sale. You're just holding the person's money for them, keeping it safe. Right? So, it is not yet truly a sale - it's a customer deposit. The entry will be debit to cash (it's in the bank, either way) and credit customer deposit, which is a liability account (you would have to refund the money if you don't do the job). If you have a lot of jobs going at any one time, you'll make your job easier if you give each job its own number in customer deposits, so you can easily keep track of how much has been turned into sales, and how much remains to be earned.
Customer deposits turn into cash as you earn them - through the purchase of materials or labor performed.
Accounts Receivable
Accounts Receivables and sales operate much the same as Accounts Payables and your purchases. Under the accrual method, you'll be entering sales as you earn them and invoice your customers. Have a simple chart that shows who owes you money each month - have a beginning balance which equals last months' ending balance. Enter any payments they've made or new charges they've incurred, and come up with an ending balance. That must equal the amount you list as AR on your books - if it doesn't, your task is to figure out where the discrepancy is.
Inventory
Inventory is a current asset account, which means it is something you have that can be turned into cash quickly. When you purchase inventory, you do so out of cash, so one side of the entry is credit cash - the other side, to increase inventory, is debit inventory. Basically, by listing an inventory item, you're just saying, I bought it this month, but I plan to keep it - or at least part of it - around, so the entire cost should not show up this month. The trick with inventory is knowing how to book it when you use it.
Some common inventory items are materials - which is simple. You have a value of raw material in inventory - which matches what you paid for it. (You cannot increase the value of your inventory as it sits in the yards, as prices go up. You make your gain when you use that cheaper material in a project where you're able to charge more for it than it cost you.) As you use your raw materials, you credit inventory, to reduce it, and debit the 4101 account, materials. Basically, think of it as buying the material from yourself, with no cash changing hands.
Another way that inventory might come up is when you buy $5,000 worth of brochures. Put that as a lump sum in your books for any given month, and you'll be a sad business owner, you'll think you're losing money hand over fist. So, try this: decide how long those brochures will last you, say three years. Divide $5,000 over 36 months, and you'll find that each month you need to book $138.89 (Call it $140 and be done with it).
What you're saying is that each month, you have to cover $140 as the cost of your brochures. It'll show up on your income statement as an actual cost. Each month the value of that inventory will decrease by that amount, until it's all gone. Theoretically your brochures will be gone about the same time - or outdated.
Deposits
Another item that has its own spot in your books is deposits you pay for various things, from workers compensations to the cleaning deposit on a rental, to a deposit with the post office for express mail. These are items that will be returned to you when you finish using the service - technically, it's your money that they're holding. These amounts all go into the account called deposits, in our system #1800, which is of course under the Asset section of your Balance Sheet.
Gain or Loss on Sale of Assets
This is where you account for assets you sell or dump. If you sell a vehicle, you have its value on that up to date list of assets you keep. You also have a record of how much it has been depreciated. You enter the cash you make off that sale in 1001, cash. Then you balance that entry with a credit to the asset account and a debit to the accumulated depreciation account, and whatever it takes to make those number balance is your gain, or loss, on that sale.
Depreciation
This is an entry that you can make the call on whether you're going to deal with it monthly or annually. It's not a cash expense, in fact it's often sniffed at as a "paper expense" but if you have a pretty good sized company and you think you're making great money, don't count those chickens until you figure in your depreciation. It's real stuff, because things DO in fact wear out and have to be replaced, and this is where that process is built into your books.
Basically, your accountant will give you a sheet listing your assets and the amount they will depreciate this year. You take those totals, and say, OK, my tools are going to depreciate a total of $890 this year. Take that number and divide by 12, and you have your monthly depreciation, which in this case is $74.17. So to give yourself a really good idea of where you are, each month make the entry of debit account 5341 (depreciation expense) $75, and credit 1601 (accumulated depreciation, tools) by the same amount. If you have office equipment, vehicles, buildings, all those will have their separate totals that you work with the same way.
Most computer accounting systems have a setup where you can tell it to make those entries for you automatically each month, and you won't have to worry about it. Don't worry about being too exact - at the end of the year, you'll go through each of these numbers and adjust it so it's exactly in line with your depreciation schedule. Making the entries monthly saves you the shock when you thought you'd made $20,000, and your depreciation expense at the end of the year cuts that in half.
Suspense
Now I'm going to let you in on a secret if you promise not to take advantage of it. If you are making all these entries and they don't balance, do this: first, check the number they don't balance by - maybe you just left out an entry. Divide that number by two and see if anything becomes obvious. Divide it by nine and if it divides cleanly and evenly by nine, that means you have transposed an entry somewhere - maybe you said 765 instead of 756. (No, this is not an old wive's tail - but I do have some good hiccup cures for you after class). IF you have tried everything you can think of, and you have just got to turn your computer off and go home, put the remainder that won't balance in suspense.
Then, while you're out of the system, look at all your entries, all your notes, and figure out the problem. Come back in, make the correcting entry, and take it back out of suspense by making the opposite entry you did before. If you had to credit suspense to make things balance, this time debit it - or you'll drive yourself even crazier.
Suspense may end up with little bits and pieces of numbers - but it should never be allowed to get large. $1.31, you can let go. $500, and you'd better get serious about finding out what that is.
Month End Adjustments
Now that you're sure you have the right amount of cash in your system, you're ready to check the rest of the books. How intense you get about this can well depend on what time of year it is - in a mid-year month, like March or July, you might be a little more lax about how closely you check every account, whereas at the end of the year you will want to tie every single account down exactly. Even those accounts you don't check over with a fine-toothed comb should at least be glanced at, to make sure they make basic sense. If a $3,500 car liability all of sudden turns into a $15,293 item, you'll know something is entered in the wrong place.
The process is this: go through your balance sheet, item by item. You've already done cash, and petty cash is a static account, so the next item is inventory. Check what your inventory was last month, total up what you know you've added to or deleted from it, and that should be your current total inventory. To make this easy, keep a list of what is in inventory: office supplies, raw materials, etc. Each item should have a beginning balance, an amount of current activity, and an ending balance.
If inventory shows on your books as a higher number than you actually know you have, adjust that against the material expense. If you have $250 less value in actual office supplies than you show on the books, the adjustment will be to debit office supplies (account 5550) and credit inventory. That will reduce your inventory - which will, by the way, also reduce your profitability...sorry!
When you close your books for the end of the year, you need to take actual inventory - count it all up and make sure you've really got what you think you do. At other times of the year, whether or not you go through this step will depend on how much inventory you carry. Any materials you have a large value of on hand, it will pay you to take a physical inventory of more often. Failing to do that may result in a shock at the end of the year when it turns out you've been underestimating your use of material all year, giving your perceived profitability one more opportunity to fly out the window. It's amazing how that bird can get up and go at the smallest opportunity!
This same process gets followed for each item on your balance sheet. If your books are computerized, you will find a good friend in your Detail Trial Balance and Detail Transaction Reports. These reports will show you the beginning balance for each account, what was added to or subtracted from that account over the month, and then an ending balance. This will be the easiest place for you to look for those items entered in the wrong account, items entered backwards (credit when you should debit, can you imagine?), items overlooked, or items that were transposed when they were entered, which are the top four ways to end up out of balance.
The good news is that you don't have to do this to every expense account - just check out that your asset and liability accounts are correct. If you have large loans, make sure you're accounting for principal and interest correctly - putting interest in its own account, and taking principal against the liability account. The easiest way to do this is to call the loan officer and get an actual report (loan history) of how much you owe as of this date, and make sure your books reflect that. As with any of this work, if you're talking about a small loan it may not be worth adjusting every month - you may want to adjust those once a year. The items you adjust monthly are the ones that can throw off your books by a large enough amount that it's worth the time it will take to adjust for them.
This process, completed through your entire balance sheet, will give you the assurance that your books are correct, and you can trust the bottom line on your income statement. This is actually about the first point in the process that I would actually look at the income statement - until you have adjusted your books to match physical reality, it can be relatively meaningless.
Paper Trail
One last point: all these numbers that are going into your books need to be backed up by something that will give you a clue about them. You or someone else will at some point need to go back and recreate something you've entered, and you need a good clean system for keeping this information.
Keep a list of everything you've done
Have a list and update it monthly, of what makes up Accounts Payable - and the total of that list needs to equal the AP entry on your balance sheet. Have a list of customer deposits, accounts receivable and a list of your assets. You need to be able to say what's in each number on your balance sheet. It's not nearly as intimidating as it sounds, and it will save you hours of head scratching later.
You will also need to keep good supporting documentation for your income and expenses.
Congratulations! You've now got a real set of books that you can use to analyze your profitability and pricing, you can take to the bank or use to produce a tax return. Every month, you'll find this process easier to follow and less time consuming, and you'll understand the inner workings of your business in a way that will make you much more powerful and confident in your decision making. Did you know that the word in the English language with the most consecutive double consonants is subbookkeeper? A heady responsibility, I'd say.
