Seventh Edition This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service If legal advice or other expert assistance is required, the services of a competent professional person should be sought Editorial Director: Jennifer Farthing Senior Managing Editor, Production: Jack Kiburz Production Artist: Janet Schroeder Cover Designer: Design Solutions © 1989, 1993, 1996, and 1998 by Linda Pinson and Jerry Jinnett © 2001, 2004, and 2007 by Linda Pinson Published by Kaplan Publishing, a division of Kaplan, Inc All rights reserved The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher Printed in the United States of America 07 08 09 10 Published by Dearborn Trade Publishing A Kaplan Professional Company All rights reserved The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher Printed in the United States of America 04 05 06 10 Library of Congress Cataloging-in-Publication Data Pinson, Linda Keeping the books: basic recordkeeping and accounting for the successful small business / Linda Pinson.—7th ed p cm Previously published: Chicago, Ill.: Dearborn Trade Pub., ©2004 Includes bibliographical reference and index ISBN-13: 978-1-4195-8438-1 (alk paper) ISBN10: 1-4195-8438-3 (alk paper) Bookkeeping Small business—United States—Accounting I Title HF5635.P649 2007 657'.2—dc22 2006036384 Kaplan Publishing books are available at special quantity discounts to use for sales promotions, employee premiums, or educational purposes Please call our Special Sales Department to order or for more information at 800-621-9621, ext 4444, e-mail kaplanpubsales@kaplan.com, or write to Kaplan Publishing, 30 South Wacker Drive, Suite 2500, Chicago, IL 60606-7481 Dedication It is with a great deal of pleasure that I dedicate this book to Virginia Haverty, a wonderful friend who is now gone, but never forgotten Her gifts of encouragement and confidence live on in this book and in my life iii Other books and software by the author Automate Your Business Plan software Anatomy of a Business Plan Steps to Small Business Start-Up Contents Preface——ix Acknowledgments——xi About the Author——xii CHAPTER Recordkeeping Basics Functions of Recordkeeping——1 When Does Recordkeeping Begin?——3 CHAPTER Income and Expenses Income (or Revenue)——5 Expenses——5 What Are “Deductible” Expenses?——6 Common Deductible Expenses——7 CHAPTER Cash Accounting versus Accrual Accounting “Cash” and “Accrual” Accounting Defined——9 Which Method Will You Be Required to Use?——10 Pros and Cons of the Two Methods——11 Can You Change Methods from Year to Year?——12 CHAPTER Essential General Records for Small Business 13 Single and Double Entry Systems——14 Chart of Accounts——16 Debits and Credits——18 v vi · Contents An Overview of Four Accounting Tasks Using QuickBooks Pro®——20 Summary: Accounting Software——24 Revenue & Expense Journal——26 Petty Cash Record——30 Inventory Record——32 Fixed Assets Log——38 Accounts Receivable——40 Accounts Payable——42 Payroll Records——44 Independent Contractors——47 Travel, Transportation, and Entertainment Expenses——50 Customer Information Records——56 Business Checkbook——58 Receipt Files——60 CHAPTER Financial Statements 61 What Are Financial Statements?——61 Balance Sheet——63 Profit & Loss Statement or Income Statement——66 Business Financial History——70 Personal Financial Statement——74 Pro Forma Cash Flow Statement——76 Preparing Your Cash Flow Statement——77 Completing Your Pro Forma Cash Flow Statement——84 Quarterly Budget Analysis——86 Three-Year Income Projection——88 Breakeven Analysis——90 CHAPTER Financial Statement Analysis 93 Financial Statements——93 Liquidity Analysis——96 Profitability Analysis——98 Debt Measures——100 Investment Measures——101 Vertical Financial Statement Analysis——102 Horizontal Financial Statement Analysis——104 Summary——105 CHAPTER Taxes and Accounting 107 Accounting and the U.S Tax System——107 Federal Taxes for Which You May Be Liable——109 Income Tax (for Sole Proprietors)——114 Home Office Deduction——117 Income Tax (Partnerships)——119 Income Tax (S Corporations)——122 Income Tax (Corporations)——124 Contents · vii Estimated Tax (for Sole Proprietor, Individual Who Is a Partner, or an S Corporation Shareholder)——127 Estimated Tax (Corporations)——130 Self-Employment Tax (for Sole Proprietor, Individual Who Is a Partner, or an S Corporation Shareholder)——132 Social Security (FICA) Tax and Withholding of Income Tax——135 Federal Unemployment (FUTA) Tax——142 Payment to Nonemployees for Services Rendered——145 Taxpayer Identification Number (EIN)——148 Free Tax Publications Available from the IRS——149 Summary——152 CHAPTER Recordkeeping and Tax Reporting Schedules 153 Organizing Your Recordkeeping——154 Building Your System——154 Recordkeeping Schedule——156 Tax Reporting Schedule——158 CHAPTER Preparing for Uncle Sam 161 What to Give Your Accountant——162 The Last Chore——163 APPENDIX I Independent Contractors: Facts versus Myths 165 APPENDIX II Blank Forms and Worksheets 173 Small Business Resources——197 Glossary——199 Index——207 Preface T hank you for choosing Keeping the Books to use as your guide for learning about recordkeeping and small business accounting I think you will be pleased with this new edition It has been the goal of each edition of this book to give you a clear, concise, and easy-tounderstand process to follow as you set up your bookkeeping and work with it throughout the life of your business I have been working with business owners for many years, and most of them have the same problem—they are experts in their industries but are novices when it comes to working with financials In fact, many times, the prospect of keeping financial information is so formidable that some business owners avoid it until tax time when they have to come up with the information for the IRS Keeping the Books should provide you with a clear, concise, and easy-to-understand process for setting up, understanding, and attending to recordkeeping and accounting If I have been successful, you should be able to follow that process, customize it for your business, and set up a system that will greatly benefit your company WHO IS THIS BOOK FOR? I frequently am asked who Keeping the Books is appropriate for This book is for all business owners who need to better familiarize themselves with recordkeeping and accounting processes and how these relate to tax accounting—even those business owners who hire inhouse bookkeepers and accountants and/or outside accounting professionals Keeping the ix ... of Congress Cataloging-in-Publication Data Pinson, Linda Keeping the books: basic recordkeeping and accounting for the successful small business / Linda Pinson.—7th ed p cm Previously published:... times, the prospect of keeping financial information is so formidable that some business owners avoid it until tax time when they have to come up with the information for the IRS Keeping the Books. .. familiarize themselves with recordkeeping and accounting processes and how these relate to tax accounting even those business owners who hire inhouse bookkeepers and accountants and/ or outside accounting