Kinds of Records
Supporting Documents
Accounting Methods
Business Expenses
Recording Business Transactions
Bookkeeping System
Why keep records?
Everyone in business must keep records. According to the U.S. Internal Revenue Service, good records will help you do the following:
Monitor the progress of your business. You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements. You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.
- An income statement shows the income and expenses of the business for a given period of time.
- A balance sheet shows the assets, liabilities and your equity in the business on a given date.
Identify source of receipts. You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from non-business receipts and taxable from nontaxable income.
Keep track of deductible expenses. You may forget expenses when you prepare your tax return unless you record them when they occur.
Prepare your tax returns. You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statements.
Support items reported on tax returns. You must keep your business records available at all times for inspection. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
Kinds of Records to Keep
The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year.
Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is the main source for entries in the business books. In addition, you must keep supporting documents.
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Supporting Documents
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips and canceled checks. These documents contain information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return.
Gross receipts. Documents that show gross receipts include:
- Cash register tapes.
- Bank deposit slips.
- Receipt books.
- Invoices.
- Credit card charge slips.
- Forms 1099-MISC.
Purchases. Purchases are the items you buy and resell to customers. If you are a manufacturer or
producer, this includes the cost of all raw materials or parts purchased for manufacture into finished
products. Your supporting documents include the following:
- Canceled checks.
- Cash register tape receipts.
- Credit card sales slips.
- Invoices.
These records will help you determine the value of your inventory at the end of the year.
Expenses. Expenses are the costs you incur (other than purchases) to carry on your business. Documents for expenses include the following:
- Canceled checks.
- Cash register tapes.
- Account statements.
- Credit card sales slips.
- Invoices.
- Petty cash slips for small cash payments.
Travel, transportation, entertainment, and gift expenses.
Employment taxes. There are specific employment tax records you must keep. For a complete list of records, refer to the U.S. Internal Revenue Web site, the WV Tax Department Web site, www.state.wv.us/taxdiv and consult with a CPA. Employment taxes include Federal Income, Social Security, and Medicare Taxes.
Federal Income, Social Security, and Medicare Taxes. You generally must withhold federal income tax from your employee’s wages. To figure how much federal income tax to withhold from each wage payment, use the employee’s Form W-4 (discussed later in Chapter 12 under Hiring Employees). Social Security and Medicare taxes pay for benefits that workers and their families receive under the Federal Insurance Contributions Act (FICA). Social Security tax pays for benefits under the old-age, survivors, and disability insurance part of FICA. Medicare tax pays for benefits under the hospital insurance part of FICA. You withhold part of these taxes from your employee’s wages and you pay a matching amount yourself.
Federal Unemployment (FUTA) Tax. The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. You report and pay FUTA tax separately from Social Security and Medicare taxes and withheld income tax. You pay FUTA tax only from your own funds. Employees do not pay this tax or have it withheld from their pay.
Report federal unemployment tax on Form 940, Employer’s Annual Federal Unemployment (FUTA)
Assets. Assets are the property, such as machinery and furniture you own and use in your business.
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Accounting Methods
An accounting method is a set of rules used to determine when and how income and expenses are reported. You choose an accounting method for your business when you file your first income tax return.
There are two basic accounting methods.
- Cash method. Under the cash method, you report income in the tax year you receive it. You usually deduct or capitalize expenses in the tax year you pay them.
- Accrual method. Under an accrual method, you generally report income in the tax year you earn it, even though you may receive payment in a later year. You deduct or capitalize expenses in the tax year you incur them, whether or not you pay them that year. If you need inventories to show income correctly, you must generally use an accrual method of accounting for purchases and sales. Inventories include goods held for sale in the normal course of business. They also include raw materials and supplies that will physically become a part of merchandise intended for sale.
You must use the same accounting method to figure your taxable income and to keep your books. Also, you must use an accounting method that clearly shows your income. In general, any accounting method that consistently uses accounting principles suitable for your trade or business clearly shows income. An accounting method clearly shows income only if it treats all items of gross income and expenses the same from year to year.
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Business Expenses
You can deduct business expenses on your income tax return. These are the current operating costs of running your business. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business, trade, or profession. A necessary expense is one that is helpful and appropriate for your business, trade, or profession. An expense does not have to be indispensable to be considered necessary.
The following are some expenses that are of interest to people starting a business:
- Business start-up costs.
- Depreciation.
- Business use of your home.
- Car and truck expenses.
- Actual expenses.
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Recording Business Transactions
A good recordkeeping system includes a summary of your business transactions. Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them at your local stationery or office supply store.
Whether you keep journals and ledgers and how you keep them depends on the type of business you are in. For example, a recordkeeping system for a small business might include the following items.
- Business checkbook.
- Daily summary of cash receipts.
- Monthly summary of cash receipts.
- Check disbursements journal.
- Depreciation worksheet.
- Employee compensation record.
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Bookkeeping System
Computerized System. There are computer software packages you can use for recordkeeping. They can be purchased in many retail stores or downloaded from the manufacturers’ Web site. These packages are very helpful and relatively easy to use; they require very little knowledge of bookkeeping and accounting.
If you use a computerized system, you must be able to produce sufficient legible records to support and verify entries made on your return and determine your correct tax liability. You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system.
If you are uncomfortable using a computerized system, a manual system of recording financial transactions for your business must be kept. Talk to an accountant about setting up a system that meets your business needs.
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